Chapter 7

Cash and Receivables

Preview of Chapter 7

Cash

Receivables

Cash Discounts (Gross and Net method)

Uncollectible accounts (Aging method vs % of Sales)

Recognition and Measurement of Short-Term/Long-Term

Notes and Loans Receivable

Derecognition of Receivables

Secured borrowings
Sales of Receivables

What is Cash?

Ex: coin, currency, available funds on deposit at the

bank, money orders, certified checks, cashiers checks,
personal checks, bank drafts and savings accounts.

Cash is reported as a current asset if it is readily available

to pay current obligations and is free of restrictions
Special reporting is needed for :
1.

Restricted cash

2.
3.

Cash in foreign currencies

Bank overdrafts

4.

Cash equivalents

Restricted Cash
Companies must segregate restricted cash from regular cash
for reporting purposes if the amount is material. Ex, cash
restricted for: (1) plant expansion, (2) retirement of long-term
debt, and (3) compensating balances.

Classified as current assets if they relate to short-term loans

Classified as non-current assets if set aside for investment or financing
purposes (e.g. plant expansion)

Compensating balances: minimum cash balances maintained by a

corporation in support of existing borrowings not available for use
by the corporation.

Note disclosure of restricted cash is required

Foreign Currencies

Amount held in foreign currencies is reported in

Canadian dollars at the balance sheet date
The exchange rate on the balance sheet date is used to
translate foreign currencies into Canadian dollars
If restrictions exist on the foreign funds, those funds are
reported as restricted

Bank Overdrafts
When a company writes a check for more
than the amount in its cash account.

Overdrafts are reported as current liabilities (often

reported as accounts payable)
In general, bank overdrafts should not be offset
against the Cash account
However, bank overdrafts may be offset against
available cash in another account if both accounts are
at the same bank

Cash Equivalents

Short-term, highly liquid investments that are readily

convertible to known amounts of cashsubject to an
insignificant risk of change in value.
Original maturity is generally three months or less
Examples: treasury bills, money-market funds, commercial
paper
Cash equivalents are reported at fair value

Receivables

Claims against customers and other parties for money,

goods, or services
Receivables are classified as either current (short-term)
or noncurrent (long-term)
Classified as current receivables if there is the
expectation to collect within one year or operating
cycle (whichever is longer)
Receivables can be classified as either trade receivables
or nontrade receivables

Accounts Receivable
Trade receivables include:
Accounts receivable (verbal promise to pay, normally
within 30 to 60 days)
Notes receivable (written promises with specified
terms, e.g. interest rate and due date)
Nontrade receivables include the following:

1.
2.
3.
4.
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Advances to employees or other officers

Receivables from the government (e.g. GST recoverable, income
tax receivable)
Dividends and interest receivable
Amounts owing by insurance companies

Accounts Receivable: Trade Discounts

vs. Cash Discounts

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Trade discounts are discounts given to customers often

for different quantities purchased (often quoted as a
percentage)
Trade discounts are generally not recorded; the price
charged (net of the discount) is recorded by the seller as
a receivable and revenue
Cash discounts (or sales discounts) encourage
customers to pay faster; they are recorded
2/10, n/30; the customer will receive a 2% discount if payment
made within 10 days otherwise the gross amount of the
invoice is due in 30 days

Accounts Receivable: Recording Cash

Discounts

Two methods: gross method and net method

Gross method records discounts when customers pay
within discount period

Net method records accounts receivable net of the

discount; discounts forfeited by customers are recorded
when not taken

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Sales Discounts are deducted from sales on the income

statement
Most common method

Preferred method but rarely used

Sales Discounts Forfeited is recorded as Other revenue if
customer does not take the discount

Cash Discounts

Gross Method/Net Method Example

July 1 sold $82,000 of computers to Robertson Corp., terms
2/15, n/30
July 5 Robertson Corp. returned for full credit one computer
with an invoice price of $6,200
July 10 - Salini received payment from Robertson for the full
amount owed from the July transactions
July 17 - Sold $160,000 in computers and peripherals to
Clarkson Store, terms 2/10, n/30
July 26 Clarkson Store paid Salini for half of its July purchases
Aug. 30 Clarkson Store paid Salini for the remaining half of its
July purchases.
1.
Prepare j/es for Salini assuming the Gross Method
2.
Prepare j/es for Salini assuming the Net Method
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Measurement of Accounts Receivable

Short-term receivables are reported at their net realizable value (NRV)

The NRV is the net amount of cash expected to be collected
Calculated as: Gross accounts receivable less estimated uncollectible
accounts and any returns, allowances, or cash discounts
Loans and receivables impaired if there is significant adverse change in
expected timing or amount of cash flows

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Estimating Uncollectible Accounts

Receivables are reported net of an Allowance for Doubtful

Accounts
The estimate of uncollectible accounts may be based
on:

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Aging method (or % of Receivables) management frequently estimates uncollectible

amounts and adjusts the Allowance for
Doubtful Accounts
Mix of Procedures - % of Sales during the year,
and Aging method at the end of the year.

