1. General Course Questions 2. Chapter 7 Cash and Receivables: A. Cash & Bank Reconciliations questions 2, 3, Ex 2 & 24 B. Trade Discounts and Sales Discounts ? 5, 6 BE 2 & 3 C. Estimating and Recording Bad Debts ?8,9,11, Ex 8 & 9 D. A/R journal entries, Analysis (turnover & liquidity Ex 20) E. Notes Receivable ex 6 & 7 3. Chapter 7 Assignments for Thursday, November 4th: A. Using Receivables to Raise Cash Questions 17, 19 & 20 BE 8,9,10, & 17, Exercise 18 B. Recording Bad Debt Expense Problems 2,4, and 6 4. Review Midterm Exam 5. Review Project 1 Columbia Sportswear 10-K Intermediate Accounting Intermediate Accounting November 2 November 2 nd nd , 2010 , 2010 1
Transcript
1. General Course Questions
2. Chapter 7 Cash and Receivables:
A. Cash & Bank Reconciliations questions 2, 3, Ex 2 & 24
B. Trade Discounts and Sales Discounts ? 5, 6 BE 2 & 3
C. Estimating and Recording Bad Debts ?8,9,11, Ex 8 & 9
D. A/R journal entries, Analysis (turnover & liquidity Ex 20)
E. Notes Receivable ex 6 & 7
3. Chapter 7 Assignments for Thursday, November 4th:
Cash & Cash EquivalentsCash & Cash EquivalentsCash & Cash Equivalents• Cash: Currency and coins held, available funds on
deposit at the bank, money orders received, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts.
• Cash Equivalents are short-term, highly liquid investments that are both:1. Readily convertible into known amounts of cash2. So near maturity that there is no risk of change in valuation
from fluctuating interest rates (original maturities of no longer than 3 months)
• Cash – reported as the most liquid current asset on the balance sheet
• Cash Equivalents– Grouped together with cash
• Restricted Cash – Disclosed separately from regular cash– Examples – restricted for 1) plant expansion, retirement of long-
term debt and 3) compensating balances.– Classify as current or long-term depending on expected use
• Bank Overdrafts– US GAAP: Disclosed as a current liability unless there are other
positive-balance cash accounts at the same bank that it can be netted against
– IFRS: Included in cash and cash equivalents if repayable on demand and form a part of an entity’s cash management
Reporting CashReporting Cash
Homework Questions 2, 3 ex 23
Summary of Cash-Related Items
Illustration 7-2
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Why are internal controls over cash so important?
Three Key Controls1) Management oversight and authorization
• Especially useful in small organizations where the owner can monitor activities (and where there are limited resources to have separation of duties)
2) Separation of duties: • Physical control, authorization and record keeping• E.g., one employee prepare the deposit slip and make the
entry, and another employee will actually make the deposit
3) Physical Protection of cash• Minimize the cash on hand; only petty cash fund 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 to the bank statement.
Control over CashControl over Cash
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Balance per bank $xxx,xxx
Add: Deposits in Transit x,xxx
Less: Outstanding Checks (x,xxx)
+/- and Bank Errors (x,xxx)
Adjusted Bank Balance $xxx,xxx*
• Should equal the current balance per books after adjusting entries on the books are made for
1. bank charges or credits noted on bank statement
2. corrections of any book errors found during reconciliation.
Why is this an effective control?
Controls and Cash: Controls and Cash: Bank ReconciliationBank Reconciliation
Exercise 246
• Trade Discounts – reduction in list price for differential volume. Sales & A/R are reduced by the discount (reflecting the amount the customer is billed) and no other accounts are affected.
• Cash discounts – reduction in amount owed if paid within a specified period (reward for prompt payment)
Possible accounting methods :– Gross method records discounts when taken by customers as
“Sales Discounts” in contra Sales account (most commonly used).
– Net method records discounts not taken by customers as “Sales Discounts Forfeited” which is an “other revenue” item on the Income Statement.
• Short term receivables are reported at their net realizable value (NRV)
• What is NRV?– less estimated non-collectible accounts – less allowance for returns.
