Acct 327 quiz 2 chapter 6 and 8

ABC Co. made a loan to XYZ and received in exchange a 5-year, $100,000 note bearing interest of 8%. The market rate of interest for a note of similar risk is 10%. How does ABC record the receipt of the note?

PV at issuance = 92,418.43 (N= 5, I/YR=10, PMT=8,000, FV=100,000, PV=?) January 1: N/R (+A) 92,418 / Cash (-A) 92,418 Dec 31: Cash (+A) 8,000 / N/R (+A) 1,242 (1) Interest Revenue (+R, +SE) 9,242 Beg. Net value X market rate = 92,418 x 10% = 9,242

For long-term notes, - Record

Record at the [PV of expected future cash flows - allowance ] = [ face value -/+ unamortized discount/premium - allowance

When a receivable does become uncollectible, do the following when REcourse is involved

Recourse liability (-L) xxx / Cash (-A) xxx

Net Sales

Sales Revenue (Gross) - Sales Returns

Gross method

Sales are recorded at the gross amount (e.g., n) • "Sales discounts" are recorded as reduction of revenue if payment is received within the discount period

Net method

Sales are recorded at the net amount (e.g., n-2%) • "Sales discounts forfeited" are recorded as interest revenue if payment is received after the discount period

Sales of Receivables (Factoring)

Sales of receivables to the factor (i.e., finance companies or banks that buy receivables from businesses for a fee)

Bad Debt expense shown /recorded as

Selling Expense

Suppose your company deposits $10,000 at two different banks: one that pays 6% simple interest and one that pays 6% interest compounded annually. After 3 years, what is the difference in the balance in your two accounts

Simple = 10,000+(10,000x0.06x3) =11,800 Compound = 10,000x1.06x1.06x1.06=10,000x(1.06)3 = 11,910.16 Difference: $110.16

Using Receivables as Collateral (Assignment)

The firm (i.e., the owner of the receivables) borrows cash by writing a note designating the receivables as collateral • The firm should recognize all discounts, returns and allowances for doubtful accounts • The firm typically makes collections on the assigned A/Rs and remits the A/R collections plus a finance charge to the bank

Time Value of Mone

The right to receive an amount of money now is worth more than the right to receive the same amount in the future

Cash equivalents examples

Treasury bills (≤ 3 months) • Money market funds, CD (Certificates of deposit) (≤ 3 months) • Commercial paper (issued by large companies) (≤ 3 months)

U.S. Treasury bills; 2-month maturity totaling $15,000, and 7-month bills totaling $20,000

U.S. T-Bills 2-month maturity $15,000 Cash Equivalents . U.S. T-Bills 7-month: Current asset $20,000 Cash equivalents Restricted cash Compensating balance Short-term investment

Write-off:

When it's clear that a specific receivable will not be collected, the amount should be removed from: Accounts Receivable and Allowance for Doubtful Accounts

At the end of 2020, ABC's accounts receivable totaled $20,000 and allowance for doubtful accounts totaled $2,000. During 2021, $1,000 were written off as uncollectible. Also, $500 was received from a customer whose account previously had been written off. In 2021, there is an increase in accounts receivable by $2,000 resulting from credit sales during the year. ABC estimates bad debts by applying a percentage of 10% to accounts receivable at the end of the year. What is the bad debt expense? What is the balance of Allowance for Uncollectible Accounts?

Write-off : Allowance for DA (-xA) 1,000 / A/R (-A) 1,000 Recovery: A/R (+A) 500 / Allowance for DA (+xA) 500 Cash (+A) 500 / A/R (-A) 500 Year-end: Bad debt expense (+E, -SE) 600 / Allowance for DA (+xA) 600

Usually Discount Rate = Market Rate, but

if there is no market it becomes a very complicated estimate (more in "Bonds" classes)

• 3.Agreed to pay a severance package to a discharged employee. The company will pay $75,000 at the end of the first year, $112,500 at the end of the second year, and $150,000 at the end of the third year. What is the PV of this obligation? (I/YR= 7)

n=1; i/yr=7; pmt= 0; fv=-75,000; pv=? 70,093 ← 75,000/(1.07) n=2; i/yr=7; pmt= 0; fv=-112,500; pv=? 98,262 ← 112,500/(1.07)2 n=3; i/yr=7; pmt= 0; fv=-150,000; pv=? 122,445 ← 150,000/(1.07)3 Sum of PVs= 290,800

