1 practical issues in cash and receivable: disposition and recognitions instructor adnan shoaib part...
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Practical Issues in Cash and Receivable: Disposition and
Recognitions
InstructorAdnan Shoaib
PART II: Corporate Accounting Concepts and Issues
Lecture 09
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1. Explain accounting issues related to recognition and valuation of notes
receivable.
2. Explain the fair value option.
3. Explain accounting issues related to disposition of accounts and notes
receivable.
4. Describe how to report and analyze receivables.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
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What is cash?
Reporting cash
Summary of cash-related items
CashSpecial Issues
Recognition of notes receivable
Valuation of notes receivable
Cash and ReceivablesCash and ReceivablesCash and ReceivablesCash and Receivables
Accounts Receivable
Notes Receivable
Recognition of accounts receivable
Valuation of accounts receivable
Fair value option
Disposition of accounts and notes receivable
Presentation and analysis
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Supported by a formal promissory note.
Recognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes Receivable
LO 1 Explain accounting issues related to recognition of notes receivable.
Notes Receivable
A negotiable instrument.
Maker signs in favor of a Payee.
Interest-bearing (has a stated rate of interest) OR
Zero-interest-bearing (interest included in face amount).
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Recognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes Receivable
LO 1 Explain accounting issues related to recognition of notes receivable.
Generally originate from:
Customers who need to extend payment period of
an outstanding receivable.
High-risk or new customers.
Loans to employees and subsidiaries.
Sales of property, plant, and equipment.
Lending transactions (the majority of notes).
6 LO 1 Explain accounting issues related to recognition of notes receivable.
Recognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes Receivable
Short-Term Long-Term
Record at Face Value,
less allowance
Record at Present Value
of cash expected to be collected
Interest Rates
Stated rate = Market rate
Stated rate > Market rate
Stated rate < Market rate
Note Issued at
Face Value
Premium
Discount
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Illustration: Bigelow Corp. lends Scandinavian Imports $10,000 in exchange for a $10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note?
Note Issued at Face ValueNote Issued at Face ValueNote Issued at Face ValueNote Issued at Face Value
0 1 2 3
1,000 1,000 Interest$1,000
$10,000 Principal
4
i = 10%
n = 3
LO 1 Explain accounting issues related to recognition of notes receivable.
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$1,000 x 2.48685 = $2,487
Interest Received Factor Present Value
Note Issued at Face ValueNote Issued at Face ValueNote Issued at Face ValueNote Issued at Face Value
PV of Interest
LO 1 Explain accounting issues related to recognition of notes receivable.
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$10,000 x .75132 = $7,513
Principal Factor Present Value
Note Issued at Face ValueNote Issued at Face ValueNote Issued at Face ValueNote Issued at Face Value
PV of Principal
LO 1 Explain accounting issues related to recognition of notes receivable.
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Summary Present value of interest $ 2,487
Present value of principal 7,513
Note current market value $10,000
Date Account Title Debit Credit
J an. yr. 1
Dec. yr. 1
Note Issued at Face ValueNote Issued at Face ValueNote Issued at Face ValueNote Issued at Face Value
LO 1 Explain accounting issues related to recognition of notes receivable.
Notes receivable 10,000
Cash 10,000
Cash 1,000
Interest revenue1,000
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Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note?
Zero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing Note
LO 1 Explain accounting issues related to recognition of notes receivable.
0 1 2 3
$0 $0 Interest$0
$10,000 Principal
4
i = 9%
n = 3
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$10,000 x .77218 = $7,721.80
Principal Factor Present Value
Zero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing Note
PV of Principal
LO 1 Explain accounting issues related to recognition of notes receivable.
13 LO 1 Explain accounting issues related to recognition of notes receivable.
Zero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing Note
Illustration 7-12
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Journal Entries for Zero-Interest-Bearing note
Present value of Principal $7,721.80
Date Account Title Debit Credit
Jan. yr. 1 Notes receivable 10,000.00
Discount on notes receivable 2,278.20
Cash 7,721.80
Dec. yr. 1 Discount on notes receivable 694.96
Interest revenue 694.96
($7,721.80 x 9%)
LO 1 Explain accounting issues related to recognition of notes receivable.
Zero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing NoteZero-Interest-Bearing Note
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Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. How does Morgan record the receipt of the note?
Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note
LO 1 Explain accounting issues related to recognition of notes receivable.
