1. Cash and Receivables Chapter 7

2. Learning Objectives 1. Define internal control and describe some key elements of an internal control system for cash receipts and disbursements. SELF-STUDY 2. Explain the possible restrictions on cash and their implications for classification on the balance sheet. 3. Distinguish between the gross and net method of accounting for cash discounts. 4. Describe the accounting treatment for merchandise returns. 5. Describe the accounting treatment of anticipated uncollectible accounts receivable. 6. Describe the two approaches to estimating bad debts. 7. Describe the accounting treatment of short-term notes receivable. 8. Differentiate between the use of receivables in financing arrangements accounted for as a secured borrowing and those as a sale. 9. Describe the variables that influence a company’s investment in receivables and calculate the key ratios. 10. Discuss the primary differences between U.S. GAAP and IFRS with respect to cash and receivables.

3. Cash and Cash Equivalents Balances in checking accounts Currency and coins Cash equivalents are short-term, highly liquid investments that can be readily converted to cash. Money market funds Treasury bills Commercial paper Cash Items for deposit such as checks and money orders from customers

4. Cash and Cash Equivalents Cash Currency, coins and amounts on deposit in bank accounts: checking accounts, and many savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders. Cash Currency, coins and amounts on deposit in bank accounts: checking accounts, and many savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders. Cash Equivalents Short-term, highly liquid investments that are: 1.Readily convertible to a known cash amount. 2.That have an original maturity date of three months or less from the date of purchase 3.US Treasury Bills & Notes: 3-month maturity. 4. 3-month CDs and Money Market Funds Cash Equivalents Short-term, highly liquid investments that are: 1.Readily convertible to a known cash amount. 2.That have an original maturity date of three months or less from the date of purchase 3.US Treasury Bills & Notes: 3-month maturity. 4. 3-month CDs and Money Market Funds 6-4

5. Cash & Cash Equivalents On Dec. 31, 2010, ABC Co's total CASH COUNT= $1,000,000 The following items are included in the CASH COUNT:  Petty cash funds=$12,000,  Customers Checks =$3,000,  Coins =$1,000 and  Stamps =$100. The following items are not included in cash count:  -Three-month CD: $10,000  -Two-month Treasury Note (Bill): $7,000 Required: Prepare the Current Assets Section of the Balance Sheet

6. Restricted Cash and Compensating Balances Restricted Cash Management’s intent to use a certain amount of cash for a specific purpose – future plant expansion, future payment of debt. Compensating Balance Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank. Restricted Cash Management’s intent to use a certain amount of cash for a specific purpose – future plant expansion, future payment of debt. Compensating Balance Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank.

7. Cash & Cash Equivalents, Restricted Cash and Compensating Balances Exercise 7–1

8. Cash & Cash Equivalents, Restricted Cash and Compensating Balances Exercise 7–1: Requirement 1 a.Balance in checking account$13,500 Balance in savings account 22,100 b.Un-deposited customer checks 5,200 c.Currency and coins on hand 580 f.U.S. treasury bills with 2-month maturity 15,000 Total$56,380 Requirement 2 d. The $400,000 savings account will be used for future plant expansion and therefore should be classified as a noncurrent asset, either in investments & Funds. e. The $20,000 in the checking account is a compensating balance for a long-term loan and should be classified as a noncurrent asset, either in investments & Funds. f. The $20,000 in 7-month treasury bills should be classified as a current asset along with other temporary investments.

