Chapter 7 Lecture

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  • Chapter 7: Cash and Receivables We begin our study of assets by looking at cash and receivables—the two assets typically listed first in a balance sheet. For cash, the key issues are internal control and classification in the balance sheet. For receivables, the key issues are valuation and the related income statement effects of transactions involving accounts receivable and notes receivable.
  • Cash includes currency and coins, balances in checking accounts, and items acceptable for deposit such as checks and money orders received from customers. Cash equivalents include short-term, highly liquid investments that are: easily converted into a known amount of cash. close to maturity. not sensitive to interest rate changes. Examples are money market funds, treasury bills, and commercial paper.
  • The success of any business enterprise depends on an effective system of internal control. Internal control refers to a company’s plan to (a) encourage adherence to company policies and procedures, (b) promote operational efficiency, (c) minimize errors and theft, and (d) enhance the reliability and accuracy of accounting data. From a financial accounting perspective, the focus is on controls intended to improve the accuracy and reliability of accounting information and to safeguard the company’s assets. Recall from our discussion in Chapter 1 that Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies document their internal controls and assess their adequacy . The Public Company Accounting Oversight Board’s Auditing Standard No. 5 further requires the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting.
  • Part I. Because cash is easily susceptible to theft, internal controls over cash are extremely important. Separation of duties is essential when dealing with cash. Different people should be responsible for receiving cash, recording cash receipt transactions, and reconciling cash balances. In addition, we should require daily bank deposits of cash receipts, verify the amount deposited from the bank receipt with the amount of cash collected, and maintain close supervision of all cash-handling and cash recording activities. Part II. Control of cash disbursements is just as important as control of cash receipts. Controls must be in place to prevent unauthorized disbursements. All cash disbursements, other than small disbursements from petty cash, should then be made by check. Again separation of duties is key. We do not want one person to be able to order an item, authorize cash payment for the item, make the payment, and record the payment. When we separate duties we are asking one employee to serve as a check on the work of another employee or group of employees. Effective separation of duties reduces the likelihood of fraud or theft by employees. All cash disbursements should be properly authorized and then, signed only be authorized individuals.
  • Restricted cash is cash that has been set aside for a particular use and is not available for paying current liabilities. Restricted cash is not a current asset, rather it is classified as an investment in the balance sheet. A compensating balance is some specified minimum amount that must be maintained on deposit with a bank that has made a loan to the company. If the arrangement with the bank requiring a compensating balance is a formal, legally-binding arrangement, the amount of cash in the compensating balance is reported as either current or noncurrent depending on the term of the loan.
  • In general, cash and cash equivalents are treated similarly under U.S. GAAP and IFRS. One difference relates to bank overdrafts, which occur when withdrawals exceed the available balance. U.S. GAAP requires that overdrafts be treated as liabilities. In contrast, IFRS allows bank overdrafts to be offset against other cash accounts when overdrafts are payable on demand and fluctuate between positive and negative amounts as part of the normal cash management program of the company.
  • Receivables represent a company’s claims to the future collection of cash, other assets, or services. Accounts receivable result from the credit sales of goods or services to customers. Most businesses provide credit to their customers, either because it’s not practical to require immediate cash payment or to encourage customers to purchase the company’s product or service. Accounts receivable are informal credit arrangements supported by an invoice and normally are due in 30 to 60 days after the sale. They almost always are classified as current assets because their normal collection period, even if longer than a year, is part of, and therefore less than, the operating cycle. We know from prior discussions that receivables should be recorded at the present value of future cash receipts using a realistic interest rate. However, because the difference between the future and present values of accounts receivable often is immaterial, GAAP specifically excludes accounts receivable from the general rule that receivables be recorded at present value. Therefore, accounts receivable initially are valued at the exchange price agreed on by the buyer and seller. Companies frequently offer trade discounts to customers, usually a percentage reduction from the list price. Trade discounts can be a way to change prices without publishing a new catalog or to disguise real prices from competitors. They also are used to give quantity discounts to large customers. A trade discount is recognized indirectly by recording the sale at the net of discount price, not at the list price.
  • Cash discounts are reductions in the amount to be paid by a customer if the customer pays within a specified period of time. If payment is not received within the specified discount period, the full amount of the sales price is due. Cash discounts are offered to increase sales, encourage early payment, and to increase the likelihood of collections.
  • Cash discount terms are typically written in terms such as shown on this slide. This particular discount term would be read as “two ten, net thirty.” The first number represents the discount percentage. The second number represents the discount period. The letter “n” stands for the word net. The last number represents the entire credit period. In this case, if the customer pays within 10 days, then a 2 percent discount may be taken. If not, then all of the amount is due within 30 days.
  • Some companies use the gross method to record sales. Under the gross method, sales are originally recorded at the full invoice amount. Sales discounts are recorded only if payment is received within the discount period. Sales discounts taken by customers are treated as contra revenue accounts and are deducted from sales revenue to obtain net sales revenue. Other companies use the net method, initially recording sales net of the discount. If a cash discount is not taken within the discount period offered, then the amount of the discount is recorded as interest revenue.
  • Part I. On October 5th, Hawthorne sold $20,000 of merchandise with terms of 2/10, n/30. The customer was able to pay a portion of the account within the discount period, and paid the remainder within the 30 day terms. Prepare the journal entries to record the transactions if Hawthorne uses: (a) the gross method. (b) the net method. Part II. Using the gross method, On October 5 th , Hawthorne would record the sale at the full sales price, debiting accounts receivable and crediting sales for $20,000. On October 14 th , the customer sent a check for $13,720, taking advantage of the 2% discount. The cash is debited, and the amount of the discount is also debited as “Sales Discount,” a contra-revenue account. The remaining $6,000 is paid on November 4 th , outside of the discount period. Part III. Using the net method, on October 5 th , Hawthorne would record the sale at net of the 2% discount by debiting accounts receivable and crediting sales for $19,600. When the October check for $13,720 arrives, the entry is simply to debit cash and credit accounts receivable for that amount. However, when the $6,000 check arrives outside of the discount period, the difference between $5,880 the amount owed at that time ($19,600 original amount minus $13,720 already paid) is considered interest revenue.
