AFDA is deducted from accounts receivable

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MGT220

Chapter 7: Cash and Receivables

Published 2 years ago

Cash and Receivables

1. Understand cash and accounts receivable from a business perspective.

How do Companies Manage and Control Cash?

 Businesses rely on cash flow budgets to help anticipate cash needs and minimize
borrowing requirements.
 Without surplus cash, businesses must carefully manage its cash resources.
 Includes implementing internal control over physical custody of cash on hand and
preparation of bank reconciliations.

What types of Companies have Extensive AR?

 Manufacturers and wholesalers often have a significant amount of Accounts Receivable.

 Retailers often have low AR. (customers use credits cards and debit cards for payments).

What Are the Types of Accounts Receivable?

 Typical AR accounts include categories such as trade receivables, loans receivable, and
non-trade receivable (e.g. interest receivables).
 Complicated items included in AR could include interest rate swaps.

How do Companies Manage Accounts Receivable?

 A “delicate balancing act” – If credit policies are too restrictive, sales may be lost and if
the policies are too flexible, an aggressive sales team may enter contracts with higher-risk
customers (collectability difficulties).
 Companies must monitor outstanding AR balances through an aged accounts receivable
analysis.
 Some customers may take advantage of the situation.
  AR must be monitored to minimize stress on working capital and encourage prompt
payment from customers.

1. Define financial assets and identify items that are considered cash and cash equivalents
and how they are reported.

 Financial Assets – They are highly liquid.

 Cash
 A contractual right to receive cash or another financial asset from another party
 A contractual right to exchange financial instruments with another party under conditions
that are potentially favourable to the entity
 An equity instrument of another entity

What is Cash?

 The most liquid asset – Standard medium of exchange and basis for
measuring/accounting for other items.
 Current financial asset.
 Coins, currency, and other available funds on deposit at a bank. (includes negotiable
instruments such as money orders and certified cheques)
 Cash Equivalents → see below.
 Short-Term Investments – Allows earning of interest.

Reporting Cash

Restricted Cash

 Restricted Cash – Cash set aside for a particular purpose.

 Often non-Material so it’s in the same account as cash.
 Material – Restricted cash is segregated from regular cash for reporting purposes – it is
separately disclosed and reported in the current assets section or separately in the long-
term assets section.
 Long-term restricted cash examples: investment, financing
 Compensating Balances – Portion of any demand deposit that a corporation keeps as
support for its existing or maturing obligations with a lending institution.
 Like a minimum balance.

Cash in Foreign Currencies

 Foreign currency is translated into Canadian dollars at the exchange rate on the date of
the statement of financial position.
 No restriction – Included as cash in current assets.
 Restriction on flow of capital out of a country → Reported as restricted.
 Can be classified as current or non-current based on circumstances.
Bank Overdrafts

 Bank Overdrafts – Cheques are written for more than the amount in the bank account.
 Recorded under current liabilities section and often added to accounts payable.
 If material → disclose it separately in notes or face of the statement.
 Typically, not offset against cash. (only offset if there is available cash in another account
in the same bank)

Cash Equivalents

 Cash Equivalents - Short term, highly liquid investments readily convertible to cash.
 Often held to meet upcoming requirements.
 Generally, they only include investments with maturities of 3 months or less.
 IFRS allows equity investments acquired close to maturity date.
 i.e. treasury bill investments, commercial paper, money market funds.
 Bank overdrafts may be deducted when the amount of cash and cash equivalents is being
determined.
 Overdrafts may be considered cash/cash equivalents if 3 conditions are met.
 They are part of the firm’s cash management activities.
 They are repayable on demand.
 The bank balance fluctuates often between a positive and negative balance.
 Disclose investments that are cash equivalents in the notes held at fair value.

Summary of Cash-Related Items

 Cash & Cash Equivalents – Include currency and most negotiable instruments.
 Investm
ents, receivables, or prepaid expenses - Item cannot be converted to coin/currency on short
notice.