0 1 2 3
1,000 1,000 Interest$1,000
$10,000 Principal
4
i = 12%
n = 3
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$1,000 x 2.40183 = $2,402
Interest Received Factor Present Value
Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note
PV of Interest
LO 1 Explain accounting issues related to recognition of notes receivable.
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$10,000 x .71178 = $7,118
Principal Factor Present Value
Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note
PV of Principal
LO 1 Explain accounting issues related to recognition of notes receivable.
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Illustration: How does Morgan record the receipt of the note?
Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note
LO 1 Explain accounting issues related to recognition of notes receivable.
Illustration 7-14
Notes Receivable 10,000
Discount on Notes Receivable
480
Cash
9,520
19 LO 1 Explain accounting issues related to recognition of notes receivable.
Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note
Illustration 7-15
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Journal Entries for Interest-Bearing Note
Date Account Title Debit Credit
Beg. yr. 1 Notes receivable 10,000
Discount on notes receivable 480
Cash 9,520
End. yr. 1
($9,520 x 12%)
LO 1 Explain accounting issues related to recognition of notes receivable.
Interest-Bearing NoteInterest-Bearing NoteInterest-Bearing NoteInterest-Bearing Note
Cash 1,000
Discount on notes receivable 142
Interest revenue1,142
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U.S. GAAP vs. IFRSU.S. GAAP vs. IFRSU.S. GAAP vs. IFRSU.S. GAAP vs. IFRS
U.S. GAAP allows a “fair value U.S. GAAP allows a “fair value option” for accounting for option” for accounting for receivables.receivables.
U.S. GAAP does not allow U.S. GAAP does not allow receivables to be accounted receivables to be accounted for as “available for sale” for as “available for sale” investments.investments.
U.S. GAAP requires more U.S. GAAP requires more disaggregation of accounts disaggregation of accounts and notes receivable in the and notes receivable in the balance sheet or notes. balance sheet or notes.
In general, IFRS and U.S. GAAP are very similar with respect to accounts receivable and notes receivable. Differences are
highlighted below.
IFRS restricts the IFRS restricts the circumstances in which a “fair circumstances in which a “fair value option” for accounting value option” for accounting for receivables is allowed.for receivables is allowed.
In the years between 2010 and In the years between 2010 and 2012, companies may account 2012, companies may account for receivables as “available for receivables as “available for sale” investments if the for sale” investments if the approach is elected initially. approach is elected initially. After January 1, 2013, this After January 1, 2013, this treatment is no longer treatment is no longer allowed.allowed.
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Recognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes Receivable
Notes Received for Property, Goods, or Services
LO 1 Explain accounting issues related to recognition of notes receivable.
In a bargained transaction entered into at arm’s length, the
stated interest rate is presumed to be fair unless:
1. No interest rate is stated, or
2. Stated interest rate is unreasonable, or
3. Face amount of the note is materially different from the
current cash sales price.
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Recognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes ReceivableRecognition of Notes Receivable
LO 1 Explain accounting issues related to recognition of notes receivable.
Illustration: Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five-year note having a maturity value of $35,247 and no stated interest rate. The land originally cost Oasis $14,000. At the date of sale the land had a fair market value of $20,000. Oasis uses the fair market value of the land, $20,000, as the present value of the note. Oasis therefore records the sale as:
Notes Receivable 35,247Discount on Notes Receivable
15,247Land
14,000Gain on Sale of Land
6,000
($35,247 - $20,000) = $15,247
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Valuation of Notes ReceivableValuation of Notes ReceivableValuation of Notes ReceivableValuation of Notes Receivable
LO 2 Explain the fair value option.
Short-Term reported at Net Realizable Value (same as
accounting for accounts receivable).
Long-Term - FASB requires companies disclose not only
their cost but also their fair value in the notes to the
financial statements.
► Fair Value Option. Companies have the option to use
fair value as the basis of measurement in the financial
statements.
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Valuation of Notes ReceivableValuation of Notes ReceivableValuation of Notes ReceivableValuation of Notes Receivable
LO 2 Explain the fair value option.
Illustration (recording fair value option): Assume that
Escobar Company has notes receivable that have a fair value of
$810,000 and a carrying amount of $620,000. Escobar decides
on December 31, 2012, to use the fair value option for these
receivables. This is the first valuation of these recently acquired
receivables. At December 31, 2012, Escobar makes an
adjusting entry to record the increase in value of Notes
Receivable and to record the unrealized holding gain, as follows.