9. Cash & Cash Equivalents, Restricted Cash and Compensating Balances RED WING CORPORATION Partial Balance Sheet As of December 31, 2013 Current Assets: Cash and cash equivalents$56,380 Marketable Securities 20,000 Investments and Funds: Plant Expansion Fund400,000 Loan Compensating Fund 20,000

10. U.S. GAAP vs. IFRS  Bank overdrafts are treated as liabilities. In general, cash and cash equivalents are treated similarly under IFRS and U.S. GAAP. One difference is highlighted below.  Bank overdrafts may be offset against other cash accounts. Exercise 4

11. Internal Control (SELF-STUDY) Encourages adherence to company policies and procedures Promotes operational efficiency Minimizes errors and theft Enhances the reliability and accuracy of accounting data

12. Internal Control Procedures (SELF-STUDY) Cash Receipts  Separate responsibilities for receiving cash, recording cash transactions, and reconciling cash balances.  Match the amount of cash received with the amount of cash deposited.  Close supervision of cash-handling and cash-recording activities. Cash Receipts  Separate responsibilities for receiving cash, recording cash transactions, and reconciling cash balances.  Match the amount of cash received with the amount of cash deposited.  Close supervision of cash-handling and cash-recording activities. Cash Disbursements  All disbursements, except petty cash, made by check.  Separate responsibilities for cash disbursement documents, check authorization, check signing, and record keeping.  Checks should be signed only by authorized individuals. Cash Disbursements  All disbursements, except petty cash, made by check.  Separate responsibilities for cash disbursement documents, check authorization, check signing, and record keeping.  Checks should be signed only by authorized individuals.

13. Internal Control Procedures PETTY CASH ACCOUNTING BANK RECONCILIATION

14. Petty cash is used for minor expenditures. Has one custodian. Replenished periodically. Petty cash fund Appendix 7-A: Cash Controls

15. Petty Cash System of Control Small payments required in most companies for items such as postage, courier fees, repairs and supplies. Internal Control requires that companies pay for these small amounts from Petty Cash Fund. Small payments required in most companies for items such as postage, courier fees, repairs and supplies. Internal Control requires that companies pay for these small amounts from Petty Cash Fund. P2 6-15

16. Operating a Petty Cash Fund Petty Cash Company Cashier Petty Cashier Accountant P2 6-16

17. Petty Cash Operating a Petty Cash Fund Petty Cashier P2 6-17

18. 39¢ Stamps $45 Courier $80 Operating a Petty Cash Fund Petty Cashier A petty cash fund is used only for business expenses. P2 6-18

19. Operating a Petty Cash Fund Receipts Petty cash receipts with either no signature or a forged signature usually indicate misuse of petty cash. Petty Cashier 39¢ Stamps $45 Courier $80 P2 6-19

20. Receipts Company Cashier $125 To reimburse petty cash fund Use a Cash Over and Short account if needed. Use a Cash Over and Short account if needed. Operating a Petty Cash Fund Petty Cashier Accountant P2 6-20

21. Operating a Petty Cash Fund Sometimes, the petty cash receipts plus the cash remaining will not total to the fund balance. i. A shortage is recorded as an expense in the reimbursing entry with a debit to the Cash Over and Short account. ii. An overage is recorded with a credit to the Cash Over and Short account in the reimbursing entry.

22. Petty Cash Example Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses $79.30 Customer Business Lunches 93.42 Express Mail Postage 55.00 Miscellaneous Office Supplies 32.48 $260.20 Let’s look at replenishing the fund if the Cash Balance on July 31 was $137.80. Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July: Travel Expenses $79.30 Customer Business Lunches 93.42 Express Mail Postage 55.00 Miscellaneous Office Supplies 32.48 $260.20 Let’s look at replenishing the fund if the Cash Balance on July 31 was $137.80. P2 6-22

23. Petty Cash Example What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 P2 6-23

24. Petty Cash Example What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 What amount of cash will be required to replenish the petty cash fund? a.$260.20 b.$262.20 c.$139.80 d.$137.80 Let’s prepare the journal entry to replenish the petty cash fund. P2 6-24

25. Petty Cash Example Journal entry to replenish petty cash fund P2 6-25

26. EXERCISE 26, 27

27. Appendix 7-A: Cash Controls Bank Balance + Deposits in Transit - Outstanding Checks ± Bank Errors = Corrected Balance Book Balance + Bank Collections - Service Charges - NSF Checks ± Book Errors = Corrected Balance Provides information for reconciling journal entries. A bank reconciliation explains the difference between cash reported on bank statement and cash balance on a company’s books.