4. Purchased a $170,000 machine on January 1, 2011 and paid cash, $40,000. A five-year note payable is signed for the balance. The note will be paid in five equal year-end payments starting on December 31, 2011. What is the amount of each of these equal annual payments? What is the total interest expense that will be incurred over 5 years? (I/YR= 7%

n=5; i/yr=7; pmt= ? ; fv=0; pv=-130,000? 31,706 Total Interest Expense = (31,705 x 5) - 130,000 = 28,530

How do write-offs affect assets shown on Balance Sheet?

no effect

Non-trade receivables arise from

other sources - e.g., tax refunds (tax receivable), dividends receivable, interest receivable

The stated rate =

periodic interest payments (cash flows) - When a stated rate of "zero" → Noninterest-bearing notes

Cash equivalents definition

short-term, highly liquid investments that can be readily converted to cash

The market (effective) rate

the discount rate to value note at the date of issuance

Calculator how to use

• "Shift" means the orange button • Set-up - Set number of payments per period=1 (1, Shift, PMT) • We'll always have this setting - Display 4 decimal places (Shift, =, 4) - Check whether annuity is in advance (beginning of year; annual due) or in arrears (end of year or ordinary annuity) (Shift, MAR 2nd row) (if there's nothing displayed it means at the end of year - which is what you want) - Inflows should be signed "+" and outflows "-" - Initialize or clear all 5 values at top (Shift, C)

Note Receivable Generally, arise from:

• Customers who need to extend the payment period • High-risk or new customers Other parties • Lending transactions (the majority of notes) • Sales of property, plant, and equipment

Accounts Receivable (Trade Receivable)

• Result from the credit sales of goods or services to customers • Are normally classified as current assets • Are reported net of trade discounts (in B/S and I/S

Disposing Receivables A company may transfer A/R or N/R to another company for cash •

• Transfer is accomplished by (1) using receivables as collateral for borrowing (assignment) or (2) sale of receivables (factoring) • Reasons: - Company needs capital, but access to additional credit is unavailable or too expensive - Other existing debt covenants may prohibit additional borrowing - Billing and collection are costly and time-consuming

Compensating Balance (one type of restricted cash)→ CA or NCA

→ CA or NCA Minimum balance that must be maintained in a company's bank account as support for funds borrowed from the bank

How do we record Bad Debt Expense?

"Allowance Method" - record estimated bad debt expense in the period when related credit sales are made.

How much do we need to invest today at 10% interest, compounded annually, if we need $1,331 in three years?

$1,000 (n=3; i=10; pv=?; pmt=0; fv=1,331

On January 1, 2012, Starbucks bought some new delivery trucks. The company signed a note agreeing to pay $200,000 on December 31, 2013. The market interest rate for this note is 12%. Part I: What is the (historical) cost of the trucks?

$159,439 (n=2; i/yr=12; pmt=0; fv=-200,000; pv=?)

What is the present value of receiving $1,000 at the end of each year for three years at an interest rate of 10%, compounded annually?

$2,486.85 (n=3; i=10; pmt=1,000; fv=0; pv=?)

Currency and coins on hand of $580 Cash or cash equivalent

$580 cash

John saves $100 per month for 5 years (at the end of each month). His savings account earns 6% per year, compounded monthly. How much does he have after 5 years?

$6,977.00 (n=5*12; i=6/12; pmt=-100; pv=0; fv=?)

Percentage-of-Sales Method (I/S method): not recommended

(1) Compute Bad Debt Expense = Credit sales x est. bad debt % - (2) Allowance for Doubtful Accounts (End Bal) = pre-existing Bal + Bad Debt Expense

Sales of receivables 2 types

(1) Sales without recourse - The factor assumes the risk of bad debt - Seller: Treated as an ordinary sale • (2) Sales with recourse - The seller bears the risk of bad debts (If the customer fails to pay, the factor can collect amounts from the seller) - Seller: "Recourse liability" should be estimated

Sales discounts are often offered to

(i) encourage prompt payment of accounts receivable, and/or (ii) increase sales

Percentage-of-Receivables Method (B/S method)

- (1) Compute desired year-end balance of the Allowance for Doubtful Accounts (= year-end balance of A/R x un-collectability (%) - (2) Bad Debt Expense = difference b/t the desired balance of Allowance for Doubtful Accounts and the pre-existing balance

Two ways to calculate Present Value (PV) of a single future sum

- 1) Formula: i = interest rate per period, n = number of periods until the single future payment - 2) Using Excel or a Financial Calculator (we'll use the calculator

Two ways to calculate Present Value (PV) of an annuity:

- 1) Treat it as multiple present value problems, discounting each cash flow back to the current year; 2) Excel or calculato

Annuities

- A stream of equal future payments over time - Carry the same interest rate in each of those periods - Have interest periods of equal length (e.g., monthly, annually) e.g, monthly payments on a car, mortgage

Interest rates are generally stated on an annual basis

- Convert to the rate per compounding period (e.g., quarterly compounding → annual rate/4

Cash Internal controls include:

- Separation of duties: cash receiving, cash disbursing, and accounting for cash should each be separated - Mandatory vacation and job rotation policies - Cash should be disbursed by means of prenumbered checks that are properly approved and verified - Proper controls for credit/debit cards, petty cash must be properly accounted for

• Recovery: If a customer makes a payment after an account has been written off, two journal entries are required.