Notes Receivable 190,000
Unrealized Holding Gain or Loss—Income 190,000
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Disposition of Accounts and Notes ReceivableDisposition of Accounts and Notes ReceivableDisposition of Accounts and Notes ReceivableDisposition of Accounts and Notes Receivable
Owner may transfer accounts or notes receivables to another company for cash.
Reasons:
Competition.
Sell receivables because money is tight.
Billing / collection are time-consuming and costly.
Transfer accomplished by:
1. Secured borrowing
2. Sale of receivables
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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Factoring ArrangementsFactoring ArrangementsFactoring ArrangementsFactoring Arrangements
FACTOR (Transferee)
SUPPLIER(Transferor)
RETAILER
1. Merchandise
2. Accounts Receivable
3. Accounts Receivable
4. Cash5.
Cas
h
A factor is a financial institution that buys receivablesfor cash, handles the billing and collection of the
receivables and charges a fee for the service.
A factor is a financial institution that buys receivablesfor cash, handles the billing and collection of the
receivables and charges a fee for the service.
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Disposition of Accounts and Notes ReceivableDisposition of Accounts and Notes ReceivableDisposition of Accounts and Notes ReceivableDisposition of Accounts and Notes Receivable
Secured Borrowing
Illustration: March 1, 2012, Howat Mills, Inc. provides
(assigns) $700,000 of its accounts receivable to Citizens Bank
as collateral for a $500,000 note. Howat Mills continues to
collect the accounts receivable; the account debtors are not
notified of the arrangement. Citizens Bank assesses a finance
charge of 1 percent of the accounts receivable and interest on
the note of 12 percent. Howat Mills makes monthly payments to
the bank for all cash it collects on the receivables.
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
29 LO 8
Secured Borrowing - IllustrationSecured Borrowing - IllustrationSecured Borrowing - IllustrationSecured Borrowing - Illustration
Illustration 7-16
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E7-13: On April 1, 2012, Prince Company assigns $500,000 of its
accounts receivable to the Third National Bank as collateral for a $300,000
loan due July 1, 2012. The assignment agreement calls for Prince Company
to continue to collect the receivables. Third National Bank assesses a
finance charge of 2% of the accounts receivable, and interest on the loan is
10% (a realistic rate of interest for a note of this type).
Secured Borrowing - ExerciseSecured Borrowing - ExerciseSecured Borrowing - ExerciseSecured Borrowing - Exercise
Instructions:
a) Prepare the April 1, 2012, journal entry for Prince Company.
b) Prepare the journal entry for Prince’s collection of $350,000 of the accounts receivable during the period from April 1, 2012, through June 30, 2012.
c) On July 1, 2012, Prince paid Third National all that was due from the loan it secured on April 1, 2012.
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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Exercise 7-13 continued
Date Account Title Debit Credit
(a) Cash 290,000
Finance Charge 10,000
Notes Payable 300,000
($500,000 x 2% = $10,000)
(b) Cash 350,000
Accounts Receivable 350,000
(c) Notes Payable 300,000
Interest Expense 7,500
Cash 307,500
(10% x $300,000 x 3/12 = $7,500)
Secured Borrowing - ExerciseSecured Borrowing - ExerciseSecured Borrowing - ExerciseSecured Borrowing - Exercise
LO 8
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Factors are finance companies or banks that buy receivables from businesses for a fee.
Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables
Illustration 7-17
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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Sale Without Recourse
Purchaser assumes risk of collection
Transfer is outright sale of receivable
Seller records loss on sale
Seller use Due from Factor (receivable) account to cover discounts, returns, and allowances
Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables
Sale With Recourse Seller guarantees payment to purchaser
Financial components approach used to record transfer
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables
Illustration: Crest Textiles, Inc. factors $500,000 of accounts
receivable with Commercial Factors, Inc., on a without recourse
basis. Commercial Factors assesses a finance charge of 3 percent of
the amount of accounts receivable and retains an amount equal to 5
percent of the accounts receivable (for probable adjustments). Crest
Textiles and Commercial Factors make the following journal entries
for the receivables transferred without recourse.
Illustration 7-18
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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Illustration: Assume Crest Textiles sold the receivables on a with
recourse basis. Crest Textiles determines that this recourse
obligation has a fair value of $6,000. To determine the loss on the
sale of the receivables, Crest Textiles computes
the net proceeds from the sale as follows.
Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables
Illustration 7-20Loss on Sale Computation
Illustration 7-19Net ProceedsComputation
LO 8
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Illustration: Prepare the journal entries for both Crest Textiles and
Commercial Factors for the receivables sold with recourse.
Sales of ReceivablesSales of ReceivablesSales of ReceivablesSales of Receivables
Cash 460,000 Due from Factor 25,000 Loss on Sale of Receivables 21,000
Accounts (Notes) Receivable 500,000
Recourse Liability 6,000Accounts Receivable 500,000
Due to Crest Textiles 25,000
Financing Revenue 15,000
Cash 460,000
Commercial Factors, Inc.
Crest Textiles, Inc.
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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Interest receivable 5,000Interest revenue 5,000
Transfers of Notes ReceivableTransfers of Notes ReceivableTransfers of Notes ReceivableTransfers of Notes Receivable
On December 31, Stridewell accepted a nine-month 10 On December 31, Stridewell accepted a nine-month 10 percent note for $200,000 from a customer. Three months percent note for $200,000 from a customer. Three months
later on March 31, Stridewell discounted the note at its later on March 31, Stridewell discounted the note at its local bank. The bank’s discount rate is 12 percent. local bank. The bank’s discount rate is 12 percent.
$200,000 × 10% × 3/12
Before preparing the journal entry to record the discounting, Stridewell must record the accrued interest on the note
from December 31 until March 31.
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Transfers of Notes ReceivableTransfers of Notes ReceivableTransfers of Notes ReceivableTransfers of Notes Receivable
Cash 202,100Loss on sale of note receivable 2,900Notes receivable 200,000Interest receivable 5,000
$205,000 - $202,100
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Deciding Whether to Account for a Transfer as Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowinga Sale or a Secured Borrowing
Deciding Whether to Account for a Transfer as Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowinga Sale or a Secured Borrowing
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U.S. GAAP vs. IFRSU.S. GAAP vs. IFRSU.S. GAAP vs. IFRSU.S. GAAP vs. IFRS
U.S. GAAP focuses on U.S. GAAP focuses on whether control of assets whether control of assets has shifted from the has shifted from the transferor to the transferee. transferor to the transferee.
The U.S. GAAP and the IFRS approaches often lead to similar accounting treatment for transfers of
receivables.
IFRS requires a more complex IFRS requires a more complex decision process. The decision process. The company has to have company has to have transferred the rights to receive transferred the rights to receive the cash flows from the the cash flows from the receivable, and then considers receivable, and then considers whether the company has whether the company has transferred “substantially all of transferred “substantially all of the risks and rewards of the risks and rewards of ownership,” as well as whether ownership,” as well as whether the company has transferred the company has transferred control.control.
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The FASB
concluded that a
sale occurs only if
the seller surrenders
control of the
receivables to the
buyer.
Three conditions
must be met.
Secured Borrowing versus SaleSecured Borrowing versus SaleSecured Borrowing versus SaleSecured Borrowing versus Sale
Illustration 7-22
LO 3 Explain accounting issues related to disposition of accounts and notes receivable.
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1. Segregate the different types of receivables that a company
possesses, if material.
2. Appropriately offset the valuation accounts against the proper
receivable accounts.
3. Determine that receivables classified in the current assets
section will be converted into cash within the year or the
operating cycle, whichever is longer.
4. Disclose any loss contingencies that exist on the receivables.
5. Disclose any receivables designated or pledged as collateral.
6. Disclose the nature of credit risk inherent in the receivables.
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
LO 4 Describe how to report and analyze receivables.
Presentation of Receivables
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Analysis of Receivables
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
This Ratio used to:
Assess the liquidity of the receivables.
Measure the number of times, on average, a company
collects receivables during the period.
Illustration 7-24
LO 4 Describe how to report and analyze receivables.
44 LO 5 Explain common techniques employed to control cash.
Management faces two problems in accounting for cash transactions:
1. Establish proper controls to prevent any unauthorized transactions by officers or employees.
2. Provide information necessary to properly manage cash on hand and cash transactions.
CASH CONTROLS
45 LO 5 Explain common techniques employed to control cash.
To obtain desired control objectives, a company can vary the number and location of banks and the types of accounts.
General checking account
Collection float.