Balance Sheet Presentation

Short-term accounts receivable are shown at their net

realizable value as follows:
Accounts Receivable
Less: Allow. for Doubtful Accounts
Net Accounts Receivable

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$ xxx
xxx
$ xxx

Allowance Method: Writing Off Accounts

Receivable

When a specific customers account is determined to

be uncollectible, the following entry is made:
Dr. Allowance for Doubtful Accounts x
Cr. Accounts Receivable specific customer

(for the amount to be written off)

If payment is received after write-off of account,

the account is reinstated and payment is recorded:
Dr. Accounts Receivable
Cr. Allowance for Doubtful
Accounts
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Dr. Cash
Cr. Accounts Receivable
(for the amount collected)

Direct Write-off Method

If uncollectible amounts are not material, the

allowance method is not required and direct write-off
method can be used
Record bad debt expense only when specific account
is determined to be uncollectible:
Dr. Bad Debt Expense
xx
Cr. Accounts Receivable
xx
No allowance account is used

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Short-Term Notes Receivable

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Notes receivable differ from accounts receivable as they

are supported by a promissory note
All notes contain some interest
Notes are either Interest bearing or Zero-interest bearing
(Interest amount is the difference between the amount
borrowed and the face amount).

Interest Bearing Short-Term Notes

Receivable
Example: On March 14, 2011, Accounts Receivable of $1,000 is
exchanged for a 6% six-month note.

What

is j/e recorded on March 14th?

What is the j/e recorded on September 14th when collection is made?

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Non-Interest Bearing
Short-Term Notes Receivable
On February 23, 2011, a $5,000 nine-month non-interest bearing
note is issued; 8% is the implied interest rate

What'

j/e is recorded Feb 23rd?

What j/e is recorded Nov. 23rd when the note is collected?

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Long-term Loans Receivable

Long-term loans receivable are recognized at fair

value (present value of the future cash flows)

When the stated interest rate is the same as the market

interest rate, the note or loan is issued at its face value

When there is a difference between interest rates, the note

or loan is issued at a premium or a discount (i.e. the
present value is greater or less than the face value)

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Long-term Loans Receivable Interest

Bearing Notes

Example: Morgan Corp. issues a $10,000, 10% three-year

note; market interest rate is 12% and annual interest
payments are $1,000 (10% x $10,000)
In calculating the notes present value, use 12% market rate
to discount all future cash flows as follows:
($10,000 x .71178) + ($1,000 x 2.40183) = $9,520
The note is issued at a discount (as proceeds < face)

Journal Entry at issuance of note:

Dr. Notes Receivable
9,520
Cr. Cash
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9,520

Long-term Loans Receivable Interest

Bearing Notes

Example continued:
At date of issue, the company has an unamortized
discount of $480 (to be amortized over the 3 years)
The discount represents interest income to be
recognized over the 3 year life of the note
$9,520 x 12% = $1,142 (first year interest income)
Journal Entry to record first $1,000 interest received:
Dr. Cash
1,000
Dr. Notes Receivable
142
Cr. Interest Income
1,142
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Long-term Loans Receivable Interest

Bearing Notes

Example continued:
Book value of Notes Receivable is now:
$10,000 ($480 - $142) = $9,662
Interest Income for second year:
$9,662 12% = $1,159
Journal Entry to record second $1,000 interest received:
Dr. Cash
1,000
Dr. Notes Receivable
159
Cr. Interest Income
1,159
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Long-term Loans Receivable Interest

Bearing Notes

Example continued:
Under straight-line method (as opposed to the
effective interest rate method), initial discount of $480
is recognized as interest income evenly over 3 years at
$480 / 3 years = $160 per year
IFRS requires the use of effective interest method of
amortization
Private entity GAAP does not specify the amortization
method

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E 7-14

Option 1: One-year note for $105,000 due Sept. 30, 2011.

Interest of 8% is payable at maturity
Option 2: One-year non-interest bearing note for
$113,400. Implied interest rate is 8%.
a)

b)

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Assume Option 1: prepare j/es required on Big Corps

books(the lender) Sept 30, 2010, December 31, 2010, and
September 30, 2011.
Assume Option 2: prepare j/es required on Big Corps books
Sept 30, 2010, December 31, 2010, and September 30, 2011.

Derecognition of Receivable

The holder of accounts or notes receivable may transfer

to another company for cash
The transfer may be:
A secured borrowing (Holder retains ownership)
A sale of receivables (Holder transfers ownership)

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Borrowing vs. Sale Treatment

Conditions
1. Are transferred assets isolated
from transferor? and
2. Does transferee have right to
pledge or sell the assets? and
3. Transferor does not maintain
control of the assets through
repurchase agreement?

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Yes

No

Sale

Secured
Borrowing

Accounting for Transfers

of Receivables
Transfers

Secured Borrowing
Continuing
involvement by seller

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Use components approach:

1. Reduce receivables,
2. Recognize component
assets and liabilities,
3. Record gain/loss

Sale
No continuing
involvement by seller
1. Reduce receivables,
2. Record gain/loss

Sale of Receivables (e.g., Factoring)

Ownership of receivables transferred to the purchaser

(the factor); receivables recorded as an asset in the
purchasers books
If sold without recourse, purchaser is fully responsible
for collections of the receivables
Seller records any retained proceeds as due from
factor (a receivable) which covers possible sales
discounts and sales returns and allowances
Seller records gain/loss on sale of receivables (normally
a loss, representing the finance charge)
Seller records any recourse liability (if receivables are
sold with recourse i.e., sellers guarantee)
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E 7-19
Chessman Corp factors $600,000 of A/R with Liquidity
Financing on a with recourse basis. Liquidity Financing will
collect the receivables. The receivable records are
transferred to Liquidity Financing on August 15, 2010.
Liquidity Financing assesses a finance charge of 2.5% of the
amount of A/R and also reserves an amount equal to 5.25%
of A/R to cover probable adjustments.
1. Prepare the j/e on August 15, 2010 for Chessman to
record the sale of receivables, assuming the recourse
obligation has a fair value of $6,000.
2. What effect will the factoring of receivables have on
A/R turnover for Chessman?
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