1. Cancellation of the write-off entry Accounts Receivable (+A) $10,000 Allowance for Doubtful Accounts (+xA) $10,000 2. Cash collection Cash (+A) $10,000 Account Receivable (-A) $10,000

Estimating Bad Debt Methods

1. Percentage-of-Receivables Method (B/S method) 2. Percentage-of-Sales Method (I/S method): not recommended

What is the present value of receiving $1,000 at the beginning of each year for three years at an interest rate of 10%, compounded annually?

1. Shift → MAR (make sure "BEG" showing) 2. Follow the same procedure! $2,735.54 (n=3; i=10; pmt=1,000; fv=0; pv=?)

Accounting for Sales Discounts (cont'd) On Oct 5, Hawthorne sold merchandise for $20,000 with terms 2/10, n/30. On Oct 14, the customer sent a check for $13,720 taking advantage of the discount to settle $14,000 of the amount. On Nov 4, the customer paid the remaining $6,000. Net method

10/5 A/R (+A) 19,600 Sales Rev (+R, +SE) 19,600 10/14 Cash (+A) 13,720 / A/R (-A) 13,720 11/4 Cash (+A) 6,000 / A/R (-A) 5,880 Sales Discount Forfeited(+R, +SE) 120

Accounting for Sales Discounts (cont'd) On Oct 5, Hawthorne sold merchandise for $20,000 with terms 2/10, n/30. On Oct 14, the customer sent a check for $13,720 taking advantage of the discount to settle $14,000 of the amount. On Nov 4, the customer paid the remaining $6,000. Gross Method

10/5: A/R (+A) 20,000 Sales Rev (+R, +SE) 20,000 10/14: Cash (+A) 13,720 Sales discount (+xR, -SE) 280 A/R (-A) 14,000 11/4: Cash (+A) 6,000 A/R (-A) 6,000 Cash (+A) 6,000 /

sales discount terms example 2/10, n/40

2 number of days discount offered 10 discount percentage N=net sales (total sale less returns is due) 40 maximum credit period

Undeposited customer checks (cashier's check) of $5,200. cash or cash equivalent?

5200 cash

Sales allowances

A reduction of sales revenue (due to price reductions) made to encourage customers to keep unsatisfactory goods

Sales Returns

A reduction of sales revenue due to a return of unsatisfactory goods

On December 1, Largo Inc factors without recourse $200,000 of A/Rs with a finance company. The factor charges a 12% finance fee and retains an amount equal to 10% of the accounts receivable for sales returns, discounts, and allowance. The factor estimates bad debt expense of $1,500 related to the $200,000 A/Rs purchased. Record the factor's entry on December 1.

A/R (+A) 200,000 Cash (-A) 156,000 Payable to Largo (+L) 20,000 Financing Revenue (+R, +SE) 24,000 Bad debt expense (+E, -SE) 1,500 / Allowance for DA (+xA) 1,500

During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). The estimated total returns to be 10% of credit sales. During the year, $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment. ACTUAL RETURNS DURING YEAR ENTRY

Actual returns during the year Sales Returns (+xR, -SE) 130,000 / A/R (-A) 130,000 Inventory (+A) 78,000 COGS (60%) (-E, +SE) 78,000

How can we compare dollar amounts in different time periods?

Adjust them using discount rates

During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). The estimated total returns to be 10% of credit sales. During the year, $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment END OF YEAR ENTRY

Adjusting entries at year-end Sales Returns (+xR, -SE) 70,000 Refund Liability (+L or +xA) 70,000 Inventory - Estimated Returns (+aA) 42,000 / COGS (60%) (-E, +SE) 42,000

FUTURE WORTH EXAMPLE 1) You deposit $100 in a savings account earning 5% interest annually. - 2) After one year,

After one year, you have $105 ($100 x 1.05). - 3) After two years, you have $110.25 ($105 x 1.05). - 4) Or the two year calculation = $100 x (1.05)2 - 5) After N years you would have $100 x (1.05)

During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). The estimated total returns to be 10% of credit sales. During the year, $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment.ENTRY AT TIME OF SALE

At time of sale A/R (+A) 2,000,000 / Sales Revenue (+R, +SE) 2,000,000 COGS (+E, -SE) 1,200,000 Inventory (-A) 1,200,000

Balances in the accounts at the First National Bank: checking $13,500, savings $22,100 cash or cash equivalent?

