Cash is the most liquid asset and consists of currency and demand deposits. Proper controls must be established to prevent improper cash use and provide necessary management information. Receivables are amounts due from customers from goods and services and include trade receivables from normal operations and non-trade receivables from other transactions. Receivables are recorded at net realizable value through use of allowances for uncollectible amounts based on percentages of credit sales or outstanding receivables. Notes receivable are formally documented promises to pay and may require present value accounting.
2. WHAT IS CASH?
• The most liquid of all assets
• The standard medium of exchange
• The basis for measuring and accounting for all
other items
• Defined as ‘cash on hand and on deposit’ (IAS
7, AASB 107)
• Consists of coin and currency on hand and
available funds on demand deposit in a bank
2
3. MANAGEMENT AND
CONTROL OF CASH
• Cash is the asset most susceptible to improper
diversion and use
• Two problems of accounting for cash
transactions
– Proper controls must be established to prevent
unauthorised use of cash
– Management must have necessary information
for proper use of cash
3
4. REPORTING CASH
• Issues related to reporting cash include
– Restricted cash
– Bank overdrafts
– Cash equivalents
4
5. Restricted cash
• Cash set aside for a particular purpose
e.g. petty cash, payroll,
dividend funds
• If material, restricted cash is segregated from
regular cash for reporting purposes
5
6. Restricted cash continued
• Compensating balances are the minimum
balances often required by banks and other
lending institutions in support of debt
arrangements
• Identified as current assets separate from
cash, if they relate to short- term loans.
• Identified as non-current assets separate from
cash, if they relate to long-term loans
6
7. Bank overdrafts
• Occur represent cheques written in excess of
amount in cash account
• Overdrafts may be offset against available
cash in another account in the same bank
• Otherwise, overdrafts are not usually offset
against cash account
• Reported under as a current liability under
‘borrowings’ (IAS 1; AASB 101)
7
8. Cash equivalents
• ‘Short-term, highly liquid investments that are
readily convertible to known amounts of cash’
(IAS 7; AASB 107)
• Generally, only refers to investments with
maturities less than or equal to three months
• Includes Treasury bills, bills of exchange,
promissory notes
8
9. RECEIVABLES
• Receivables refers to amounts due from
individuals and other entities fro goods or
services that are expected to be collected in
cash
• Current receivables are expected to be
collected with one year
• All other receivables are classified as non-
current
9
10. RECEIVABLES continued
• Receivables are classified as either
trade or non-trade (IAS 39; AASB 139)
Trade Receivables
• Amounts owed by customers for goods
sold and services rendered as part of
normal business operations
• Also known as accounts receivable
• Normally collectable within 30 to 60
days
10
11. RECEIVABLES continued
Non-trade Receivables
• Arise from a variety of transactions
• Notes receivable are written promises to pay
a certain sum of money on a specified future
date
• They may arise from sales, financing or other
transactions
• May be current or non-current
11
12. RECEIVABLES continued
12
Examples of Non-trade Receivables
- Advances to offices and employees
- Advances to subsidiaries
- Deposits to cover potential damages or losses
- Deposits as a guarantee of performance/payment
- Dividends and interest receivable
- Claims against insurance, defendants under suit,
government for tax refunds, carriers for damaged
goods, creditors for returned or damaged goods,
customers for returnable items
13. RECOGNITION OF ACCOUNTS
RECEIVABLE
• Exchange price is amount due from the debtor
(customer or borrower)
• Generally evidence by business document
such as invoice
• Two complicating factors are
– Availability of discounts (trade and cash discounts)
– Length of time between sale and due date of
payment (interest element)
13
14. Trade discounts
• Trade discounts are used to quote different
prices for different quantities purchased
• Trade discounts are taken into account in
measurement of revenue
• Example
– Item listed at $4.65 sold at trade discount of 16% (i.e.
$3.90)
– Sale revenue and accounts receivable is recorded as
$3.90 not $4.65
14
15. Cash discounts
• Cash discounts (sales discounts) are
inducements to customers for prompt
payment of accounts (e.g. 2/10, n/30)
• Cash discounts are recorded in books as
reductions of sales revenue
• There are two methods of accounting for cash
discounts
– Gross method
– Net method
15
16. Cash discounts continued
• Record revenue at
gross amount of sales
• When customer takes
the discount, record
cash discounts
• Cash discounts reduce
gross sales revenue
• Record revenue at
gross amount of sales
less cash discount
• When customer forfeits
discount, record
discounts not taken.
