Intermediate Accounting 1 Chapter 6

4 items that affect transaction price

(1) trade discounts, (2) cash discounts, (3) sales returns and allowances, and (4) time value of money.

Percentage-of-receivables approach

- Estimate the balance in the allowance account based on a percentage of accounts receivables. - Reports receivables at net realizable value. - Companies may apply this method using one composite rate (%), or an aging schedule of A/R, which applies a different percentage based on past experience to the various age categories.

sale without recourse

- Purchaser assumes risk of collection - Transfer is outright sale of receivable - Seller records loss on sale - Seller use Due from Factor (receivable) account to cover discounts, returns, and allowances *the seller of the receivable assumes no responsibility for any credit losses associated with the transferred receivables 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 Receivable 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.

sale with recourse

- Seller guarantees payment to purchaser - Financial components approach used to record transfer *the seller guarantees payment to the purchaser in the event the debtor fails to pay. therefore, you are going to have to recognize a liability related to possible losses on uncollectible accounts. use financial component approach to record transaction.

Recognition of Notes Receivable

- Supported by a formal promissory note. - Can be a negotiable instrument which may be transferred to other parties. Companies record and report long-term notes receivable at the present value of the cash they expect to collect. *Interest rates involved when determining PV: stated interest rate (nominal or face) & effective-interest rate (market rate or effective yeild) --> When the stated interest rate on an interest-bearing note equals the effective interest rate, the note sells at face value. --> When the two interest rates are not equal, the present value of the note will be different 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.

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

Notes receivable generally originate from:

- customers who need to extend payment period of an outstanding receivable - high-risk or new customers - loans to employees and subsidiaries - sales of property, plant, and equipment - lending transactions (majority of notes)

short-term vs long term recognition of notes receivable

- short-term: record at face value, less allowance; reported at Net Realizable Value (same as accounting for accounts receivable). - long-term: record at present value of cash expected to be collected; FASB requires companies disclose not only their cost but also their fair value in the notes to the financial statements. *Note: Fair Value Option: Companies have the option to use fair value as the basis of measurement in the financial statements. 1. stated rate = market rate: face value 2. stated rate > market rate: premium 3. stated rate < market rate: discount

lockbox accounts

--> used by multilocation companies in cities with heavy customer billing. 1. The company rents a local post office box and authorizes a local bank to pick up the remittances mailed to that box number. 2. The bank empties the box at least once a day and immediately credits the company's account for collections.

Cash Discounts (Sales Discounts)

-offered to induce prompt payment -gross method vs. net method -generally presented in terms such as 2/10, n/30 (2% discount if paid within 10 days, gross amount due in 30 days)

Recovery of Uncollectible Account

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. to reverse write-off of account: Dr. Accounts Receivable Cr. Allowance for Doubtful Accounts to record collection of account (the money): Dr. Cash Cr. Accounts Receivable

items that seem like cash but aren't

1. Postdated checks: These are checks, usually from customers, that are dated in the future. These checks cannot be deposited until that future date. Therefore, they are listed as receivables until they can be deposited. 2. I.O.U.s.: These represent amounts owed to the company, typically from employees. I.O.U.s. are classified as receivables. 3. Travel advances: If a company advances money to employees and intends to collect it from employees in the future or deduct it from their salaries, then the amounts are recorded as receivables. If the travel advance will not be reimbursed by the employee, it is classified as a prepaid expense. 4. Postage stamps on hand: These are included as part of office supplies inventory or as a prepaid expense.

presentation (classifying) of receivables

1. Segregate the different types of receivables that a company possesses, 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.

average days to collect receivables

= 365 days / accounts receivable turnover Companies frequently use the average collection period to assess the effectiveness of a company's credit and collection policies.

NSF check

= not-sufficient-funds check A check returned to the depositor by the bank because there are not sufficient funds in the drawer's checking account to cover the check.

Collection Float

= the difference between the amount on deposit according to the company's records and the amount of collected cash according to the bank record. --> Multiple collection centers generally reduce the size of a company's this.

Non-Recognition of Interest Element

A company should measure receivables in terms of their present value. In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period.

Write-off of uncollectible accounts

A debit to Allowance for Uncollectible Accounts and a credit to Accounts Receivable. *affects only balance sheet accounts (no IS accounts).

Accounts Receivable Turnover

A measure of the liquidity of accounts receivable; measures the number of times, on average, a company collects receivables during the period. = net sales divided by average net accounts receivable.

net method

A method in which a company considers purchase discounts lost as a financial expense and reports it in the "Other expenses and losses" section of the income statement. Under this, a company recognizes the accounts receivable and related revenue at the invoice price less the cash discount.

zero-interest-bearing notes

A note receivable that includes interest as part of the face amount. Also called non-interest-bearing notes.

interest-bearing note

A note that requires payment of the principal plus interest on the maturity date. having a stated interest rate

Internal Control

A process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the reliability of financial reporting, the effectiveness and efficiency of operations, and compliance with applicable laws and regulations. *To safeguard cash and to ensure the accuracy of the accounting records for cash, companies need effective internal control over cash.

bank reconciliation

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 difference arises from other items, either the bank or the company must adjust its records.

imprest bank account

An account used for special purposes such as payroll or branch banking that is maintained at a zero or fixed balance in the general ledger. Checks written on the account are offset by deposits of the same amount.

imputed interest rate

An approximated interest rate, used when a company cannot determine the interest rate of a note receivable because it has no ready market. To estimate the present value of the note, the company approximates an applicable interest rate, which may differ from the stated interest rate.

loan (secured borrowing)

Borrowing money from a financial institution like a bank. To borrow funds, you generally will have to pledge or assign your accounts receivable as collateral for the loan (secured borrowing). - Under a pledge, the assigned receivables remain under control of the borrower. - If the loan is not paid when due, the lender can convert the collateral to cash.

