Intermediate Accounting Ch. 7

reporting cash

1. cash equivalents 2. restricted cash 3. bank overdrafts

secured borrowing versus sale

FASB says a sell occurs only if the sellers surrenders control of the receivables to the buyer. the following 3 conditions must be met before a company can record a sell: 1. the transferred asset has been isolated from the transferor (put beyond reach of the transferor and its creditors) 2. the transferees have obtained the right to pledge or exchange either the transferred assets or beneficial interests in the transferred assets 3. the transferor does not maintain effective control over the transferred assets through an agreement to repurchase or redeem them before their maturity. if 3 conditions are met, a sale occurs. otherwise is it secured borrowing. if there is continuing involvement in a sale transaction, a company must record the assets obtained and liabilities incurred.

4. time value of money

a company should measure receivables in terms of their PV, that is, the discounted value of the cash to be received in the future. when expected cash receipts require a waiting period, the receivable face amount is not worth the amount that the company ultimately receives. money today is worth more now than in future. any revenue after the period of sale is interest revenue. companies ignore interest revenue related to accounts receivable because the amount of the discount is not usually material in relation to the net income for the period.

recognition of accounts receivable

accounts receivable arise as part of a revenue arrangement. recognize revenue when it satisfies its performance obligation by transferring the good or service to the customer. the concept of change of control is the deciding factor in determining when a performance obligation is satisfied and an account receivable recognized. some indicators that shows that control has be obtained by second party: -store has the right to payment from the customer -store has passed legal title to the customer -store has transferred physical possession of goods -store no longer has significant risks and rewards of ownership of good -customer has accepted the asset

analysis of receivables: accounts receivable turnover

analysts frequently compute financial ratios to evaluate the liquidity of a company's accounts receivable. to assess the liquidity of the receivables, they use the accounts receivable turnover. this ratio measures the # of times, on average, a company collects receivables during the period. computed by dividing net sales by average (net) accounts receivable outstanding during the year. shows how successful the company is in collecting its outstanding receivables. aging schedule is good too.

non-trade receivables

arise fro variety of transactions. ex: 1. advances to officers and employees 2. advances to subsidiaries 3. deposits paid to cover potential damages or loses 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 carries for damaged or lost goods -creditors for returned, damaged, or lost goods -customers for returnable items (crates, containers, etc) non-trade receivables are reported as separate items on balance sheet

reconciliation of bank balances

at the end of the calendar month the bank supplies each customer with a bank statement (copy of the bank's account with the customer) together with the customer's checks that the bank paid during the month. if everything turns out right, the balance of cash reported by the bank to the customer equals that shown in the customer's own records. this rarely occurs due to one or more of the reconciling items presented below: so a company expects differences between its record of cash and the bank's record. therefore, it must reconcile the 2 to determine the nature of the differences between the 2 accounts. a bank reconciliation is a schedule explaining any differences between the bank's and the company's records of cash. if the difference results only from transactions not yet recorded by the bank, the company's record of cash is considered correct, but if some part of the differences arise from other items, either the bank or the company must adjust its records. a company may prepare 2 forms of a bank reconciliation. 1.) one form reconciles from the bank statement balance to the book balance or vice versa. 2.) reconciles both the bank statement balance and the book balance to a correct cash balance. most companies use this one. this form consists of 2 sections: A.) balance per bank statement and B.) balance per depositor's books. both sections end with correct cash balance. the correct cash balance is the amount to which the books must be adjusted and is the amount reported on the balance sheet. companies prepare adjusting journal entries for all the addition and deduction items appearing in the balance per depositor's books selection.

RC cont.

banks and other lending institutions often require customers to maintain minimum cash balances in checking or savings accounts. the SEC defines these minimum balances, called Compensating Balances, as "that portion of any demand deposit (or any time deposit or certificate of deposit) maintained by a corporation which constitutes support for existing borrowing arrangements of the corporation with a lending institution. would include both outstanding borrowings and the assurance of future credit availability. to avoid misleading investors about the amount of cash available to meet recurring obligations, the SEC recommends that companies state separately legally restricted deposits held as compensating balances against short-term borrowing arrangements among the "cash and cash equivalents items" in current assets. companies should classify separately restricted deposits held as compensating balances against long-term borrowing arrangements as concurrent assets in either the investments or other assets sections, using a caption such as "cash on deposit maintained as compensating balance." in cases where compensating balance arrangements exist without agreements that restrict the use of cash amounts shown on the balance sheet, companies should describe the arrangements and the amounts involved in the notes.

