acct550 ch 7 summary for students

8/10/2019 ACCT550 Ch 7 Summary for Students

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CHAPTER 7

Cash and Receivables

LEARNING OBJECTIVES

1. Identify items considered cash.2. Indicate how to report cash and related items.

3. Define receivables and identify the different types of receivables.

4. Explain accounting issues related to recognition of accounts receivable.

5. Explain accounting issues related to valuation of accounts receivable.

6. Explain accounting issues related to recognition and valuation of notes receivable.

7. Explain the fair value option.

8. Explain accounting issues related to disposition of accounts and notes receivable.

9. Describe how to report and analyze receivables.

*10. Explain common techniques employed to control cash.*11. Describe the accounting for a loan impairment.

*12. Compare the accounting procedures for cash and receivables under GAAP and IFRS

*Note: All asterisked (*) items relate to material contained in the Appendix to the chapte

1. Chapter 7 presents a detailed discussion of two of the primary liquid assets a company, cash and receivables. Cash is the most liquid asset held by a company possesses unique problems in its management and control. Receivables are composeboth accounts and notes receivables. Chapter coverage of accounts receivable plaemphasis on trade receivables. In covering notes receivables, the chapter includes b

short-term and long-term notes.

Nature of Cash

2. (S.O. 1)Cashconsists of coin, currency, bank deposits, and negotiable instruments sas money orders, checks, and bank drafts.

Reporting Cash

3. (S.O. 2)Cash equivalents are short-term, highly liquid investments that are bo(a) readily convertible to known amounts of cash and (b) so near their maturity that tpresent insignificant risk of changes in value because of changes in interest rates. Ifasset is not cash and is short-term in nature, it should be reported as as a temporinvestment.

4. It is common practice for a corporation to have an agreement with a bank concerncredit and borrowing arrangements. When such an agreement exists, the bank usurequires the company to maintain a minimum cash balance on deposit. This minimbalance is known as a compensating balance.Compensating balances that resulegally restricted deposits must be separately classified in the balance sheet. The nat

Copyright 2013 John Wiley & Sons, Inc. Ki eso, Intermediate Accounting,15/e Instructors Manual ( For Instructor Use Only)


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of the borrowing arrangement determines whether the compensating balance is classifiedas a current asset or a noncurrent asset.

5. Cash that has been designated for some specific use, other than for payment of currentlymaturing obligations, is segregated from the general cash account. This amount may beclassified as a current asset if it will be disbursed within one year or the operating cycle,whichever is longer. Otherwise, the amount should be shown as a noncurrent asset.

6. Bank overdrafts occur when a company writes a check for more than the amount in thecash account. Bank overdrafts should be accounted for as accounts payable or, if material,separately disclosed on the balance sheet or in the related notes.

Accounts Receivable

7. (S.O. 3)Receivables are claims held against customers and others for money, goods, orservices. Receivables may generally be classified as trade or nontrade. Tradereceivables (accounts receivable and notes receivable) are the most significant receivablesan enterprise possesses. Accounts receivable are oral promises of the purchaser to payfor goods and services sold. Notes receivable are written promises to pay a certain sum of

money on a specified future date. Nontrade receivables arise from a variety of transactionsand can be written promises either to pay or to deliver. Nontrade receivables are generallyclassified and reported as separate items in the balance sheet.

8. (S.O. 4) In most receivable transactions, the amount to be recognized is the exchange price(amount due from the debtor) between the two parties. Two factors that may complicate themeasurement of the exchange are (a) the availability of discounts (trade and cash) and (b)the length of time between the sale and the payment due date (the interest element).

9. Two types of discounts that must be considered in determining the value of receivablesare trade discounts and cash discounts.Trade discounts represent reductions from the

list or catalog prices of merchandise. They are often used to avoid frequent changes incatalogs or to quote different prices for different quantities purchased. Cash discounts(also called sales discounts) are offered as an inducement for prompt payment and arecommunicated in terms that read, for example, 2/10, n/30 (2% discount if paid within10 days of the purchase or invoice date, otherwise the gross amount is due in 30 days).

10. (S.O. 5) It is highly unlikely that a company that extends credit to its customers will besuccessful in collecting all of its receivables. Thus, some method must be adopted toaccount for receivables that ultimately prove to be uncollectible. The two methods currentlyused are the direct write-off method and the allowance method.