• Report discounts not
taken as other revenue
16
Gross Method Net Method
17. Cash discounts continued
Sales of $10 000, terms 2/10, n/30
Accounts Receivable 10 000 Accounts Receivable 9 800
Sales 10 000 Sales 9 800
Payment of $4000 received within discount period
Cash 3 920 Cash 3 920
Sales Discounts 80 Accounts Receivable 3 920
Accounts Receivable 4 000
Payment of $6000 received after discount period
Cash 6 000 Accounts Receivable 120
Accounts Receivable 6 000 Sales Discounts Forfeited 120
Cash 6 000
Accounts Receivable 6 000
17
Gross Method Net Method
18. Non-recognition of interest element
• Ideally, receivables should be measured in
present value terms
• When cash receipts require waiting period,
receivable face amount is not worth amount
received
• However, interest revenue related to accounts
receivable is ignored because discount
amount is not normally material
18
19. VALUATION OF ACCOUNTS
RECEIVABLE
• Current receivables are valued and reported
at net realisable value
• Net realisable value is the net amount
expected to be received in cash
• Requires estimation of
– Uncollectable receivables
– Returns or allowances granted
19
20. Uncollectable accounts receivable
• Not based on matching
principle
• Accounts written off
when determined
uncollectable
• Appropriate only if
amounts are not
material
• Based on matching
principle
• Estimated bad debts
matched against
revenue
• Must be followed if
amounts are material
20
Direct Write-Off Method Allowance Method
Two procedures are used to record
uncollectable accounts:
21. Uncollectable accounts receivable
continued
• The estimate of uncollectable accounts is
normally based on one of two approaches
– Percentage-of-credit sales (or income statement)
approach
– Percentage-of-receivables (or balance sheet)
approach
21
22. Uncollectable accounts receivable
continued
1. Percentage-of-sales approach
• Appropriate if there is a fairly stable
relationship between credit sales and bad
debts
• Matches costs with revenues because it
relates expense to period in which sale is
recorded
• Allowance for Doubtful Debts is a contra
account which is subtracted from
accounts receivable on the balance sheet
22
23. Uncollectable accounts receivable
continued
• Example
– From past experience it is estimated that 2% of credit
sales will be uncollectable.
– Credit sales in 2007 is $400 000
– Journal entry:
23
Bad Debt Expense 8 000
Allowance for Doubtful Debts 8 000
24. Uncollectable accounts receivable
continued
2. Percentage-of-receivables approach
• Allows a firm to estimate percentage of
uncollectable outstanding receivables without
identifying specific accounts
• Objective is to report receivables in balance
sheet at net realisable values
• Often use an ageing schedule which applies a
different percentage based on past
experience of age categories
24
25. Uncollectable accounts receivable
continued
Matching
Sales Bad Debts
Expense
Income statement approach
Net realisable value
Accounts Allowance for
Receivable doubtful debts
Balance sheet approach
25
Percentage-of-sales Percentage-of-receivables
Comparison of methods
of estimating uncollectables:
26. Uncollectable accounts receivable
continued
Collection of accounts receivable written off
• When a particular account receivable is
determined uncollectable:
26
Allowance for Doubtful Debts XXX
Accounts Receivable – A. Customer XXX
27. Uncollectable accounts receivable
continued
• When collection is received that was
previously written off, two journal entries are
required as the account must be first
reinstated
27
Accounts Receivable –A. Customer XXX
Allowance for Doubtful Debts XXX
Cash XXX
Accounts Receivable – A. Customer XXX
28. RECOGNITION OF NOTES RECEIVABLE
• A note receivable is supported by a formal
promissory note promising to pay a certain
sum of money at a specific future date
• A negotiable instrument signed by maker in
favour of designated payee
• May be sold or otherwise transferred
• May be interest-bearing or non-interest-
bearing
28
29. RECOGNITION OF NOTES RECEIVABLE
continued
• Zero-interest notes (non-interest-
bearing notes) include interest as part of
their face amount instead of stating it
explicitly
• Considered fairly liquid because they
can be readily converted into cash
• Short-term notes generally recorded at
face value (less allowances)
• Notes with maturities of ≤ 3 months, not
subject to premium or amortisation
29
30. RECOGNITION OF NOTES
RECEIVABLE continued
• Longer term notes should be recorded and
reported at present value of cash expected to
be collected
• Stated interest rate (face rate, coupon rate) is
rate contracted as part of note
• Effective interest rate (market rate, effective
yield) is rate used to determine value of note
i.e. discount rate used to determine present
value
30
31. Notes issued at face value
Example
• M Ltd lends A Ltd $10 000 in exchange for a
$10 000 3 year note bearing interest at 10%
p.a.
• Market rate of interest for note of similar risk
is also 10%.
• PV of exchange price and PV of interest
payments must be calculated.
