Chapter 7 (Cash and Receivables)

What is a securitization arrangement?

A company creates a "special purpose entity", usually a trust of a subsidiary. The SPE buys a pool of trade receivables, credit cards receivables, or loans form the company, and then sells related securities, typically debt such as bonds or commercial paper, that are backed by the receivables

What is a factoring arrangement?

A company sells its accounts receivable to a financial institution, the institution typically buys receivables for cash, handles the billing and collection of the receivables, and charges a fee for this service.

What is an interest bearing note?

A loan that requires the payment of the face amount (the principal) plus the payment of interest paid at a stated percentage of the face amount

What are the 2 approaches used to finance with receivables

1. A secured borrowing 2. A sale of receivables

What are the 2 most common types of selling arrangements?

1. Factoring 2. Securitization

What are the 2 ways to record cash discounts?

1. Gross method 2. Net method

What 2 ways are commonly used to arrive at the estimate of future bad debts?

1. Income statement approach 2. Balance sheet approach

What is a compensating balance?

A minimum balance that must be maintained in an account. The compensating balance is often used to offset a portion of the cost that a bank faces when extending a loan or credit to an individual or business, and is usually calculated as a percentage of the loan outstanding.

What is an accounts receivable aging schedule?

An accounting table that shows the relationship between a company's bills and invoices and its due dates. Often created by accounting software, aging schedules can be produced for both accounts payable and accounts receivable to help a company see whether it is current on its payments to others and whether its customers are paying it on time.

What is the allowance method?

An application of matching in accounting for bad debts

What is a bad debt expense?

An inherent cost of granting credit, it is an operating expense incurred to make sales

When is revenue and related accounts receivable recognized?

At the point of delivery of the product or service

what is the balance sheet approach?

Bad debt expense is an incidental result of estimating the net realizable value of accounts receivable

Hoe can a note receivable be used to obtain immediate cash from a financial institution?

By pledging the note as collateral or by selling the note

Are accounts receivables considered current or non current?

Current because they will be converted to cash within the normal operating cycle

The classification and discourse of a compensating balance depends on the nature of the restriction and the classification of the related debt. If the restriction is legally binding, the cash is classified as either?

Current or noncurrent

What most investments have to be considered a cash equivalent?

It must have a maturity date no longer than 3 months form the date of purchase

What should a company include in its discourse notes for cash equivalents?

It should describe which short term, highly liquid investments it classifies as cash equivalents

What are account receivables?

Receivables resulting form the sale of goods or services on account

How do companies account for a bad debt expense?

Recording an adjusting entry that debits bad debt expense and reduces accounts receivable indirectly by crediting a contra account (allowance for noncollectable accounts) to accounts receivable for an estimate of the amount that eventually will prove noncollectable

What does a write off of an account receivable reduce?

Reduces both receivables and the allowance thus having no effect on income or financial position

What is required when a company pledges account receivable as collateral for debt?

They must include a disclosure note the describes the arrangement

What are receivables?

They represent a company's claims to the future collection of cash, other assets or services.

What are 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 (provides incentive for quick payments)

If the compensating balance arrangement is informal with no contractual agreement that restricts the use of cash, the compensating balance can be reported as?

part of cash and cash equivalents

What does the Sarbanes-Oxley Act require a company to document?

the internal controls of the company

What is the separation of duties?

Employees in a company should not have control of more than one part in the cash truncations. This is a way to help against fraud and other issues.

When should sales returns be recorded?

If material: they should be estimated and recorded in the same period as the related sales If immaterial: they can be recorded as they occur

What is the net method?

It considers sales revenue to be the net amount, after discount, and any discounts not taken by the customer as interest revenue

What is considered cash?

It includes currency and coins, balances in checking accounts, and items acceptable for deposit in these accounts, such as checks and one orders received for customers

What is a trade discount?

Something companies offer to customers, usually a percentage reduction form the list price of an item.

What is the typical account receivable valued at?

The amount expected to be received, not the present value of that amount

what is the Income statement approach?

The balance sheet amount is an incidental result of estimating bad debt expense as a percentage of net credit sales

What happens when a factoring arrangement is made without recourse?

The buyer assumes the risk of uncollectibility

What method is used for income tax purposes?

The direct write-off method

What must occur when a account receivable is recovered?

The reinstatement of both the receivable and the allowance

What happens when a factoring arrangement is made with recourse?

The seller retains all of the risk of bad debts. The seller guarantees that the buyer will be paid even if some receivables prove to be uncollectable

What is the difference between the two methods for recognizing cash discounts?

The timing of the recognition of any discounts not taken Gross method: recognizes discounts not taken as revenue when the sale is made Net method: recognizes them as revenue after the discount period has passed and the cash is collected

What is discounting?

The transfer of a note receivable to a financial institution

What is a sale of receivables?

The transferor "de-recognizes" the receivables from its balance sheet, acting like it sold them to the trasnferee. The transferee recognizes the receivables as assets in its balance sheet and measures them at their fair value.

What is a secured borrowing?

The transferor simply acts like it borrowed money form the transferee with the receivables remaining in the transferor's balance sheet and serving as collateral for the loan. The transferee recognizes a note receivable

What is a non-interest bearing note?

These notes do still bear interest, but the interest is deducted from the face amount to determine the cash proceeds made available to the borrower at the outset

What is the gross method?

Views a discount not taken by the customer as part of sales revenue

What is a note receivable?

When a receivable, trade or non-trade, is accompanied by a formal promissory note

What is a sales return?

When merchandise is returned for a refund or for credit to be applied to other purchases

What does a company's internal control refer to?

it 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