Intermediate Accounting
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INTERMEDIATE F I F T E E N T H
E D I T I O N
Intermediate ACCOUNTING Intermediate Accounting Accounting
Prepared by Prepared by Harsono Coby Harmon
7-1
Prepared by Harmon University of California, Santa Coby Barbara University of California, Santa Barbara Westmont College
kieso weygandt warfield team for success
PREVIEW OF CHAPTER
7
Intermediate Accounting 15th Edition Kieso Weygandt Warfield 7-2
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to:
7-3
1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Cash What is Cash?
7-4
Most liquid asset.
Standard medium of exchange.
Basis for measuring and accounting for all items.
Current asset.
Examples: coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts.
LO 1 Identify items considered cash.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to:
7-5
1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Cash Reporting Cash Cash Equivalents Short-term, highly liquid investments that are both a) readily convertible to cash, and b) so near their maturity that they present insignificant risk of changes in value. Examples: Treasury bills, Commercial paper, and Money market funds.
7-6
LO 2 Indicate how to report cash and related items.
Reporting Cash Restricted Cash Companies segregate restricted cash from “regular” cash. Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances. Illustration 7-1
7-7
LO 2
Reporting Cash Bank Overdrafts Company writes a check for more than the amount in its cash account.
7-8
Generally reported as a current liability.
Offset against other cash accounts only when accounts are with the same bank.
LO 2 Indicate how to report cash and related items.
Cash-Related Items Illustration 7-2
7-9
LO 2
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-10
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Accounts Receivable Receivables - Claims held against customers and others for money, goods, or services.
7-11
Oral promises of the purchaser to pay for goods and services sold.
Written promises to pay a sum of money on a specified future date.
Accounts Receivable
Notes Receivable
LO 3 Define receivables and identify the different types of receivables.
Accounts Receivable Nontrade Receivables 1. Advances to officers and employees. 2. Advances to subsidiaries. 3. Deposits paid to cover potential damages or losses. 4. Deposits paid as a guarantee of performance or payment. 5. Dividends and interest receivable. 6. Claims against: Insurance companies for casualties sustained; defendants under suit; governmental bodies for tax refunds; common carriers for damaged or lost goods; creditors for returned, damaged, or lost goods; customers for returnable items (crates, containers, etc.). 7-12
LO 3 Define receivables and identify the different types of receivables.
Accounts Receivable Nontrade Receivables Illustration 7-3 Receivables Balance Sheet Presentations
7-13
LO 3 Define receivables and identify the different types of receivables.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-14
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Recognition of Accounts Receivables Trade Discounts
7-15
Reductions from the list price. Not recognized in the accounting records. Customers are billed net of discounts.
10 % Discount for new Retail Store Customers
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Cash Discounts (Sales Discounts)
7-16
Offered to induce prompt payment.
Gross Method vs. Net Method.
Payment terms are 2/10, n/30
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Cash Discounts (Sales Discounts)
7-17
Illustration 7-4
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the gross method. June 3
Accounts Receivable
2,000
Sales June 12
Cash ($2,000 x 98%) Sales Discounts Accounts Receivable
7-18
2,000 1,960 40 2,000
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method. June 3
Accounts Receivable
1,960
Sales June 12
Cash ($2,000 x 98%) Accounts Receivable
7-19
1,960 1,960 1,960
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method, and Arquette did not remit payment until July 29.
June 3
Accounts Receivable
1,960
Sales June 12
Account Receivable Sales Discount Forfeited
7-20
1,960 40 40
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Non-Recognition of Interest Element A company should measure receivables in terms of their present value. In practice, companies ignore interest revenue related to accounts receivable because the discount is not usually material in relation to the net income for the period.
7-21
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables How are these accounts presented on the Balance Sheet?
Accounts Receivable
Allowance for Doubtful Accounts
Beg.
500
25
Beg.
End.
500
25
End.
7-22
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables ABC Corporation Balance Sheet (partial) Current Assets: Cash Accounts receivable
500
Less: Allowance for doubtful accounts
(25)
Inventory Prepaid expense Total current assets
7-23
$
330 475 812 40 1,657
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables ABC Corporation Balance Sheet (partial)
Alternate Presentation
Current Assets: Cash
330
Accounts receivable, net of $25 allowance
475
Inventory
812
Prepaid expense Total current assets
7-24
$
40 1,657
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Journal entry for credit sale of $100? Accounts Receivable
Sales
Accounts Receivable
100
100
Allowance for Doubtful Accounts
Beg.
500
25
Beg.
End.
500
25
End.
7-25
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Journal entry for credit sale of $100? Accounts Receivable
Sales
Accounts Receivable Beg.
500
Sale
100
End.
600
7-26
100
100
Allowance for Doubtful Accounts 25
Beg.
25
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Collected $333 on account? Cash
333
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End.
600
7-27
333
Allowance for Doubtful Accounts 25
Beg.
25
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Collected $333 on account? Cash
333
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End.
267
7-28
333
333
Allowance for Doubtful Accounts 25
Beg.
25
End.
Coll.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Adjustment of $15 for estimated bad debts? Bad Debt Expense
15
Allowance for Doubtful Accounts
Accounts Receivable Beg.
500
Sale
100
End.
267
7-29
333
15
Allowance for Doubtful Accounts 25
Beg.
25
End.
Coll.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Adjustment of $15 for estimated bad debts? Bad Debt Expense
15
Allowance for Doubtful Accounts
Accounts Receivable Beg.
500
Sale
100
End.
267
7-30
333
Coll.
15
Allowance for Doubtful Accounts 25
Beg.
15
Est.
40
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End.
267
7-31
333
Coll.
10
10
Allowance for Doubtful Accounts 25
Beg.
15
Est.
40
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts
10
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End. 7-32
257
333
Coll.
10
W/O
10
Allowance for Doubtful Accounts
W/O
25
Beg.
15
Est.
30
End.
10
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables ABC Corporation Balance Sheet (partial) Current Assets: Cash
330
Accounts receivable, net of $30 allowance
227
Merchandise inventory
812
Prepaid expense Total current assets
7-33
$
40 1,409
LO 4 Explain accounting issues related to recognition of accounts receivable.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-34
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Accounts Receivable Valuation of Accounts Receivable
Reporting of receivables involves 1) classification and 2) valuation on the balance sheet.
7-35
Classification involves determining the length of time each receivable will be outstanding.
Value and report short-term receivables at net realizable value.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Uncollectible Accounts Receivable
Record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense).
Normal and necessary risk of doing business on credit.
Two methods to account for uncollectible accounts: 1) the direct write-off method and 2) the allowance method.
7-36
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Methods of Accounting for Uncollectible Accounts
Direct Write-Off Theoretically deficient:
Losses are estimated:
No matching.