Balance in checking account $13,500 CASH Balance in saving account $22,100 cash

Prepaid expenses or accounts receivable

CA (or NCA) - Travel advances to employees - Post-dated checks, Non-sufficient funds (NSF) checks

Restricted Cash

CA or NCA Management's intent to use a certain amount of cash for a specific purpose - e.g., future plant expansion, future payment of debt, bond sinking fund

Bank overdrafts

CL Money is withdrawn from a bank account and the available balance goes below zero

On December 1, Largo Inc factors without recourse $200,000 of A/Rs with a finance company. The factor charges a 12% finance fee and retains an amount equal to 10% of the accounts receivable for sales returns, discounts, and allowance. The factor estimates bad debt expense of $1,500 related to the $200,000 A/Rs purchased. • Record Largo's entry on December 1.

Cash (+A) 156,000 Receivable from Factor (+A) 20,000 Loss on Sale of A/R (+E, -SE) 24,000 A/R (-A) 200,000 ( calc:200,000 (A/R) - 24,000 (finance fee) - 20,000 (retainment) =156,000)

On December 1, Largo Inc. factors with recourse $200,000 of A/Rs with a finance company. The factor charges a 6% finance fee and retains an amount equal to $10,000 of the accounts receivable for sales returns, discounts, and allowance. Largo estimated its recourse liability for bad debts to be $3,000 (bad debts have not yet been recorded) Record Largo's entry on December 1.

Cash (+A) 178,000 Receivable from Factor (+A) 10,000 Loss on sale of A/R (+E, -SE) 15,000 A/R (-A) 200,000 Recourse Liability (+L) 3,000 ( calculation:200,000 (A/R) - 12,000 (finance fee) - 10,000 (retainment) =178,000) Plugged-in; conceptually it's the sum of finance fee and bad debt expense (15,000)

By the end of December, A&M has collected $46,000 cash on $50,000 of assigned accounts less $3,000 sales returns and $1,000 sales discounts, and remits the $46,000 to the finance company. Assume A&M used the gross method. • What is the journal entry on Dec 31 to record collection on account?

Cash (+A) 46,000 Sales Return (xR, -SE) 3,000 Sales Discount (xR, -SE) 1,000 A/R (-A) 50,000

On Nov 30, A&M Company secures a loan with a finance company using its A/R of $80,000 as collateral for the loan. A&M agrees to remit customer collections as payment on the loan. Loan proceeds are 85% of the A/Rs less a $1,500 flat-fee finance charge. In addition, the finance company charges 12% interest on the unpaid loan balance, payable at the end of each month. • What is the journal entry on Nov 30 to record the loan proceeds?

Cash (+A) 66,500 Finance expense (+E, -SE) 1,500 N/P (+L) 68,000 (80,000 x 85%)

Cash definition

Cash: must be readily available for payment of current obligations

Sales Returns is a

Contra Revenue account (xR

Allowance for doubtful accounts shown as

Contra asset to AR

Cash examples

Currency and coins • Balances in checking & savings accounts • Secured form of payment (e.g., cashier's checks, certified check, money orders)

On January 1, 2012, Starbucks bought some new delivery trucks. The company signed a note agreeing to pay $200,000 on December 31, 2013. The market interest rate for this note is 12%. Part II: Journal entries • At the time of purchase?

Delivery Trucks (+A) $159,439 / Notes Payable (+L) $159,439

Bad Debt Expense:

Expenses associated with A/R that will not be collected because a customer is either - unable or unwilling to pay

Future worth

Future worth of a single sum compounded at a given interest rate.

Accounting for Sales Discounts • Receivables may be recorded using the

Gross or Net method

(With Recourse) If more receivables are collected than expected, the liability

If more receivables are collected than expected, the liability is reversed, and income is increased Recourse liability (-L) xxx / Gain on sales of A/R (+R, +SE) xxx

Are Bad Debt Expenses avoidable?