  • Customers frequently are given the right to return merchandise if they are not satisfied. When merchandise is returned for a refund or for credit to be applied to other purchases, the situation is called a sales return. When practical, a dissatisfied customer might be given a special price reduction as an incentive to keep the merchandise purchased, which is sometimes referred to as a sales allowance. Returns are common and often substantial in some industries such as food products, publishing, and retailing. In these cases, recognizing returns and allowances only as they occur could cause profit to be overstated in the period of the sale and understated in the return period. To avoid misstating the financial statements, sales revenue and accounts receivable should be reduced by the amount of returns in the period of sale if the amount of returns is anticipated to be material. We must account for all returns, including those that occur in the period of sale and those that are estimated to occur in future periods. The returns that occur in the period of sale are easy to account for, but the returns estimated for future periods are more difficult. We reduce sales revenue and accounts receivable for estimated returns by debiting a sales returns account (which is a contra account to sales revenue) and crediting an “allowance for sales returns” account (which is a contra account to accounts receivable). When returns actually occur in a following reporting period, the allowance for sales returns is debited and accounts receivable is credited. In this way, income is not reduced in the return period but in the period of the sales revenue. Note that this process requires that we be able to estimate returns. If we cannot, we may need to defer revenue recognition, as discussed in chapter 5.
  • During 2011, its first year of operation, the Hawthorne Manufacturing Company sold merchandise on account for $2,000,000. This merchandise cost $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be returned. Customers returned $130,000 in sales during 2011, prior to making payment. Assume a perpetual inventory method is used. For the actual returns that occur in the period of sale, Sales Returns, a contra revenue account, is debited, and Accounts Receivable is credited for $130,000. Since the company uses a perpetual inventory method, a second entry must be made to debit Inventory and credit Cost of Goods Sold for the cost of the items, 60% of the $130,000 actually returned. An adjusting entry must be recorded for returns that are estimated to occur in future periods. In this case, industry experience indicates a 10% return rate which would be $200,000 of returns for the $2,000,000 in sales. So far, only $130,000 has been returned, so we estimate future returns of $70,000 ($200,000 - $130,000). In an adjusting entry, sales revenue and accounts receivable are reduced for estimated returns by debiting Sales returns (a contra account to sales revenue) and crediting Allowance for sales returns (a contra account to accounts receivable). An additional entry must also be made to increase Inventory by $42,000 (60% of 70,000) for the cost of the estimated returns and to decrease Cost of goods sold. When returns actually occur in a following reporting period, the allowance for sales returns is debited and accounts receivable is credited. In this way, income is not reduced in the return period but in the period of the sales revenue.
  • Whenever a company extends credit on the sale of merchandise or provides a service on account, there is always the possibility that the customer may not be able to pay the amount due. Bad debts result from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts. In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in which the sales related to the uncollectible account were recorded. We will accomplish this with the allowance method of accounting for bad debts. The allowance method attempts to match bad debts expense in the period with the related revenue. This method has two advantages:  It adheres to the matching principle because the bad debts expense is recorded in the period of the sale, and  It reports accounts receivable on the balance sheet at the estimated amount of cash to be collected. Note that, as with sale returns, this process requires that we be able to estimate bad debts. If we cannot, we may need to defer revenue recognition and use the installment or cost-recovery methods, as discussed in chapter 5.
  • The actual amount of bad debts may not be known with certainty at the end of an accounting period. So, at the end of the period, a company estimates how much of its accounts receivable will not be collected. This estimate is based on past collection history and current economic information. Using the allowance method, the results of the estimation are recorded with a debit to Bad debts expense and a credit to Allowance for uncollectible accounts. Bad debts expense is normally classified as a selling expense and, along with other expenses, closed at the end of the accounting period. We do not want to run the risk of overstating accounts receivable, knowing that some of the receivables will ultimately become uncollectible. Allowance for uncollectible accounts is a contra-asset account with a normal credit balance that enables us to reduce accounts receivable to the amount that we actually think we will collect.
  • On the balance sheet, the allowance for uncollectible accounts is subtracted from the accounts receivable balance. The reported value is called the net realizable, which is the amount of accounts receivable that we actually think we will collect. How does a company arrive at the estimate for the bad debt expense adjusting entry at the end of the year? There are two methods from which to choose:  the income statement approach (percentage of credit sales method).  the balance sheet approach (percentage of accounts receivable method). Under the balance sheet approach, there are actually two separate methods a company can use: percent of accounts receivable and aging of accounts receivable. Let’s look at the income statement approach first.
  • Using the income statement approach, bad debt percentage is based on records of actual uncollectible accounts from prior years’ credit sales. The focus is on determining the amount to record on the income statement as bad debt expense. The income statement approach emphasizes the matching principle by estimating the bad debt expense associated with the current period’s credit sales. When using the income statement approach, we determine the estimated bad debt expense at the end of the period by multiplying current period credit sales by an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. Also, the sales transactions included in this computation are typically only the credit sales. There are not any collection issues to consider for cash sales transactions.
  • In 2012, MusicLand has credit sales of $400,000 and estimates that 0.6 percent of credit sales are uncollectible. MusicLand’s bad debt expense is 2,400, determined by multiplying the credit sales of $400,000 times 0.6 percent. Now let’s make the adjusting entry to recognize the bad debt expense. We debit bad debt expense and credit allowance for uncollectible accounts for $2,400.
  • When using the balance sheet approach, we focus on the collectibility of accounts receivable to make an estimate of uncollectible accounts. We compute the desired balance in allowance for uncollectible accounts using a percentage of accounts receivable. First, we compute the desired balance in allowance for uncollectible accounts by multiplying the year-end accounts receivable balance times an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. Second, because the allowance for uncollectible accounts is a permanent account, it will always have an existing balance. The estimated bad debt expense is the difference between the desired balance in allowance for uncollectible accounts and the existing balance in allowance for uncollectible accounts. After determining the estimated bad debt expense, we make the entry for the amount needed to arrive at the desired balance.
  • MusicLand has a $50,000 balance in accounts receivable and a $200 credit balance in allowance for uncollectible accounts on December 31, 2012. Based on its past experience, MusicLand estimates that that 5% of receivables are uncollectible. What is MusicLand’s bad debt expense for 2012?
  • First, we must determine the desired balance in allowance for uncollectible accounts. To do this, we multiply the accounts receivable balance of $50,000 times the five percent that is expected to be uncollectible to obtain a $2,500 desired balance in allowance for uncollectible accounts. Remember that allowance for uncollectible accounts is a permanent account that has an existing $200 credit balance. So, if we want the balance to be $2,500, we only need to credit this account for $2,300. The entry would be a debit to bad debt expense and a credit to allowance for uncollectible accounts for $2,300.
