Intermediate Accounting Chapter 7

Front 1

Identify items considered cash

Back 1

To be reported as "cash" an asset must be readily available for the payment of current obligations and free from contractual restrictions that limit its use in satisfying debts. Cash consists of coin, currency, and available funds on deposit at the bank. Negotiable instruments such as money orders, certified checks, cashier's checks, personal checks, and bank drafts are also viewed as cash. Savings accounts are usually classified as cash.

Front 2

Indicate how to report cash and related items

Back 2

Companies report cash as a current asset in the balance sheet. The reporting of other related items are: 1. restricted cash: The SEC recommends that companies state separately legally restricted deposits held as compensating balances against short-term borrowning among the "Cash and cash equivalent items" in current assets. Restricted deposits held against long-term borrowing arrangements should be separately classified as noncurrent assets in either the investments or other assets section. 2. Bank overdrafts: Companies should report overdrafts in the current liabilities section and usually add them to the amount reported as accounts payable. If material, these items should be separately disclosed either on the face of the balance sheet or in the related notes. 3. Cash equivalents: Companies often report this item together with cash as "Cash and cash equivalents."

Front 3

Define receivables and identify the different types of receivables

Back 3

Receivables are claims held against customers and others for money, goods, or services. The receivables are classified into three types. 1. Current or noncurrent. 2. trade or nontrade. 3. accounts receivable or notes receivable.

Front 4

Explain accounting issues related to recognition of accounts receivable

Back 4

Two issues that may complicate the measurement of accounts receivable are: 1. The availability of discounts (trade and cash discounts), and 2. the length of time between the sale and the payment due dates (the interest element).
Ideally companies should measure receivables in terms of their present value--that is, the discounted value of the cash to be received in the future. The profession specifically exclueds from the presetnt- value considerations receivables arising from normal business transactions that are due in customary trade terms within approximately one year.

Front 5

Explain accounting issues related to valuation of accounts receivable

Back 5

Companies value and report short-term receivables at net realizable value--the net amount expected to be received in cash, which is not necessarily the amount legally receivable. Determining net realizable value requires estimating uncollectible receivables.

Front 6

Explain accounting issues related to recognition of notes receivable

Back 6

Companies record short term notes at face value and long term notes receivable at the present value of the cash they expect to collect. When the interest stated on an interest bearing note equals the effective (market) rate of interest, the note sells at face value. When the stated rate differs from the effective rate, a company records either a discount or a premium.

Front 7

Explain accounting issues related to valuation of notes receivable

Back 7

Like accounts receivable, companies record and report short term notes receivable at their net realizable value, This same is also true of long term receivables. Special issues relate to uncollectibles, use of the fair value option, and impairments.

Front 8

Explain accounting issues related to dispositon of accounts and notes receivable

Back 8

To accelerate the receipt of cash from receivables, the owner may transfer the receivables to another company for cash in one of 2 ways. 1. Secured borrowing: A creditor often requires that the debtor designate or pledge receivables as security for the loan. 2. Sales (factoring) of receivables: Factors are finance companies or banks that buy receivables from businesses and thne collect the remittances directly from the customers But in many cases, transferors may have some continuing involvement with the receivable sold. Companies use a financial components approach to record this type of transaction.

Front 9

Describe how to report and analyze receivables.

Back 9

Comapnies should report receivables with appropriate offset of valuation accounts against receivables, classify receivables as current or noncurrent, identify pledged or designated receivables, and identify concentrations of risks arising from receivables, Analysts assess receivables based on turnover and days outstanding.

Front 10

Accounts receivable

Back 10

oral promises of the purchaser to pay for goods and services sold. They represent a short term extension of credit and are normally collected in 60-90 days.

Front 11

Percentage of receivables

Back 11

Balance sheet approach. Using past experience the company can estimate the percentage of outstanding receivables that will become uncollectible without identifying specific accounts. They can use a composite rate or an aging schedule. The entry made to record this is bad debt expense credit allowance for doubtful accounts. This method gives us the ending balance in allowance account so if there is a beginning balance in the account the entry we make has to bring the allowance account to the amount we calculate.

Front 12

Aging schedule

Back 12

A schedule of accounts receivable which applies a different percentage based on past experience to the various age categories. it also identifies which accounts require special attention by indicating the extent to which certain accounts are past due.