summary of cash-related items

cash and cash equivalents include the medium of exchange and most negotiable instruments. if the item cannot be quickly converted to coin or currency, a company separately classifies it as an investment, receivable, or prepaid expense. companies segregate and classify cash that is unavailable for payment of currently maturing liabilities in the long-term assets section.

cash controls

cash is the asset most susceptible to improper diversion and use. 2 problems in accounting for cash transactions 1. to establish proper controls to prevent any unauthorized transactions by officers or employees 2. to provide info necessary to properly manage cash on hand and cash transactions. error can and do happen. to safeguard cash and to ensure the accuracy of the accounting records for cash, companies need effective internal control over cash. provisions of the Sarbanes-Oxley Act call for enhanced efforts to increase the quality of internal control. this should result in improved financial reporting.

3. bank charges

charges recorded by the bank against the depositor's balance for such items as bank services, printing checks, not-suffieicent funds (NFS) checks, and safe deposit box rentals. the depositor may not be aware of these charges until the receipt of the bank statement

2. outstanding checks

checks written by the depositor are recorded when written but may not be recorded by (may not be clear) the bank until the next month

4. bank credits

collections or deposits by the bank for the benefit of the depositor that may be unknown to the depositor until receipt of the bank statement. examples are note collection for the depositor and interest earned on interest-bearing checking accounts

sales of receivables

common type is a sale to a factor. factors are finance companies or banks that buy receivables from businesses for a fee and then collect the remittance directly from the customers. factoring receivables is traditionally associated with the textile, apparel, footwear, furniture, and home furnishing industries. in a factoring or a securitization transaction, a company sells receivables on either a without recourse or a with recourse basis.

estimating the allowance

companies must estimate the amount of expected uncollectible's when they use the allowance method. from past events (loss experience), adjusted for current conditions and reasonable forecasts of factors that would affect uncollectible receivables. a company can estimate the % of its outstanding receivables that will become uncollectible without identifying specific accounts. this provides a reasonably accurate estimate of the receivables' realizable value, referred to as the percentage-of-receivables approach. using either a composite rate or aging schedule- identifies which accounts require special attention by indicating the extent to which certain accounts are past due(risk factor). cannot ignore the balance in the allowance account because the % is related to a real account (acc rec). companies do not prepare an aging schedule only to determine bad debt expense. they often prepare it as a control device to determine the composition of receivables and to identify delinquent accounts. other approaches are acceptable as long as the estimation techniques are applied consistently over time with the objective of faithfully estimating expected uncollectible accounts. historical- for customers with different credit ratings as a basis for estimating uncollectible accounts probability weighted discounted cash flow model- to estimate expected credit losses discounted cash flow approach is generally appropriate when analyzing an individual loan or receivable

recognition of notes receivable

companies record and report long-term notes receivables at the present value of the cash they expect to collect. when interest stated on an interest-bearing note equals the effective (market) rate of interest, the note sells at face value. when the stated rate differs from the market rate, the cash exchanged (pv) differs from the face value of the note. companies then record this difference, either a discount or a premium, and amortize it over the life of a note to approximate the effective (market) interest rate. TMV concept are applied to accounting measurement

valuation of accounts receivable

companies record credit loses as debits to bad debt expense (uncollectible accounts expense). 2 methods are used in accounting for uncollectible accounts: 1. the direct write-off method 2. allowance method

collectibility assessment based on expected cash flows

companies usually evaluate their receivables to determine their ultimate collectibility. many companies start with historical loss rates and modify these rates for changes in economic conditions that could affect a borrower's ability to repay the loan. companies commonly evaluate loans (long-term notes receivables) for collectibility based on an analysis of the expected contractual cash flows. they then apply discounted expected cash flow methods (ch.6) to measure the allowance and to report the loan at net realizable value.

secured borrowing

debtor assigns (pledges) receivables as security for a loan. if the loan is not paid when due, the creditor can convert the collateral to cash- collect the receivables. must recognize collection of receivables, discounts. returns and allowances, and bad debts.