1. Define receivables and identify the different types of receivables from an accounting
perspective.

Receivables Definition and Types

 Receivables – Claims a company has against customers and others for specific cash
receipts in the future.
 If the claim is contractual, the receivable is a financial asset.
 Current Receivables – Realized within a year or within the cycle. (Others are non-
current)
 Loans and Receivables – Result from one party delivering cash to a borrower in
exchange for a promise to repay the amount on a specified date/dates or on demand with
interest.
 Not usually acquired to be held as a cash equivalent – they aren’t traded in an active
market.
 Trade Receivables – Amounts owed by customers to whom the company has sold
goods/services as part of normal business operations.
 Open Accounts Receivable - Short-term extensions of credit based on a verbal promise
to pay for goods/services sold.
  Notes Receivable – Written promises to pay a certain amount of money on a specified
future date from sales or other transactions.
 Loans Receivable – One party advances cash/other assets to a borrower and receives a
promise to be repaid later.
 Can also be called note receivable if there are written terms/conditions.
 Nontrade Receivables – Written promises to pay cash or to deliver assets.
 Caused by many different transactions including advances to associates, amounts owing
from a purchaser on sale with agreed delayed payment terms, dividends and interest
receivable, claims against insurance companies.
 Classified and reported as separate items in the statement of financial position or in a
note.

1. Account for and explain the accounting issues related to the recognition and measurement
of accounts receivable.

Recognition and Measurement of Accounts Receivable

 General Accounting standards of recognition and initial measurements of AR:

 Recognize an AR when the entity becomes a party to the contractual provisions of the
financial instrument.
 Occurs when the entity has a legal claim to receive cash or other financial assets.
 Measure the receivable initially at its fair value.
 Fair value may be different from the exchange price.
 After initial recognition, measure receivables at amortized cost.
 Two factors make measuring fair value of short-term receivables difficult:
 Availability of discounts (Trade & Cash discounts)
 Length of time between sale and payment due date. (interest)

Trade Discounts

 Used to avoid frequent changes in catalogues, to quote different prices for different
quantities purchased, or to hide the true invoice price from competitors.
 Quoted as a percentage – Deduct the trade discount from the list price and recognize the
net amount as the receivable and revenue.

Cash Discounts (Sale Discounts)

 Offered to encourage fast payment.

 Expressed as percentage discount / amount of days, n/gross amount due.
 i.e. 2/10, n/30 means 2% discount if paid within 10 days, and gross amount due in 30
days.
 Net Method – Sales to customers who pay within the discount period are reported at the
cash price.
 If they pay after the discount period, company records amount in the Sales Discounts
Forfeited account.
 Rarely used because it requires more bookkeeping.
  Gross Method – Record the gross amounts of the receivable and sale - full amount
assuming no discount taken.
 Sales discounts only recognized when payment received in the discount period. Deduct
them from sales to get to net sales.
 Allowance for Sales Discounts – A contra account to AR to estimate the taken discounts
after the balance sheet is prepared.
 MORE COMMON METHOD.

Sales Returns and Allowances

 IFRS → Debit Sales Revenue, Credit Refund Liability

 ASPE → Debit Sales Returns and Allowances, Credit Allowance for Sales Returns and
Allowances
 Sales returns/price reductions estimated and deducted as contra accounts against sales on
the income statement and AR on the balance sheet.
 Reported in the same period as the sales they relate to.
 Significant returns require allowance for sales returns.

Nonrecognition of Interest Element

 In practice: Accountants do not log amounts as separate interest revenue because the
discount amount is not usually material when compared with the net income for the
period.
 IFRS and ASPE support measuring financial assets at present value of the cash
expected to be received.

Measurement of Accounts Receivable after Acquisition

 AR is measured in subsequent accounting periods at amortized cost.

 There’s no interest element though, so there is nothing to amortize. (Amortized cost =
cost)
 Notes and loans receivable with interest: asset’s carrying amount is amortized.