Percentage-of-sales.
Receivable not stated at cash realizable value.
Percentage-of-receivables.
GAAP requires when material in amount.
7-37
Allowance Method
Not GAAP when material in amount.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration 7-6
The percentage-of-sales basis results in a better matching of expenses with revenues
7-38
The percentage-of-receivables basis produces the better estimate of net realizable value
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Percentage-of-Sales Approach
7-39
Percentage based upon past experience and anticipate credit policy.
Achieves better matching of expenses with revenues.
Any balance in Allowance for Doubtful Accounts is ignored.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration: Gonzalez Company estimates that about 1% of net credit sales become uncollectible. If net credit sales for are $800,000 for the year, it records bad debt expense as follows. Bad Debt Expense
Allowance for Doubtful Accounts
8,000
8,000 Illustration 7-7
7-40
LO 5
Valuation of Accounts Receivable Percentage-of-Receivables Approach
Not matching.
Reports estimate of receivables at realizable value.
Companies may apply this method using
7-41
one composite rate, or
an aging schedule using different rates.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration 7-8 Accounts Receivable Aging Schedule
What entry would Wilson make assuming that the allowance account had a zero balance?
Bad Debt Expense Allowance for Doubtful Accounts 7-42
37,650 37,650
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration 7-8 Accounts Receivable Aging Schedule
What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment?
Bad Debt Expense ($37,650 – $800) Allowance for Doubtful Accounts 7-43
36,850 36,850
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration: Sandel Company reports the following financial information before adjustments.
Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable.
7-44
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration: Sandel Company reports the following financial information before adjustments.
Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 1% of net sales. Bad Debt Expense Allowance for Doubtful Accounts
7,500 7,500
($800,000 – $50,000) x 1% = $7,500 7-45
LO 5
Valuation of Accounts Receivable Illustration: Sandel Company reports the following financial information before adjustments.
Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 5% of accounts receivable. Bad Debt Expense Allowance for Doubtful Accounts
6,000 6,000
($160,000 x 5%) – $2,000) = $6,000 7-46
LO 5
Write-Off of Uncollectible Accounts Illustration: The financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. in March 1. The entry to record the write-off is: Allowance for Doubtful Accounts
1,000
Accounts Receivable
1,000
Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries:
7-47
Accounts Receivable Allowance for Doubtful Accounts
1,000
Cash Accounts Receivable
1,000
1,000 1,000 LO 5
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-48
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Notes Receivable Supported by a formal promissory note.
7-49
Written promise to pay a certain sum of money at a specific future date.
A negotiable instrument.
Maker signs in favor of a Payee.
Interest-bearing (has a stated rate of interest) OR
Zero-interest-bearing (interest included in face amount).
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Notes Receivable Generally originate from:
7-50
Customers who need to extend payment period of an outstanding receivable.
High-risk or new customers.
Loans to employees and subsidiaries.
Sales of property, plant, and equipment.
Lending transactions (majority of notes).
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Recognition of Notes Receivable
7-51
Short-Term
Long-Term
Record at Face Value, less allowance
Record at Present Value of cash expected to be collected
Interest Rates
Note Issued at
Stated rate = Market rate
Face Value
Stated rate > Market rate
Premium
Stated rate < Market rate
Discount LO 6
Note Issued at Face Value Illustration: Bigelow Corp. lends Scandinavian Imports $10,000 in exchange for a $10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note? i = 10% $10,000 Principal
0
$1,000
1,000
1
2
1,000 Interest
3
4
n=3 7-52
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Note Issued at Face Value PV of Interest
$1,000
x
Interest Received 7-53
2.48685 Factor
=
$2,487 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Note Issued at Face Value PV of Principal
$10,000 Principal 7-54
x
.75132 Factor
=
$7,513 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Note Issued at Face Value Summary
Present value of interest
$ 2,487
Present value of principal
7,513
Note current market value
$10,000
Journal Entries Jan. yr. 1
Dec. yr. 1
7-55
Notes Receivable Cash
Cash Interest Revenue
10,000 10,000
1,000 1,000
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note? i = 9% $10,000 Principal
0
$0
$0
1
2
$0 Interest
3
4
n=3
7-56
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note PV of Principal
$10,000 Principal 7-57
x
.77218 Factor
=
$7,721.80 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration 7-12
7-58
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration 7-12
Prepare the journal entry to record the receipt of the note.
Notes Receivable
7-59
10,000.00
Discount on Notes Receivable
2,278.20
Cash
7,721.80 LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration 7-12
Prepare the journal entry to record interest revenue at the end of the first year.
Discount on Notes Receivable Interest Revenue
7-60
694.96 694.96
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. Prepare the journal entry to record the receipt of the note? i = 12% $10,000 Principal
0
$1,000
1,000
1
2
1,000 Interest
3
4
n=3
7-61
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note PV of Interest
$1,000
x
Interest Received 7-62
2.40183 Factor
=
$2,402 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note PV of Principal
$10,000 Principal 7-63
x
.71178 Factor
=
$7,118 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration: Record the receipt of the note? Illustration 7-14
Notes Receivable Discount on Notes Receivable Cash
7-64
10,000
480 9,520
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration 7-15
7-65
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration 7-15
Prepare the journal entry to record interest revenue at the end of the first year.
Cash
1,000
Discount on Notes Receivable Interest Revenue 7-66
142 1,142
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Recognition of Notes Receivable Notes Received for Property, Goods, or Services In a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless: 1. No interest rate is stated, or
2. Stated interest rate is unreasonable, or 3. Face amount of the note is materially different from the current cash sales price.
7-67
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Recognition of Notes Receivable Illustration: Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five-year note having a maturity value of $35,247 and no stated interest rate. The land originally cost Oasis $14,000. At the date of sale the land had a fair market value of $20,000. Oasis uses the fair market value of the land, $20,000, as the present value of the note. Oasis therefore records the sale as: ($35,247 - $20,000) = $15,247
Notes Receivable Discount on Notes Receivable Land Gain on Disposal of Land
7-68
35,247 15,247 14,000 6,000
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Notes Receivable Valuation of Notes Receivable
Short-Term reported at net realizable value (same as accounting for accounts receivable).
Long-Term - FASB requires companies disclose not
only their cost but also their fair value in the notes to the financial statements.
7-69
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-70
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Special Issues Fair Value Option
Companies have the option to use fair value as the basis of measurement in the financial statements.
If companies choose the fair value option
7-71
►
Receivables are recorded at fair value.
►
Unrealized holding gains or losses reported as part of net income.
Company reports the receivable at fair value each reporting date.
LO 7 Explain the fair value option.
Special Issues Fair Value Option
7-72
Companies may elect at time the financial instrument is ►
originally recognized or
►
when some event triggers a new basis of accounting.