1. deposits in transit

end-of-month deposits of cash recorded on the depositor's books in one month are received and recorded by the bank in the following month

5. bank or depositor errors

errors on either the part of the bank or the part of the depositor cause the bank balance to disagree with the depositor's book balance

using bank accounts

establishing collection accounts in strategic locations can accelerate the flow of cash into the company by shortening the time between a customer's mailing of a payment and the company's use of the cash. multiple collection centers generally reduce the size of a company's collection float. this is the difference between the amount on deposit according to the company's records and the amount of collected cash according to the company's records and the amount of collected cash according to the bank record. large multilocation companies frequently use lock box accounts to collect in cities with heavy customer billing. biggest advantage for this is that it accelerates the availability of collected cash, they do it once a day. it improves the control over cash and accelerates collection of cash. checking account- principal bank account in most companies and frequently the only bank account in small businesses. deposits and disburses cash from this account. cycles all transactions through it. imprest bank accounts- to make a specific amount of cash available for a limited purpose. acts as a clearing account for a large volume of checks or for a specific type of check. often use it for disbursing payroll checks, dividends, commissions, bonuses, confidential expenses (officer salaries), and travel expenses.

receivables

financial assets, referred to as loans and receivables. claims held against customers and others for money, goods, or services. classify receivables as either current (short-term) or concurrent (long-term). companies expect to collect current receivables within a year or during the current operating cycle, whichever is longer. all the rest are classified as non-current. and in balance sheet are trade or non-trade receivables. represent open accounts resulting from short-term extensions of credit, collects within 30-60 days. notes receivables: are written promises to pay a certain sum of money on a specified future date. ex- sales, financing, or other traditions, short or long. account receivables and notes receivable=trade receivables issues for accounting: recognition, valuation, and disposition

2. allowance method for uncollectible accounts

for bad debts involves estimating uncollectible accounts at the end of each period. this ensures that companies state receivables on the balance sheet at their net realizable value. Net realizable value is the net amount the company expects to receive in cash. many companies set their credit policies to provide for a certain % of uncollectible accounts, (many feel that failure to reach that % means that they are losing sales due to overly restrictive credit policies). so the FASB requires the allowance method for financial reporting purposes when bad debts are material in amount. this method has 3 essential features 1. companies estimate uncollectible accounts receivable and compare the new estimate to the current balance in the allowance account 2. companies debit estimated increases in uncollectible's to bad debt expense and credit them to allowance for doubtful accounts (contra asset account) through an adjusting entry at the end of each period 3. when companies write off a specific account, they debit actual uncollectible to allowance for doubtful accounts and credit that amount to accounts receivables

presentation of receivables

general rules for classifying are: 1. segregate the different type of receivables that a company possess, 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, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. except some additional disclosures, companies are required to disaggregate based on type of receivable. the FASB rules for companies to provide the following disclosures about its receivables on a disaggregated basis: 1. a roll forward schedule of the allowance for doubtful accounts from the beginning of the reporting period to the end of the reporting period 2. the nonaccural status of receivables by class of receivables 3. impaired receivables by type of receivable also companies should disclose credit quality indicators and the aging of past due receivables. companies must disclose concentrations of credit risk for all financial instruments (including receivables). concentrations of credit risk exist when receivables have common characteristics that may affect their collection. these common characteristics might be companies in the same industry or same region of the country. no numerical guidelines are provided to what is meant for this.

choice of interest rate

in note transactions, other factors involved in the exchange, such as the fair value of the property, goods, or services, determine the effective or real interest rate. but if a company cannot determine that fair value and if the note has no ready market, determining the PV is hard. to estimate it, the company must approximate an applicable interest rate that may differ from the stated interest rate. this process is called imputation (interest rate). the prevailing rates for similar instruments, from issuers with similar credit ratings, affect the choice of a rate. restrictive covenants, collateral, payment schedule, and the existing prime interest rate also impact the choice. a company determines the imputed interest rate when it receives the note. it ignores any subsequent changes in prevailing interest rates.

variable consideration

in some cases the price of a good or service is dependent on future events. events often include discounts, returns and allowances, rebates, and performance bonuses. four items that affect the transaction price and acc receivables balance 1. trade discounts: prices may be subject to trade or quantity discount. use these to avoid frequent changes in catalogs, to alter prices for different quantities purchased, or to hide the true invoice price from competitors. commonly quoted in %. 2. cash discounts (sales discounts): offer to induce prompt payment. generally presented in terms such as 2/10, n/30 (2% if paid within 10 days, gross amount due in 30 days) or 2/10, E.O.M., net 30, E.O.M. (2% if paid any time by the 10th day of the following month, with full payment due by the 13th of the following month). customers usually take sales discounts unless their cash is severely limited, to avoid the rate of interest cost. record as the amount of consideration expected to be received from a customer. at net price=net method, attempts to value the receivable at its net realizable value net method is correct because the receivable is stated at net realizable value, and the net sales measures the revenue recognize from the sale. some still use the gross method: recognizes sales discounts when it receives payment within the discount period. because the net method requires additional analysis and book keeping to record sales discounts forfeited on accounts receivable that have passed the discount period. if collection periods are short, the amounts for both are the same