Classification of Accounts Receivable US GAAP:– Must separately disclose material related party
receivables (i.e., trade receivables separate from non-trade)
Valuation of Accounts Valuation of Accounts ReceivableReceivable
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Allowance MethodAllowance MethodLosses are Estimated using an contra account (Allowance for Bad Debts):
Percentage-of-sales Meets GAAP Matching
requirement - Bad Debt expense estimated in same period as Sale.Percentage-of-receivables
Meets GAAP - Receivables are carried at net realizable value
Methods of Accounting for Uncollectible Accounts
Direct Write-OffDirect Write-OffTheoretically undesirable:
A/R are written off when determined uncollectibleNo matching (Expense and Revenue not likely recorded in the same period)Receivables not stated at net realizable value (no Balance Sheet account for “allowance for bad debts”)Not GAAP, unless bad debt expense in immaterial
Direct write-off (used only if low & infrequent bad debts)Bad debt expense (I/S) XXX
AR (B/S - Asset) XXX
Indirect (allowance method)In year of the sale:Bad debt expense (I/S) XXX
Allowance for bad debts (B/S – Asset) XXX
When found to be uncollectible:Allowance for bad debts (B/S – Asset) XXX
AR (B/S – Asset) XXX
If payment received after account written off:AR (B/S – Asset) XXX
Allowance for bad debts (B/S – Asset) XXXCash (B/S – Asset) XXX
AR (B/S – Asset) XXX11
Uncollectible Accounts Receivable
Income Statement Approach (ignore Balance Sheet Accounts – A/R & Allowance Account) Use “Sales” to estimate the “Bad debt expense” for the period.
Income Statement Approach (ignore Balance Sheet Accounts – A/R & Allowance Account) Use “Sales” to estimate the “Bad debt expense” for the period.
Balance Sheet Approach (ignore Income Statement accounts – Sales and Bad Debt Expense) Use A/R to determine what the ending Balance in the Allowance Account should be (adjust it).
Balance Sheet Approach (ignore Income Statement accounts – Sales and Bad Debt Expense) Use A/R to determine what the ending Balance in the Allowance Account should be (adjust it).
Entry: Debit: Bad Debt Expense (temporary account, 0 before adj.) Credit: Allowance for Doubtful Accounts (permanent account)
Instructions: Prepare the journal entry to record bad debt expense assuming Tuyet-Mai Company estimates bad debts at(a)1% of net sales and
(b) 5% of accounts receivable.
Computing the Adjusting Entry Computing the Adjusting Entry for Bad Debt Expense for Bad Debt Expense
Instructions: Prepare the journal entry to record bad debt expense assuming Tuyet-Mai Company estimates bad debts at(a)1% of net sales and
(b) 5% of accounts receivable.
Computing the Adjusting Entry Computing the Adjusting Entry for Bad Debt Expense for Bad Debt Expense
Bad Debt Expense 7,500
Allowance for Doubtful Accounts 7,500($800,000 – $50,000) x 1% = $7,500
Instructions: Prepare the journal entry to record bad debt expense assuming Tuyet-Mai Company estimates bad debts at(a)1% of net sales and
(b) 5% of accounts receivable.
Computing the Adjusting Entry Computing the Adjusting Entry for Bad Debt Expense for Bad Debt Expense
Bad Debt Expense 7,500
Allowance for Doubtful Accounts 7,500($800,000 – $50,000) x 1% = $7,500
Bad Debt Expense 6,000
Allowance for Doubtful Accounts 6,000($160,000 x 5%) – $2,000) = $6,000
AR Allowance Methods: AR Allowance Methods: Determining the Amount of Determining the Amount of
the Adjustmentthe AdjustmentPercent of Receivables Allowance method
• Balance-sheet oriented• Uses one B/S account (AR) to estimate another B/S
account (Allowance)• Estimates the ENDING balance in the allowance
account• Bad debt expense is the “plug”
Percent of Sales Allowance method• Income-statement oriented• Uses one I/S account (revenue) to estimate another I/S
account (bad debt expense)• Estimates the TOTAL bad debt expense• The allowance is the “running total”
16Entry: Debit: Bad Debt Expense (temporary account, 0 before adj.) Credit: Allowance for Doubtful Accounts (permanent account)
Allowance ExampleAllowance Example
1. “Percent of Receivables” method (B/S-oriented) Irwin Co. has $60,000 in sales in 2010. AR at 12/31/10 is $24,000. Allowance for doubtful accounts at 12/31/10 is $200. What adjusting entry should be made at year end?