In theory - but would require selling either (i) only for cash, or (ii) to such low-risk customers that a lot of sales would be missed. - Practically speaking - they're not completely avoidable

Effects on Income Statement and Balance Sheet net Method

Income Statement Revenue $19,600 Interest Revenue Sales Discount Forfeited 120

Effects on Income Statement and Balance Sheet gross

Income Statement Sales Revenue $20,000 (Sales Discount) (280) Net Sales Revenue 19,720

On January 1, 2012, Starbucks bought some new delivery trucks. The company signed a note agreeing to pay $200,000 on December 31, 2013. The market interest rate for this note is 12% In 2012 at year-end?

Interest Expense (+E, -SE) $19,133 / Notes Payable (+L) $19,133 *19,133 comes from Present Value ($159,439)*Interest Rate (12%) = 19,133.

On January 1, 2012, Starbucks bought some new delivery trucks. The company signed a note agreeing to pay $200,000 on December 31, 2013. The market interest rate for this note is 12% In 2013 at year-end?

Interest Expense (+E, -SE) $21,428 / Notes Payable (+L) $21,428 *21,428 comes from Present Value ($159,439 +19,133) * Interest Rate (12%) = 21,428. Notes Payable (-L) $200,000/ Cash (-A) $200,000

By the end of December, A&M has collected $46,000 cash on $50,000 of assigned accounts less $3,000 sales returns and $1,000 sales discounts, and remits the $46,000 to the finance company. Assume A&M used the gross method What is the journal entry on Dec 31 to record repayment to finance company?

Interest expense (+E, -SE) 680 (68,000 x 12% x 1/12 = 680) N/P (-L) 45,320 (Plugged-in) Cash (-A) 46,000

Compound interest

Interest is computed on the principal and on any interest earned - Used for almost all long-term transactions - Compounding period: Interest may be compounded annually, semiannually, quarterly, monthly, weekly, or daily

Simple interest

Interest is computed on the principal only - Used for short-term transactions

Internal Controls for Cash

Main concerns are to prevent theft or loss

Calculator Buttons

N= # of compounding periods - I (or I/YR) = interest (discount) rate per period (10% entered as 10) - PMT = payment (or annuity amount) - PV = present value (or current inflow/outflow) - FV= future value (or future inflow/outflow)

Borrowed $115,000 for seven years at 7% annual market interest rate. Will pay $8,050 interest at the end of each year and repay $115,000 at the end of the 7th year. What is the PV of the debt?

N=7; I/YR=7; PMT= -8,050; FV= -115,000; PV =? $115,000

Established a plant addition fund of $490,000 to be available at the end of Year 8. A single sum that will grow to $490,000 will be deposited on January 1 of this year (Year1). What single sum amount must the company deposit on January 1st this year? What is the total amount of interest revenue that will be earned over the entire period? Use the same interest rate of Q1.

N=8; I/YR =7; PMT= 0; FV= 490,000; PV =? $285,184 Total Interest Revenue = 490,000 - 285,184 = 204,814

How do write-offs affect Net Income?

No Effect

$20,000 in a checking account at the East Bay Bank. The balance in the account represents a 20% compensating balance for a $100,000 loan with the bank. Red Wing may not withdraw the funds until the loan is due in 2018

Noncurrent asset $20,000 Compensating balance

Saving account at the East Bay Bank with a balance of $400,000. This account is being used to accumulate cash for future plant expansion (in 2018)

Noncurrent asset $400,000 Restricted Cash

For short-term notes

Notes with maturities of one year or less - Record at [face value - allowance for uncollectibles]

ABC Co. lends XYZ $100,000 on January 1 in exchange for a $100,000, 5- year note bearing interest at 8% annually. The market rate of interest for a note of similar risk is also 8%. How does ABC record the receipt of the note? Also, record receipt of interest on Dec. 31

PV at issuance = 100,000 (N= 5, I/YR=8, PMT= 8,000, FV=100,000, PV=?) January 1: Note receivable (+A) 100,000 / Cash (-A) 100,000 Dec 31: Cash (+A) 8,000 / Interest revenue (+R,+SE) 8,000 E effective interest method Beg. Net BV of N/R x market rate = 100,000 x 8% = 8,000

ABC made a loan to XYZ and received a 5-year, $100,000 zero-interestbearing note on January 1st. The market rate of interest for a note of similar risk is 6%. How does ABC record the receipt of the note? What is the journal entry on December 31 of the first year?

PV at issuance = 74,725.82 (N= 5, I/YR=6, PMT=0, FV=100,000, PV=?) January 1: N/R (+A) 74,726 / Cash (-A) 74,726 Dec 31: N/R (+A) 4,484 / Interest Revenue (+R) 4,484 Beg. Net BV of N/R x market rate = 74,726 x 6% = 4,484