valuation of notes receivables

like accounts receivable, companies record and report short-term notes receivable at their net realizable value, that is, at their face amount less all necessary allowances. the primary notes receivables allowance account is allowance for doubtful accounts. the computation and estimations involved in valuing short-term notes receivables and in recording bad debt expense and the related allowance exactly parallel that for trade accounts receivables. long-term notes involve additional estimation problems. the value of a notes can change significantly over time from its original cost. with passage of time, historical #'s become less and less relevant. the FASB requires that for financial instruments such as receivables, companies disclose not only their cost but also their fair value in the notes to the financial statements.

imprest petty cash system

method for obtaining reasonable control , while adhering to the rule of disbursement by check. 1. the company designates a petty cash custodian, and gives them a small amount of currency from which to make payments. 2 the petty cash custodian obtains signed receipts from each individual to whom he or she pays cash, attaching evidence of the disbursement to the petty cash receipt. petty cash transactions are not recorded until the fund is reimbursed; someone other than the petty cash custodian records those entries. 3. when the supple of cash runs low, the custodian presents to the controller or accounts payable cashier a request for reimbursement supported by the petty cash receipts and other disbursement evidence. 4. if the company decides that the amount of cash in the petty cash fund is excessive, it lowers the fund balance A company only makes entries in the petty cash fund to increase or decrease the size of the fund. a company uses a cash over and short account when the petty cash fund fails to prove out. if cash proves out short, the company debits the shortage to the cash over and short account. if cash proves out over, it credits the overage to cash over and short. company closes both only at end of the year. in income statement it is shown as other expense or revenue. to maintain accurate financial statements, a company must reimburse the funds at the end of each accounting period and also when nearly depleted. The petty cash custodian is responsible at all times for the amount of the fund on hand either as cash or in the form of signed receipts. a company follows 2 additional procedures to obtain more complete control over the petty cash fund: 1. superior of the petty cash custodian makes surprise counts of the fund from time to time to determine that a satisfactory accounting of the fund has occurred. 2. the company cancels or mutilates petty cash receipts after they have been submitted for reimbursement, so that they cannot be used to secure a second reimbursement.

disposition of accounts and notes receivables

normally, companies collect amounts and notes when due and then remove them from the books. however due to growing of credit sales and receivables has led to changes. in order to acerbate the receipt of cash from receivables, the owner may transfer accounts or notes receivables to another company for cash. reasons for this are- A.) for competitive reasons: providing sales financing for customers is virtually mandatory in many industries. in the sale of durable goods, most sales are on an installment contract basis. B.) the holder may sell receivables because money is tight and access to normal credit is unavailable or too expensive. also a firm may sell its receivables, instead of borrowing, to avoid violating existing lending agreements. C.) billing and collection of receivables are time consuming and costly. the transfer of receivables to a third party for cash happens in 2 ways: 1. sales of receivables 2. secured borrowing

physical protection of cash balances

not only must a company safeguard cash receipts and cash disbursements through internal control measures, but it must also protect the cash on hand and in banks. because receipts become cash on hand and disbursements are made from cash in banks, adequate control of receipts and disbursements is part of the protection of cash balances, along with certain other procedures. a company should make sure to minimize cash on hand in the office. it should only have on hand a petty cash fund, the current day's receipts, and funds for making change. should keep these in a vault, safe, or locked cash drawer. a company must periodically prove the balance shown in the general ledger. for cash on deposit, a company prepares a bank reconciliation- a reconciliation of the company's record and the bank's record of the company's cash.

recovery of an uncollectible account

occasionally a company collects from a customer after is has written off the account as uncollectible. the company makes 2 entries to record the recovery of a bad debt 1. it reverses the entry made in writing off the account. this reinstates the customer's account. 2. it journalizes the collection in the usual manner. the recovery of a bad debt affects only balance sheet accounts.

bank overdrafts

occur when a company writes a check for more than the amount in its cash account. companies should report bank overdrafts in the current liabilities section, adding them to the amount reported as accounts payable. if material, companies should disclose these items separately, either on the face of the balance sheet or in the related notes. bank overdrafts are generally not offset against the cash account. a major exception is when available cash is present in another account in the same bank on which the overdraft occurred. offsetting in this case is required

analysis of receivables: average days to collect receivables

often accounts receivable turnover is transformed to days to collect accounts receivable or days outstanding-an average collection period. use this to assess the effectiveness of a company's credit and collection policies. this should not greatly exceed the credit term period.

