Intermediate accounting 15e kieso warfield chapter 07

Explain accounting issues related to recognition and valuation of notes receivable.7.. Explain accounting issues related to disposition of accounts and notes receivable.. Explain account

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F I F T E E N T H E D I T I O N

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PREVIEW OF CHAPTER 7

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6 Explain accounting issues related to recognition and valuation of notes receivable.

7 Explain the fair value option.

8 Explain accounting issues related to disposition of accounts and notes receivable.

9 Describe how to report and analyze

After studying this chapter, you should be able to:

Cash and Receivables

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LEARNING OBJECTIVES

1 Identify items considered cash.

2 Indicate how to report cash and related

items.

3 Define receivables and identify the

different types of receivables.

4 Explain accounting issues related to

recognition of accounts receivable.

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 Most liquid asset.

 Standard medium of exchange

 Basis for measuring and accounting for all items.

 Current asset.

 Examples: coin, currency, available funds on deposit at

the bank, money orders, certified checks, cashier’s checks,

Cash

What is Cash?

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8 Explain accounting issues related to disposition of accounts and notes receivable.

9 Describe how to report and analyze

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recognition of accounts receivable.

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Short-term, highly liquid investments that are both

Cash

Cash Equivalents

a) readily convertible to cash, and

b) so near their maturity that they present insignificant

risk of changes in value.

Reporting Cash

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Companies segregate restricted cash from “regular” cash.

Examples, restricted for:

(1) plant expansion, (2) retirement of long-term debt, and (3)

compensating balances

Reporting Cash

Restricted Cash

Illustration 7-1

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Company writes a check for more than the amount in its

cash account.

Reporting Cash

Bank Overdrafts

 Generally reported as a current liability.

 Offset against other cash accounts only when

accounts are with the same bank.

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Cash-Related Items

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8 Explain accounting issues related to disposition of accounts and notes

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Accounts Receivable

Written promises to pay a sum of money on a specified future date.

Receivables - Claims held against customers and

others for money, goods, or services.

Oral promises of the purchaser to pay for goods

and services sold.

Accounts Receivable Receivable Notes

Notes Receivable

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Nontrade Receivables

1 Advances to officers and employees.

2 Advances to subsidiaries.

3 Deposits paid to cover potential damages or losses.

4 Deposits paid as a guarantee of performance or payment.

5 Dividends and interest receivable.

6 Claims against: Insurance companies for casualties sustained;

defendants under suit; governmental bodies for tax refunds;

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Receivables Balance Sheet Presentations

Nontrade Receivables

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Recognition of Accounts Receivables

 Reductions from the list

Trade Discounts

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 Offered to induce prompt

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Cash Discounts (Sales Discounts)

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Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b shipping point On June 12, the company received a check for the

balance due from Arquette Company Prepare the journal entries on

Bolton Company books to record the sale assuming Bolton records sales using the gross method

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Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b shipping point On June 12, the company received a check for the

balance due from Arquette Company Prepare the journal entries on

Bolton Company books to record the sale assuming Bolton records sales using the net method

June 12

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Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b shipping point Prepare the journal entries on Bolton Company books to

record the sale assuming Bolton records sales using the net method , and

Arquette did not remit payment until July 29.

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A company should measure receivables in terms of their

present value.

Non-Recognition of Interest Element

In practice, companies ignore

interest revenue related to accounts

receivable because the discount is

not

usually material in relation to the

net income for the period.

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How are these accounts presented on the Balance Sheet?

Accounts Receivable Doubtful Accounts Allowance for

Beg 500 25 Beg

Accounts Receivables

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Total current assets 1,657

Balance Sheet (partial) ABC Corporation

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Balance Sheet (partial) ABC Corporation Presentation Presentation Alternate Alternate

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Beg 500 25 Beg

End 600 25 End Sale 100

Collected $333 on account?

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Beg 500 25 Beg

Sale 100

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Adjustment of $15 for estimated bad debts?

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Beg 500 25 Beg

Sale 100 333 Coll

Adjustment of $15 for estimated bad debts?

15 Est

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Write-off of uncollectible accounts for $10?

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Beg 500 25 Beg

Sale 100 333 Coll

15 Est

Write-off of uncollectible accounts for $10?

W/O 10

10 W/O

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Balance Sheet (partial) ABC Corporation

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 Reporting of receivables involves

1) classification and

2) valuation on the balance sheet

 Classification involves determining the length of time each

receivable will be outstanding.

 Value and report short-term receivables at net realizable

value

Valuation of Accounts Receivable

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 Record credit losses as debits to Bad Debt Expense (or

Uncollectible Accounts Expense)

 Normal and necessary risk of doing business on credit.