  • A second method of arriving at the desired balance in allowance for uncollectible accounts is based on the aging of accounts receivable. First we classify accounts receivable by age. Second, for each age group we determine the likelihood of the accounts being uncollectible. Third, for each age group we calculate a separate allowance amount and add up all the allowance amounts to give us the desired balance in allowance for uncollectible accounts. Fourth, we compare the desired balance in allowance for uncollectible accounts with the existing balance in the account. The difference in the two balances is the amount necessary for the bad debts adjusting entry.
  • Let’s use our four-step aging process for EastCo. First, we group Eastco’s accounts receivable into age categories such as current, 1 to 30 days past due, 31 to 60 days past due, and so on. Second, for each of these age groups, we determine how much we estimate to be uncollectible. For the current age group, one percent is expected to be uncollectible. For the 1 to 30 days past due age group, three percent is expected to be uncollectible, and so on. Notice that the older the age group the higher the uncollectible percentage. Third, we multiply the balance of each age group by its uncollectible percentage. Then, we add the uncollectible amounts for each age category and get a total of $1,350. This is the balance we want in the allowance for uncollectible accounts.
  • EastCo’s unadjusted, existing balance in allowance for uncollectible accounts is $500. Our aging procedure in steps one through three resulted in a $1,350 desired balance in allowance for uncollectible accounts. In step four of the process, we compare the desired balance with the existing balance. The difference in the two balances is the amount of our bad debt adjusting entry that results in the desired balance in allowance for uncollectible accounts. Now let’s prepare the entry to record bad debt expense. If we want the balance to be $1,350, we only need to credit the allowance for uncollectible accounts for $850. We debit bad debt expense and credit allowance for uncollectible accounts for $850.
  • The actual write-off of a receivable occurs when it is determined that all or a portion of the amount due will not be collected. Using the allowance method, the write-off is recorded as a debit to allowance for uncollectible accounts and a credit to accounts receivable. Note that, because both accounts receivable and the allowance for uncollectible accounts are being reduced, the net carrying value of accounts receivable (which is the account receivable minus the allowance) is unchanged. That net carrying value changes when we recognized bad debt expense, not when we write off specific bad debts. Sometimes, after an account receivable has been written off, a customer will send in a payment. When this happens, two entries are necessary. The first entry is required to reverse the write-off and re-establish the account receivable. This entry includes a debit to accounts receivable and a credit to allowance for uncollectible accounts. The second entry records the receipt of cash with a debit to cash and a credit to accounts receivable.
  • If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account). When using the direct write-off method, customers’ accounts receivable are written off to bad debt expense at the time the company becomes aware that the customer will not be able to pay the amounts owed. The direct write-off method does not attempt to match bad debt expense in the period that the sale occurred, and does not attempt to state accounts receivable at the value the company estimates they will receive. As a result, this method can not be used when preparing financial statements using generally accepted accounting principles unless there is an immaterial impact on the financial statements. Therefore, most companies preparing financial statements using generally accepted accounting principles use one of the two allowance methods to account for bad debts.
  • A note is a written promise to pay a specific amount at a specific future date. The following information is included in a note: term of the note, the payee, the maker, the principal amount, and the interest rate. The payee on the note is the recipient of the cash at maturity. The maker on the note is the debtor who owes the money. Most notes receivable have an interest rate associated with them. For the borrower, this is the interest expense that is paid, and for the lender, this is the interest revenue that is received. Interest is calculated as principal times the interest rate times the time the note is outstanding. Time is expressed as a fraction of a year, the number of months out of twelve that the interest period covers.
  • On November 1, 2012, West, Incorporated loans $25,000 to Winn Company. The note bears interest at 12% and is due on November 1, 2013. Prepare the journal entry on November 1, 2012, December 31, 2012, (year-end) and November 1, 2013 for West. On November 1, 2012, we record the note with a debit to notes receivable and a credit to cash for $25,000. For the two months from November 1 to December 31, the interest accrual is computed as follows: $25,000 times 12 percent times the fraction 2 months over 12 months. The interest for the two-month period is $500. We record the interest accrual with a debit to interest receivable and a credit to interest revenue for $500. On November 1, 2013, West receives $28,000, which is the total of $25,000 principal repayment and $3,000 of interest. We accrued $500 of the interest on December 31, 2012. The remaining $2,500 of the $3,000 total was earned in the ten-month period from January 1, 2013 until November 1, 2013. To record the receipt of $28,000, we debit cash for $28,000, credit note receivable for $25,000, credit interest receivable for $500, and credit interest revenue for $2,500.
  • Sometimes a receivable assumes the form of a so-called noninterest-bearing note. The name is a misnomer, though. Noninterest-bearing notes actually do bear interest, but the interest is deducted (or discounted) from the face amount to determine the cash proceeds made available to the borrower at the outset.
  • On January 1, 2012, West, Incorporated accepted a $25,000 noninterest-bearing note from Winn Company as payment for a sale. The note is discounted at 12 percent and is due on December 31, 2012. Prepare the journal entries on January 1, 2012, and December 31, 2012 for West. The actual amount borrowed is less than $25,000, because the $25,000 face amount of the note includes interest. To compute the amount of interest on the note, we multiply $25,000 times 12 percent and get $3,000. To record the transaction of January 1, 2012, we debit notes receivable for $25,000, credit sales revenue for $22,000, and credit discount on notes receivable for $3,000. To record the cash receipt from Winn Company on December 31, 2012, we debit cash for $25,000, debit discount on notes receivable for $3,000, credit interest revenue for $3,000, and credit notes receivable for $25,000.
  • In general, IFRS and U.S. GAAP are very similar with respect to accounts receivable and notes receivable. One difference relates to the “fair value option.” U.S. GAAP allows a “fair value option” for accounting for receivables while IFRS restricts the circumstances in which a “fair value option” for accounting for receivables is allowed. Another difference relates to the treatment of receivables as “available for sale” investments. U.S. GAAP does not allow receivables to be accounted for as “available for sale” investments. For IFRS, in the years between 2010 and 2012, companies may account for receivables as “available for sale” investments under IAS 39 if the approach is elected initially. However, after January 1, 2013, this treatment is no longer allowed. Finally, U.S. GAAP requires more disaggregation of accounts and notes receivable in the balance sheet or notes.