1. Under the direct write-off method, the receivable account is reduced and an expense isrecorded when a specific account is determined to be uncollectible. The direct-write offmethod is theoretically deficient because it usually does not match costs and revenues ofthe period, nor does it result in receivables being stated at estimated realizable value onthe balance sheet. The direct write-off method is not appropriate if the amount deemeduncollectible is material.

7-2 Copyright 2013 John Wiley & Sons, Inc. Ki eso, Intermediate Accounting,15/e Instructors Manual ( For Instructor Use Only)


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12. Use of the allowance method requires a year-end estimate of expected uncollectaccounts based upon credit sales or outstanding receivables. This ensures companies state receivables on the balance sheet at their net realizable value. realizable value is the net amount the company expects to receive in cash. The estimatuncollectible accounts is recorded by debiting an expense and crediting the allowaaccount in the period in which the sale is recorded. Then, in a subsequent period, wan account is deemed to be uncollectible, an entry is made debiting the allowaaccount and crediting accounts receivable.

13. Advocates of the allowance method contend that its use provides for a proper matchinrevenues and expenses as well as reflecting a proper carrying value for accounts receivaat the end of the period. When the allowance method is used, the estimated amoununcollectible accounts is normally based upon a percentage of sales or outstanding receivabThe percentage-of-sales method attempts to match costs with revenues, and is frequereferred to as the income statement approach. The percentage-of-receivables approprovides a reasonably accurate estimate of the net realizable value of receivables shoon the balance sheet. This approach is commonly referred to as the balance sheet approa

14. The method used to determine the amount of bad debt expense each year affects

amount of expense recorded. Under the percentage-of-sales method, the amount recoras bad debt expense is the amount determined by multiplying the estimated percentage timthe credit sales. However, under the percentage-of-receivables approach, the unadjusending balance in the allowance account must be considered in arriving at bad deexpense for the year.

Notes Receivable

15. (S.O. 6) The major differences between trade accounts receivables and trade noreceivables are (a) notes represent a formal promise to pay and (b) notes bearinterest element because of the time value of money. Notes are classified as nobearing interest equal to the effective rate and those bearing interest different than effective rate. Interest-bearing notes have a stated rate of interest, whereas zeinterest-bearing notes (noninterest-bearing) include the interest as part of their famount instead of stating it explicitly.

16. Short-term notes are generally recorded at face value (less allowances) because interest implicit in the maturity value is immaterial. A general rule is that notes treatedcash equivalents (maturities of 3 months or less) are not subject to premium or discoamortization. Long-term notes receivable, however, are recorded at the present valuthe future cash inflows. Determination of the present value can be complicated, particuwhen a zero-interest-bearing note or a note bearing an unreasonable interest rateinvolved.

17. Long-term notes receivable should be recorded and reported at the present value of cash expected to be collected. When the interest stated on an interest-bearing notequal to the effective (market) rate of interest, the note sells at face value. When stated rate is different from the market rate, the cash exchanged (present valuedifferent from the face value of the note. The difference between the face value and



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cash exchanged, either a discount or a premium,is then recorded and amortized overthe life of the note to approximate the effective interest rate. The discount or premium isshown on the balance sheet as a direct deduction from or addition to the face of the note.

18. Whenever the face amount of a note does not reasonably represent the present value ofthe consideration given or received in the exchange, the accountant must evaluate theentire arrangement to properly record the exchange and the subsequent interest. Notesreceivable are sometimes issued with no (zero) interest rate stated or at a stated rate that

is unreasonable. In such instances the present value of the note is measured by the cashproceeds to the borrower or fair value of the property, goods, or services rendered. Thedifference between the face amount of the note and the cash proceeds or fair value of theproperty represents the total amount of interest during the life of the note. If the fair value ofthe property, goods, or services rendered is not determinable, estimation of the presentvalue requires use of an imputed interest rate.The choice of a rate may be affectedspecifically by the credit standing of the issuer, restrictive covenants, collateral, paymentschedule, and the existing prime interest rate. Determination of the imputed interest rate ismade when the note is received; any subsequent changes in prevailing interest rates areignored.

19. The FASB requires that companies disclose the fair value of receivables in the notes tothe financial statements. Recently the Board has given companies the option to use fairvalue as the basis of measurement in the financial statements. If companies choose thefair value option, the receivables are recorded at fair value, with unrealized holding gainsor losses reported as part of net income. An unrealized holding gain or loss is the netchange in the fair value of the receivable from one period to another, exclusive of interestrevenue.

