11111 intermediate accounting, 9ed kieso and weygandt prepared by catherine katagiri, cpa the...
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11111
Intermediate Accounting, Intermediate Accounting, 9ed9ed
Kieso and WeygandtKieso and Weygandt
Prepared byPrepared by
Catherine Katagiri, CPACatherine Katagiri, CPA
The College of Saint RoseThe College of Saint Rose
Albany, New YorkAlbany, New York
John Wiley & Sons, IncJohn Wiley & Sons, Inc..
Chapter 7: Cash and Chapter 7: Cash and ReceivablesReceivables
After studying this chapter you should be able to:After studying this chapter you should be able to:• Identify items considered cash.
• Indicate how cash and related items are reported.
• Define receivables and identify the different types of receivables.
• Explain accounting issues related to recognition of accounts receivable.
• Explain accounting issues related to valuation of accounts receivable.
• Explain accounting issues related to recognition of notes receivable.
• Explain accounting issues related to valuation of notes receivable.
• Explain accounting issues related to the disposition of accounts and notes receivable.
• Explain how receivables are reported and analyzed.
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CashCash
• Cash--Current asset unless restricted.
– Demand deposits
– Petty cash
– Money orders
– Certificates of deposit
– Savings
– IOUs, postdated checks (these are receivables)
– Restrictions:
• Compensating balances--Arrangements must be
properly disclosed.
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CashCash
– Bank overdrafts--Current liabilities. Generally not
offset against current assets unless in same bank as
another cash account. Proper disclosure required.
• Cash and cash equivalents
– Cash equivalents are short-term, highly liquid
investments that are both
• readily convertible to cash.
• so near to maturity that they represent
insignificant risk of interest rate changes.
– Generally only investments with original maturities of
three months or less fall under this classification.
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Cash ControlsCash Controls
• Management--Control of cash.
– Cash--Highly liquid, easily removed, etc.
– Need to avoid deficiency or excess of cash.
– Control
• Limit access.
• Separate assets from the records for the asset.
• Separation of duties.
– Electronic funds transfers, use of ATMs, debit cards
(your account to the bank is an A/P--Decrease your
balance by a debit to reflect payment of bills, etc.)
– Minimize the float period (lockboxes, credit cards, etc.)
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• Imprest Petty Cash Account--See appendix on cash
controls.
– Set up correctly to minimize any potential loss as well
as time spent on what should be an immaterial
account.
– Violates internal control (no separation).
– Use of the over and short account.
– Review entries for
• Setting up of fund.
• Reimbursement of fund.
• Increase in the size of the fund.
Cash ControlsCash Controls
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• Physical protection of cash.
– Minimize cash on hand.
– Deposit receipts intact, daily.
– Timely bank reconciliations done.
– Prenumbered checks used and accounted for.
– Use of a voucher system for cash disbursements.
Cash ControlsCash Controls
• Bank Reconciliation (see reconciling items page 361)
– Please see the following example of the bank
reconciliation form. From the bank reconciliation the
required AJEs to update balance of cash are drawn
up.
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Books (GL amount) Bank statement (end of period)Books (GL amount) Bank statement (end of period)
Plus: Receipts Plus:
Notes collected Deposits in transit
Interest earned Errors
Errors
Less: Disbursements Less:
NSF checks Outstanding Checks
Service charges Errors
Bank fees
Errors
**End Balance of cash **End Balance of Cash
**The above figures should agree = “True” Cash
Bank ReconciliationBank Reconciliation
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• Current receivables--Collected within the operating cycle
or one year, whichever is longer.
– Trade receivables--From sale of stock-in-trade.
• Accounts receivable
• Notes receivable
– Non-trade receivables--Sundries-separately reported.
• Advances to employees, officers or subsidiaries.
• Deposits paid by you.
• Interest, dividends, taxes, etc.
ReceivablesReceivables
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Accounts ReceivableAccounts Receivable
Accounts receivable concerns:
• Recognition
• Valuation
• Disposition
• Recognition of A/R--Timing and Measurement
– Recorded at exchange or settlement price.