28. Bank Statement Once a month, the bank sends each depositor a bank statement showing activities of a bank account. A bank statement includes, at least, the following: 1. Beginning cash balance per bank; 2. Check & other debits decreasing the balance; 3. Deposits & other credits increasing the balance; 4. Ending cash balance per bank.

30. Bank Reconciliation A bank reconciliation is prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on company’s books. Why are the balances different? Why are the balances different? * P3 6-30

31. Reconciling Items Bank Statement Balance Add: Deposits in transit. Deduct: Outstanding Checks Add or Deduct: Bank errors. Adjusted Bank Balance Bank Statement Balance Add: Deposits in transit. Deduct: Outstanding Checks Add or Deduct: Bank errors. Adjusted Bank Balance Book Balance Add: Collections made by the bank. Add: Interest earned on checking account. =>CM Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge =>DM Add or Deduct: Book errors Adjusted Book Balance. Book Balance Add: Collections made by the bank. Add: Interest earned on checking account. =>CM Deduct: Nonsufficient funds check (NSF). Deduct: Bank service charge =>DM Add or Deduct: Book errors Adjusted Book Balance. 6-31

32. Reconciling Items Identify and list any unrecorded Debit Memoranda (DM) from the bank for NSF Checks, service charges, and errors over­ stating the book balance. => Deduct them from the book balance. Identify and list any unrecorded Credit Memoranda (CM) from the bank for interest, collections, and errors under­stating the book balance. => Add them to the book balance.

33. Bank Reconciliation Two sections: 1. Reconcile bank statement balance to the adjusted bank balance. 2. Reconcile book balance to the adjusted book balance. The adjusted balances should be equal. Two sections: 1. Reconcile bank statement balance to the adjusted bank balance. 2. Reconcile book balance to the adjusted book balance. The adjusted balances should be equal. P3 6-33

34. Bank Reconciliation Example Let’s prepare a July 31 bank reconciliation statement for the Simmons Company.  The July 31 bank statement indicated a balance of $9,610.  The cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen. Let’s prepare a July 31 bank reconciliation statement for the Simmons Company.  The July 31 bank statement indicated a balance of $9,610.  The cash general ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next screen. P3 6-34

35. Bank Reconciliation Example 1. Outstanding checks totaled $2,417. 2. A $500 check mailed to the bank for deposit had not reached the bank at the statement date. 3. The bank returned a customer’s NSF check for $225 received as payment on account receivable. 4. The bank statement showed $30 interest earned during July. 5. Check No. 781 for supplies expense cleared the bank for $268 but was erroneously recorded in our books as $240. 6. A $486 deposit by Acme Company was erroneously credited to our account by the bank. 6-35

36. Bank Reconciliation Example P3 6-36

37. Recording Adjusting Entries from a Bank Reconciliation Only amounts shown on the book portion of the reconciliation require an adjusting entry. P3 6-37

38. Recording Adjusting Entries from a Bank Reconciliation After posting the reconciling entries the cash account looks like this: Adjusted balance on July 31. P3 6-38

39. Exercises 28, 29

40. Accounts Receivable Result from the credit sales of goods or services to customers. Are classified as current assets. Are recorded net of trade discounts.

