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 ShortTerm/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.

Cash in foreign currencies

3.

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

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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 cash
subject 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
xxx

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$ 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 Zerointerest 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% sixmonth note.
What

is j/e recorded on March 14th?

What is the j/e recorded on September 14 th 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% threeyear 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 7-13

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

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Sale

Continuing
involvement by seller

No continuing
involvement by seller

Use components approach:

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

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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