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  2. Cash and Cash Equivalents Cash Currency and coins Balances incurrent bank accounts Items for deposit such as checks and money orders from customers Cash equivalents are short-term, highly liquid investments that can be readily converted to cash. Money marketfunds Treasury bills Commercialpaper

  3. Internal Control Encourages adherence to company policiesand procedures Promotes operational efficiency Minimizes errorsand theft Enhances the reliability and accuracy of accounting data

  4. Internal Control Procedures 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.

  5. Restricted Cash andCompensating Balances Restricted Cash Management’s intent to use a certain amountof cash for a specific purpose – future plant expansion, future payment of debt. Compensating Balance Minimum balance that must bemaintained in a company’s bankaccount as support for fundsborrowed from the bank.

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

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

  8. Cash Discounts increase sales encourage early payment Cash discounts increase likelihood of collections

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

  10. Cash Discounts Gross Method Net Method Sales are recorded at theinvoice amount less the discount. Sales are recorded at the invoice amounts. Sales discounts are recorded as reduction of revenue if payment is receivedwithinthe discount period. Sales discounts forfeited are recordedas interest revenue if payment is receivedafter the discount period.

  11. Cash 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.

  12. Sales Returns A special price reduction, called an allowance, may be given as an incentive to keep the merchandise. Merchandise may be returned by a customer to a supplier. 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.

  13. 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 10% return rate. During the year $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment. Actual Returns Sales returns 130,000 Accounts receivable 130,000 Inventory 78,000 Cost of goods sold (60%) 78,000 Adjusting Entries Sales returns 70,000 Allowance for sales returns 70,000 Inventory-estimated returns 42,000 Cost of goods sold (60%) 42,000

  14. Subsequent valuation of AR: The Incurred Loss Model

  15. The Incurred Loss Model

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

  17. On November 1, 2013, West, Inc. loans $25,000 to Winn Co. The note bears interest at 12% and is due on November 1, 2014. Prepare the journal entry on November 1, 2013, December 31, 2013, (year-end) and November 1, 2014 for West. Interest-Bearing Notes November 1, 2013 Notes receivable 25,000 Cash 25,000 December 31, 2013 Interest receivable 500 Interest revenue 500 November 1, 2014 Cash 28,000 Note receivable 25,000 Interest receivable 500 Interest revenue 2,500

  18. Noninterest-Bearing Notes • Actually do bear interest. • Interest is deducted (discounted) from the face value of the note. • Cash proceeds equal face value of note less discount.

  19. On Jan. 1, 2013, 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, 2013. Prepare the journal entries on Jan. 1, 2013, and Dec. 31, 2013. Noninterest-Bearing Notes January 1, 2013 Notes receivable 25,000 Discount on notes receivable 3,000 Sales revenue 22,000 ($25,000 * 12% = $3,000) December 31, 2013 Cash 25,000 Discount on notes receivable 3,000 Interest revenue 3,000 Note receivable 25,000

  20. Subsequent valuation of NR: Impairment

  21. Subsequent valuation of NR: When Receivable is Continued but with Modified Terms 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.

  22. Subsequent valuation of NR: When Receivable is Settled Outright

  23. U.S. GAAP vs. IFRS 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. In the years between 2010 and 2014, 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. • 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 statement of financial position or notes.

  24. Financing With Receivables Companies may use their receivables to obtain immediate cash. Secured Borrowing Sale of Receivables

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

  26. Secured Borrowing

  27. Sale of Receivables Treat as a sale only if the conditions for derecognition, under IFRS No. 9 and IAS No. 39, can be met. Yes Rights to cash flows from the receivables expire? NO Yes Yes Transfer rights to receive cash flows from the receivables? Transfer substantially all the risks and reward of the receivables? NO NO Yes Assume obligations to pay cash flows that meet three conditions? Retain substantially all the risks and rewards of the receivables? NO NO NO Retain control of the receivables? Yes Continue to recognize the receivables Derecognize the receivables Continuing Investment

  28. Sale of Receivables Withoutrecourse • 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.

  29. 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% 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 sold the receivables to Factor with recourse and estimates the fair value of the recourse obligation to be $5,000.

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

  31. $200,000 × 10% × 3/12 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. Before preparing the journal entry to record the discounting, Stridewell must record the accrued interest on the note from December 31 until March 31. Interest receivable 5,000 Interest revenue 5,000

  32. $205,000 - $202,100 Transfers of Notes Receivable Cash 202,100 Loss on sale of note receivable 2,900 Notes receivable 200,000 Interest receivable 5,000

  33. U.S. GAAP vs. IFRS 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. • U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee.

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

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

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

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

  38. PAST DUE Appendix 7-B: Methods for Estimating Future Bad Debts Bad debtsresult from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts. In conformity with thematching principle,bad debt expense should be recorded in thesameaccounting period in which the sales related to the uncollectible account were recorded.

  39. Most businesses record anestimateof thebad debt expenseby an adjusting entry at the end of the accounting period. Normally classified asaselling expenseandclosed at year-end. Contra assetaccount toAccounts Receivable. Appendix 7-B: Methods for Estimating Future Bad Debts Bad debt expense xxx Allowance for uncollectible accounts xxx

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

  41. Income Statement Approach • Focuses on pastcredit salesto make estimate of bad debt expense. • Emphasizes thematching principleby estimating thebad debt expenseassociated with the current period’s credit sales. Bad debt expense is computed as follows:

  42. Income Statement Approach In 2013, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit sales are uncollectible. What is Bad Debt Expense for 2013? MusicLand computes estimated Bad Debt Expense of $2,400. Bad debt expense 2,400 Allowance for uncollectible accounts 2,400

  43. Focuses on the collectability of accounts receivable to make the estimate of uncollectible accounts. Involves the direct computation of the desired balance in the allowance for uncollectible accounts. Balance Sheet Approach • Compute the desired balance in the Allowance for Uncollectible Accounts. • Bad Debt Expense is computed as:

  44. Balance Sheet ApproachComposite Rate On Dec. 31, 2013, MusicLand has$50,000 in Accounts Receivable and a$200 credit balance in Allowance for Uncollectible Accounts. Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Bad Debt Expense for 2013?

  45. Balance Sheet ApproachComposite Rate Desired balance in Allowancefor Uncollectible Accounts Bad debt expense 2,300 Allowance for uncollectible accounts 2,300

  46. Balance Sheet Approach Aging of Receivables • Year-end Accounts Receivable is broken down into age classifications. • Each age grouping has a different likelihood of being uncollectible. • Compute desired uncollectible amount. • Compare desired uncollectible amount with the existing balance in theallowance account.

  47. Balance Sheet Approach Aging of Receivables At December 31, 2013, the receivables for EastCo, Inc. were categorized as follows:

  48. Balance Sheet Approach Aging of Receivables • EastCo’s unadjusted balance in the allowance account is $500. • Per the previous computation, the desired balance is $1,350. Bad debt expense 850 Allowance for uncollectible accounts 850

  49. Uncollectible Accounts As accounts become uncollectible, this entry is made: Allowance for uncollectible accounts 500 Accounts receivable 500 When a customer makes a payment after an account has been written off, two journal entries are required. Accounts receivable 500 Allowance for uncollectible accounts 500 Cash 500 Accounts receivable 500

  50. Direct Write-off Method If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account). Bad debts expense xxx Accounts receivable xxx