interest bearing notes

often the stated rate and the effective rate differ. if the effective rate of interest exceeds the stated rate, then the PV of the note is less than the face value. so that is exchanged the note at a discount. when the PV exceeds the face value, the note is exchanged at a premium. companies record the premium on a note receivable as a debit and amortize it using the effective-interest method over the life of the note as annual reductions in the amount of interest revenue rocognized

restricted cash

petty cash, payroll, and dividend funds are examples of cash set aside for a particular purpose. in most cases, these fund balances are not material. therefore, companies do not segregate them from cash in the financial statements. when material in amount, companies segregate restricted cash from "regular" cash for reporting purposes. companies classify restricted cash either in the current assets or in the long-term assets section, depending on the date of availability or disbursement. classification in the current section is appropriate if using the cash for payment of existing or maturing obligations (within a year or the operating cycle, whichever is longer). classified in long-term section if holding the cash for a longer period of time. and is frequently set aside for plant expansion, retirement of long-term debt, or in the case of International Thoroughbred Breeders, for entry fee deposits.

summary

primary objective for financial statement purposes is to report receivables in the balance sheet at net realizable value. the allowance for doubtful accounts as a % of receivables will vary, depending on the industry and the economic climate. determining the expense associated with uncollectible accounts requires judgment, with any approach. some banks use this judgment to manage earnings, by overstating the amounts of uncollectible loans in a good earnings per year, the bank can save for a rainy day in a future period. and in less profitable periods banks can reduce the overly conservative allowance for loan loss account to increase earnings.

recording estimated uncollectible's

reports bad debt expense in the income statement as an operating expense. thus, records the increased estimated uncollectible's as bed debt expense in the period of credit deterioration. allowance for doubtful accounts shows the estimated amount of claims on customers that the company expects it will not collect in the future. companies use a contra account instead of a direct credit to accounts receivable because they do not know which customers will not pay. the credit balance in the allowance account will absorb the specific write-offs when they occur. companies do not close allowance for doubtful accounts at the end of the fiscal year.

3. sales returns and allowances

saying that if customer is dissatisfied, company will grant an allowance on the sales price or agree to take the product back. as similar to sales discount, company will record acc receivable and related revenue at the moment of consideration expected to be received. sakes returns and allowances is a contra revenue account to sales revenue and offsets sales revenue on the income statement. allowance for sales returns and allowances is a contra asset account to accounts receivable and offsets accounts receivable on the balance sheet. the allowance account will absorb any additional write-offs that occur in the future. all are helpful to use for management because they help identify potential problems associated with inferior merchandise, inefficiencies in filling orders, or delivery or shipment mistakes.

cash equivalents

short-term, highly liquid investments that are both 1. readily convertible to known amounts of cash 2. so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. generally only investments with original maturities of 3 months or less qualify under these definitions. examples are treasury bill, commercial paper, and money market funds. some companies combine cash with temporary investments on the balance sheet. in these cases they describe the amount of the temporary investments either parenthetically or in the notes. the cash-equivalent classification was misleading, no market existed. the FASB has studied whether to eliminate the cash-equivalent classification from financial statement presentations altogether. one idea would have companies report only cash. if an asset is not cash and is short-term in nature, it should be reported as a temporary investment. sloppy accounting can lead to misleading and harmful effects for users of the financial statements.

notes receivables

supported by a formal promissory note-a written promise to pay a certain sum of money at a specific future date. such a note is a negotiable instrument that a maker signs in favor of a designated payee who may legally and readily sell or otherwise transfer the note to others. although all notes contain an interest element bc of time value money, companies classify them as interest bearing or non-interest bearing. interest have a stated rate of interest. non or zero, include interest as part of their face amount. notes receivables are considered fairly liquid, even if long term, bc companies may easily convert them to cash (might have to pay a fee). companies frequently accept notes receivable from customers who need to extend the payment period of an outstanding receivable. or they require notes from high-risk or new customers. companies often use notes in loans to employees and subsidiaries, and in the sales of property, plant and equipment. in some industries like pleasure and sport boat, notes support all credit sales. majority of notes, originate from lending transactions. issues for accounting are recognition, valuation, and disposition.

