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