  • Financial institutions have developed a wide variety of ways for companies to use their receivables to obtain immediate cash. Companies can find this attractive because it shortens their operating cycles by providing cash immediately rather than having to wait until credit customers pay the amounts due. Also, many companies avoid the difficulties of servicing (billing and collecting) receivables by having financial institutions take on that role. Of course, financial institutions require compensation for providing these services, usually interest and/or a finance charge. The various approaches used to finance with receivables differ with respect to which rights and risks are retained by the transferor (the company who was the original holder of the receivables) and which are passed on to the transferee (the new holder, the financial institution). Despite this diversity, any of these approaches can be described as either: A secured borrowing. Under this approach, the transferor (borrower) simply acts like it borrowed money from the transferee (lender), with the receivables remaining in the transferor’s balance sheet and serving as collateral for the loan. On the other side of the transaction, the transferee recognizes a note receivable. A sale of receivables. Under this approach, the transferor (seller) “derecognizes” (removes) the receivables from its balance sheet, acting like it sold them to the transferee (buyer). On the other side of the transaction, the transferee recognizes the receivables that it obtained and measures them at their fair value.
  • In the diagram on your screen, the retailer buys merchandise on account from a supplier. The supplier (transferor) then transfers the receivables to a factor (transferee) in exchange for cash. A factor is a financial institution who buys receivables for cash, handles the billing and collection of the receivables and charges a fee for the service. The transferor usually relinquishes all rights to the receivables in exchange for cash from the factor.
  • Part I Companies sometimes use receivables as collateral for loans. In these arrangements, the lender typically lends an amount of money that is less than the amount of receivables assigned by the borrower. The difference provides some protection for the lender to allow for possible uncollectible accounts. Also, the lender (sometimes called an assignee) usually charges the borrower (sometimes called an assignor) an up-front finance charge in addition to the stated interest on the loan. The receivables might be collected either by the lender or the borrower, depending on the details of the arrangement. On December 1, 2011, the Santa Teresa Glass Company borrowed $500,000 from Finance Bank and signed a promissory note. Interest at 12% is payable monthly. The company assigned $620,000 of its receivables as collateral for the loan. Finance Bank charges a finance fee equal to 1.5% of the accounts receivable assigned. In the first journal entry, a liability of $500,000 is recorded. The finance fee of 1.5% of the accounts receivable assigned is recorded as an expense, and the difference of $490,700 represents the cash received. In this assignment, Santa Teresa will continue to collect the receivables, and will record any discounts, sales returns, and bad debt write-offs, but will remit the cash to Finance Bank, usually on a monthly basis. When $400,000 of the receivables assigned are collected in December, Santa Teresa Glass first records the usual entry which debits cash and credits accounts receivable for the $400,000 received. A second entry is made to show that this cash, plus monthly interest of $5,000 will be paid Finance Bank at the end of December reducing the amount of the liability. Part II In Santa Teresa’s December 31, 2011, balance sheet, the company would offset the remaining balance in the “Liability—financing receivable” against the remaining balance in the “Accounts receivable assigned” account to show the net equity in accounts receivable assigned. Netting a liability against a related asset, also called offsetting, usually is not allowed by GAAP. However, in this case, we deduct the note payable from the accounts receivable assigned because, by contractual agreement, the note will be paid with cash collected from the receivables. In Santa Teresa’s financial statements, the arrangement is described in a disclosure note.
  • In many financing arrangements involving receivables it is unclear whether the transaction is a sale or a borrowing. The basic issue that determines the substance of the transaction is the degree to which control of the surrendered receivables has been transferred. Regardless of how the transaction is characterized, control is judged to have been transferred, and the transaction is treated as a sale of the receivables, if all of these three conditions are met:  the receivables are isolated from transferor.  the transferee has right to pledge or exchange the receivables.  the transferor does not have control over the receivables. The transferor does not have control over the transferred receivables if the: Receivables cannot be repurchased by the transferor before maturity. Transferor cannot require return of specific receivables.
  • Receivables may be sold with or without recourse. When a company sells receivables without recourse, the: transaction is essentially treated just like an ordinary sale of any other asset. factor (transferee) assumes all of the risk of uncollectibility. control of the receivable passes to the factor. receivables are removed from the books, fair value of cash and other assets received is recorded, and a financing expense or loss is recognized. When a company sells receivables with recourse, the transferor (seller) retains risk of uncollectibility, if the transaction fails to meet the three conditions necessary to be classified as a sale, it will be treated as a secured borrowing.
  • Part I In December 2011, the Santa Teresa Glass Company factored accounts receivable that had a book value of $600,000 to Factor Bank. The transfer was made without recourse. Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor, and Factor immediately remits to Santa Teresa cash equal to 90% of the factored amount (90% × $600,000 = $540,000). Factor retains the remaining 10% to cover its factoring fee (equal to 4% of the total factored amount; 4% × $600,000 = $24,000) and to provide a cushion against potential sales returns and allowances. Part II When a company sells accounts receivable with recourse, the seller retains all of the risk of bad debts. In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible. If the receivables were sold with recourse, Santa Teresa Glass still could account for the transfer as a sale so long as the conditions for sale treatment are met. The only difference would be the additional requirement that Santa Teresa record the estimated fair value of its recourse obligation as a liability. The recourse obligation is the estimated amount that Santa Teresa will have to pay Factor Bank as a reimbursement for uncollectible receivables. In this example, Santa Teresa estimates the fair value of the recourse obligation to be $5,000. Notice that the estimated recourse liability increases the loss on sale. If the factor collects all of the receivables, Santa Teresa eliminates the recourse liability and increases income (reduces the loss).