41. Trade Discounts Used by manufacturers and wholesalers to offer better prices for greater quantities purchased. Used by manufacturers and wholesalers to offer better prices for greater quantities purchased. Example Matrix, Inc. offers a 30% trade discount on orders of 1,000 units or more of their popular product Racer. Each Racer has a list price of $5.25. Example Matrix, Inc. offers a 30% trade discount on orders of 1,000 units or more of their popular product Racer. Each Racer has a list price of $5.25. P1 4-41

42. increase sales encourage early payment increase likelihood of collections Cash discounts Cash (Sales) Discounts

43. A deduction from the invoice price granted to induce early payment of the amount due. Terms Time Due Discount Period Due: Invoice price minus discount Credit Period Due: Full Invoice Price Date of Invoice P1 4-43

44. 2/10,n/30 Number of days discount is available Otherwise, net (or all) is due Credit period Discount percent Cash (Sales) Discounts

45. When Discount is Not Taken If we fail to take a 2/10, n/30 discount, is it really expensive? 365 days ÷ 20 days × 2% = 36.5% annual rate Days in a year Days in a year Number of additional days before payment Number of additional days before payment Percent paid to keep money Percent paid to keep money P1 4-45

46. Cash (Sales) Discounts Sales are recorded at the invoice amounts. Sales discounts are recorded as reduction of revenue if payment is received within the discount period. Gross Method Net Method

47. Cash (Sales) Discounts On October 5, Hawthorne sold merchandise for $20,000 with terms 2/10, n/30. On October 14, the customer sent a check for $13,720 taking advantage of the discount to settle $14,000 of the amount. On November 4, the customer paid the remaining $6,000.

48. Cash (Sales) Discounts Exercise 5 (1 & 2) and Exercise 6

49. Merchandise may be returned by a customer to a supplier. A special price reduction, called an allowance, may be given as an incentive to keep the merchandise. Sales Returns To avoid misstating the financial statements, sales revenue and accounts receivable should be reduced by the amount of returns in the period of sale if the amount of returns is anticipated to be material.

50. Accounting for Merchandise Sales Sales discounts and returns and allowances are Contra Revenue accounts. P2 4-50

51. Sales Returns During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). Industry experience indicates a10% return rate. During the year $130,000 was returned prior to customer payment. Record all necessary Journal Entries including YE adjustment. Accounts Receivable 2,000,000 Sales 2,000,000 Cost of Goods Sold 1,200,000 Inventory 1,200,000 Actual Returns Sales returns (I/S Account) 130,000 Accounts receivable 130,000 Inventory 78,000 Cost of goods sold (60%) 78,000 Adjusting Entries Sales returns (200,000 – 130,000) 70,000 Allowance for sales returns (B/S Account) 70,000 Inventory  estimated returns 42,000 Cost of goods sold (60%) 42,000

52. Sales Returns Exercise 8

53. Uncollectible Accounts Receivable Bad debts result from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts. In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in which the sales related to the uncollectible account were recorded.

54. Uncollectible Accounts Receivable Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period. Bad debt expensexxx Allowance for uncollectible accounts xxx Contra asset account to accounts receivable. Normally classified as a selling expense and closed at year-end.

55. Allowance for Uncollectible Accounts Net realizable value is the amount of the accounts receivable that the business expects to collect. Accounts Receivable Less: Allowance for Uncollectible Accounts Net Realizable Value Accounts Receivable Less: Allowance for Uncollectible Accounts Net Realizable Value  Income Statement Approach  Balance Sheet Approach  Composite Rate  Aging of Receivables  Income Statement Approach  Balance Sheet Approach  Composite Rate  Aging of Receivables

56. Two Methods 1.Percent of Sales Method (Income Statement) 2. Accounts Receivable Methods (Balance Sheet) l Percent of Accounts Receivable Method l Aging of Accounts Receivable Method Two Methods 1.Percent of Sales Method (Income Statement) 2. Accounts Receivable Methods (Balance Sheet) l Percent of Accounts Receivable Method l Aging of Accounts Receivable Method Allowance Method of estimating Bad Debts Expenses 7-56

57. Barton has credit sales of $1,400,000 in 2009. Management estimates 0.5% of credit sales will eventually prove uncollectible. What is Barton’s Bad Debts Expense for 2009? Percent of Sales Metho d Bad debts expense is computed as follows: 7-57

58. Barton’s accountant computes estimated Bad Debts Expense of $7,000. Percent of Sales Method P2 7-58

59. Percent of Sales Method Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on Dec.31, 2009. What is the balance in AFDA on Dec. 31, 2009? Prepare the ‘T’ accounts for A/R and AFDA showing the balances as of 12/31/09.