The company estimates allowance based on 1% of AR < 31 days, 2% 31-60 days, 5% 61-90 days and 20% > 90 days:Amount 0-30 31-6061-9091+$24,000 10,000 8,0004,0002,000Uncollectible % 1% 2% 5% 20%Allow. Est. $860 = 100 160 200 400
Entry: 17
Allowance ExampleAllowance Example
1. “Percent of Receivables” method (B/S-oriented) Irwin Co. has $60,000 in sales in 2010. AR at 12/31/10 is $24,000. Allowance for doubtful accounts at 12/31/10 is $200. What adjusting entry should be made at year end?The company estimates allowance based on 1% of AR < 31 days, 2% 31-60 days, 5% 61-90 days and 20% > 90 days:
3. % of Sales Method is based on Keele’s credit sales:
Keele Total sales, 2010: $20,000,000Keele Credit sales, 2010: $15,000,000Keele A/R Balance, Dec 31, 2010: $1,900,000Allow. for bad debt balance (before adjustment)
12/31/10: $62,000Prior history: 1% of credit sales are uncollectible
What is the journal entry to record bad debt expense for 2010
3. % of Sales Method is based on Keele’s credit sales:
Keele Total sales, 2010: $20,000,000Keele Credit sales, 2010: $15,000,000Keele A/R Balance, Dec 31, 2010: $1,900,000Allow. for bad debt balance (before adjustment)
12/31/10: $62,000Prior history: 1% of credit sales are uncollectible
What is the journal entry to record bad debt expense for 2010
4. Percent of Receivables Now assume Keele estimates their Allowance using an A/R aging. Prior collections history is used to estimate the percentage of each category that is uncollectible. Age Balance % bad0-30 days 1,200,000 x 0.75% = 9,00031-60 days 500,000 x 8.00% = 40,00061+ days 200,000 x 20.00% = 40,000
$1,900,000 89,000Total sales, 2010: $20,000,000, Credit sales, 2010: $15,000,000Allow. for bad debt balance (before adjustment) 12/31/10: $62,000
4. Percent of Receivables Now assume Keele estimates their Allowance using an A/R aging. Prior collections history is used to estimate the percentage of each category that is uncollectible. Age Balance % bad0-30 days 1,200,000 x 0.75% = 9,00031-60 days 500,000 x 8.00% = 40,00061+ days 200,000 x 20.00% = 40,000
$1,900,000 89,000Total sales, 2010: $20,000,000, Credit sales, 2010: $15,000,000Allow. for bad debt balance (before adjustment) 12/31/10: $62,000
Allowance for Doubtful Accounts $27,000($89,000 – $62,000) = $27,000
A/R Write offsA/R Write offsAffect on the Allowance & Affect on the Allowance &
Adj EntryAdj Entry5. Percent of Receivables – Write off’s and recovery. At the beginning of 2009, the balance in the Allowance account was $11,000 (CR). During the year, $8,000 of delinquent accounts were written off. Then, $2,000 of these delinquent accounts was surprisingly collected.
What Entries would be made to record the Write off:
The Subsequent Collection of $2,000:
No other entries have been made for bad debts during the year, what is the Current balance in the Allowance Account, before the Year End Adjusting entry to record Bad Debt Expense? $______ 25
A/R Write offsA/R Write offsAffect on the Allowance & Affect on the Allowance &
Adj EntryAdj Entry5. Percent of Receivables – Write off’s and recovery. At the beginning of 2009, the balance in the Allowance account was $11,000 (CR). During the year, $8,000 of delinquent accounts were written off. Then, $2,000 of these delinquent accounts was surprisingly collected.