Must continue to use fair value measurement for the specific instrument until the company no longer owns this instrument.
If not elected at date of recognition, company may never use fair value option on that specific instrument.
LO 7 Explain the fair value option.
Valuation of Notes Receivable Illustration: Escobar Company has notes receivable that have a fair value of $810,000 and a carrying amount of $620,000. Escobar decides on December 31, of the current year, to use the fair value option for these receivables. This is the first valuation of these recently acquired receivables. At December 31, Escobar makes an adjusting entry to record the increase in value of Notes Receivable and to record the unrealized holding gain, as follows. Notes Receivable
190,000
Unrealized Holding Gain or Loss—Income
7-73
190,000
LO 7 Explain the fair value option.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-74
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Disposition of Accounts and Notes Receivable Owner may transfer accounts or notes receivables to another company for cash. Reasons:
Competition.
Sell receivables because money is tight.
Billing and collection are time-consuming and costly.
Transfer accomplished by:
7-75
Secured borrowing.
Sale of receivables.
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Disposition of Accounts and Notes Receivable Secured Borrowing Illustration: March 1, 2014, Howat Mills, Inc. provides (assigns) $700,000 of its accounts receivable to Citizens Bank as collateral for a $500,000 note. Howat Mills continues to collect the accounts receivable; the account debtors are not notified of the arrangement. Citizens Bank assesses a finance charge of 1 percent of the accounts receivable and interest on the note of 12 percent. Howat Mills makes monthly payments to the bank for all cash it collects on the receivables.
7-76
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Secured Borrowing Illustration 7-16
7-77
LO 8
Secured Borrowing Illustration: On April 1, 2014, Prince Company assigns $500,000 of its accounts receivable to the Third National Bank as collateral for a $300,000 loan due July 1, 2014. The assignment agreement calls for Prince Company to continue to collect the receivables. Third National Bank assesses a finance charge of 2% of the accounts receivable, and interest on the loan is 10% (a realistic rate of interest for a note of this type). Instructions:
7-78
a)
Prepare the April 1, 2014, journal entry for Prince Company.
b)
Prepare the journal entry for Prince’s collection of $350,000 of the accounts receivable during the period from April 1, 2014, through June 30, 2014.
c)
On July 1, 2014, Prince paid Third National all that was due from the loan it secured on April 1, 2014. LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Secured Borrowing Instructions: a)
Prepare the April 1, 2014, journal entry for Prince Company.
b)
Prepare the journal entry for Prince’s collection of $350,000.
c)
On July 1, 2014, Prince paid Third National all that was.
a)
Cash
Finance Charge ($500,000 x 2%) Notes Payable b)
Cash
290,000
10,000 300,000 350,000
Accounts Receivable c)
Notes Payable Interest Expense (10% x $300,000 x 3/12) Cash
7-79
350,000 300,000 7,500 307,500 LO 8
Disposition of Accounts and Notes Receivable Sales of Receivables Sale Without Recourse
Purchaser assumes risk of collection.
Transfer is outright sale of receivable.
Seller records loss on sale.
Sale With Recourse
7-80
Seller guarantees payment to purchaser.
Financial components approach used to record transfer. LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Sales of Receivables Factors are finance companies or banks that buy receivables from businesses for a fee. Illustration 7-17
7-81
LO 8
Sales of Receivables Illustration: Crest Textiles, Inc. factors $500,000 of accounts receivable with Commercial Factors, Inc., on a without recourse basis. Commercial Factors assesses a finance charge of 3 percent of the amount of accounts receivable and retains an amount equal to 5 percent of the accounts receivable (for probable adjustments). Crest Textiles and Commercial Factors make the following journal entries for the receivables transferred without recourse. Illustration 7-18
7-82
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Sales of Receivables Illustration: Assume Crest Textiles sold the receivables on a with recourse basis. Crest Textiles determines that this recourse obligation has a fair value of $6,000. To determine the loss on the sale of the receivables, Crest Textiles computes the net proceeds from the sale as follows. Illustration 7-19 Net Proceeds Computation
Illustration 7-20 Loss on Sale Computation
7-83
LO 8
Sales of Receivables Illustration: Prepare the journal entries for both Crest Textiles and Commercial Factors for the receivables sold with recourse. Crest Textiles, Inc.
Commercial Factors, Inc.
7-84
Cash Due from Factor Loss on Sale of Receivables Accounts (Notes) Receivable Recourse Liability
460,000 25,000 21,000
Accounts Receivable 500,000 Due to Customer (Crest Textiles) Interest Revenue Cash
500,000 6,000
25,000 15,000 460,000 LO 8
Secured Borrowing versus Sale Illustration 7-22
The FASB concluded
that a sale occurs only if the seller surrenders control of the receivables to the
buyer. Three conditions must be met.
7-85
LO 8
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-86
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Presentation and Analysis Presentation of Receivables
7-87
1.
Segregate the different types of receivables that a company possesses, if material.
2.
Appropriately offset the valuation accounts against the proper receivable accounts.
3.
Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer.
4.
Disclose any loss contingencies that exist on the receivables.
5.
Disclose any receivables designated or pledged as collateral.
6.
Disclose the nature of credit risk inherent in the receivables. LO 9 Describe how to report and analyze receivables.
Presentation and Analysis Analysis of Receivables Accounts Receivable Turnover Ratio:
Use to evaluate the liquidity of accounts receivable.
Measures the number of times, on average, a company collects receivables during the period. Illustration 7-24
7-88
LO 9 Describe how to report and analyze receivables.
APPENDIX
7A
CASH CONTROLS
Management faces two problems in accounting for cash transactions: 1. Establish proper controls to prevent any unauthorized transactions by officers or employees.
2. Provide information necessary to properly manage cash on hand and cash transactions.
7-89
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
The Imprest Petty Cash System To pay small amounts for miscellaneous expenses.
Steps: 1. Record $300 transfer of funds to petty cash: Petty Cash Cash
300 300
2. The petty cash custodian obtains signed receipts from each individual to whom he or she pays cash.
7-90
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
The Imprest Petty Cash System Steps: 3. Custodian receives a company check to replenish the fund. Supplies Expense
42
Postage Expense
53
Miscellaneous Expense
76
Cash Over and Short Cash
7-91
2 173
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
The Imprest Petty Cash System Steps: 4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows. Cash
50
Petty cash
7-92
50
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Physical Protection of Cash Balances Company should
7-93
Minimize the cash on hand.
Only have on hand petty cash and current day’s receipts.
Keep funds in a vault, safe, or locked cash drawer.
Transmit each day’s receipts to the bank as soon as practicable.
Periodically prove (reconcile) the balance shown in the general ledger.