measurement of collectibility

the allowance for doubtful accounts and related bad debt expense on a loan or note receivable can be estimated as the difference between the investment in the loan (generally the principal plus accrued interest or amortized cost) and the expected future cash flows discounted at the loan's historical effective-interest rate. when using historical effective loan rate, the value of the investment will change only if some of the legally contracted cash flows are reduced. a company recognizes a loss in this case bc the expected future cash flows are now lower. the company ignores interest rate changes caused by current economic events that affect the fair value of the loan.

cash

the most liquid of assets, is the standard medium of exchange and the basis for measuring and accounting for all other items. companies generally classify cash as a current asset. cash consists of coin, currency, and available funds on deposit at the bank. negotiable instruments such as money orders, certified checks, cashier's checks, personal checks, and bank drafts are also viewed as cash. banks do have the legal right to demand notice before withdrawal. but because banks rarely demand prior notice, savings accounts nevertheless are considered cash. some negotiable instruments provide small investors with an opportunity to earn interest. these items, more appropriately classified as temporary investments than as cash, include money market funds, money market savings certificates, certificated of deposits CD, and similar types of deposits and "short-term paper". these securities usually contain restrictions or penalties on their conversion to cash. money market funds that provide checking account privileges are usually classified as cash.

sale with recourse

the seller guarantees payment to the purchaser in the event the debtor fails to pay. to record this type of transaction, the seller uses a financial components approach bc the seller has a continuing involvement with the receivable. values are now assigned to such components as the recourse provision, servicing rights, and agreement to reacquire. in this approach, each party to the sale only recognizes the assets and liabilities that it controls after the sale.

sale without recourse

the seller of the receivable assumes no responsibility for any credit losses associated with the transferred receivables. the transfer of accounts receivable in this is therefore an outright sale of the receivables both in form (transfer of title) and substance (transfer of control). in non-recourse transactions (as in any sale of assets,) the seller: 1. debits cash for the proceeds and credits accounts receivable for the face value of the receivables 2. recognizes the difference, reduced by any provision for probable adjustments (discounts, returns, allowances, etc), as loss on sale of receivables 3. uses a due from factor account (reported as a receivable) to account for the proceeds retained by the factor to cover probable sales discounts, sales returns, and sales allowances.

measurement of transaction price

the transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods or services. in some cases, companies must consider items such as variable consideration which may affect the accounts receivable balance.

fair value option

three additional special issues for accounting and reporting of receivables relate to the following: 1. fair value option 2. disposition of receivables 3. presentation and disclosure

special issues

three additional special issues for accounting and reporting of receivables relate to the following: 1. fair value option 2. disposition of receivables 3. presentation and disclosure

1. direct write off method

when a company determines a particular account to be uncollectible, it charges the loss to bad debt expense. under this method, bad debt expense will show only actual losses from uncollectible's. the company will report accounts receivable at its gross amount. often used for tax purposes. supporters contend that it records facts, not estimates. it assumes that a good account receivables resulted from each sale, and that later events revealed certain accounts to be uncollectible and worthless. method is simple and convenient to apply, but is theoretically deficient. it usually fails to record expenses in the same period as associated revenues. and it doesn't result in receivables being stated at net realizable value on the balance sheet. as a result, using this method is not considered appropriate, except when the amount uncollectible is immaterial.

notes received for property, goods, or services

when a note is received in exchange 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 2. the stated interest rate is unreasonably 3. the face amount of the note is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument. in these circumstances, the company measures the PV of the note by the fair value of the property, goods, or services or by an amount that reasonably approximates the fair value of the note.

recording the write off of an uncollectible account

when companies have exhausted all means of collecting a past-due account and collection appears impossible, the company should write off the account. in the credit card industry, it is standard practice to write off accounts that are 210 days past due. bad debt expense does not increase when the write off occurs. under the allowance method, companies debt every bad debt write off to the allowance account rather than to bad debt expense. a debit to bad debt expense would be incorrect because the company has already recognized the expense when it made the adjusting entry for estimated bad debts. instead, the entry to record the write off of an uncollectible account reduces both accounts receivable and allowance for doubtful accounts.

note not issued at face value

zero-interest-bearing notes. if a company receives one, its PV is the cash paid to the issuer. the rate for this is often referred to as the implicit interest rate. companies companies record the difference between the FV (face) amount and the PV (cash paid) as a discount and amortize it to interest revenue over the life of the note. discount on notes receivables is a valuation account. companies report it on the balance sheet as a contra asset account to notes receivable. they then amortize the discount, and recognize the interest revenue annually using the effective-interest method.