Intermediate 1 Class Notes Chapter 6
Intermediate 1 Class Notes Chapter 6 3310
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This 6 page Class Notes was uploaded by Emily Sears on Tuesday January 26, 2016. The Class Notes belongs to 3310 at Auburn University taught by Dr. Duane Brandon in Spring 2016. Since its upload, it has received 31 views. For similar materials see Intermediate Accounting I in Accounting at Auburn University.
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Date Created: 01/26/16
CHAPTER 6: Cash and Receivables Cash and Cash Equivalents Included in Cash: Coins and currency Checking accounts Savings accounts Negotiable checks Bank drafts Excluded fromCash: Sinking funds (L-T Investments) Certificate of deposit (S-T Investments) Bank overdrafts (Current liabilities) Postdated checks (receivable) Travel advances (prepaid expenses) Cash equivalents: short-term, highly liquid investments that are readily convertible into known amounts of cash near their maturity (90 days) when purchased (commercial paper T-bills, money market funds) Receivables Receivables- amounts owed to the company by customers and other parties arising from the company’s operations Receivables expected to be collected or satisfied within one year or the current operating cycle, whichever is longer, are classified as current assets; the remainder are classified as noncurrent Trade receivables- arise from the sale of the company’s products or services to customers. Can be classified into two categories: 1. Accounts Receivable- non-written promises to pay 2. Notes Receivable- unconditional written promises to pay Nontrade receivables- arise from transactions not directly related to the sale of products or services to customers Examples include deposits with utilities, advances to subsidiaries, loans made by nonfinancial companies, deposits made to guarantee performance, and declared dividends and accrued interest on investments Normal Revenue Recognition A company records revenue from credit sales by applying the revenue recognition principle. Revenue is recognized when a company satisfies its performance obligations to a customer. Trade receivables are normally valued and reported at Net realizable value, which is the amount that the company expects to collect in cash Trade (Quantity) Discounts Companies may offer a trade (quantity) discount for purchases in excess of certain quantity. Example – A company offers a 10% trade discount and a customer purchases 100 units of an item with a list price of $80 per unit, the customer is billed $7,200 [$8,000 – (0.10 * $8,000)] as the invoice price. This $7,200 is then subject to any cash (sales) discounts (explained on following slides). Cash (Sales) Discounts Companies may offer cash/sales discount to encourage prompt payments. Example – “2/10, n/30” 2% discount if payment is made within 10 days, otherwise the total amount is due within 30 days (net of returns and allowances) Equal to an annual effective rate > 30%! Two alternative methods may be followed when accounting for cash discounts ** (Carefully study Example 6.1 in text) ** Net Method- record net invoice price at time of sale (assume discount will be taken). If the customer does not take advantage of the discount and pays an amount greater than originally recorded, the change in transaction price will be recognized as a credit to Sales Revenue. Gross Method- record total invoice price at time of sale (assume discount will not be taken). If the customer takes advantage of the discount and pays an amount lower than originally recorded, the change in the transaction price will be recognized as a debit to Sales Revenue. Alternatively, the company may choose to use a “Sales Discounts Taken” account (contra-sales revenue account that reduces Net Sales). Sales Returns and Allowances When goods are sold that are found to be defective, the customer may return goods to the seller. The exchange is called a sales return. Alternatively, the customer may retain the goods and be allowed a reduction in the purchase price. This reduction is called a sales allowance. If material, a company should record the estimated amount of future returns and allowances in the period of sale so as to correctly report net sales revenue and value ending accounts receivable. The estimated amount is recorded as a Return Liability (which represents the company’s obligation to return the customer’s consideration). Estimated Bad DebtsMethod Bad debts represent a loss contingency that is probable and reasonably estimated, thus estimated bad debts are to be expensed. This accounting treatment correctly values receivables and matches expenses with revenues. Bad debts can be estimated based on sales or on accounts receivable: 1. Relationship to sales (income statement approach): Percentage of net credit sales 2. Relationship to accounts receivable (balance sheet approach): Percentage of outstanding accounts receivable Aging of accounts receivable Bad Debt Expense Computations Income statement approach example: ABC estimates that 2% of net credit sales will be uncollectible. Net credit sales total $525,000 for the period. Note, the Allowance account balance is ignored for purposes of computing Bad Debt Expense. Bad Debt Expense $10,500 Allowance for Bad Debts $10,500 Balance sheet approach example: ABC estimates that 4% of A/R will be uncollectible. A/R