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Reconciliation of Bank Balances Schedule explaining any differences between the bank’s and the company’s records of cash. Reconciling Items: 1. Deposits in transit. 2. Outstanding checks. 3. Bank charges and credits.
Time Lags
4. Bank or Depositor errors.
7-94
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Reconciliation of Bank Balances
7-95
Illustration 7A-1 Bank Reconciliation Form and Content
LO 10 Explain common techniques employed to control cash.
APPENDIX
7-96
7A
CASH CONTROLS
LO 10
APPENDIX
7A
CASH CONTROLS Illustration 7A-2
7-97
Advance slide in presentation mode to reveal answer.
APPENDIX
7A
CASH CONTROLS
Illustration: Journalize the adjusting entry on the books of Nugget Mining Company. Nov. 30
Cash
542
Office Expense Accounts Receivable
7-98
18 220
Accounts Payable
180
Interest Revenue
600
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Question The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: a. outstanding checks.
b. deposit in transit. c. a bank error. d. bank service charges.
7-99
LO 10 Explain common techniques employed to control cash.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Companies evaluate their receivables to determine their ultimate collectibility.
Allowance method is appropriate when:
probable that an asset has been impaired and
amount of the loss can be reasonably estimated.
Long-term receivables such as loans that are identified as impaired, companies perform an additional impairment evaluation.
7-100
LO 11 Describe the accounting for a loan impairment.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Impairment Measurement and Reporting Impairment loss is calculated as the difference between
7-101
the investment in the loan (generally the principal plus accrued interest) and
the expected future cash flows discounted at the loan’s historical effective-interest rate.
LO 11 Describe the accounting for a loan impairment.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Illustration: At December 31, 2013, Ogden Bank recorded an investment of $100,000 in a loan to Carl King. The loan has an historical effective-interest rate of 10 percent, the principal is due in full at maturity in three years, and interest is due annually. The loan officer performs a review of the loan’s expected future cash flow and utilizes the present value method for measuring the required impairment loss. Illustration 7B-1
7-102
LO 11 Describe the accounting for a loan impairment.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Illustration: Computation of impairment loss. Illustration 7B-2
Recording Impairment Loss Bad Debt Expense
12,434
Allowance for Doubtful Accounts
7-103
12,434
LO 11 Describe the accounting for a loan impairment.
LOST IN TRANSLATION WHAT’S YOUR PRINCIPLE Floyd Norris, noted financial writer for the New York Times, recently wrote in his blog that he attended a conference to discuss the financial crisis in subprime lending. He highlighted, and provided “translations” of, some of the statements he heard at that conference: • “There is a problem of misaligned incentives.” Translation: Many parties in the lending process were complicit in not performing due diligence on loans because there were lots of fees to be had if the loans were made, good loans or bad. • “It is pretty clear that there was a failure in some key assumptions that were supporting our analytics and our models.” Translation: The rating agencies that evaluated the risk level of these securities made many miscalculations. Some structured finance products that were given superior ratings are no longer worth much. • “The plumbing of the U.S. economy has been deeply damaged. It is a long window of vulnerability.” 7-104
Translation: The U.S. has caused a financial crisis as a result of poor lending practices, and many financial institutions are fighting to survive. • “I’m glad that this time we did not cause it.” Translation: Other countries realized they had caused financial crises in the past but were not to blame for the current U.S. financial situation. • “What you see is what you get. If you don’t see it, it will get you.” Translation: A large number of financial institutions have to take losses on assets that are not reported on their balance sheet. Their continuing interest in some of the loans that they supposedly sold is now coming back to them and they will have to report losses.
Source: Floyd Norris blog, http://www.norris.blogs.nytimes.com/ (accessed June 2008).
LO 11
RELEVANT FACTS - Similarities
7-105
The accounting and reporting related to cash is essentially the same under both IFRS and GAAP. In addition, the definition used for cash equivalents is the same.
Like GAAP, cash and receivables are generally reported in the current assets section of the balance sheet under IFRS.
Similar to GAAP, IFRS requires that loans and receivables be accounted for at amortized cost, adjusted for allowances for doubtful accounts.
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Differences
7-106
Under IFRS, companies may report cash and receivables as the last items in current assets under IFRS. Under GAAP, these items are reported in order of liquidity.
While IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. GAAP has explicit guidance in the area.
The fair value option is similar under GAAP and IFRS but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard. In addition, there is some difference in the financial instruments covered.
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Differences
7-107
Under IFRS, bank overdrafts are generally reported as cash. Under GAAP, such balances are reported as liabilities.
IFRS and GAAP differ in the criteria used to account for transfers of receivables. IFRS is a combination of an approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS generally permits partial transfers; GAAP does not.
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
ON THE HORIZON Both the IASB and the FASB have indicated that they believe that financial statements would be more transparent and understandable if companies recorded and reported all financial instruments at fair value. That said, in IFRS 9, which was issued in 2009, the IASB created a split model, where some financial instruments are recorded at fair value but other financial assets, such as loans and receivables, can be accounted for at amortized cost if certain criteria are met. Critics say that this can result in two companies with identical securities accounting for those securities in different ways. A proposal by the FASB would require that nearly all financial instruments, including loans and receivables, be accounted for at fair value. It has been suggested that IFRS 9 will likely be changed or replaced as the FASB and IASB continue to deliberate the best treatment for financial instruments. In fact, one member of the IASB said that companies should ignore IFRS 9 and continue to report under the old standard, because in his opinion, it is extremely likely that it would be changed before the mandatory adoption date of this standard in 2013. 7-108
LO 12
IFRS SELF-TEST QUESTION Under IFRS, receivables are to be reported on the balance sheet at: a. amortized cost. b. amortized cost adjusted for estimated loss provisions.
c.
historical cost.
d. replacement cost.
7-109
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
IFRS SELF-TEST QUESTION Which of the following statements is false? a. Receivables include equity securities purchased by the company.
b. Receivables include credit card receivables. c.
Receivables include amounts owed by employees as result of company loans to employees.
d. Receivables include amounts resulting from transactions with customers.
7-110
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
IFRS SELF-TEST QUESTION Under IFRS: a. the entry to record estimated uncollected accounts is the same as GAAP.
b. loans and receivables should only be tested for impairment as a group. c.
it is always acceptable to use the direct write-off method.
d. all financial instruments are recorded at fair value.
7-111
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
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Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the
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7-112
E D I T I O N
Intermediate ACCOUNTING Intermediate Accounting Accounting
Prepared by Prepared by Harsono Coby Harmon
7-1
Prepared by Harmon University of California, Santa Coby Barbara University of California, Santa Barbara Westmont College
kieso weygandt warfield team for success
PREVIEW OF CHAPTER
7
Intermediate Accounting 15th Edition Kieso Weygandt Warfield 7-2
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to:
7-3
1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Cash What is Cash?