Lockbox accounts
Imprest bank accounts
Using Bank Accounts
CASH CONTROLS
46 LO 5 Explain common techniques employed to control cash.
To pay small amounts for miscellaneous expenses.
The Imprest Petty Cash System
Steps:
1. Record $300 transfer of funds to petty cash:
Petty Cash 300
Cash 300
2. The petty cash custodian obtains signed receipts from each individual to whom he or she pays cash.
CASH CONTROLS
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Steps:
LO 5 Explain common techniques employed to control cash.
The Imprest Petty Cash System
Office Supplies Expense 42
Postage Expense 53
Entertainment Expense 76
Cash Over and Short 2
Cash 173
3. Custodian receives a company check to replenish the fund.
CASH CONTROLS
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Steps:
LO 5 Explain common techniques employed to control cash.
The Imprest Petty Cash System
Cash 50
Petty cash 50
4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows.
CASH CONTROLS
49 LO 5 Explain common techniques employed to control cash.
Physical Protection of Cash Balances
Company should
Minimize the cash on hand.
Only have on hand petty cash and current day’s receipts.
Keep funds in a vault, safe, or locked cash drawer.
Transmit each day’s receipts to the bank as soon as practicable.
Periodically prove (reconcile) the balance shown in the general ledger.
CASH CONTROLS
50 LO 5 Explain common techniques employed to control cash.
Reconciliation of Bank Balances
Schedule explaining any differences between the bank’s and the company’s records of cash.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Bank charges and credits.
4. Bank or Depositor errors.
Time Lags
CASH CONTROLS
51 LO 5 Explain common techniques employed to control cash.
Reconciliation of Bank Balances Illustration 7A-1Bank Reconciliation Form and Content
CASH CONTROLS
52 LO 10
CASH CONTROLS
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Illustration 7A-2
CASH CONTROLS
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Cash 542Nov. 30
Office expense 18
Accounts receivable 220
Accounts payable
180Interest revenue
600
Illustration: Journalize the adjusting entries at November 30 on the books of Nugget Mining Company.
LO 5 Explain common techniques employed to control cash.
CASH CONTROLS
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The reconciling item in a bank reconciliation that will result
in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
Review Question
LO 5 Explain common techniques employed to control cash.
CASH CONTROLS
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IMPAIRMENT OF RECEIVABLES
LO 6 Describe the accounting for a loan impairment.
Companies evaluate their receivables to determine their ultimate collectibility.
Allowance method is appropriate when:
probable that an asset has been impaired and
amount of the loss can be reasonably estimated.
Long-term receivables such as loans that are identified as impaired, companies perform an additional impairment evaluation.
57 LO 6 Describe the accounting for a loan impairment.
Impairment Measurement and Reporting
Impairment loss is calculated as the difference between
the investment in the loan (generally the principal plus
accrued interest) and
the expected future cash flows discounted at the loan’s
historical effective interest rate.
IMPAIRMENT OF RECEIVABLES
58 LO 7 Describe the accounting for a loan impairment.
Illustration: At December 31, 2011, Ogden Bank recorded an
investment of $100,000 in a loan to Carl King. The loan has an
historical effective-interest rate of 10 percent, the principal is due in full
at maturity in three years, and interest is due annually. The loan officer
performs a review of the loan’s expected future cash flow and utilizes
the present value method for measuring the required impairment loss.
Illustration 7B-1
IMPAIRMENT OF RECEIVABLES
59 LO 7 Describe the accounting for a loan impairment.
Illustration: Computation of Impairment LossIllustration 7B-2
Recording Impairment Losses
Bad Debt Expense 12,437
Allowance for Doubtful Accounts 12,437
IMPAIRMENT OF RECEIVABLES
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RELEVANT FACTS
The accounting and reporting related to cash is essentially the same under both IFRS and GAAP. In addition, the definition used for cash equivalents is the same. One difference is that, in general, IFRS classifies bank overdrafts as cash.
Like GAAP, cash and receivables are generally reported in the current assets section of the balance sheet under IFRS. However, companies may report cash and receivables as the last items in current assets under IFRS.
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RELEVANT FACTS
The fair value option is similar under GAAP and IFRS but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard.
IFRS and GAAP differ in the criteria used to account for transfers of receivables. IFRS is a combination of an approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS generally permits partial transfers; GAAP does not.
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End of Lecture 09End of Lecture 09End of Lecture 09End of Lecture 09