What Entries would be made to record the Write off:
The Subsequent Collection of $2,000:
No other entries have been made for bad debts during the year, what is the Current balance in the Allowance Account, before the Year End Adjusting entry to record Bad Debt Expense? $______ 26
Allowance for Doubtful Accounts $8,000
Accounts Receivable $8,000
Accounts Receivable $ 2,000
Allowance for Doubtful Accounts $ 2,000
Cash $ 2,000
Accounts Receivable $ 2,000
A/R Write offsA/R Write offsAffect on the Allowance & Affect on the Allowance &
Adj EntryAdj Entry5. Percent of Receivables – Write off’s and recovery. At the beginning of 2009, the balance in the Allowance account was $11,000 (CR). During the year, $8,000 of delinquent accounts were written off. Then, $2,000 of these delinquent accounts was surprisingly collected.
What Entries would be made to record the Write off:
The Subsequent Collection of $2,000:
No other entries have been made for bad debts during the year, what is the Current balance in the Allowance Account, before the Year End Adjusting entry to record Bad Debt Expense? $__5,000_____ 27
Allowance for Doubtful Accounts $8,000
Accounts Receivable $8,000
Accounts Receivable $ 2,000
Allowance for Doubtful Accounts $ 2,000
Cash $ 2,000
Accounts Receivable $ 2,000
A/R Write offsA/R Write offsAffect on the Allowance & Affect on the Allowance &
Adj EntryAdj Entry5. Percent of Receivables – Write off’s and recovery.
At the beginning of 2009, the balance in the Allowance account was $11,000 (CR). During the year, $8,000 of delinquent accounts were written off. Then, $2,000 of these delinquent accounts was surprisingly collected.
What is the year end entry to estimate Bad Debt Expense if the 2009 n ending balance in A/R is $150,000 and the company estimates that 5 % 5% of A/R is uncollectible?
What would be the ending balance in the Allowance for Doubtful Accounts account?
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A/R Write offsA/R Write offsAffect on the Allowance & Affect on the Allowance &
Adj EntryAdj Entry5. Percent of Receivables – Write off’s and recovery.
At the beginning of 2009, the balance in the Allowance account was $11,000 (CR). During the year, $8,000 of delinquent accounts were written off. Then, $2,000 of these delinquent accounts was surprisingly collected.
What is the year end entry to estimate Bad Debt Expense if the 2009 n ending balance in A/R is $150,000 and the company estimates that 5 % 5% of A/R is uncollectible?
What would be the ending balance in the Allowance for Doubtful Accounts account?
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Bad Debt Expense $2,500
Allowance for Doubtful Accounts $2,500($150,000 x 5%) – $5,000) = $2,500
A/R Write offsA/R Write offsAffect on the Allowance & Affect on the Allowance &
Adj EntryAdj Entry5. Percent of Receivables – Write off’s and recovery. At
the beginning of 2009, the balance in the Allowance account was $11,000 (CR). During the year, $8,000 of delinquent accounts were written off. Then, $2,000 of these delinquent accounts was surprisingly collected.
What is the year end entry to estimate Bad Debt Expense if the 2009 n ending balance in A/R is $150,000 and the company estimates that 5 % 5% of A/R is uncollectible?
What would be the ending balance in the Allowance for Doubtful Accounts account?
$5,00030
Bad Debt Expense $2,500
Allowance for Doubtful Accounts $2,500($150,000 x 5%) – $5,000) = $2,500
Short-term accounts receivable are shown at their net realizable value as follows:
Ratios used AR Turnover = Net Sales/Average net Trade AR
Days AR or Average Collection Period = 365 days/AR turnover
Analysis of ReceivablesAnalysis of Receivables
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• The holder of accounts or notes receivable may use them (transfer them) to raise cash.
• The transfer may be either:1. A secured borrowing (A/R is used as s collateral for a
loan; transferor is borrowing from the transferee)– No transfer of ownership, A/R stays on transferor’s
books 2. A sale of receivables
– Transferor sells A/R and transfers ownership of receivables in a sale
Disposition of Accounts Disposition of Accounts and Notes Receivableand Notes Receivable
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Transfers
Secured Borrowing Sale
Without RecourseWith Recourse
Accounting for Transfers Accounting for Transfers of Receivablesof Receivables
-Seller guarantees payment if debtor does not pay
-Factored receivables are written off, but a recourse liability is recognized based on estimate of future payment firm will have to make
-Seller has no future obligation
-Write-off factored receivables (and recognize any gain / loss)34
• Overall - Receivables remain on the books of the company borrowing money (i.e. – no sale) (and continue to treat A/R as usual (collections, write-off, etc.)