Secured Borrowing

20. (S.O. 8) Receivables are often used as collateral in a borrowing transaction. A creditor

often requires that the debtor designate (assign) or pledge receivables as security for theloan. If the loan is not paid when due, the creditor has the right to convert the collateral tocash, that is, to collect the receivables.

Sales of Receivables

21. When accounts and notes receivable are factored (sold), the factoring arrangement canbe with recourse or without recourse. If receivables are factored on a with recoursebasis, the seller guarantees payment to the factor in the event the debtor does not makepayment. When a factor buys receivables without recourse, the factor assumes the risk ofcollectibility and absorbs any credit losses. Receivables that are factored with recourse

should be accounted for as a sale, recognizing any gain or loss, if all three of the followingconditions are met: (a) the transferred asset has been isolated from the transferor, (b) thetransferees have obtained the right to pledge or exchange either the transferred assets orbeneficial interests in the transferred assets, and (c) the transferor does not maintaineffective control over the transferred assets through an agreement to repurchase or redeemthem before their maturity.

Presentation and Analysis



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22. (S.O. 9) The presentation of receivables in the balance sheet includes the followconsiderations: (a) segregate the different types of receivables that a company possessif material; (b) appropriately offset the valuation accounts against the proper receivaaccounts: (c) determine that receivables classified in the current assets section wilconverted into cash within the year or the operating cycle, whichever is longer; (d) disclany loss contingencies that exist on the receivables; (e) disclose any receivables designaor pledged as collateral; and (f) disclose the nature of credit risk inherent in

receivables, how that risk is analyzed and assessed in arriving at the allowance for crlosses, and the changes and reasons for those changes in the allowance for crelosses.

23. The ratio used to assess the liquidity of receivables is the receivables turnover ratio, wmeasures the number of times, on average, receivables are collected during the period

Accounts ReceivableTurnover

= Net SalesAverage Trade Receivables (net)

Days to CollectAccounts Receivable

= 365Accounts Receivable Turnover

*Cash Controls

*24. (S.O. 10) Control over the handling of cash and cash transactions is an important csideration for any company. Among the control procedures that are used for ctransactions are the use of a petty cash system, or the use of bank accounts such ageneral checking account, imprest bank accounts, and lockbox accounts.

*Petty Cash

*25. In an imprest petty cash system, a petty cash custodian is given a small amouncurrency from which to make small payments (minor office supplies, tolls, postage, e

Each time a disbursement is made, the petty cashier obtains a signed receipt and makepayment. When cash in the fund runs low, the petty cashier submits the signed receiptthe general cashier and a check is prepared to replenish the petty cash fund. This procis designed to promote control over small cash disbursements that would be awkwardimpossible to pay by check.

*Physical Protection of Cash Balances

*26. Adequate control of receipts and disbursements is part of the protection of cash balancalong with certain other procedures. A company should minimize the cash on hand in toffice which is often in the form of a petty cash fund, the current days receipts, and

perhaps funds for making change. It should keep these funds in a vault, safe, or lockedcash drawer. The company should transmit intact each days receipts to the bank as soas practicable. A company must periodically prove the balance shown in the generalledger by counting the cash actually present in the officepetty cash, change funds, aundeposited receiptsfor comparison with the company records.

*Bank Reconciliation



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27. A basic cash control is preparation of a monthly bank reconciliation. The bank reconciliation,when properly prepared, proves that the cash balance per bank and the cash balance perbook are in agreement. The items that cause the bank and book balances to differ, andthus require preparation of a bank reconciliation, are the following:

a. Deposits in Transit. Deposits recorded in the cash account in one period, but notreceived by the bank until the next period.

b. Outstanding Checks. Checks written by the depositor that have yet to be presentedat the bank for collection.

c. Bank Charges. Charges by the bank for services that are deducted from the accountby the bank for which the company may not be aware until it receives the bankstatement.

d. Bank Credits. Col lections or deposits in the companys account for which thecompany may not be aware until it receives the bank statement.

e. Bank or Depositor Errors. Errors made by the company or the bank that must be

corrected for the reconciliation to balance.

28. Two forms of bank reconciliation may be prepared. One form reconciles from the bankstatement balance to the book balance or vice versa. The other form is described as thereconciliation of bank and book balances to corrected cash balance. This form iscomposed of two separate sections that begin with the bank balance and book balance,respectively. Reconciling items that apply to the bank balance are added and subtractedto arrive at the corrected cash balance. Likewise, reconciling items that apply to the bookbalance are added and subtracted to arrive at the same corrected cash balance. Thecorrected cash balance is the amount that should be shown on the balance sheet at thereconciliation date.

