cash and ar


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cash and ar

  1. 1. Cash and Receivables 1
  2. 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. 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. 4. REPORTING CASH • Issues related to reporting cash include – Restricted cash – Bank overdrafts – Cash equivalents 4
  5. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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 = ÷