60. Percent of Sales Method (Income Statement Approach) Exercise 10

61.  Compute the estimate of the Allowance for Doubtful Accounts:  Bad Debts Expense is computed as: Percent of Accounts Receivable Method 7-61

62. Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009. Past experience suggests that 4% of receivables are uncollectible. What is the balance in AFDA on Dec. 31, 2009? What is Barton’s Bad Debts Expense for 2009? Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009. Past experience suggests that 4% of receivables are uncollectible. What is the balance in AFDA on Dec. 31, 2009? What is Barton’s Bad Debts Expense for 2009? Percent of Accounts Receivable 7-62

63. Desired balance in Allowance for Doubtful Accounts. Percent of Accounts Receivable 7-63

64. Percent of Accounts Receivable

65. Exercise 11, 12, 13

66.  Each receivable is grouped by how long it is past its due date.  Estimated bad debts for each group are totaled. Aging of Accounts Receivable Method  Each age group is multiplied by its estimated bad debts percentage. 7-66

67.   Aging of Accounts Receivable     P2 7-67

68. Barton’s unadjusted balance in the allowance account is $900. We estimated the proper balance to be $5,320. Barton’s unadjusted balance in the allowance account is $900. We estimated the proper balance to be $5,320. Aging of Accounts Receivable P2 7-68

69. Percent of Accounts Receivable Method (AGING of A/R) Problem 1, 4(c)

70. With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts. Writing Off a Bad Debt under the Allowance Method Barton determines that Martin’s $300 account is uncollectible. 7-70

71. Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded. Recovery of a Bad Debt P2 7-71

72. Summary of Measurement and Reporting Issues for Accounts Receivable Recognition Depends on the earnings process; for most credit sales, revenue and the related receivables are recognized at the point of delivery. Initial valuation Initially recorded at the exchange price agreed upon by the buyer and seller. Subsequent valuation Initial valuation reduced to net realizable value by: 1. Allowance for sales returns 2. Allowance for uncollectible accounts:  The income statement approach  The balance sheet approach Classification Almost always classified as a current asset.

73. Notes Receivable A written promise to pay a specific amount at a specific future date. Even for maturities less than 1 year, the rate is annualized.

74. Interest-Bearing Notes On November 1, 2014, West, Inc., loans $25,000 to Winn Co. The note bears interest at 12% and is due on November 1, 2015. Prepare the journal entry on November 1, 2014, December 31, 2014, (year-end) and November 1, 2015, for West. November 1, 2014 Notes receivable 25,000 Cash 25,000 December 31, 2014 Interest receivable 500 Interest revenue 500 November 1, 2015 Cash 28,000 Note receivable 25,000 Interest receivable 500 Interest revenue 2,500

75. Interest-Bearing Notes Exercise 14

76. Noninterest-Bearing Notes  Actually do bear interest.  Interest is deducted (discounted) from the face value of the note.  Cash proceeds or Sales Value equal face value of note less discount.

77. Noninterest-Bearing Notes On Jan. 1, 2014, West, Inc., accepted a $25,000 noninterest bearing note from Winn Co. as payment for a sale. The note is discounted at 12% and is due on Dec. 31,2014. Prepare the journal entries on Jan. 1, 2014, and Dec. 31, 2014. On Jan. 1, 2014, West, Inc., accepted a $25,000 noninterest bearing note from Winn Co. as payment for a sale. The note is discounted at 12% and is due on Dec. 31,2014. Prepare the journal entries on Jan. 1, 2014, and Dec. 31, 2014. January 1, 2014 Notes receivable 25,000 Discount on notes receivable *3,000 Sales revenue (Cash) 22,000 *($25,000 * 12% = $3,000) December 31, 2014 Cash 25,000 Discount on notes receivable 3,000 Interest revenue 3,000 Note receivable25,000 ***Effective Interest Rate = (3,000 / 22,000) = 13.64%