31
32. Notes issued at face value continued
• Calculation of exchange price
32
Face value of note $10 000
PV of principal
$10 000(PVF3,10%) = $10 000(0.75132) $7 513
PV of interest
$1000(PVA3,10%) = $1000(2.48685) 2 487
PV of note 10 000
Difference $ –
33. Notes issued at face value continued
• Journal entry to record receipt of note
• Journal entry to recognise interest earned
each year
33
Notes Receivable 10 000
Cash 10 000
Cash 1 000
Interest Revenue 1 000
34. Note not issued at face value
Zero-interest bearing notes
• If a zero-interest-bearing note is received
solely for cash, its present value is the cash
paid to the issuer
• Because both future (face) amount and
present value are known, interest can be
calculated (implied)
• Implicit interest rate equates cash paid with
amounts receivable
34
35. Note not issued at face value continued
• Difference between future amount and
present value is recorded at a discount
and amortised to interest revenue over
the life of the note
Example
– K Ltd receives a 3-year, $10 000 zero-
interest-bearing note the PV of which is
$7721.80
– Implicit rate is 9% because it equates FV
of $10 000 with PV of $7721.80
35
36. Note not issued at face value continued
– Journal entry to record transaction
– Journal entry to recognise interest at end of first
year
36
Notes Receivable 10 000
Discount on Notes Receivable
($10 000 – $7721.80) 2 278.20
Cash 7 721.80
Discount on Notes Receivable 694.96
Interest Revenue
($7721.80 x 9%) 694.96
37. Note not issued at face value continued
Interest-bearing notes
• Often the stated rate and the effective rate
are different
Example
– M Ltd made loan to N Ltd and received 3-year $10
000 note bearing interest at 10% p.a.
– Market rate for note of similar risk is 12%
37
38. Note not issued at face value continued
• Calculation of PV of two cash flows
38
Face value of note $10 000
PV of principal
$10 000(PVF3,12%) = $10 000(0.71178) $7 118
PV of interest
$1000(PVA3,12%) = $1000(2.40183) 2 402
PV of note 9 520
Difference $ 480
39. Note not issued at face value continued
– Journal entry to record receipt of note at
a discount
– Journal entry to recognise receipt of
interest and amortisation of discount for
the first year
39
Notes Receivable 10 000
Discount on Notes Receivable 480
Cash 9 520
Cash 1 000
Discount on Note Receivable ($9520 x 12%) 142
Interest Revenue 1 142
40. Note not issued at face value continued
Notes received for property, goods or services
• When this transaction occurs at arm’s length,
the stated interest rate is assumed to be at
fair value
• Present value is the amount that reasonably
approximates market value of the note
40
41. Choice of interest rates
• In most transactions, effective or real interest
rate is either evident or determinable
• However, it is difficult to determine PV of note
if either
– fair value of goods not determinable
– note has no ready market
• Interest rate is approximated to by using an
imputed interest rate
41
42. VALUATION OF NOTES RECEIVABLE
• Short-term notes receivable are recorded and
reported at their net realisable value
• Longer term notes receivable pose additional
estimation problems
• They are considered impaired when it is
probable that creditor will be unable to collect
all amounts due (both principal and interest)
42
43. DISPOSITION OF ACCOUNTS AND
NOTES RECEIVABLE
• Owner may transfer accounts or notes
receivable to accelerate cash receipts by
secured borrowing or sales of receivables
• Reasons for early transfer
– Providing sales financing for customers imperative in
many industries, e.g. sale of vehicles
– Money may be tight and access to normal credit not
available or too expensive
43
44. Secured borrowing
• Receivables often used as collateral in a
borrowing transaction
• If loan is not paid, creditor has right to convert
collateral to cash
44
45. Sale of receivables
• Factors are finance companies or banks
that buy receivables from firms for a fee
and then collect money owed directly from
customers
45
CUSTOMER
Retailer of
wholesaler
COMPANY
Manufacturer of
distributor
FACTOR
(3) Approves credit
(4) Advances cash
(5) Ships goods
(6) Makes payment
(1) Places order
(2) Requests credit review
46. Sale of receivables continued
• Securitisation takes a pool of assets such as
credit card receivables and sells shares in
these pools of interest and principal payments
• In a factoring or securitisation transaction,
receivables are sold on either a ‘without
recourse’ or a ‘with recourse’ basis
46
47. Sale of receivables continued
• Purchaser assumes
risk of collectability and
absorbs any credit
losses
• Transfer is an outright
sale of receivables both
in form (title) and
substance (control)
• Seller guarantees
payment to purchaser
in event debtor fails to
pay
• Seller has continuing
interest
• Each party recognises
assets and liabilities it
controls
47
Sales without Recourse Sales with Recourse
48. Secured borrowing versus sale
Sale occurs if all the following occur:
1. Significant risks and rewards of ownership
transferred to buyer
2. Transferor retains neither managerial interest nor
control
3. Revenue amount can be reliably measured
4. Probable economic benefits will flow to transferor
5. Costs incurred can be reliably measured
48
49. PRESENTATION AND ANALYSIS
General rules in classifying receivables
1. Segregate different types if material
2. Ensure valuation accounts are offset against proper
receivables accounts
3. Determine receivables classified as current assets
will be converted to cash within the operating cycle
4. Disclose any loss contingencies that exist on
receivables
49
50. Analysis of receivables
• Receivables turnover ratio is used to
assess liquidity of receivables
• Provides indication of
– Quality of receivables
– Success of firm in collecting outstanding
receivables
• Ageing schedule should be prepared to
determine how long receivables have
been outstanding
50
Average accounts
receivable (net)
Net
sales
Accounts receivable
turnover = ÷
