ACCTG301 Chapter #7
discount on note receivable account
a contra account to the note receivable account. *the discount becomes interest revenue in a noninterest bearing note upon the expiration/payment date
sales discounts account
a contra revenue account, deducted from sales revenue to derive the net sales
accounts receivable
-referred to as trade receivables - receivables resulting from the sale of goods or services on account
cash discounts
*often called sales discounts = represent reductions not in the selling price of a good or service but in the amount to be paid by a credit customer if paid within a specified period of time - two ways to record discount: gross and net method
key difference between gross and net method
*the timing of the recognition of any discounts not taken* The gross method recognizes discounts not taken as revenue when the sale is made. The net method recognizes them as revenue after the discount period has passed and the cash is collected
if the estimate of future sales returns is wrong
- when estimates are wrong we merely incorporate the new estimate in any related accounting determinations from that point on - say you overestimated the 2014 returns from 2013 sales: the balances in the accounts can be used to offset actual returns in 2014 from 2014 sales
cash disbursement control system
1. all disbursements, other than small disbursements from petty cash, should be made by check. this provides a permanent record 2. all expenditures should be authorized before the check is prepared 3. checks should be signed only by authorized individuals
subsequent valuation of accounts receivable
2 situations could cause the cash ultimately collected to be less than the initial valuation of the receivable: 1. the customer could return the product 2. the customer could default and not pay the agreed upon sales price
estimating future bad debts
2 ways: 1. income statement approach 2. balance sheet approach
trade discounts
=usually a percentage reduction from the list price - trade discounts can be a way to change prices without publishing a new catalog or to disguise real prices from competitors. - the trade discount is not recognized directly when recording the transaction. it is recognized indirectly by recording the sale at the net discount price, not the list price.
initial valuation of accounts receivable
GAAP specifically excludes accounts receivable from the general rule that receivables should be recorded at present value. - therefore, accounts receive are initially valued at the exchange price aka the amount expected to be received
receivables
represent a company's claims to the future collection of cash, other assets or services
surrendering control over receivables conditions
a. the transferred assets have been isolated from the transferor - beyond the reach of the transferor and its creditors b. each transferee has the right to pledge or exchange the assets it received c. the transferor does not maintain effective control over the transferred assets, *if all of these conditions are met, the transferor accounts for the transfer as a sale. if any of the conditions are not met, the transferor treats the transaction as a secured borrowing
accounts receivable
accounts receivable are informal credit arrangements supported by an invoice and normally are due in 30 to 60 days after the sale - almost always classified as current because their normal collection period, even if longer than a year, is part the operating cycle
add collections made by the bank
add collections by the bank on the company's behalf and other increases in cash that the company is unaware of until the bank statement is received
the allowance method
an application of matching in accounting for bad debts
bad debt expense
an operating expense incurred to make sales`
accounts receivable aging schedule
applying different percentages to accounts receivable balances depending on the length of time outstanding
nontrade receivables
are those other than trade receivables and include tax refund claims, interest receivable and loans by the company to other entities.
