ACCT 3233 Chapter 7

Cash equivalents must be both:

(1) readily converted to cash for known amounts and (2) so near maturity that they have little risk of loss, these amounts are deemed to be equivalent to cash.

What are the weaknesses of the Direct Write-Off Method?

1. Balance Sheet: Accounts Receivable are overstated because some won't be collected. Recall that assets are probable future economic benefits and the company knows that some accounts receivables won't be collected. 2. Income Statement: Net income is overstated in the period of sale and understated in the period following the sale, if the company doesn't determine that a customer won't pay until the period following the sale.

Restrictions cash can be:

1. Voluntary Management Restrictions: Arise from management's intent to use a certain amount of cash for a specific purpose. 2. Contractually Imposed: Arise from legal restrictions.

What is a compensating balance?

A compensating balance is the minimum cash balance required by a lender to be maintained at the financial institution of the lender, which may be legally restricted for use

What does the Committee of Sponsoring Organizations (COSO) define internal control as?

A process, undertaken by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: • Effectiveness and efficiency of operations • Reliability of financial reporting • Compliance with applicable laws and regulations.

Sales discounts

Are reductions in the amount to be received if a customer pays within a specified period of time.

Sale of Receivables

Can be sold at a gain or a loss like other assets • Responsibility for collection of the receivables transfers to the financial institution • Accounting treatment is similar to that of the sale of other assets • The accounting varies with whether the sale is with recourse or without recourse.

What is included in Cash Equivalents?

Cash Equivalents include money market funds, treasury bills, and commercial paper.

What is included in Cash?

Cash includes currency and coins, balances in checking accounts, and items acceptable for deposit in these accounts,

Two Methods:

Direct Write-Off Method, Allowance Method (GAAP)

Interest is calculated as:

Face Amount x APR x Fraction of the annual period

2 most common types of selling arrangements

Factoring and securitization.

Gross Method

Gross Method records revenue at the full invoice price (ignores the sales discount).

When is Bad Debt Expense recorded using the Allowance Method?

It is helpful to first understand when it is not recognized. It is not recognized when specific receivables are written off.

Do you believe the presentation of Sales Discounts Forfeited as an addition to Net Sales Revenue represents the economics of the transaction? Asked differently, why is the customer paying $800 and not $39,200?

No.

Do we typically incorporate time value of money in accounting for accounts receivable?

No. The financing component is typically immaterial.

What are notes receivable?

Notes receivable are formal credit arrangements between a creditor (lender) and a debtor (borrower) that specify payment terms.

Trade discounts

Percentage reduction from the list price.

Secured Borrowing

Pledge (or assign) accounts receivable as collateral for a loan • Entire receivables balance serves as collateral • Responsibility for collection of the receivables remains solely with the company • The arrangement should be described in a disclosure note

What are receivables?

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

Net Method

Records revenue at the invoice prices less the sales discount.

There are two main issues with initial measurement of accounts receivable:

Sales discounts and sales returns

What are the two categories of approaches to receivables-financing arrangements?

Secured Borrowing & Sale of Receivables

What is the most critical control for cash?

Separation of duties - which means individuals who have physical responsibility for assets should not also have access to accounting records

What is the main problem with allowing customers to pay for goods and services 30-60 days after the date of sale?

Some customers won't pay! These are called bad debts (or credit losses). The amount that is never collected from customers is considered a cost of extending credit to customers and recorded to an account called Bad Debt Expense.

What are the two methods for accounting for sales discounts?

The Gross Method and the Net Method.

What are the two types of discounts companies commonly offer?

Trade discounts and sales discounts.

What are trade and non-trade receivables?

Trade receivables are receivables resulting from the sale of goods or services on account and are called Accounts Receivable. Non-trade receivables are those other than trade receivables and include tax refund claims, interest receivable, and advances to employees.

Key concern with cash disbursements

Unauthorized payments

When is a company allowed to account for the transfer of receivables as a sale?

When the company (the transferor) surrenders control over the assets transferred.

The accounting for a factoring arrangement depends on whether the receivables are transferred

Without recourse or with recourse.

Note Receivable

accompanied by a formal promissory note

Secured Borrowing - Assignment

company assigning specific receivables as collateral against the loan.

Securitization

is a more complicated transaction where accounts receivable are sold to a "special purpose entity" specifically set up to own and collect on the receivables.

Secured Borrowing - Pledge

pledges its receivables as collateral in exchange for a loan.

In a factoring arrangement without recourse,

the buyer takes on the credit risk of bad debts and can't ask the seller for more money if the receivables prove to be uncollectible.

If the restriction is legally binding

the cash is classified as either current or noncurrent (investments or other assets) depending on the classification of the related debt.

Factoring

the company sells its accounts receivable to a financial institution.

If the restriction is informal and not contractual

the compensating balance can be included with cash and cash equivalents with note disclosure of the arrangement.

In a factoring arrangement with recourse,

the seller retains the credit risk of bad debts. That is, if receivables end up being uncollectible, the seller pays the buyer the amounts that are uncollectible.

The transferor is deemed to have surrendered control over the receivables if and only if all of the following conditions are met:

• The transferred assets have been isolated from the transferor - beyond the reach of the transferor and its creditors. • Each transferee (the buyer) has the right to pledge or exchange the assets it received. • The transferor does not maintain effective control over the transferred assets.