7-4
Most liquid asset.
Standard medium of exchange.
Basis for measuring and accounting for all items.
Current asset.
Examples: coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts.
LO 1 Identify items considered cash.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to:
7-5
1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Cash Reporting Cash Cash Equivalents Short-term, highly liquid investments that are both a) readily convertible to cash, and b) so near their maturity that they present insignificant risk of changes in value. Examples: Treasury bills, Commercial paper, and Money market funds.
7-6
LO 2 Indicate how to report cash and related items.
Reporting Cash Restricted Cash Companies segregate restricted cash from “regular” cash. Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances. Illustration 7-1
7-7
LO 2
Reporting Cash Bank Overdrafts Company writes a check for more than the amount in its cash account.
7-8
Generally reported as a current liability.
Offset against other cash accounts only when accounts are with the same bank.
LO 2 Indicate how to report cash and related items.
Cash-Related Items Illustration 7-2
7-9
LO 2
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-10
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Accounts Receivable Receivables - Claims held against customers and others for money, goods, or services.
7-11
Oral promises of the purchaser to pay for goods and services sold.
Written promises to pay a sum of money on a specified future date.
Accounts Receivable
Notes Receivable
LO 3 Define receivables and identify the different types of receivables.
Accounts Receivable Nontrade Receivables 1. Advances to officers and employees. 2. Advances to subsidiaries. 3. Deposits paid to cover potential damages or losses. 4. Deposits paid as a guarantee of performance or payment. 5. Dividends and interest receivable. 6. Claims against: Insurance companies for casualties sustained; defendants under suit; governmental bodies for tax refunds; common carriers for damaged or lost goods; creditors for returned, damaged, or lost goods; customers for returnable items (crates, containers, etc.). 7-12
LO 3 Define receivables and identify the different types of receivables.
Accounts Receivable Nontrade Receivables Illustration 7-3 Receivables Balance Sheet Presentations
7-13
LO 3 Define receivables and identify the different types of receivables.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-14
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Recognition of Accounts Receivables Trade Discounts
7-15
Reductions from the list price. Not recognized in the accounting records. Customers are billed net of discounts.
10 % Discount for new Retail Store Customers
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Cash Discounts (Sales Discounts)
7-16
Offered to induce prompt payment.
Gross Method vs. Net Method.
Payment terms are 2/10, n/30
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Cash Discounts (Sales Discounts)
7-17
Illustration 7-4
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the gross method. June 3
Accounts Receivable
2,000
Sales June 12
Cash ($2,000 x 98%) Sales Discounts Accounts Receivable
7-18
2,000 1,960 40 2,000
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method. June 3
Accounts Receivable
1,960
Sales June 12
Cash ($2,000 x 98%) Accounts Receivable
7-19
1,960 1,960 1,960
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method, and Arquette did not remit payment until July 29.
June 3
Accounts Receivable
1,960
Sales June 12
Account Receivable Sales Discount Forfeited
7-20
1,960 40 40
LO 4 Explain accounting issues related to recognition of accounts receivable.
Recognition of Accounts Receivables Non-Recognition of Interest Element A company should measure receivables in terms of their present value. In practice, companies ignore interest revenue related to accounts receivable because the discount is not usually material in relation to the net income for the period.
7-21
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables How are these accounts presented on the Balance Sheet?
Accounts Receivable
Allowance for Doubtful Accounts
Beg.
500
25
Beg.
End.
500
25
End.
7-22
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables ABC Corporation Balance Sheet (partial) Current Assets: Cash Accounts receivable
500
Less: Allowance for doubtful accounts
(25)
Inventory Prepaid expense Total current assets
7-23
$
330 475 812 40 1,657
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables ABC Corporation Balance Sheet (partial)
Alternate Presentation
Current Assets: Cash
330
Accounts receivable, net of $25 allowance
475
Inventory
812
Prepaid expense Total current assets
7-24
$
40 1,657
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Journal entry for credit sale of $100? Accounts Receivable
Sales
Accounts Receivable
100
100
Allowance for Doubtful Accounts
Beg.
500
25
Beg.
End.
500
25
End.
7-25
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Journal entry for credit sale of $100? Accounts Receivable
Sales
Accounts Receivable Beg.
500
Sale
100
End.
600
7-26
100
100
Allowance for Doubtful Accounts 25
Beg.
25
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Collected $333 on account? Cash
333
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End.
600
7-27
333
Allowance for Doubtful Accounts 25
Beg.
25
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Collected $333 on account? Cash
333
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End.
267
7-28
333
333
Allowance for Doubtful Accounts 25
Beg.
25
End.
Coll.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Adjustment of $15 for estimated bad debts? Bad Debt Expense
15
Allowance for Doubtful Accounts
Accounts Receivable Beg.
500
Sale
100
End.
267
7-29
333
15
Allowance for Doubtful Accounts 25
Beg.
25
End.
Coll.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Adjustment of $15 for estimated bad debts? Bad Debt Expense
15
Allowance for Doubtful Accounts
Accounts Receivable Beg.
500
Sale
100
End.
267
7-30
333
Coll.
15
Allowance for Doubtful Accounts 25
Beg.
15
Est.
40
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End.
267
7-31
333
Coll.
10
10
Allowance for Doubtful Accounts 25
Beg.
15
Est.
40
End.
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts
10
Accounts Receivable
Accounts Receivable Beg.
500
Sale
100
End. 7-32
257
333
Coll.
10
W/O
10
Allowance for Doubtful Accounts
W/O
25
Beg.
15
Est.
30
End.
10
LO 4 Explain accounting issues related to recognition of accounts receivable.
Accounts Receivables ABC Corporation Balance Sheet (partial) Current Assets: Cash
330
Accounts receivable, net of $30 allowance
227
Merchandise inventory
812
Prepaid expense Total current assets
7-33
$
40 1,409
LO 4 Explain accounting issues related to recognition of accounts receivable.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-34
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Accounts Receivable Valuation of Accounts Receivable
Reporting of receivables involves 1) classification and 2) valuation on the balance sheet.
7-35
Classification involves determining the length of time each receivable will be outstanding.
Value and report short-term receivables at net realizable value.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Uncollectible Accounts Receivable
Record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense).
Normal and necessary risk of doing business on credit.
Two methods to account for uncollectible accounts: 1) the direct write-off method and 2) the allowance method.
7-36
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Methods of Accounting for Uncollectible Accounts
Direct Write-Off Theoretically deficient:
Losses are estimated:
No matching.
Percentage-of-sales.
Receivable not stated at cash realizable value.
Percentage-of-receivables.
GAAP requires when material in amount.