  • Part I Another popular arrangement used to sell receivables has been securitization. In a typical accounts receivable securitization, the company creates a “special purpose entity” (SPE), usually a trust or a subsidiary. The SPE buys a pool of trade receivables, credit card receivables, or loans from the company, and then sells related securities, typically debt such as bonds or commercial paper, that are backed (collateralized) by the receivables. Securitizing receivables using an SPE can provide significant economic advantages, allowing companies to reach a large pool of investors and to obtain more favorable financing terms. But, what if a company had to consolidate its securitization SPE? In that case, it would eliminate any transactions between the SPE and the company, such that, after consolidation, it no longer would appear as if the company had sold its receivables to an outside entity. Instead, the company would appear to have kept its receivables and engaged in a secured borrowing with whoever loaned money to the SPE. Until recently, companies that securitized their receivables could avoid some consolidation rules by setting up a particular type of SPE, called a “qualifying SPE” (“QSPE”), which operated solely to facilitate securitization transactions. The company would sell its receivables to its QSPE, often recognizing a gain on the sale, and the QSPE (not the company) would hold the receivables and related debt in the QSPE’s balance sheet. Effective in 2010, the FASB eliminated the QSPE concept, leaving these SPEs vulnerable to consolidation requirements. The FASB also tightened consolidation requirements with respect to these sorts of entities. As a consequence, securitizations are much less likely to qualify for sales treatment after 2009 than they were previously. Part II What if, rather than transferring all of a particular receivable, a company transfers only part of it? For example, what if a company transfers the right to receive future interest payments on a note, but retains the right to receive the loan principal? Recent changes in U.S. GAAP require that a partial transfer be treated as a secured borrowing unless the amount transferred qualifies as a “participating interest” as well as meeting the “surrender of control” requirements described above. Participating interests are defined as sharing proportionally in the cash flows of the receivable and having equal and substantial rights with respect to the receivable. Many common financing arrangements do not qualify as participating interests, so this change in GAAP makes it harder for partial transfers to qualify for the sale approach. However, GAAP also emphasizes that the particular legal form of a transfer determines its accounting, so anticipate the financial services industry working creatively to structure transfers in a manner that achieves the accounting that its customers desire.
  • Like accounts receivable, notes receivable can also be used to obtain immediate cash from a financial institution. The transfer of a note to a financial institution for immediate cash is called discounting. Let’s look at an example. On December 31, Stridewell accepted a nine-month 10 percent note for $200,000 from a customer. Three months later on March 31, Stridewell discounted the note at its local bank. The bank’s discount rate is 12 percent. Prepare the journal entry to record the discounting of the note receivable as a sale. Before preparing the journal entry to record the discounting, the accrued interest on the note from December 31 until March 31 must be recorded. The amount of interest is $5,000, computed by multiplying the $200,000 face amount of the note times 10 percent times 3 months over 12 months. To record the interest, we debit interest receivable and credit interest revenue for $5,000.
  • The maturity value of the note is the total of the face amount and the interest to maturity. The interest to maturity is the face amount, $200,000 times the stated interest rate of 10 percent times the fraction 9 months over 12 months. The multiplication yields $15,000 of interest to maturity. The note is discounted for 6 months, the time remaining to maturity. The discount fee is the maturity value of the note, $215,000 times the discount rate of 12 percent times the fraction 6 months over 12 months. This multiplication yields a discount fee of $12,900. The $202,100 of cash proceeds is determined by subtracting the $12,900 discount fee from the $215,000 maturity value of the note. To record this transaction, we debit cash for $202,100, debit loss on sale of note for $2,900, credit notes receivable for $200,000, and credit interest receivable for $5,000. The $2,900 loss is the difference between $205,000 note receivable plus interest and the $202,100 cash received. If the three conditions for sale treatment are not met, the transaction would be recorded as a secured borrowing.
  • To summarize, transfers of a receivable may be accounted for as either a sale of a secured borrowing. Transferors usually prefer to use the sales approach rather than the secured borrowing approach because the sales approach which removes the receivable will make the transferor seem less leveraged, more liquid, and perhaps more profitable than the secured borrowing approach. First, companies must distinguish whether the arrangement to finance with receivables is a transfer of specific receivables of simply a pledging of receivables in general as collateral for a loan. If it is a transfer of receivables, the critical element is the extent to which the company surrenders control over the assets transferred. GAAP requires three conditions to determine if control has been surrendered: Transferred assets have been isolated from the transferor—beyond the reach of the transferor and its creditors. Each transferee has the right to pledge or exchange the assets it received. The transferor does not maintain effective control over the transferred assets. If these three conditions are met, the transfer may be recorded as a sale which means that the receivables are removed from the books, proceeds are recorded, and any gain or loss is recognized. If any of the three conditions are not met, the transaction is treated as a secured borrowing.
  • The U.S. GAAP and the IFRS approaches often lead to similar accounting treatment for transfers of receivables. Both seek to determine whether an arrangement should be treated as a secured borrowing or a sale, and, having concluded which approach is appropriate, both account for the approaches in a similar fashion. However, where they differ is in the conceptual basis for the choice of accounting treatment and in the decision process required to determine which approach to use.
  • Now we’ll discuss two ratios that are commonly used by managers, financial analysts and investors to evaluate receivables management. The receivables turnover ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. This ratio measures how many times a company converts its receivables into cash each year. A higher receivables turnover ratio is usually consider better than a lower receivables turnover ratio. It is calculated by dividing net sales by average accounts receivable. Average accounts receivable is determined by adding together the beginning and ending accounts receivable balances and dividing this total by two. The average collection period is computed by dividing the number of days in a year by the receivables turnover ratio. This ratio is an approximation of the number of days the average accounts receivable balance is outstanding. A lower average collection period is usually considered to be better than a higher average collection period.
  • Here we see the reported accounts receivable balances for years 2009 and 2008 for both Symantec, Corp. and CA, Inc. These numbers will enable us to compute the average accounts receivables balance for both companies for 2009. In addition, net sales for both companies is given. The receivables turnover ratio is calculated by dividing net sales by average accounts receivable. When we divide Symantect, Corp.’s net sales by its average receivables balance, we get a receivables turnover of 7.7 times per year. When we divide Ca, Inc.’s net sales by its average receivables balance, we get a receivables turnover of 4.7 times per year. The average collection period is computed by dividing the number of days in a year by the receivables turnover ratio. When we divide 365 days by Symantec Corp’s receivables turnover ratio of 7.7, we get an average collection period of 47 days. When we divide 365 days by CA, Inc.’s receivables turnover ratio of 4.7, we get an average collection period of 77 days. Symantec, Corp. has a higher turnover ratio and shorter collection period than both CA, Inc. and the industry averages.