• Also called “pledged” receivables• Transferor:
– Records liability – amount borrowed, using A/R as collateral– Records a finance charge.– Collects accounts receivable.– Records sales returns and sales discounts.– Absorbs bad debts expense.– Records interest expense on notes payable.– Pays on the note periodically from collections.
Secured Borrowing – the Secured Borrowing – the BasicsBasics
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Secured Borrowing Example To help overcome a cash shortage, H Software took out a
loan with T Bank. H Software used $1000 of A/R as collateral for the loan. T Bank withheld $30 as a finance charge, and forwarded $970 to H Software on July 1. H Software collected the on the accounts on July 31 ($120 were written off), and repaid T Bank on August 2nd with interest of $50.
July 1:Dr. Cash 970Dr. Finance charge 30Cr. Note Payable 1,000
July 31:Dr. Cash 880Dr. Allowance for doubtful accounts 120Cr. A/R 1,000
August 2:Dr. Interest Expense 50Dr. Note Payable 1,000Cr. Cash 1,050
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• Factor records the (transferred) accounts as assets in its books.
• Transferor:– Transfers ownership of receivables to factor.– Records any amount retained by transferee as “due from factor.”
• This is an amount held back to protect the transferee in case of non-payment by customer
– Records loss on sale of receivables.– Records any component liability IF with recourse
• i.e., any estimated future liability that the transferor will need to pay if customers do not pay (and if the amount held back by the factor is insufficient)
SaleSale of Receivables – the of Receivables – the BasicsBasics
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Transfer of Receivables: Sale Without Recourse
To help overcome a cash shortage, H Software factored $1,000 of receivables to W Factor on July 1, 2006. W Factor withheld $100 pending collectability, and charged H Software $40. The remaining $860 was forwarded to H Software on July 1. W Factor collected on the A/R, without recourse. On August 2nd, W Factor informed H Software that $75 of the accounts were uncollectible, and W Factor returned to H Software the appropriate payment.
Dr. CashDr. Due from FactorDr. Loss on sale of A/R Cr. A/R
Dr. Cash Dr. Loss Cr. Due from Factor
What if instead, W Factor informed H Software on Aug 2 that it was able to collect all of the AR? What would be the journal entry?
Dr. Cash Cr. Due from Factor
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Transfer of Receivables: Sale With Recourse
To help overcome a cash shortage, H Software factored $1,000 of receivables to W Factor on July 1, 2006. W Factor withheld $100 pending collectability, and charged H Software $40. The remaining $860 was forwarded to H Software on July 1. W Factor collected on the A/R, but had recourse in case of bad debts. H Software estimated that $150 of the receivables would ultimately be uncollectible. On August 2nd, W Factor informed H Software that $120 of the accounts were uncollectible, and H Software sent W Factor the appropriate recourse payment.
Dr. CashDr. Due from FactorDr. Loss on Sale of A/R (plug)Cr. A/RCr. Recourse Liability
Dr. Recourse Liability Cr. Cash Cr. Due from FactorCr. Recovery of loss sale
What if W Factor informed H Software that $220 of the accounts were uncollectible?
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On January 1, 2006, Dawson Associates is considering outsourcing the collection of its accounts receivable. The following factoring options are available to Dawson.
Speedy Finance, Inc. Under the terms of the agreement, Speedy Finance would pay Dawson 98% of the gross amount of the transferred receivables and Dawson would be responsible to pay Speedy Finance for any uncollectible accounts. Dawson estimates its recourse liability would be $60,000. Speedy Finance will collect the receivables and will have the right to pledge or sell the receivables to another party.
Strapped Solutions, Inc. Under the terms of the agreement, Strapped Solutions would pay Dawson 96.5% of the gross amount of Dawson’s receivables without recourse. Strapped Solutions will collect the receivables and will have the right to pledge or sell the receivables to another party.