7-37
Allowance Method
Not GAAP when material in amount.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration 7-6
The percentage-of-sales basis results in a better matching of expenses with revenues
7-38
The percentage-of-receivables basis produces the better estimate of net realizable value
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Percentage-of-Sales Approach
7-39
Percentage based upon past experience and anticipate credit policy.
Achieves better matching of expenses with revenues.
Any balance in Allowance for Doubtful Accounts is ignored.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration: Gonzalez Company estimates that about 1% of net credit sales become uncollectible. If net credit sales for are $800,000 for the year, it records bad debt expense as follows. Bad Debt Expense
Allowance for Doubtful Accounts
8,000
8,000 Illustration 7-7
7-40
LO 5
Valuation of Accounts Receivable Percentage-of-Receivables Approach
Not matching.
Reports estimate of receivables at realizable value.
Companies may apply this method using
7-41
one composite rate, or
an aging schedule using different rates.
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration 7-8 Accounts Receivable Aging Schedule
What entry would Wilson make assuming that the allowance account had a zero balance?
Bad Debt Expense Allowance for Doubtful Accounts 7-42
37,650 37,650
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration 7-8 Accounts Receivable Aging Schedule
What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment?
Bad Debt Expense ($37,650 – $800) Allowance for Doubtful Accounts 7-43
36,850 36,850
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration: Sandel Company reports the following financial information before adjustments.
Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable.
7-44
LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts Receivable Illustration: Sandel Company reports the following financial information before adjustments.
Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 1% of net sales. Bad Debt Expense Allowance for Doubtful Accounts
7,500 7,500
($800,000 – $50,000) x 1% = $7,500 7-45
LO 5
Valuation of Accounts Receivable Illustration: Sandel Company reports the following financial information before adjustments.
Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 5% of accounts receivable. Bad Debt Expense Allowance for Doubtful Accounts
6,000 6,000
($160,000 x 5%) – $2,000) = $6,000 7-46
LO 5
Write-Off of Uncollectible Accounts Illustration: The financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. in March 1. The entry to record the write-off is: Allowance for Doubtful Accounts
1,000
Accounts Receivable
1,000
Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries:
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Accounts Receivable Allowance for Doubtful Accounts
1,000
Cash Accounts Receivable
1,000
1,000 1,000 LO 5
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-48
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Notes Receivable Supported by a formal promissory note.
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Written promise to pay a certain sum of money at a specific future date.
A negotiable instrument.
Maker signs in favor of a Payee.
Interest-bearing (has a stated rate of interest) OR
Zero-interest-bearing (interest included in face amount).
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Notes Receivable Generally originate from:
7-50
Customers who need to extend payment period of an outstanding receivable.
High-risk or new customers.
Loans to employees and subsidiaries.
Sales of property, plant, and equipment.
Lending transactions (majority of notes).
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Recognition of Notes Receivable
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Short-Term
Long-Term
Record at Face Value, less allowance
Record at Present Value of cash expected to be collected
Interest Rates
Note Issued at
Stated rate = Market rate
Face Value
Stated rate > Market rate
Premium
Stated rate < Market rate
Discount LO 6
Note Issued at Face Value Illustration: Bigelow Corp. lends Scandinavian Imports $10,000 in exchange for a $10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note? i = 10% $10,000 Principal
0
$1,000
1,000
1
2
1,000 Interest
3
4
n=3 7-52
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Note Issued at Face Value PV of Interest
$1,000
x
Interest Received 7-53
2.48685 Factor
=
$2,487 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Note Issued at Face Value PV of Principal
$10,000 Principal 7-54
x
.75132 Factor
=
$7,513 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Note Issued at Face Value Summary
Present value of interest
$ 2,487
Present value of principal
7,513
Note current market value
$10,000
Journal Entries Jan. yr. 1
Dec. yr. 1
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Notes Receivable Cash
Cash Interest Revenue
10,000 10,000
1,000 1,000
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note? i = 9% $10,000 Principal
0
$0
$0
1
2
$0 Interest
3
4
n=3
7-56
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note PV of Principal
$10,000 Principal 7-57
x
.77218 Factor
=
$7,721.80 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration 7-12
7-58
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration 7-12
Prepare the journal entry to record the receipt of the note.
Notes Receivable
7-59
10,000.00
Discount on Notes Receivable
2,278.20
Cash
7,721.80 LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Zero-Interest-Bearing Note Illustration 7-12
Prepare the journal entry to record interest revenue at the end of the first year.
Discount on Notes Receivable Interest Revenue
7-60
694.96 694.96
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. Prepare the journal entry to record the receipt of the note? i = 12% $10,000 Principal
0
$1,000
1,000
1
2
1,000 Interest
3
4
n=3
7-61
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note PV of Interest
$1,000
x
Interest Received 7-62
2.40183 Factor
=
$2,402 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note PV of Principal
$10,000 Principal 7-63
x
.71178 Factor
=
$7,118 Present Value
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration: Record the receipt of the note? Illustration 7-14
Notes Receivable Discount on Notes Receivable Cash
7-64
10,000
480 9,520
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration 7-15
7-65
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Interest-Bearing Note Illustration 7-15
Prepare the journal entry to record interest revenue at the end of the first year.
Cash
1,000
Discount on Notes Receivable Interest Revenue 7-66
142 1,142
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Recognition of Notes Receivable Notes Received for Property, Goods, or Services In a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless: 1. No interest rate is stated, or
2. Stated interest rate is unreasonable, or 3. Face amount of the note is materially different from the current cash sales price.
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LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Recognition of Notes Receivable Illustration: Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five-year note having a maturity value of $35,247 and no stated interest rate. The land originally cost Oasis $14,000. At the date of sale the land had a fair market value of $20,000. Oasis uses the fair market value of the land, $20,000, as the present value of the note. Oasis therefore records the sale as: ($35,247 - $20,000) = $15,247
Notes Receivable Discount on Notes Receivable Land Gain on Disposal of Land
7-68
35,247 15,247 14,000 6,000
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Notes Receivable Valuation of Notes Receivable
Short-Term reported at net realizable value (same as accounting for accounts receivable).
Long-Term - FASB requires companies disclose not
only their cost but also their fair value in the notes to the financial statements.
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LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-70
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Special Issues Fair Value Option
Companies have the option to use fair value as the basis of measurement in the financial statements.
If companies choose the fair value option
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►
Receivables are recorded at fair value.
►
Unrealized holding gains or losses reported as part of net income.
Company reports the receivable at fair value each reporting date.
LO 7 Explain the fair value option.
Special Issues Fair Value Option
7-72
Companies may elect at time the financial instrument is ►
originally recognized or
►
when some event triggers a new basis of accounting.
Must continue to use fair value measurement for the specific instrument until the company no longer owns this instrument.
If not elected at date of recognition, company may never use fair value option on that specific instrument.