  • Appendix 7-A: Cash Controls A bank reconciliation explains the difference between cash reported on the bank statement and cash recorded on the company’s books in its cash account. The amounts are different because of timing differences. For example the company may have written a check that reduced the cash balance on the company’s books, but the check has not cleared the bank at the bank statement date. In addition to arriving at the correct cash balance amount, a bank reconciliation will provide us with information for adjusting entries to bring the book balance of cash to the correct balance. There are two sides to a bank reconciliation. We always add the deposits in transit to the bank balance, deduct any checks outstanding at the bank statement date, and add or subtract bank errors as necessary. On the book’s side, we start with the cash balance in the ledger and add collections made by the bank on our behalf, deduct customer checks that were drawn on accounts that were nonsufficient, deduct bank service charges, add any interest earned, and add or subtract errors that we made as necessary. Examples of collections made by the bank on our behalf are when the bank acts as a collection box for customer payments or when the bank collects a note receivable for us from a customer. All reconciling items on the book balance side require an adjusting entry to the cash account. The adjustments change the general ledger cash balance to the corrected cash balance.
  • Sometimes, a quick disbursement is needed for minor expenditures. Going through all of the approval processes needed to have a check prepared is a waste of both management and clerical time. Companies usually keep a small amount of cash on hand to use for small, immediate needs. Here is how a petty cash system works. The company cashier processes a check for the petty cash amount and gives it to the petty cash custodian. The accountant makes an entry to debit petty cash and credit cash for the amount of the check. The petty cash custodian takes the check to the bank and cashes it. The cash is brought back and placed in a secure location. As petty cash is needed, the petty cash custodian supplies the cash for the purchases Receipts supporting the petty cash disbursements are given to the petty cash custodian. When the petty cash fund is close to depletion, the petty cash custodian takes the receipts to the company cashier and requests a check in that amount to replenish the petty cash fund. When the check is issued, the accountant makes an entry to debit the expenses or assets indicated on the receipts and credits cash.
  • Part I Appendix 7-B: Impairment of a Receivable due to a Troubled Debt Restructuring When a company holds a receivable from another company, there is some potential that the receivable will eventually be impaired. Earlier in this chapter you learned about accounting for bad debts, which is how impairments of ordinary receivables are handled. For longer-term notes and loans receivable, present values come into play. Impairment of a receivable occurs if the company believes it is probable that it will not receive all of the cash flows (principal and any interest payments) associated with the receivable. In that case, the receivable is remeasured based on the discounted present value of currently expected cash flows at the loan’s original effective rate. Often the original terms of a debt agreement are changed as a result of financial difficulties experienced by the debtor (borrower). In that case, the new arrangement is referred to as a troubled debt restructuring. We discuss troubled debt restructurings in much more detail in Chapter 14. The essential point here is that such an arrangement involves some concessions on the part of the creditor (lender), resulting in the impairment of the creditor’s asset, the receivable. Part II Consider the following example. Brillard Properties owes First Prudent Bank $30 million under a 10% note with two years remaining to maturity. Due to financial difficulties of the developer, the previous year’s interest ($3 million) was not paid. First Prudent Bank agrees to: 1. Forgive the interest accrued from last year. 2. Reduce the remaining two interest payments to $2 million each. 3. Reduce the principal to $25 million. Looking at the analysis, the previous value of the receivable is $33 million which includes the principal and the accrued interest. The new value of the note is based on the present value of the restructured terms. There are two remaining interest payments at $2 million each and the principal has been reduced to $25 million. These are discounted back to present value using 10%, the loan’s original effective rate. By comparing the new value of the receivable based on the present value analysis to the previous value which is the carrying amount of the receivable, a loss of $8,867,670 is calculated. This will be recorded by debiting a “Loss on troubled debt restructuring” and crediting the $3,000,000 of accrued interest receivable and crediting the note receivable by the remainder.
  • Sometimes a receivable in a troubled debt restructuring is actually settled at the time of the restructuring with the receipt of cash (or a noncash asset), or even shares of the debtor’s stock. In that case, the creditor simply records a loss for the difference between the carrying amount of the receivable and the fair value of the asset(s) or equity securities received. Consider the following example. First Prudent Bank is owed $30 million by Brillard Properties under a 10% note with two years remaining to maturity. Due to financial difficulties of the developer, the previous year’s interest ($3 million) was not received. The bank agrees to settle the receivable (and accrued interest receivable) in exchange for property having a fair value of $20 million. The loss is calculated by comparing the fair value of what is received, the land at $20 million, to the carrying value of the receivable, the principal plus interest, or $33 million. In this case the loss is $13 million. The above journal entry shows how the transaction would be recorded.
  • End of chapter 7.
  • Chapter 7 Lecture

    1. 1. Cash and Receivables 7 Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
    2. 2. Cash and Cash Equivalents Balances in checking accounts Currency and coins Cash equivalents are short-term, highly liquid investments that can be readily converted to cash. Money market funds Treasury bills Commercial paper Cash Items for deposit such as checks and money orders from customers
    3. 3. Internal Control Encourages adherence to company policies and procedures Promotes operational efficiency Minimizes errors and theft Enhances the reliability and accuracy of accounting data
    4. 4. Internal Control Procedures <ul><li>Cash Receipts </li></ul><ul><li>Separate responsibilities for receiving cash, recording cash transactions, and reconciling cash balances. </li></ul><ul><li>Match the amount of cash received with the amount of cash deposited. </li></ul><ul><li>Close supervision of cash-handling and cash-recording activities. </li></ul><ul><li>Cash Disbursements </li></ul><ul><li>All disbursements, except petty cash, made by check. </li></ul><ul><li>Separate responsibilities for cash disbursement documents, check authorization, check signing, and record keeping. </li></ul><ul><li>Checks should be signed only by authorized individuals. </li></ul>
    5. 5. Restricted Cash and Compensating Balances <ul><li>Restricted Cash </li></ul><ul><ul><li>Management’s intent to use a certain amount of cash for a specific purpose – future plant expansion, future payment of debt. </li></ul></ul><ul><li>Compensating Balance </li></ul><ul><ul><li>Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank. </li></ul></ul>
    6. 6. U.S. GAAP vs. IFRS <ul><li>Bank overdrafts are treated as liabilities. </li></ul><ul><li>Bank overdrafts may be offset against other cash accounts. </li></ul>In general, cash and cash equivalents are treated similarly under IFRS and U.S. GAAP. One difference is highlighted below.