• Trade discounts
–To adjust sales price.
–Taken “off-the-top” and net
price used in accounting records.
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Accounts ReceivableAccounts Receivable
– Sales discounts
• Common terms are 2/10, net 30.
• Gross method--Overstates sales and A/R;
purchases and A/P (most common).
• Net method (theoretically best)--Must adjust
beyond due date. Discounts lost represents
additional revenue or, on purchases, interest
expense.
• Please see Illustration 7-5 for entries.
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• Valuation--Follow conservatism--Disregard Present Value!
– Carry at the Net Realizable Value (NRV)
• Historical value of A/R less a reasonable estimate of
uncollectible accounts.
• Estimated value of A/R to be ultimately collected by the firm.
– Match expenses to revenues. Concept of bad debts.
• Direct write-off method (not allowed unless immaterial
difference between it and the allowance method).
• Allowance Method--Use of the contra account the Allowance for
Doubtful (or Uncollectible) Accounts (ADA).
Bad Debt ExpenseBad Debt Expense
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– Allowance method leads to:
• Less manipulation of income.
• Follows conservatism and matching.
• Smoothes assets and income.
• Methods:
–% of sales method (I/S approach, page 340)
–% of A/R method (B/S approach , page 341)
• Please see the following example of the creation and
use of the ADA.
Bad Debt ExpenseBad Debt Expense
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Bad Debt ExpenseBad Debt Expense
• % of sales method--Income statement approach:
– Through analysis and judgment a firm decides the
percent of current credit sales that will prove
uncollectible. It then records the following entry:
Bad debt expense XX
Allowance for doubtful accounts XX
Notice you did not reference the existing balance in the
ADA. A firm will need to periodically review the ADA to
prevent excessive debit or credit (usual) balances.
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Bad Debt ExpenseBad Debt Expense
• % of receivables method--Balance sheet approach.
– Receivables classified by age (“aging”-see Illustration 7-7)
– Based on analysis, judgment and the age of the receivables,
percentages are applied to the various age groups of the
receivables.
• Generally percentages increase as receivables age.
• This yields the desired balance in the contra-A/R account the
allowance for doubtful accounts (ADA). Entry made:
Bad debt expense XX
Allowance for doubtful accounts XX
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Bad Debt ExpenseBad Debt Expense
– If a credit balance already exists, only the amount
needed to bring the balance to the proper credit
balance is entered.
– If a debit balance already exists, you have written off
more than you previously provided. You must
increase the ADA by the sum of the debit balance and
the needed credit balance from your calculations.
– This method follows the ADA closely. Matching is
not adhered to as closely as the percent of sales
method.
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Bad Debt ExpenseBad Debt Expense
• Collection of previously written-off accounts.
– Reinstate A/R to the amount collected, increase ADA.
– Reduce A/R for that amount and record cash.
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– Special Allowance Accounts:
• Allowance for Sales Returns
–To avoid distortion of A/R
–To anticipate large returns
Accounts ReceivableAccounts Receivable
Sales R & A XX
Allowance for Sales Returns (contra A/R) XX
– Allowance for Collection Expenses--to provide for
material expenses in the collection of the A/R.
Collection Expense XX
Allowance for Collection Expense (contra A/R) XX
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Notes ReceivableNotes Receivable
• Written promise to pay you, i.e., you are the payee.
– Stated amount (principle), face value.
– Stated (face) rate of interest (SR)
– Prevailing (market) rate of interest (MR)
– Maturity date; maturity value
Interest-bearing notes (Long-term):
If the stated rate (what the seller (maker) is willing to give up) equals what the buyer (you-the payee) demand, then the note will sell at face value.
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Notes ReceivableNotes Receivable
• For example: $8,000 Note Receivable (N/R); 4 years,
interest and principle paid at the end of the period,
stated rate of interest = market rate of interest = 8%
Annual cash interest = $8,000 x .08 x 360/360 days = $640
What is the “price” of this note?
Note will sell for the present value of the future cash flows
which equal the sum of (PV + PV-AO).(PV + PV-AO).