Bank charges

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

Outstanding checks

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

Receivables

Claims held against customers and others for money, goods, or services.

nontrade receivables

Claims that arise from a variety of transactions outside the normal course of business/non-sales transactions. Examples: 1.Advances to officers and employees. 2.Deposits to cover potential damages or losses. 3.Deposits as a guarantee of performance or payment. 4.Dividends and interest receivable. 5.Claims against: Insurance companies for casualties sustained; defendants under suit; governmental bodies for tax refunds; common carriers for damaged or lost goods.

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.

Disposition of [accounts and notes] Receivables

Companies may transfer receivables to other companies in order to get cash now. Reasons: - Competition. - Sell receivables because money is tight. - Billing / collection are time-consuming and costly. Transfer accomplished by: 1. Secured borrowing 2. Sale of receivables

physical protection of cash balances

Company should: - Minimize the cash on hand. - Only have on hand petty cash and current day's receipts. - Keep funds in a vault, safe, or locked cash drawer. - Transmit each day's receipts to the bank as soon as practicable. - Periodically prove (reconcile) the balance shown in the general ledger.

deposits in transit

Deposits recorded by the company but not yet recorded by its bank. 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.

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.

secured borrowing vs sale

FASB concluded that a sale occurs only if the seller surrenders control of receivables to buyer. Three (3) conditions must be met: 1. transferred assets isolated from transferor. 2. transferee has right to pledge or sell assets. 3. transferor does not maintain control through repurchase agreement.

beginning balance in allowance for doubtful accounts

If the leftover balance is a credit, that means the company overestimated and did not write off as many accounts as expected. If the leftover balance is a debit, that means the company underestimated and wrote-off more accounts than expected. debit: add to year-end balance of allowance for doubtful accounts credit: subtract from year-end balance of allowance for doubtful accounts

problems in accounting for cash transactions

Management faces two problems in accounting for cash transactions: 1. Establish proper controls to prevent any unauthorized transactions by officers or employees. 2. Provide information necessary to properly manage cash on hand and cash transactions.

gross method

Method of recording purchases at the full invoice price without deducting any cash discounts. Under this method, a company recognizes the receivable and related revenue at the invoice price.

time value of money

Money's potential to grow in value over time. The relationship between time, money, a rate of return, and earnings growth.

Recognition of Accounts Receivable

Recognize with revenue when the performance obligations are met.( the change in control) change in control occurs when: 1. company has the right to payment from the customer. 2. company has passed legal title to the customer. 3. company has transferred physical possession of the goods. 4. company no longer has significant risks and rewards of ownership of the goods. 5. customer has accepted the asset.

Imprest Petty Cash System

Requires​ that, at any point in time​, the petty cash box contains cash and petty cash tickets that total the amount of the imprest balance. This clearly identifies the amount of cash for which the custodian is responsible​, and it is the ​system's main internal control feature.

reconciliation of bank balances

Schedule explaining any differences between the bank's and the company's records of cash. Reconciling Items: 1.Deposits in transit. 2.Outstanding checks. 3.Bank charges and credits. 4.Bank or Depositor errors.

cash equivalents

Short-term, highly liquid investments that can 1. be readily converted to a specific amount of cash and which are 2. so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Examples: "short-term paper" such as Treasury bills, certificates of deposit, Commercial paper, and Money market funds (negotiable instruments). *only investments with original maturities of 3 months or less *Short-term paper investments with maturities of 3 to 12 months would be reported as short-term investments in current assets.

Effective-interest rate (market rate or effective yield)

The interest rate used in the market to determine the value of the note, also referred to as the discount rate used to determine present value.

stated (nominal or face) interest rate

The interest rate written into the notes receivable contract. The stated rate represents the cash rate of interest paid by the borrower.

bank reconciliation form

This form of reconciliation consists of two sections: 1. Balance per bank statement. 2. Balance per depositor's books. Both sections end with the same "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" section.