LO 7 Explain the fair value option.
Valuation of Notes Receivable Illustration: Escobar Company has notes receivable that have a fair value of $810,000 and a carrying amount of $620,000. Escobar decides on December 31, of the current year, to use the fair value option for these receivables. This is the first valuation of these recently acquired receivables. At December 31, Escobar makes an adjusting entry to record the increase in value of Notes Receivable and to record the unrealized holding gain, as follows. Notes Receivable
190,000
Unrealized Holding Gain or Loss—Income
7-73
190,000
LO 7 Explain the fair value option.
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-74
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Disposition of Accounts and Notes Receivable Owner may transfer accounts or notes receivables to another company for cash. Reasons:
Competition.
Sell receivables because money is tight.
Billing and collection are time-consuming and costly.
Transfer accomplished by:
7-75
Secured borrowing.
Sale of receivables.
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Disposition of Accounts and Notes Receivable Secured Borrowing Illustration: March 1, 2014, Howat Mills, Inc. provides (assigns) $700,000 of its accounts receivable to Citizens Bank as collateral for a $500,000 note. Howat Mills continues to collect the accounts receivable; the account debtors are not notified of the arrangement. Citizens Bank assesses a finance charge of 1 percent of the accounts receivable and interest on the note of 12 percent. Howat Mills makes monthly payments to the bank for all cash it collects on the receivables.
7-76
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Secured Borrowing Illustration 7-16
7-77
LO 8
Secured Borrowing Illustration: On April 1, 2014, Prince Company assigns $500,000 of its accounts receivable to the Third National Bank as collateral for a $300,000 loan due July 1, 2014. The assignment agreement calls for Prince Company to continue to collect the receivables. Third National Bank assesses a finance charge of 2% of the accounts receivable, and interest on the loan is 10% (a realistic rate of interest for a note of this type). Instructions:
7-78
a)
Prepare the April 1, 2014, journal entry for Prince Company.
b)
Prepare the journal entry for Prince’s collection of $350,000 of the accounts receivable during the period from April 1, 2014, through June 30, 2014.
c)
On July 1, 2014, Prince paid Third National all that was due from the loan it secured on April 1, 2014. LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Secured Borrowing Instructions: a)
Prepare the April 1, 2014, journal entry for Prince Company.
b)
Prepare the journal entry for Prince’s collection of $350,000.
c)
On July 1, 2014, Prince paid Third National all that was.
a)
Cash
Finance Charge ($500,000 x 2%) Notes Payable b)
Cash
290,000
10,000 300,000 350,000
Accounts Receivable c)
Notes Payable Interest Expense (10% x $300,000 x 3/12) Cash
7-79
350,000 300,000 7,500 307,500 LO 8
Disposition of Accounts and Notes Receivable Sales of Receivables Sale Without Recourse
Purchaser assumes risk of collection.
Transfer is outright sale of receivable.
Seller records loss on sale.
Sale With Recourse
7-80
Seller guarantees payment to purchaser.
Financial components approach used to record transfer. LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Sales of Receivables Factors are finance companies or banks that buy receivables from businesses for a fee. Illustration 7-17
7-81
LO 8
Sales of Receivables Illustration: Crest Textiles, Inc. factors $500,000 of accounts receivable with Commercial Factors, Inc., on a without recourse basis. Commercial Factors assesses a finance charge of 3 percent of the amount of accounts receivable and retains an amount equal to 5 percent of the accounts receivable (for probable adjustments). Crest Textiles and Commercial Factors make the following journal entries for the receivables transferred without recourse. Illustration 7-18
7-82
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Sales of Receivables Illustration: Assume Crest Textiles sold the receivables on a with recourse basis. Crest Textiles determines that this recourse obligation has a fair value of $6,000. To determine the loss on the sale of the receivables, Crest Textiles computes the net proceeds from the sale as follows. Illustration 7-19 Net Proceeds Computation
Illustration 7-20 Loss on Sale Computation
7-83
LO 8
Sales of Receivables Illustration: Prepare the journal entries for both Crest Textiles and Commercial Factors for the receivables sold with recourse. Crest Textiles, Inc.
Commercial Factors, Inc.
7-84
Cash Due from Factor Loss on Sale of Receivables Accounts (Notes) Receivable Recourse Liability
460,000 25,000 21,000
Accounts Receivable 500,000 Due to Customer (Crest Textiles) Interest Revenue Cash
500,000 6,000
25,000 15,000 460,000 LO 8
Secured Borrowing versus Sale Illustration 7-22
The FASB concluded
that a sale occurs only if the seller surrenders control of the receivables to the
buyer. Three conditions must be met.
7-85
LO 8
7
Cash and Receivables
LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.
Identify items considered cash.
2.
Indicate how to report cash and related items.
3.
Define receivables and identify the different types of receivables.
4.
Explain accounting issues related to recognition of accounts receivable.
5.
Explain accounting issues related to valuation of accounts receivable.
7-86
6.
Explain accounting issues related to recognition and valuation of notes receivable.
7.
Explain the fair value option.
8.
Explain accounting issues related to disposition of accounts and notes receivable.
9.
Describe how to report and analyze receivables.
Presentation and Analysis Presentation of Receivables
7-87
1.
Segregate the different types of receivables that a company possesses, if material.
2.
Appropriately offset the valuation accounts against the proper receivable accounts.
3.
Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer.
4.
Disclose any loss contingencies that exist on the receivables.
5.
Disclose any receivables designated or pledged as collateral.
6.
Disclose the nature of credit risk inherent in the receivables. LO 9 Describe how to report and analyze receivables.
Presentation and Analysis Analysis of Receivables Accounts Receivable Turnover Ratio:
Use to evaluate the liquidity of accounts receivable.
Measures the number of times, on average, a company collects receivables during the period. Illustration 7-24
7-88
LO 9 Describe how to report and analyze receivables.
APPENDIX
7A
CASH CONTROLS
Management faces two problems in accounting for cash transactions: 1. Establish proper controls to prevent any unauthorized transactions by officers or employees.
2. Provide information necessary to properly manage cash on hand and cash transactions.
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LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
The Imprest Petty Cash System To pay small amounts for miscellaneous expenses.
Steps: 1. Record $300 transfer of funds to petty cash: Petty Cash Cash
300 300
2. The petty cash custodian obtains signed receipts from each individual to whom he or she pays cash.
7-90
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
The Imprest Petty Cash System Steps: 3. Custodian receives a company check to replenish the fund. Supplies Expense
42
Postage Expense
53
Miscellaneous Expense
76
Cash Over and Short Cash
7-91
2 173
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
The Imprest Petty Cash System Steps: 4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows. Cash
50
Petty cash
7-92
50
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Physical Protection of Cash Balances Company should
7-93
Minimize the cash on hand.