    7. 7. Accounts Receivable Result from the credit sales of goods or services to customers. Are classified as current assets. Are recorded net of trade discounts.
    8. 8. Cash Discounts Cash discounts
    9. 9. Cash Discounts 2/10,n/30 Number of days discount is available Otherwise, net (or all) is due Credit period Discount percent
    10. 10. Cash Discounts Sales are recorded at the invoice amounts. Sales discounts are recorded as reduction of revenue if payment is received within the discount period. Gross Method Sales are recorded at the invoice amount less the discount. Sales discounts forfeited are recorded as interest revenue if payment is received after the discount period. Net Method
    11. 11. Cash Discounts <ul><li>On October 5, Hawthorne sold merchandise for $20,000 with terms 2/10, n/30. On October 14, the customer sent a check for $13,720 taking advantage of the discount to settle $14,000 of the amount. On November 4, the customer paid the remaining $6,000. </li></ul>
    12. 12. Sales Returns Merchandise may be returned by a customer to a supplier. A special price reduction, called an allowance, may be given as an incentive to keep the merchandise. To avoid misstating the financial statements, sales revenue and accounts receivable should be reduced by the amount of returns in the period of sale if the amount of returns is anticipated to be material.
    13. 13. Sales Returns <ul><li>During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). Industry experience indicates 10% return rate. During the year $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment. </li></ul>Actual Returns Sales returns 130,000 Accounts receivable 130,000 Inventory 78,000 Cost of goods sold (60%) 78,000 Adjusting Entries Sales returns 70,000 Allowance for sales returns 70,000 Inventory-estimated returns 42,000 Cost of goods sold (60%) 42,000
    14. 14. Uncollectible Accounts Receivable <ul><li>Bad debts result from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts. </li></ul>In conformity with the matching principle , bad debt expense should be recorded in the same accounting period in which the sales related to the uncollectible account were recorded. PAST DUE
    15. 15. Uncollectible Accounts Receivable <ul><li>Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period. </li></ul>Bad debt expense xxx Allowance for uncollectible accounts xxx Contra asset account to Accounts Receivable. Normally classified as a selling expense and closed at year-end.
    16. 16. Allowance for Uncollectible Accounts <ul><li>Net realizable value is the amount of the accounts receivable that the business expects to collect. </li></ul>Accounts Receivable Less: Allowance for Uncollectible Accounts Net Realizable Value <ul><li>Income Statement Approach </li></ul><ul><li>Balance Sheet Approach </li></ul><ul><ul><li>Composite Rate </li></ul></ul><ul><ul><li>Aging of Receivables </li></ul></ul>
    17. 17. Income Statement Approach <ul><li>Focuses on past credit sales to make estimate of bad debt expense. </li></ul><ul><li>Emphasizes the matching principle by estimating the bad debt expense associated with the current period’s credit sales. </li></ul>Bad debt expense is computed as follows:
    18. 18. Income Statement Approach In 2012, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit sales are uncollectible. What is Bad Debt Expense for 2012? MusicLand computes estimated Bad Debt Expense of $2,400. Bad debt expense 2,400 Allowance for uncollectible accounts 2,400
    19. 19. Balance Sheet Approach <ul><li>Focuses on the collectability of accounts receivable to make the estimate of uncollectible accounts. </li></ul><ul><li>Involves the direct computation of the desired balance in the allowance for uncollectible accounts. </li></ul><ul><li>Compute the desired balance in the Allowance for Uncollectible Accounts. </li></ul><ul><li>Bad Debt Expense is computed as: </li></ul>
    20. 20. Balance Sheet Approach Composite Rate On Dec. 31, 2012, MusicLand has $50,000 in Accounts Receivable and a $200 credit balance in Allowance for Uncollectible Accounts . Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Bad Debt Expense for 2012?
    21. 21. Balance Sheet Approach Composite Rate Desired balance in Allowance for Uncollectible Accounts Bad debt expense 2,300 Allowance for uncollectible accounts 2,300
    22. 22. Balance Sheet Approach Aging of Receivables <ul><li>Year-end Accounts Receivable is broken down into age classifications. </li></ul><ul><li>Each age grouping has a different likelihood of being uncollectible. </li></ul><ul><li>Compute desired uncollectible amount. </li></ul><ul><li>Compare desired uncollectible amount with the existing balance in the allowance account. </li></ul>
    23. 23. Balance Sheet Approach Aging of Receivables At December 31, 2012, the receivables for EastCo, Inc. were categorized as follows:
    24. 24. Balance Sheet Approach Aging of Receivables <ul><li>EastCo’s unadjusted balance in the allowance account is $500. </li></ul><ul><li>Per the previous computation, the desired balance is $1,350. </li></ul>Bad debt expense 850 Allowance for uncollectible accounts 850
    25. 25. Uncollectible Accounts <ul><li>As accounts become uncollectible, this entry is made: </li></ul>When a customer makes a payment after an account has been written off, two journal entries are required. Allowance for uncollectible accounts 500 Accounts receivable 500 Accounts receivable 500 Allowance for uncollectible accounts 500 Cash 500 Accounts receivable 500
    26. 26. <ul><li>If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account). </li></ul>Direct Write-off Method Bad debts expense xxx Accounts receivable xxx
    27. 27. Notes Receivable A written promise to pay a specific amount at a specific future date. Even for maturities less than 1 year, the rate is annualized.