Single sum payment is the principle, 4 years hence.
Ordinary annuity is the cash interest, 4 payments which
constitute a 4 year annuity.
Discount factor = Market return = 8%; n = 4 periods
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PV = $8,000 (.73503) = $5,880
PV-AO = $640 (3.31213) = 2,120
$8,000
Notes ReceivableNotes Receivable
Journal Entry:
Note receivable 8,000
Cash 8,000
There is a “meeting of the minds!”
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What if SR not equal to the MR?
SR = 8% MR = 12% This is to say you (the payee-the
market) demand a return of 12%-you could get that with
alternative investments. The maker (the seller) is willing
to pay only 8%. What will happen to the price of the
note?
To calculate what the note will sell for: PV + PV-AOPV + PV-AO
n = 4; i = 12% (i.e., the MR)
PV = $8,000 (.63552) = $5,084
PV-AO = $640 (3.03735) = 1944
$7,028
Notes ReceivableNotes Receivable
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Notes ReceivableNotes Receivable
Journal entry:
Note receivable 8000
Cash 7028
Discount on N/R 972
Balance Sheet Presentation:
Note Receivable, par (face) $8000
- Discount N/R (+ Premium) 972
Note Receivable,net (carrying or book value) $7,028
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• The CV of the note will approach its par or face value as The CV of the note will approach its par or face value as
the maturity date approaches. the maturity date approaches.
– In this case the discount will be amortized to increase
cash revenue to the actual total interest revenue (i.e.,
to reflect the higher market rate you are actually
receiving).
– As it is amortized the discount falls and the carrying
value of the note rises. So, too, should the reported
interest revenue.
– The effective interest method reports a constant rate
of interest (not constant amount) on the changing
asset (or liability from the maker’s point of view).
Notes ReceivableNotes Receivable
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To record the receipt of interest: Use of the effective
interest method (yields constant rate of interest based
on carrying value of the asset).
Carrying value = (8,000 - 972) x .12 = 844
Notes ReceivableNotes Receivable
To record
Cash 640
Discount 204
Interest revenue 844
Now remaining discount = 972 - 204 = 768
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Notes ReceivableNotes Receivable
Next period: CV (8,000 - 768) (.12) = 868 (revenue rises)
You could also record the note at the PV to start:
N/R 7028
Cash 7028
And then record interest revenue:
Cash 640
N/R 204
Interest revenue 844
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Received for cash:Non-interest bearing note (or
unreasonable rates)
Notes ReceivableNotes Receivable
N/R 8,000
Cash 6,500
Discount N/R 1,500
Interest rate must be
imputed.
Discount is amortized to
revenue.
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Receivables
– Assigned or pledged
• As collateral in a secured borrowing
• General assignment (footnote disclosure)
Disposition of A/R and Notes Disposition of A/R and Notes ReceivableReceivable
Cash XX
A/R
XX• Specific assignment--particular A/R assigned
–Accounts are transferred to a special account.
–Collections received by borrower are remitted
(plus a fee) to the lender.
–For entries please Illustration 7-14 on page 351
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– Sales of A/R to a factor--Please see page 352.
• Note: With recourse or without recourse
• If the following conditions are met, account for as a sale and
record any gain or loss:
–Control effectively given up.
–Repurchase not required of transferor.
–Future obligation is minimal.
• Please see Illustration 7-16, sales without recourse.
• Please see Illustration 7-19, sales with recourse.
• If the above three conditions are not met it is a borrowing and
gives rise to interest expense (discount on A/R) See entries in
Illustration 7-20.
Disposition of A/R and Notes Disposition of A/R and Notes ReceivableReceivable
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Analysis of ReceivablesAnalysis of Receivables
• To help analyze the liquidity of a company’s accounts
receivable, a common financial ratio is calculated:
– Accounts receivable turnover ratio
• Measures the number of times, on average, the A/R
balance is collected within one period.Net credit sales
Average accounts receivable balance
• Note both numerator and denominator cover a
period of time.
• Yields a trend figure, not extremely precise.
• Can be converted to days by dividing into 365 days.