78. Noninterest-Bearing Notes Exercise 15

79. U.S. GAAP vs. IFRS  U.S. GAAP allows a “fair value option” for accounting for receivables.  U.S. GAAP does not allow receivables to be accounted for as “available for sale” investments.  U.S. GAAP requires more disaggregation of accounts and notes receivable in the balance sheet or notes. In general, IFRS and U.S. GAAP are very similar with respect to accounts receivable and notes receivable. Differences are highlighted below.  IFRS restricts the circumstances in which a “fair value option” for accounting for receivables is allowed.  Until 2015, companies may account for receivables as “available for sale” investments if the approach is elected initially. After January 1, 2015, this treatment is no longer allowed.

80. Financing with Receivables (Not Covered) Companies may use their receivables to obtain immediate cash.

81. Factoring Arrangements FACTOR (Transferee) SUPPLIER (Transferor) RETAILER 1. Merchandise 2. Accounts Receivable 3. Accounts Receivable 4. Cash 5. Cash A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables, and charges a fee for the service.

82. Secured Borrowing On December 1, 2013, the Santa Teresa Glass Company borrowed $500,000 from Finance Bank and signed a promissory note. Interest at 12% is payable monthly. The company assigned $620,000 of its receivables as collateral for the loan. Finance Bank charges a finance fee equal to 1.5% of the accounts receivable assigned. Cash (difference) 490,700 Finance charge expense (1.5% * $620,000) 9,300 Liability – financing arrangement 500,000 Santa Teresa Glass will continue to collect the receivables, and will record any discounts, sales returns, and bad debt write-offs, but will remit the cash to Finance Bank, usually on a monthly basis. When $400,000 of the receivables assigned are collected in December, Santa Teresa Glass records the following entries. Cash 400,000 Accounts receivable 400,000 Interest expense ($500,000 * 12% * 1/12) 5,000 Liability – financing arrangement 400,000 Cash405,000

83. Sale of Receivables Treat as a sale if all of these conditions are met:  receivables are isolated from transferor.  transferee has right to pledge or exchange receivables.  transferor does not have control over the receivables.  Transferor cannot repurchase receivable before maturity.  Transferor cannot require return of specific receivables. Treat as a sale if all of these conditions are met:  receivables are isolated from transferor.  transferee has right to pledge or exchange receivables.  transferor does not have control over the receivables.  Transferor cannot repurchase receivable before maturity.  Transferor cannot require return of specific receivables.

84. Sale of Receivables Without recourse  An ordinary sale of receivables to the factor.  Factor assumes all risk of uncollectibility.  Control of receivable passes to the factor.  Receivables are removed from the books, fair value of cash and other assets received is recorded, and a financing expense or loss is recognized. Without recourse  An ordinary sale of receivables to the factor.  Factor assumes all risk of uncollectibility.  Control of receivable passes to the factor.  Receivables are removed from the books, fair value of cash and other assets received is recorded, and a financing expense or loss is recognized. With recourse  Transferor (seller) retains risk of uncollectibility.  If the transaction fails to meet the three conditions necessary to be classified as a sale, it will be treated as a secured borrowing. With recourse  Transferor (seller) retains risk of uncollectibility.  If the transaction fails to meet the three conditions necessary to be classified as a sale, it will be treated as a secured borrowing.

85. Sale of Receivables In December 2013, the Santa Teresa Glass Company factored accounts receivable that had a book value of $600,000 to Factor Bank. The transfer was made without recourse. Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor, and Factor immediately remits to Santa Teresa cash equal to 90% of the factored amount (90% × $600,000 = $540,000). Factor retains the remaining 10% (estimated to have a fair value of $50,000) to cover its factoring fee (equal to 4% of the total factored amount; 4% × $600,000 = $24,000) and to provide a cushion against potential sales returns and allowances. Assume the same facts as above, except that Santa Teresa Glass sold the receivables to Factor with recourse and estimates the fair value of the recourse obligation to be $5,000.