Using Bank Accounts

To obtain desired control objectives, a company can vary the number and location of banks and the types of accounts. - General checking account - Collection float. - Lockbox accounts - Imprest bank accounts

Sales Returns and Allowances

Transactions in which the seller either accepts goods back from the purchaser (a return) or grants a reduction in the purchase price (an allowance) so that the buyer will keep the goods. *deducted from sales revenue to equal net sales

Sale of Receivables

Under this approach, the transferor (seller) "derecognizes" (removes) the receivables 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 their fair value. *Often involves a factor.

financial components approach

Used to record a sale with recourse, where each party to the sale only recognizes the assets and liabilities that it controls after the sale. Ex in picture: Assume the same information as in Example 6.13, except that EBC sold the receivables on a with recourse basis. You determine that this recourse liability has a fair value of $6,000. QUESTION How would you determine the loss on sale of the receivables, and what entries would EBC and Blue Line make to record this type of transaction?

valuation of A/R

What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment? = dr. Bad Debt Expense ($37,650 - $800) 36,850 cr. Allowance for Doubtful Accounts 36,850

compensating balance

a minimum balance that must be maintained in a bank account, which is used to offset the cost incurred by the bank to set up a loan. - balances against short-term borrowings should be reported in current assets as "cash and cash equivalents." - balances against long-term borrowings should be reported as noncurrent assets in either the investments or other assets sections, using a caption such as "Cash on deposit maintained as ________ balance."

current expected credit loss (CECL) model

a model used to estimate credit losses (bad debts) for receivables and for debt investments that are accounted for as held to maturity or available for sale. companies look at both historical write-offs as well as forward-looking data to best estimate the total allowance for existing receivables.

promissionary note

a written promise to pay a specified amount of money on demand or at a definite time/ specific future date. Although all notes contain an interest element because of the time value of money, companies classify them as interest-bearing or non-interest-bearing.

Cash Over and Short

an income statement account that records the discrepancies between deposited amounts of actual cash received and the total of the cash register tape short (less than what it should be) = debit cash over and short account over (more than what it should be) = credit cash over and short account

restricted cash

cash that is held by a company for a specific purpose and is therefore not available for immediate general use. Ex: Petty cash, payroll, and dividend funds Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances. Companies segregate restricted cash from "regular" cash if the amount is considered material. In most situations, these fund balances are not material. Therefore, companies do not separate them from cash in the financial statements. When material in amount, companies separate 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.

trade discounts

discounts off list price of products to members of the channel of distribution who perform various marketing functions. Companies 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 percentages. - Reductions from the list price - Not recognized in the accounting records - Customers are billed net of discounts

allowance method

estimating uncollectible accounts at the end of each period. 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 uncollectibles to Bad Debt Expense and credit them to Allowance for Doubtful Accounts, a contra asset account, through an adjusting entry at the end of each period. 3. When companies write off a specific customer account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable. Losses are Estimated: -Percentage-of-receivables. -GAAP requires when material in amount.

factor

finance companies that buy receivables from businesses for a fee and then collect the payments directly from customers. can be arranged as either a: 1. sale without recourse 2. sale with recourse *sale=transfer

negotiable instrument

form of cash equivalent: a written document signed by a person who makes an unconditional promise to pay a specific sum of money on demand or at a certain time to the holder of the instrument; an acceptable medium for exchanging value from one person to another. ex: money orders, certified checks, cashier's checks, personal checks, and bank drafts.

trade receivables

notes and accounts receivable that result from sales transactions

bank overdrafts

occur when a company writes a check for more than the amount in its cash account. Companies should report these 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. *Offset against other cash accounts only when accounts are with the same bank.

Accounts Receivable

oral promises of the purchaser to pay for goods and services sold. They represent "open accounts" resulting from short-term extensions of credit. A company normally collects them within 30 to 60 days.

direct write-off method

records bad debt expense at the time a specific customer account is deemed uncollectible, is often used for tax purposes, but it is not allowed under GAAP unless the amount uncollectible is immaterial. Theoretically deficient: -No matching. -Receivable not stated at cash realizable value. -Not GAAP when material in amount. *Under this method, Bad Debt Expense will show only actual losses from uncollectibles.

Uncollectible Accounts Receivable

sales on account raise the possibility of accounts not being collected. An uncollectible account receivable is a loss of revenue that requires, through proper entry in the accounts, -a decrease in the asset accounts receivable and -a related decrease in income and stockholders' equity. - Companies record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense). - Such losses are a normal and necessary risk of doing business on a credit basis. Two methods used in accounting for uncollectible accounts: (1) the direct write-off method and (2) the allowance method.

Treasury Bills

short-term United States government obligation with a maturity of 4, 13, 26, or 52 weeks and a minimum denomination of $100

commercial paper

short-term note issued by corporations with good credit ratings. generally yield a higher rate than treasury bills.

transaction price

the amount of consideration that a company expects to receive from a customer in exchange for transferring goods or services.

cash

the most liquid of assets, is the standard medium of exchange and the basis for measuring and accounting for all other items. generally classified as a current asset. Examples consist of: 1. Coin, currency, petty cash, and available funds on deposit at the bank, such as checking and savings accounts and money market accounts with check-writing privileges. 2. Negotiable instruments such as money orders, certified checks, cashier's checks, personal checks, and bank drafts.

money market fund

type of mutual fund that uses investors' money to make short-term loans to businesses and banks. a variation of the mutual fund, the mix of treasury bills and commercial paper making up the fund's portfolio determines the yield.

Notes Receivable

written promises to pay a certain sum of money on a specified future date. They may arise from sales, financing, or other transactions. Notes may be short-term or long-term and generally include an interest component.