step 1: adjustments to bank balance
bank balance + deposits outstanding - checks outstanding +/- erros = corrected balance
compensating balances
banks frequently require cash restrictions in connection with loans or loan commitments. - typically the borrower is asked to maintain a specified balance in a low interest or non interest-bearing account at the bank. - the required balance is usually some percentage of the committed amount *a compensating balance results in the borrower's paying an effective interest rate higher than the state rate on the debt
step 2: adjustments of the book balance
book balance + collections by bank - service charges - NSF checks +/- errors (company errors) = corrected balance
restricted cash
cash that is restricted in some way and not available for current use usually is reported as a concurrent asset such as investments and funds or other assets - restrictions can be informal - sometimes restrictions are contractually imposed: ex being debt instruments requiring the borrower to set aside funds (sinking fund)
net method
considers sales revenue to be the net amount, after discount and any discounts not taken by the customer as interest revenue p. 365 example - record initial revenue and a/r at the agreed-on price LESS the % discount applied to the whole price - payments made within the period are recorded as debits to cash and credits to a/r for the amount received - if a customer does not take advantage of the discount, the discount amount is recorded as interest revenue
Committee of Sponsoring Organizations
dedicated to improving the quality of financial reporting through, among other things, effective internal controls
deduct service and other charges
deduct service and other charges made by the bank that the company is unaware of until the bank statement is received
bank reconciliation
differences between the cash book and bank balance occur due to differences in the timing of recognition of certain transactions and errors
assign (type of secured borrowing)
financing arrangements can require that companies assign particular receivables to serve as collateral for loans - the lender typically lends an amount of money that is less than the amount of receivables assigned by the borrower. the difference provides some protection for the lender in case of uncollectible accounts p. 380 example
notes receivable
formal credit arrangements between a creditor (lender) and a debtor (borrower)
subsequent valuation of notes receivable
if a company anticipates bad debts on short-term notes, it uses an allowance account to reduce the receivable to net realizable value.
notes received solely for cash
if a note with an unrealistic interest rate, even a non interest bearing note, is received solely in exchange for cash, the cash paid to the issuer is considered to be its present value.
cash equivalents
include money market funds, treasury bills and commercial paper. - to be classified as cash equivalents, these investments must have a maturity date no longer than three months from the date of purchase
cash
includes currency and coins, balances in checking accounts, and items acceptable for deposit into these accounts such as checks and money orders received from customers. - short term, highly liquid investments that can be readily converted to cash with little risk of loss are viewed as cash equiv
separation of duties
individuals that have physical responsibility for assets should not also have access to accounting records. So, employees who handle cash should not be involved in or have access to accounting records nor be involved in the reconciliation of cash book balances.
the discount
is computed by applying a discount rate to the maturity value and represents the financing fee the financial institution charges for the transaction.
petty cash
most companies keep a small amount of cash on hand to pay for low-cost items such as postage, office supplies, etc. A petty cash fund provides an efficient way to handle these payments - fund is established by transferring a specified amount of cash from the company's general checking account to an employee designated as the petty cash custodian. - the fund always should have cash and receipts that together equal the amount of the fund
sinking fund
previously explained, a debt instrument, restricted cash. *in these instances, the restricted cash is classified as noncurrent investments and funds or other assets if the debt is classified as noncurrent. *if the liability is current, the restricted cash is also classified as current
internal control
refers to a company's plan to (a) encourage adherence to company policies and procedures, (b) promote operational efficiency, (c) minimize errors and theft and (d) enhance the reliability and accuracy of accounting data
sale of receivables
similar to accounting for the sale of other assets a. the seller removes from the accounts rec b. recognizes at fair value any assets required or liabilities assumed by the seller c. records the difference as a gain or loss
pledge (type of secured borrowing)
sometimes companies pledge accounts rec as collateral for a loan. No particular receivables are associated with the loan, rather the entire receivables balance serves as collateral *no special accounting treatment needed, just a necessary disclosure note
discounting calculation
step 1: accrue interest revenue on the note prior to its being discounted step 2: add interest maturity to calculate maturity value step 3: deduct discount to calculate cash proceeds
when accounts are deemed uncollectible
the actual write-off of a receivable occurs when it is determined that all or a portion of the amount due will not be collected - recorded as a debit to allowance for uncollectible accounts and a credit to accounts receivable
net realizable value
the balance sheet should report only the expected net realizable value of the asset (recognizing bad debt expense results in accounts receivable) - account for bad debts by recording an adjusting entry that debits bad debt expense and reduces accounts rec. by crediting a contra account --> allowance for bad debts
sale without recourse
the buyer assumes the risk of uncollectibility when accounts receivable are sold
factoring
the company sells its accounts to a financial institution. the institution typically buys the receivables for cash and then handles the billing and collection of the receivables and charges a fee for this service.