86. Sale of Receivables Securitization: Transfer receivables to a SPE Special Purpose Entity (SPE) Qualifying Special Purpose Entity (QSPE) New rules eliminate QSPE and require consolidation! Participating Interests: Transfer portion of a receivable Example: transfer right to interest, but retain right to principal New rules require a partial transfer be treated as a secured borrowing, unless specific conditions are met!

87. Interest receivable 5,000 Interest revenue 5,000 Transfers of Notes Receivable On December 31, Stridewell accepted a nine-month 10 percent note for $200,000 from a customer. Three months later on March 31, Stridewell discounted the note at its local bank. The bank’s discount rate is 12 percent. $200,000 × 10% × 3/12 Before preparing the journal entry to record the discounting, Stridewell must record the accrued interest on the note from December 31 until March 31.

88. Transfers of Notes Receivable Cash 202,100 Loss on sale of note receivable 2,900 Notes receivable 200,000 Interest receivable 5,000 $205,000  $202,100

89. Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowing

90. U.S. GAAP vs. IFRS  U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee. The U.S. GAAP and the IFRS approaches often lead to similar accounting treatment for transfers of receivables.  IFRS requires a more complex decision process. The company has to have transferred the rights to receive the cash flows from the receivable, and then considers whether the company has transferred “substantially all of the risks and rewards of ownership,” as well as whether the company has transferred control.

91. This ratio measures how many times a company converts its receivables into cash each year. Net Sales Average Accounts Receivable Receivables Turnover Ratio = This ratio is an approximation of the number of days the average accounts receivable balance is outstanding. 365 Receivables Turnover Ratio Average Collection Period = Receivables Management

92. Symantec Corp. vs. CA, Inc., comparison Receivables Management (All dollar amounts in millions)

93. When a company holds a receivable from another company, there is some potential that the receivable will eventually be impaired. Impairment of a receivable occurs if the company believes it is probable that it will not receive all of the cash flows (principal and any interest payments) associated with the receivable. Appendix 7-B: Accounting for Impairment of a Receivable and a Troubled Debt Restructuring

94. Bad debt expense 8,867,670 Accrued interest receivable 3,000,000 Allowance for uncollectible accounts 5,867,670 ($30,000,000 - $24,132,330)

95. Appendix 7-B: Accounting for Impairment of a Receivable and a Troubled Debt Restructuring A troubled debt restructuring occurs when a creditor makes concessions in response to a debtor’s financial difficulties. (in millions) Land (fair value) 20 Bad debt expense 13 Accrued interest receivable 3 Notes receivable 30 Sometimes a receivable in a troubled debt restructuring is actually settled at the time of the restructuring by the debtor making a payment of cash, some other noncash assets, or even shares of the debtor’s stock.

96. U.S. GAAP vs. IFRS  Under U.S. GAAP the level of analysis is individual receivables.  U.S. GAAP provides an illustrative list of information to consider when evaluating receivables for impairment, and requires measurement of potential impairment if impairment (a) is viewed as probable and (b) can be estimated reliably.  Both U.S. GAAP and IFRS treat reversal of impairments the same. The U.S. GAAP and the IFRS approaches to impairments of receivables are similar, but the process and criteria are somewhat different.  Under IFRS the level of analysis starts with consideration of impairment for individually significant receivables.  IFRS provides an illustrative list of “loss events” and requires measurement of an impairment if there is objective evidence that a loss event has occurred that has an impact on the future cash flows collected and that can be estimated reliably.  Both U.S. GAAP and IFRS treat reversal of impairments the same.

97. End of Chapter 7