totals $475,000. The Allowance for Bad Debts account totals $4,500 (credit) before any adjustments are made. The Allowance account should be $19,000 (4% x $475,000). Thus, the Allowance account is increased by $14,500. Bad Debt Expense $14,500 Allowance for Bad Debts $14,500 Writing-Off Uncollectible Accounts When a company determines that a specific account is uncollectible, the account is written off. At the time of write-off the following entry is made: Allowance for Bad Debt $*** Accounts Receivable $*** Note, this write-off has no effect on the net realizable value of accounts receivable (ex: A/R less Allowance for Bad Debts) reported on the balance sheet. Collection of an Account Previously Written Off Occasionally, a company will receive payment from a customer whose account has been written off. The following entries should be made to account for this transaction. Step1 – Reestablish the A/R (i.e., reverse the write-off) Accounts Receivable $ ** Allowance for Bad Debts $ ** Step2 – Record the cash collection Cash $ ** Accounts Receivable $ ** Direct Write-Off Method In addition to the allowance method, the direct write-off method is a second method of recording uncollectible accounts. When a company uses the direct write off-method, it records bad debt expense when it determines that a specific customer account is uncollectible. This method isgenerally not allowed under GAAP! Financing Accounts Receivable There are two basic forms of financing agreements to obtain cash from accounts receivable. These forms are evaluated on a continuum based on (1) transfer of risks of ownership and (2) control over the benefits of the receivables: 1. Secured Borrowing- usually retains some of the risks and benefits (assigned/pledging the recourse) 2. Factoring (sale)- transfer all risks and benefits of ownership (sale without recourse) 3. Securitization (sales)- transfer A/R to another entity who uses them for collateral for financial securities it sells These agreements should be disclosed parenthetically or in the notes to the financial statements Notes Receivable A note receivable is unconditional written agreement that gives the holder the right to collect a certain sum of money on a specific date Notes receivable generally have two attributes that are not found in accounts receivable. 1. They are negotiable instruments, which means that they are legally and readily transferable among parties and may be used to satisfy debts by the holders of these instruments. 2. They usually involve interest, requiring the separation of the receivable into its principle and interest components. A company may receive two types of short-term notes: 1. Interest bearing- the amount borrowed (principle) is listed as the face value, and the interest charged is stated as a specific rate applied to this face value 2. Non-interest bearing- the maturity value (the amount to be collected, including implicit interest and principal) is listed as the face value. Note, the title “non-interest bearing note” is misleading because all notes carry interest. These types of notes are sometimes referred to as “notes without a stated interest rate.” Non-interest Bearing Notes Receivable E.g., ABC Corp. receives a $1,000, 60-day non-interest bearing note from a customer. The current market rate of interest on similar notes is 12%. Assume a 360-day year. Implied principle = $1,000 – [$1,000 x 0.12 x 60/360)] = $980 Date of sale - Notes Rec. $1,000 Discount on Notes Rec. $ 20 Sales $ 980 Collection - Cash $ 1,000 Discount on Notes Rec. $ 20 Interest Revenue $ 20 Notes Rec. $1,000 Note, the “Discount on Notes Rec.” account is a contra-Notes Receivable account. Notes Receivable Sales/ assignments of Notes Receivable- when a company sales or assigns a customer’s note receivable at the bank, it transfers the note to the bank in exchange for cash. The financing arrangement is subject to the conditions of FASB Statement No. 140. If all the conditions are met, the arrangement is treated as a sale. Otherwise, the arrangement is treated as an assignment Petty Cash A petty cash system involves a cash fund under the control of an employee that enables a company to pay small amounts that might be impractical or impossible to pay by check. The design and operation of this system involves the following: 1) Assign custodian and establish fund Petty Cash $300 Cash (in bank) $300 2) Payments are made from petty cash. Pre-numbered vouchers are completed as evidence of the expenditures. Journal entries are not made at the time of the payments. 3) When cash becomes low or at the end of the accounting period, vouchers are used to record expenses. A “Cash Short and Over” account (a miscellaneous expense/ revenue account used for control purposes) is used to record any shortage (debit balance) or overage (credit balance) Bank Reconciliation Bank Reconciliation- schedule that a company prepares to analyze the difference between the ending cash balance in its accounting records and the ending cash balance reported by its bank in a bank statement Differences can arise from the following: 1. Outstanding checks 2. Deposits in transit 3. Charges made directly by the bank 4. Deposits made directly by the bank 5. Errors (Note, bank errors [company errors] are considered the bank’s [company’s] responsibility and do not [do] require AJEs)
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