discounting
the transfer of a note receivable to a financial institution - the institution accepts the note and gives the seller cash equal to the maturity value of the note reduced by a discount
secured borrowing
the transferor (borrower) simply acts like it borrowed money from the transferee (lender), with the receivables remaining on the transferor's balance sheet and serving as collateral for the loan. on the other side of the transaction, the transferee recognizes a note receivable
sale of receivables
the transferor (seller) "derecognizes" (removes) the receivable from its balance sheet, acting like it sold them to the transferee (buyer). on the other side of the transaction, the transferee recognizes the receivables as assets in its balance sheet and measures them at fair value.
interest-bearing notes
the typical note requires payment of a specified face amount, the principal, at specified dates/date and in addition interest is paid at a stated percentage of the face amount.
deduct NSF (nonsufficient funds) checks
these are checks previously deposited for which the payors do not have sufficient funds in their accounts to cover the amount of the checks. The checks are returned to the company whose responsibility it is to seek payment
noninterest-bearing notes
these notes actually do bear interest, but the interest is deducted from the face amount to determine the cash proceeds made available to the borrower at the outset.
add deposits outstanding
these represent cash amounts received by the company and debited to cash that have not yet been deposited in the bank by the bank statement cutoff date and cash receipts deposited in the bank near the end of the period that are not recorded by the bank until after the cutoff date
deduct checks outstanding
these represent checks written and recorded by the company as credits to cash that have not yet by processed by the bank before the cutoff date
securitization
typically the company creates a "special purpose entity" (SPE), usually a trust or a subsidiary. the SPE buys a pool of trade receivables, credit card receivables, or loans from the company, and then sells related securities, typically debt such as bonds or commercial paper that are back by the receivables.
direct write-off method
used rarely for financial reporting, if uncollectible accounts are not anticipated or are immaterial, an allowance for uncollectible accounts is not appropriate. In these cases any bad debts that do arise simple are written off as bad debt expense
gross method
views the cash discount not taken by a customer as sales revenue p. 365 example - initially record the revenue and related receivable at the full price - on remittance within the discount period, the amount is recorded as a debit to SALES DISCOUNTS
balance sheet approach
we determine the bad debt expense by estimating the net realizable value of accounts receivable to be reported on the balance sheet - we determine what the ending balance of the allowance for uncollectible accounts should be and then we record the amount of bad debt expense that is necessary to adjust the allowance to that desired balance
income statement approach
we estimate bad debt expense as a percentage of each period's net credit sales - this approach focuses on the current year's credit sales. The effect on the balance sheet is an incidental result of estimating the expense
transfers of note receivables
we handle transfers of notes receivable in the same manner as transfers of accounts receivable
estimating returns
we reduce sales revenue and accounts receivable for estimated returns by debiting a sales returns account (contra to sales rev) and crediting an "allowance for sales returns" (contra account to a/r) - when returns actually occur in the following period, the allowance for sales returns is debited and a/r is credited
sale with recourse
when a company sells accounts receivable with recourse, the seller retains all of the risk of bad debts. In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible. - only difference between with and w/o recourse is the "recourse liability" account recorded with recourse
effective interest rate
when interest is discounted from the face amount of the note, the effective interest rate is higher than the stated discount rate
impaired
when it becomes probable that a creditor will be unable to collect all amounts due according to the contractual terms of the note
sales returns
when merchandise is returned for a refund or credit to be applied to other purchases - recognizing returns and allowances only as they occur could cause profit to be overstated in the period of the sale and understated in the return period
when previously written off accounts are collected
when this happens, the receivable and the allowance should be reinstated 2 parts to the entry: reversing the write off collecting the cash and crediting a/r
financing with receivables
wide variety of ways for companies to use their receivables to obtain immediate cash. Companies can find this attractive because it shortens their operating cycles by providing cash immediately rather than having to wait until customer pay the amounts due. - of course, financial institutions require compensation for providing these services - Any of the approaches can be defined as either (1) secured borrowing, (2) sales of receivables