 Two methods to account for uncollectible accounts:

1) the direct write-off method and

2) the allowance method.

Uncollectible Accounts Receivable

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cash realizable value.

amount.

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The percentage-of-sales basis

The percentage-of-sales basis The The percentage-of-receivables percentage-of-receivables

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Percentage-of-Sales Approach

 Percentage based upon past experience and anticipate

credit policy.

 Achieves better matching of expenses with revenues

 Any balance in Allowance for Doubtful Accounts is

ignored.

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Illustration: Gonzalez Company estimates that about 1% of net

credit sales become uncollectible If net credit sales for are

$800,000 for the year, it records bad debt expense as follows.

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Percentage-of-Receivables Approach

 Not matching.

 Reports estimate of receivables at realizable value.

Companies may apply this method using

 one composite rate, or

 an aging schedule using different rates.

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What entry would Wilson make assuming that the allowance account had a zero balance?

Illustration 7-8 Accounts Receivable Aging Schedule

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Bad Debt Expense ($37,650 – $800) 36,850

What entry would Wilson make assuming the allowance account had a

credit balance

of $800 before adjustment?

Illustration 7-8 Accounts Receivable Aging Schedule

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Illustration: Sandel Company reports the following financial

information before adjustments.

expense assuming Sandel Company estimates bad debts

at (a) 1% of net sales and (b) 5% of accounts receivable.

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Allowance for Doubtful Accounts 7,500

estimates bad debts at (b) 1% of net sales

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estimates bad debts at (b) 5% of accounts receivable

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Illustration: The financial vice president of Brown Furniture

authorizes a write-off of the $1,000 balance owed by Randall Co in March 1 The entry to record the write-off is:

Allowance for Doubtful Accounts 1,000

Assume that on July 1, Randall Co pays the $1,000 amount that

Brown had written off on March 1 These are the entries:

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Supported by a formal promissory note.

Written promise to pay a certain sum of money at a specific

future date.

A negotiable instrument.

Maker signs in favor of a Payee.

Interest-bearing (has a stated rate of interest) OR

Zero-interest-bearing (interest included in face amount).

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Generally originate from:

outstanding receivable

Sales of property, plant, and equipment.

Lending transactions (majority of notes).

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Recognition of Notes Receivable

Record at Face Value , less allowance

Record at Present Value

of cash expected to

be collected

Interest Rates Stated rate = Market rate Stated rate > Market rate Stated rate < Market rate

Note Issued at Face Value Premium Discount

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Illustration: Bigelow Corp lends Scandinavian Imports

$10,000 in exchange for a $10,000, three-year note bearing

interest at 10 percent annually The market rate of interest for a note of similar risk is also 10 percent How does Bigelow record the receipt of the note?

Note Issued at Face Value

1,000 1,000 Interest

$1,000

$10,000 Principal

i = 10%

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$1,000 x 2.48685 = $2,487

Interest Received Factor Present Value

PV of Interest

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$10,000 x 75132 = $7,513

PV of Principal

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Summary Present value of interest $ 2,487

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Illustration: Jeremiah Company receives a three-year, $10,000

note of similar risk is 9 percent How does Jeremiah record the receipt of the note?

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$10,000 x 77218 = $7,721.80

Zero-Interest-Bearing Note

PV of Principal

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Illustration: Morgan Corp makes a loan to Marie Co and

receives in exchange a three-year, $10,000 note bearing interest

at 10 percent annually The market rate of interest for a note of similar risk is 12 percent Prepare the journal entry to record the receipt of the note?

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$1,000 x 2.40183 = $2,402

Interest-Bearing Note

PV of Interest

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$10,000 x 71178 = $7,118

PV of Principal

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Illustration: Record the receipt of the note?

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Prepare the journal

entry to record

interest revenue at

the end of the first

year.

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Notes Received for Property, Goods, or Services

In a bargained transaction entered into at arm’s length, the

stated interest rate is presumed to be fair unless:

1 No interest rate is stated, or

2 Stated interest rate is unreasonable, or

3 Face amount of the note is materially different from the

current cash sales price.

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Illustration: Oasis Development Co sold a corner lot to Rusty

Pelican as a restaurant site Oasis accepted in exchange a five-year

note having a maturity value of $35,247 and no stated interest rate

The land originally cost Oasis $14,000 At the date of sale the land

had a fair market value of $20,000 Oasis uses the fair market value

of the land, $20,000, as the present value of the note Oasis

therefore records the sale as:

Discount on Notes Receivable 15,247

($35,247 - $20,000) = $15,247

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 Short-Term reported at net realizable value (same as

accounting for accounts receivable).

 Long-Term - FASB requires companies disclose not

only their cost but also their fair value in the notes to the financial statements.

Valuation of Notes Receivable

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