Front 13

Allowance method

Back 13

An estimate is made of the expected uncollectible accounts from all sales made on account or from the total of outstanding receivables. This estimate is entered as an expense and an indirect reduction in accounts receivable (via an increase in the allowance account) in the period in which the sale was recorded. THIS METHOD IS GAAP.

Front 14

Bank overdrafts

Back 14

Occur when a company writes a check for more than the amount in its cash account. Should be recorded as a current liability and should be added to the amount recorded in accounts payable. They are generally not offset by a cash account. A major exception is when available cash is present in another account in the same bank on which the overdraft occurred. Offsetting in this case is required.

Front 15

Cash

Back 15

Cash is the most liquid of assets, is the standard medium of exchange, and the basis for measuring and accounting for all other items. Consists of coin, currency, and available funds on deposit. Also money orders, certified checks, cashiser's checks, personal checks, and bank drafts. Savings accounts are considered cash. Postdated checks and IOU's are receivables. Postage stamps on hand are prepaid expenses. And petty cash funds and change funds are used to meet current expenses these are included in cash.

Front 16

Cash discounts

Back 16

Companies often offer those to indcue prompt payment that'd be like 2/10 n/30 which means a 2% discount if paid any time before the tenth day of the following month with ful payument received by the 30th day of the following month.

Front 17

Cash equivalents

Back 17

highly liquid investments that are both (a) readily convertible to known amounts of cash and (b) so near their maturity that they present insignificant risk of changes in interest rates. Generally only investments with original maturity values of three months or less qualify. Examples include treasury bills, commercial paper, and money market funds.

Front 18

Compensating balances

Back 18

Banks and other lending institutions often require customers to maintain minimum balances in checking or savings accounts. The SEC defines these minimum balances, called compensating balances, as "that portion of any demand deposit (or any time deposit or certificate of deposit) maintained by a corporation which constitutes support for existing borrowing arrangements of the corporation with a lending institution. SEC recommends companies state separately legally restricted deposits held as compensating balances against short term borrowing arrangements among "cash and cash equivalents". Restricted balances held as compensating balances against long term borrowing arrangements as noncurrent assets in investments or other assets as "cash on deposit maintained as compensating balance."

Front 19

Direct write off Method

Back 19

No entry is made until a specific amount has definitely been established as uncollectible. The the loss is recorded by crediting accounts receivable and debiting bad debt expense. This method is not GAAP. Fails to match costs with revenues. Using it is considered inappropriate except when the amount is immaterial.

Front 20

Factoring Receivables

Back 20

Factors are finance companies that buy receivables from businesses for a fee and then collect the remittances directly from the customers. Factoring receivables is traditionally associated with the textile, apparel, footwear, furniture, and home furnishing industries. Factor advances cash to person see illustration 7-16 pg. 339

Front 21

Fair Value Option

Back 21

Receivables are recorded at fair value with unrealized holding gains or losses reported as part of net income. If you start at fair value you should use it in all subsequent periods. The unrealized holding gain is the difference between the carrying amount and the fair value at the end of the year.

Front 22

Financial components approach

Back 22

Receivables sold with recourse. The seller guarantees payment ot the purchaser in the event the debtor fails to pay. In this type of transaction the seller uses a financial components approach because the seller has a continuing involvement with the receivables. Each party to the sale only recognizes teh assets and liabilities that it controls after the sale.

Front 23

Without recourse

Back 23

The purchaser assumes the risk of collectibility and absorbs any credit losses. The transfer of accounts in a non recourse transaction is an outright sale of the receivables both in form (transfer of title) and substance (transfer of control) The seller debits cash for proceeds and credits receivables for face value. Any difference is recognized as a loss on the receivables.

Front 24

Imputed interest rate

Back 24

If a company cannot determie fair value and the note has no ready market, determining the present value is difficult. To estimate the company must approximate an applicable interest rate that may differ from the stated interest rate. This process of interest rate approximation is called imputation. The resulting interest rate is called an imputed interest rate.

Front 25

Net realizable value

Back 25

Companies value and report short term receivables at net realizable value--the net amount they expect to collect. Determining net realizable value requires estimating both uncollectible recevibales and any returns or allowanes to be granted.