Only have on hand petty cash and current day’s receipts.
Keep funds in a vault, safe, or locked cash drawer.
Transmit each day’s receipts to the bank as soon as practicable.
Periodically prove (reconcile) the balance shown in the general ledger.
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Reconciliation of Bank Balances Schedule explaining any differences between the bank’s and the company’s records of cash. Reconciling Items: 1. Deposits in transit. 2. Outstanding checks. 3. Bank charges and credits.
Time Lags
4. Bank or Depositor errors.
7-94
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Reconciliation of Bank Balances
7-95
Illustration 7A-1 Bank Reconciliation Form and Content
LO 10 Explain common techniques employed to control cash.
APPENDIX
7-96
7A
CASH CONTROLS
LO 10
APPENDIX
7A
CASH CONTROLS Illustration 7A-2
7-97
Advance slide in presentation mode to reveal answer.
APPENDIX
7A
CASH CONTROLS
Illustration: Journalize the adjusting entry on the books of Nugget Mining Company. Nov. 30
Cash
542
Office Expense Accounts Receivable
7-98
18 220
Accounts Payable
180
Interest Revenue
600
LO 10 Explain common techniques employed to control cash.
APPENDIX
7A
CASH CONTROLS
Question The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: a. outstanding checks.
b. deposit in transit. c. a bank error. d. bank service charges.
7-99
LO 10 Explain common techniques employed to control cash.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Companies evaluate their receivables to determine their ultimate collectibility.
Allowance method is appropriate when:
probable that an asset has been impaired and
amount of the loss can be reasonably estimated.
Long-term receivables such as loans that are identified as impaired, companies perform an additional impairment evaluation.
7-100
LO 11 Describe the accounting for a loan impairment.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Impairment Measurement and Reporting Impairment loss is calculated as the difference between
7-101
the investment in the loan (generally the principal plus accrued interest) and
the expected future cash flows discounted at the loan’s historical effective-interest rate.
LO 11 Describe the accounting for a loan impairment.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Illustration: At December 31, 2013, Ogden Bank recorded an investment of $100,000 in a loan to Carl King. The loan has an historical effective-interest rate of 10 percent, the principal is due in full at maturity in three years, and interest is due annually. The loan officer performs a review of the loan’s expected future cash flow and utilizes the present value method for measuring the required impairment loss. Illustration 7B-1
7-102
LO 11 Describe the accounting for a loan impairment.
APPENDIX
7B
IMPAIRMENT OF RECEIVABLES
Illustration: Computation of impairment loss. Illustration 7B-2
Recording Impairment Loss Bad Debt Expense
12,434
Allowance for Doubtful Accounts
7-103
12,434
LO 11 Describe the accounting for a loan impairment.
LOST IN TRANSLATION WHAT’S YOUR PRINCIPLE Floyd Norris, noted financial writer for the New York Times, recently wrote in his blog that he attended a conference to discuss the financial crisis in subprime lending. He highlighted, and provided “translations” of, some of the statements he heard at that conference: • “There is a problem of misaligned incentives.” Translation: Many parties in the lending process were complicit in not performing due diligence on loans because there were lots of fees to be had if the loans were made, good loans or bad. • “It is pretty clear that there was a failure in some key assumptions that were supporting our analytics and our models.” Translation: The rating agencies that evaluated the risk level of these securities made many miscalculations. Some structured finance products that were given superior ratings are no longer worth much. • “The plumbing of the U.S. economy has been deeply damaged. It is a long window of vulnerability.” 7-104
Translation: The U.S. has caused a financial crisis as a result of poor lending practices, and many financial institutions are fighting to survive. • “I’m glad that this time we did not cause it.” Translation: Other countries realized they had caused financial crises in the past but were not to blame for the current U.S. financial situation. • “What you see is what you get. If you don’t see it, it will get you.” Translation: A large number of financial institutions have to take losses on assets that are not reported on their balance sheet. Their continuing interest in some of the loans that they supposedly sold is now coming back to them and they will have to report losses.
Source: Floyd Norris blog, http://www.norris.blogs.nytimes.com/ (accessed June 2008).
LO 11
RELEVANT FACTS - Similarities
7-105
The accounting and reporting related to cash is essentially the same under both IFRS and GAAP. In addition, the definition used for cash equivalents is the same.
Like GAAP, cash and receivables are generally reported in the current assets section of the balance sheet under IFRS.
Similar to GAAP, IFRS requires that loans and receivables be accounted for at amortized cost, adjusted for allowances for doubtful accounts.
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Differences
7-106
Under IFRS, companies may report cash and receivables as the last items in current assets under IFRS. Under GAAP, these items are reported in order of liquidity.
While IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. GAAP has explicit guidance in the area.
The fair value option is similar under GAAP and IFRS but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard. In addition, there is some difference in the financial instruments covered.
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Differences
7-107
Under IFRS, bank overdrafts are generally reported as cash. Under GAAP, such balances are reported as liabilities.
IFRS and GAAP differ in the criteria used to account for transfers of receivables. IFRS is a combination of an approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS generally permits partial transfers; GAAP does not.
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
ON THE HORIZON Both the IASB and the FASB have indicated that they believe that financial statements would be more transparent and understandable if companies recorded and reported all financial instruments at fair value. That said, in IFRS 9, which was issued in 2009, the IASB created a split model, where some financial instruments are recorded at fair value but other financial assets, such as loans and receivables, can be accounted for at amortized cost if certain criteria are met. Critics say that this can result in two companies with identical securities accounting for those securities in different ways. A proposal by the FASB would require that nearly all financial instruments, including loans and receivables, be accounted for at fair value. It has been suggested that IFRS 9 will likely be changed or replaced as the FASB and IASB continue to deliberate the best treatment for financial instruments. In fact, one member of the IASB said that companies should ignore IFRS 9 and continue to report under the old standard, because in his opinion, it is extremely likely that it would be changed before the mandatory adoption date of this standard in 2013. 7-108
LO 12
IFRS SELF-TEST QUESTION Under IFRS, receivables are to be reported on the balance sheet at: a. amortized cost. b. amortized cost adjusted for estimated loss provisions.
c.
historical cost.
d. replacement cost.
7-109
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
IFRS SELF-TEST QUESTION Which of the following statements is false? a. Receivables include equity securities purchased by the company.
b. Receivables include credit card receivables. c.
Receivables include amounts owed by employees as result of company loans to employees.
d. Receivables include amounts resulting from transactions with customers.
7-110
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
IFRS SELF-TEST QUESTION Under IFRS: a. the entry to record estimated uncollected accounts is the same as GAAP.
b. loans and receivables should only be tested for impairment as a group. c.
it is always acceptable to use the direct write-off method.
d. all financial instruments are recorded at fair value.
7-111
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
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