    28. 28. Interest-Bearing Notes <ul><li>On November 1, 2012, West, Inc. loans $25,000 to Winn Co. The note bears interest at 12% and is due on November 1, 2013. </li></ul><ul><li>Prepare the journal entry on November 1, 2012, December 31, 2012, (year-end) and November 1, 2013 for West. </li></ul>November 1, 2012 Notes receivable 25,000 Cash 25,000 December 31, 2012 Interest receivable 500 Interest revenue 500 November 1, 2013 Cash 28,000 Note receivable 25,000 Interest receivable 500 Interest revenue 2,500
    29. 29. Noninterest-Bearing Notes <ul><li>Actually do bear interest. </li></ul><ul><li>Interest is deducted (discounted) from the face value of the note. </li></ul><ul><li>Cash proceeds equal face value of note less discount. </li></ul>
    30. 30. Noninterest-Bearing Notes <ul><li>On Jan. 1, 2012, West, Inc. accepted a $25,000 noninterest-bearing note from Winn, Co as payment for a sale. The note is discounted at 12% and is due on Dec. 31, 2012. </li></ul><ul><li>Prepare the journal entries on Jan. 1, 2012, and Dec. 31, 2012. </li></ul>January 1, 2012 Notes receivable 25,000 Discount on notes receivable 3,000 Sales revenue 22,000 ($25,000 * 12% = $3,000) December 31, 2012 Cash 25,000 Discount on notes receivable 3,000 Interest revenue 3,000 Note receivable 25,000
    31. 31. U.S. GAAP vs. IFRS <ul><li>U.S. GAAP allows a “fair value option” for accounting for receivables. </li></ul><ul><li>U.S. GAAP does not allow receivables to be accounted for as “available for sale” investments. </li></ul><ul><li>U.S. GAAP requires more disaggregation of accounts and notes receivable in the balance sheet or notes. </li></ul><ul><li>IFRS restricts the circumstances in which a “fair value option” for accounting for receivables is allowed. </li></ul><ul><li>In the years between 2010 and 2012, companies may account for receivables as “available for sale” investments if the approach is elected initially. After January 1, 2013, this treatment is no longer allowed. </li></ul>In general, IFRS and U.S. GAAP are very similar with respect to accounts receivable and notes receivable. Differences are highlighted below.
    32. 32. Financing With Receivables Companies may use their receivables to obtain immediate cash.
    33. 33. Factoring Arrangements FACTOR (Transferee) SUPPLIER (Transferor) RETAILER A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables and charges a fee for the service. 1. Merchandise 2. Accounts Receivable 3. Accounts Receivable 4. Cash 5. Cash
    34. 34. Secured Borrowing
    35. 35. Sale of Receivables <ul><li>Treat as a sale if all of these conditions are met: </li></ul><ul><li>receivables are isolated from transferor. </li></ul><ul><li>transferee has right to pledge or exchange receivables. </li></ul><ul><li>transferor does not have control over the receivables. </li></ul><ul><ul><li>Transferor cannot repurchase receivable before maturity. </li></ul></ul><ul><ul><li>Transferor cannot require return of specific receivables. </li></ul></ul>
    36. 36. Sale of Receivables <ul><li>Without recourse </li></ul><ul><li>An ordinary sale of receivables to the factor. </li></ul><ul><li>Factor assumes all risk of uncollectibility. </li></ul><ul><li>Control of receivable passes to the factor. </li></ul><ul><li>Receivables are removed from the books, fair value of cash and other assets received is recorded, and a financing expense or loss is recognized. </li></ul><ul><li>With recourse </li></ul><ul><li>Transferor (seller) retains risk of uncollectibility. </li></ul><ul><li>If the transaction fails to meet the three conditions necessary to be classified as a sale, it will be treated as a secured borrowing . </li></ul>
    37. 37. Sale of Receivables In December 2011, the Santa Teresa Glass Company factored accounts receivable that had a book value of $600,000 to Factor Bank. The transfer was made without recourse . Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor, and Factor immediately remits to Santa Teresa cash equal to 90% of the factored amount (90% × $600,000 = $540,000). Factor retains the remaining 10% to cover its factoring fee (equal to 4% of the total factored amount; 4% × $600,000 = $24,000) and to provide a cushion against potential sales returns and allowances. Assume the same facts as above, except that Santa Teresa sold the receivables to Factor with recourse and estimates the fair value of the recourse obligation to be $5,000.
    38. 38. Sale of Receivables Securitization: Transfer receivables to a SPE Special Purpose Entity (SPE) (usually a trust or subsidiary) Qualifying Special Purpose Entity (QSPE) Changing rules…eliminate QSPE…require consolidation! Participating Interests: Transfer portion of a receivable Example: transfer right to interest, but retain right to principal Changing rules…require a partial transfer be treated as a secured borrowing, unless specific conditions are met!
    39. 39. Transfers of Notes Receivable <ul><li>On December 31, Stridewell accepted a nine-month 10 percent note for $200,000 from a customer. Three months later on March 31, Stridewell discounted the note at its local bank. The bank’s discount rate is 12 percent. </li></ul>Interest receivable 5,000 Interest revenue 5,000 Before preparing the journal entry to record the discounting, Stridewell must record the accrued interest on the note from December 31 until March 31. $200,000 × 10% × 3/12
    40. 40. Transfers of Notes Receivable Cash 202,100 Loss on sale of note receivable 2,900 Notes receivable 200,000 Interest receivable 5,000 $205,000 - $202,100
    41. 41. Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowing
    42. 42. U.S. GAAP vs. IFRS <ul><li>U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee. </li></ul><ul><li>IFRS requires a more complex decision process. The company has to have transferred the rights to receive the cash flows from the receivable, and then considers whether the company has transferred “substantially all of the risks and rewards of ownership,” as well as whether the company has transferred control. </li></ul>The U.S. GAAP and the IFRS approaches often lead to similar accounting treatment for transfers of receivables.
    43. 43. Receivables Management This ratio measures how many times a company converts its receivables into cash each year. This ratio is an approximation of the number of days the average accounts receivable balance is outstanding. Net Sales Average Accounts Receivable Receivables Turnover Ratio = 365 Receivables Turnover Ratio Average Collection Period =
    44. 44. Receivables Management Symantec Corp. vs. CA, Inc. comparison (All dollar amounts in millions)
    45. 45. Appendix 7-A: Cash Controls Bank Balance + Deposits in Transit - Outstanding Checks ± Bank Errors = Corrected Balance Book Balance + Bank Collections - Service Charges - NSF Checks ± Book Errors = Corrected Balance A bank reconciliation explains the difference between cash reported on bank statement and cash balance on a company’s books.
    46. 46. Appendix 7-A: Cash Controls Petty cash is used for minor expenditures. Has one custodian. Replenished periodically. Petty cash fund
    47. 47. Appendix 7-B: Impairment of a Receivable due to a Troubled Debt Restructuring When a company holds a receivable from another company, there is some potential that the receivable will eventually be impaired. Impairment of a receivable occurs if the company believes it is probable that it will not receive all of the cash flows (principal and any interest payments) associated with the receivable.
    48. 48. Appendix 7-B: Impairment of a Receivable due to a Troubled Debt Restructuring
    49. 49. End of Chapter 7

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