Front 26

Nontrade receivables

Back 26

Arise from a variety of transactions. Examples include 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 A. Insurance companies for casualties sustained, B. Defendants under suit. C. Governmental bodies for tax refunds, D. Common carriers for damaged or lost goods. E. Creditors for returned, damaged, or lost goods. F. Customers for returnable items.

Front 27

Notes receivable

Back 27

Written promises to pay a certain amount of money on a specified future date. They may arise from sales, financing, or other transaction. Can be short or long term.

Front 28

Percentage of sales

Back 28

Income statement approach. Matches cost to revenue because it relates the charge to the period in which a company records the sale. The amount of bad debt expense and the related credit to the allowance account are unaffected by any balance currently existing in the allowance account. Because the bad debt expense estimate is related to a nominal account (sales) the balance in allowance is ignored.

Front 29

Promissory note

Back 29

Supports a note receivable. It is a written promise to pay a certain sum of money at a specific future date. It is a negotiable instrument that a maker signs in favor of a designated payee who may legally and readily sell or otherqise transfer the note to others.

Front 30

Receivables

Back 30

Claims held against customers and others for money, goods, or services.

Front 31

Receivables turnover ratio

Back 31

Ratio used to assess the liquidity of receivables. It measures the number of times, on average, a company collects receivables during the period. It is computed by dividing net sales by average net receivables outstanding during the year.

Front 32

Financial components approach

Back 32

Receivables sold with recourse. The seller guarantees payment ot the purchaser in the event the debtor fails to pay. In this type of transaction the seller uses a financial components approach because the seller has a continuing involvement with the receivables. Each party to the sale only recognizes teh assets and liabilities that it controls after the sale.

Front 33

Without recourse

Back 33

The purchaser assumes the risk of collectibility and absorbs any credit losses. The transfer of accounts in a non recourse transaction is an outright sale of the receivables both in form (transfer of title) and substance (transfer of control) The seller debits cash for proceeds and credits receivables for face value. Any difference is recognized as a loss on the receivables.

Front 34

Imputed interest rate

Back 34

If a company cannot determie fair value and the note has no ready market, determining the present value is difficult. To estimate the company must approximate an applicable interest rate that may differ from the stated interest rate. This process of interest rate approximation is called imputation. The resulting interest rate is called an imputed interest rate.

Front 35

Net realizable value

Back 35

Companies value and report short term receivables at net realizable value--the net amount they expect to collect. Determining net realizable value requires estimating both uncollectible recevibales and any returns or allowanes to be granted.

Front 36

Nontrade receivables

Back 36

Arise from a variety of transactions. Examples include 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 A. Insurance companies for casualties sustained, B. Defendants under suit. C. Governmental bodies for tax refunds, D. Common carriers for damaged or lost goods. E. Creditors for returned, damaged, or lost goods. F. Customers for returnable items.

Front 37

Restricted cash

Back 37

When material in amount, companies segregate restricted cash from regular cash for reporting purposes. The restricted cash is either in the current assets or long term assets section depending on the date of availability or disburseent. Classification in the current section is appropriate if using the cash for payment of existing or maturing obligations (within one year or the operating cycle, whichever is longer.)

Front 38

Securitization

Back 38

Recent phenomenon in sale (transfer) of receivables is securitization which takes a pool of assets such as credit card receivables, mortgage receviables or car loan receivables, and sells shares in these pools of interest and principal payments. This creates securities backed by pools of assets.

Front 39

Trade Discounts

Back 39

Trade discounts are used to avoid frequent changes in catalogs, to alter prices for different quantities purchased or to hide the true invoice price from competiters. Typically quoted in percentages.

Front 40

Trade receivables

Back 40

Composed of accounts receivable and notes receivable.

Front 41

unrealized holding gain or loss

Back 41

The unrealized holding gain is the difference between the fair valueand the carrying amount. The adjusting entry is debit note receivable. Credit unrealized holding gain or loss income. Add the difference between the fair value and the cost as the fair value on balance sheet.

Front 42

Zero interest bearing

Back 42

They include interest as part of their face value amount. The company knows the future and amount and present value so it can compute the interest rate. The difference between the future amount and the present value (cash paid) is recorded as a discount and amortized to interest revenue over the life of the note. When it issues it it debits note receviable. Credit discount and cash. then it records debit to discount on note and credits interest revenue.