The following information is available from Dawson’s Balance Sheet at Dec. 31, 2005:
Accounts Receivable $5,000,000Allowance for doubtful accounts 80,000
Transfer of Receivables: Dawson Example
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Prepare the journal entry that Dawson would record on January 1, 2006 if it decides to enter into the agreement with Speedy Finance.
Transfer of Receivables: Dawson Example
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Prepare the journal entry that Dawson would record on January 1, 2006 if it decides to enter into the agreement with Strapped Solutions.
Transfer of Receivables: Dawson Example
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Which alternative should Dawson select if it wants to maximize reported income in 2006?
Transfer of Receivables: Dawson Example
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Notes Receivable
Short term N/R Long term N/R
Record at face valueless allowance
Record at present valueof cash expected to
be collected
Recognition of Notes Recognition of Notes ReceivableReceivable
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• Why does a company issue a notes receivable?• NR provides a stream of cash to the issuer
– Principle– Interest
• Present value cash inflow = fair value transaction• Interest rates: Stated vs. market
– Stated rate = effective (market rate) note issued at face value– Stated rate < market rate note issued at a discount.– Stated rate > market rate note issued at a premium.– The discount or premium is amortized to interest revenue by the
effective interest method.• Record interest revenue each period using the effective
interest method
Long-Term Notes Long-Term Notes Receivable: The BasicsReceivable: The Basics
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On December 31, 2007, Nemo, Inc. finished consultation services and accepted in exchange a promissory note with a face value of $600,000, a due date of December 31, 2010, and a stated rate of 6%, with interest receivable at the end of each year. The note is considered to have a market rate of interest of 6%.
How much should the Note Receivable be recorded for?
What is the fair value of the transaction?– PV of cash interest payments
On December 31, 2007, Nemo, Inc. finished consultation services and accepted in exchange a promissory note with a face value of $600,000, a due date of December 31, 2010, and a stated rate of 3%, with interest receivable at the end of each year. The note is considered to have a market rate of interest of 6%.
Is this a discount or a premium?
How much should the Note Receivable be recorded for?
On December 31, 2007, Nemo, Inc. finished consultation services and accepted in exchange a promissory note with a face value of $600,000, a due date of December 31, 2010, and a stated rate of 9%, with interest receivable at the end of each year. The note is considered to have a market rate of interest of 6%.
Is this a discount or a premium?
How much should the Note Receivable be recorded for?
On 1/1/06 Mickey Co. purchases a machine from Mouse. Co. with a list price of $10,000. Mickey signs a non-interest bearing note promising to pay Mouse Co. $10,000 on December 31, 2007. The fair value of the machine on 1/1/06 is $7,972.
Implicitly, how much interest revenue will Mouse receive over the 2 year period of the note?
What is the implicit interest rate on this note receivable?– It is the rate that equates $7972 at t=0 to $10,000 at t=2– 7,972F = 10,000; or F=10,000/7,972 = 1.2544– In table 6.1, Future Value of 1 (p. 303), the rate is 12% (F=1.2544, n =
• How is the impairment measured?– Book value less PV future cash flows
Impairment of Long-Term Impairment of Long-Term ReceivablesReceivables
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Example: Brillard Properties owes First Prudent Bank $30million under a 10% note with two years remaining until maturity. Due to financial difficulties of the developer, the previous year’s interest of $3million was not paid. First Prudent agrees to 1. Suspend the interest payment from last year until the following year2. Reduce the remaining two interest payments to $2 million each3. Reduce the principal to $25 million4. Later decides to forgive the interest payment from last year.
How much impairment loss should be recorded?
Impairment of Long-Term Impairment of Long-Term ReceivablesReceivables
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Book value of asset:Accrued interest (10% x $30million) $ 3,000,000Principal 30,000,000Carrying amount of the receivable $33,000,000
New Value:PV of future interest ($2million x 1.73554) $3,471,080PV of principal ($25million x .82645) 20,661,250PV of receivable (24,132,330)
Loss $8,867,670
Journal EntryLoss on troubled debt restructuring 8,867,670