Impairments of Receivables

29. (S.O. 11) A loan receivable is considered impaired when it is probable, based on currentinformation and events, that the company will be unable to collect all amounts due (bothprincipal and interest). If a loan is determined to be individually impaired, the loss due tothe impairment is calculated as the difference between the investment in the loan(generally the principal plus accrued interest) and the expected future cash flowsdiscounted at the loans historical effective interest rate.

M. (L.O. 12) IFRS Insights

The basic accounting and reporting issues related to recognition and measurement ofeceivables, such as the use of allowance accounts, how to record discounts, use of the

allowance method to account for bad debts, and factoring, are similar for both IFRS and U.S.GAAP. IAS 1(Presentation of Financial Statements) is the only standard that discussesssues specifically related to cash. IFRS 7 (Financial Instruments: Disclosure) and IAS 39Financial Instruments: Recognition and Measurement) are the two international standardshat address issues related to financial instruments and more specifically receivables.



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RELEVANT FACTS

a. The accounting and reporting related to cash is essentially the same under both IFand U.S. GAAP. In addition, the definition used for cash equivalents is the same. Odifference is that, in general, IFRS classifies bank overdrafts as cash.

b. Like the U.S. GAAP, cash and receivables are generally reported in the current assection of the balance sheet under IFRS. However, companies may report cash areceivables as the last items in current assets under IFRS.

c. IFRS requires that loans and receivables be accounted for at amortized cost, adjusfor allowances for doubtful accounts. IFRS sometimes refers to these allowancesprovisions.

d. Although IFRS implies that receivables with different characteristics should be reposeparately, there is no standard that mandates this segregation.

e. IFRS and U.S. GAAP on the fair value option are similar, but not identical. international standard related to the fair value option is subject to certain qualifycriteria not in the U.S. standard. In addition, there is some difference in the finaninstruments covered.

f. IFRS and U.S. GAAP differ in the criteria used to account for transfers of receivab

IFRS is a combination of an approach focused on risks and rewards and loss of conU.S. GAAP uses loss of control as the primary criterion. In addition, IFRS generpermits partial transfers; U.S. GAAP does not.

g. Impairment evaluation processUnder IFRS, companies assess their receivables for impairment each reporting perioand start the impairment assessment by considering whether objective evidenceindicates that one or more loss events have occurred. GAAP does not identify a specapproach.

h. Recovery of impairment lossSubsequent to recording an impairment, events or economic conditions may change

such that the extent of the impairment loss decreases (e.g., due to an impairment in tdebtors credit rating). Under IFRS, some or all of the previously recognized impairmloss shall be reversed either directly, with a debit to Accounts Receivable, or by debitthe allowance account and crediting Bad Debt Expense.

ON THE HORIZON

The question of recording fair values for financial instruments will continue to be an importissue to resolve as the Boards work toward convergence. Both the IASB and the FASB hindicated that they believe that financial statements would be more transparent understandable if companies recorded and reported all financial instruments at fair value.

a. In IFRS 9,which was issued in 2009, the IASB created a split model, where so

financial instruments are recorded at fair value, but other financial assets, suchloans and receivables, can be accounted for at amortized cost if certain criteria met.

b. A proposal by the FASB would require that nearly all financial instruments, includloans and receivables, be accounted for at fair value.



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c. It has been suggested that IFRS 9will likely be changed or replaced as the FASBand IASB continue to deliberate the best treatment for financial instruments. In fact,one member of the IASB said that companies should ignore IFRS 9and continue toreport under the old standard, because in his opinion, it was extremely likely that itwould be changed before the mandatory adoption date of this standard arrived in2013.

ILLUSTRATION 7-1

METHODS OF ESTIMATING THE YEAR-END ADJUSTING ENTRYFOR BAD DEBT EXPENSE



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ILLUSTRATION 7-2ESTIMATING BAD DEBT EXPENSE



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LLUSTRATION 7-3NTEREST-BEARING AND ZERO-INTEREST-BEARING

NOTES RECEIVABLE



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ILLUSTRATION 7-3 (continued)



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LLUSTRATION 7-4ACCOUNTING FOR TRANSFERS OF RECEIVABLES



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ILLUSTRATION 7-5PETTY CASH



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LLUSTRATION 7-6BANK RECONCILIATION


acct550 ch 7 summary for students

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