1. Account for and explain the accounting issues related to the impairment in value of
accounts receivable.

Impairment of Accounts Receivable

 Bad Debts or Noncollectable Accounts – Impaired trade receivables where there has
been a loss in expected collection.
Estimating Noncollectable Trade Accounts Receivable

 Credit Risk – Likelihood of loss due to failure to fully pay the amount owed.
 Credit policy must be balanced to allow a certain percentage of bad debt.
 Accounting Issue: ensuring a reasonable estimate is made of the amount of AR unlikely
to be collected.
 Based on reasonable and supportable info readily available at year-end based on past
events, current conditions, and expected future economic conditions.
 Indicators of DA →
 Age of the Accounts – How long the amounts owed have been outstanding
 Past Loss Experience
 Current Economic Conditions
 Percentage-of-receivables Method – Allows a company to use past experience to
estimate percentage of receivables that will be uncollectible without identifying accounts.
 Objective - Report receivables on statement of financial position at net realizable value
(net amount expected to receive in cash).
 Aging Schedule – Determines the age of each account receivable and uses a provision
matrix to apply a different percentage estimated uncollectible to each age category based
on historical observed default rates.
Allowance Method

 Used to account for the estimate of impairment.

 If there is no previous balance in the allowance account, to initialize it, debit bad debt
expense and credit allowance for doubtful accounts.
 If we add more to the allowance accounts, add in the same way.

Bad Debt Expense and the Allowance Account

 The allowance method reports receivables at estimated realizable value and recognizes
bad debt losses as an expense in the same accounting period.
 Companies follow one of two procedures:
 Allowance Procedure only – Management carries out an analysis of the Accounts
Receivable balances and assesses the estimated uncollectible accounts at the end of each
month.
 Adjust the allowance to a correct balance.
 Mix of Procedures – Management estimates the month’s bad debt expense at its end
based on a percentage of the sales reported (percentage-of-sales approach).
 Stable relationships between credit sales and bad debt may be used to estimate a period’s
bad debt expense.
 Fast and simple → Debit Bad Debt Expense and credit Allowance for Doubtful Accounts
 At the end of the fiscal year, management must assess year-end receivables to ensure that
the allowance account is appropriate. (adjustments may bring it to the right balance)
Accounts Written Off and the Allowance Account

Accounts Receivable Written Off

 A specific account is determined to be noncollectable, so its balance is removed from

accounts receivable and allowance for DA is reduced.
 Debit Allowance for Doubtful Accounts and credit Accounts Receivable.
 No effect on income statement.

Collection of an Account Previously Written Off

 Collection is made on a receivable already written off, so we must re-establish it by

reversing the write off entry.
 Reversing: Debit AR and credit allowance for doubtful accounts.
 Collection: Debit cash and credit accounts receivable.

Effects on Accounts

 Accounts Receivables:
 Debit → Opening Balance, Credit Sales, reinstatement of accounts previously written off.
 Credit → Cash received on account, accounts written off.
 Bad Debt Expense
 Debit → Bad debt expense recognized, year-end adjustment to increase balance in
allowance account.
 Credit → Year-end adjustment to reduce balance in allowance account.
 Allowance for Doubtful Accounts
 Debit → Accounts written off, year end adjustment to reduce balance in allowance
account
 Credit → Opening balance, bad debt expense recognized, reinstatement of accounts
previously written off, year-end adjustment to increase balance in allowance account
 Sales
 Credit
→ Credit Sales

 Ending balance of the AR account represents the total of all amounts owed to the
company at statement date.
 Ending balance of the allowance account represents the total accounts receivable that
will not be collected.
 Together → Net amount - estimated net realizable value of total amount owed.

Direct Write Off Method

 No estimates are made in advance and no allowance account is used.

 When an account is determined to be noncollectable, the specific account receivable is
written off as bad debt expense.
 Useful for when the allowance method is highly immaterial.
 Write Off - Debit bad debt expense and credit accounts receivable
 Collection (reversal) - Debit cash and credit Noncollectable Amounts Recovered

1. Account and explain the accounting issues related to the recognition and measurement of
short-term notes and loans receivable.

Short-Term Notes and Loans Receivable

 Note Receivable – Similar to AR but is supplied by a promissory note (negotiable

written promise to pay a specific sum of money at a specific future date.)
 Signed by a maker in favor of the payee, who can legally/readily sell it to others.
 Contain an interest element due to time value of money but may be classified as:
 Interest Bearing-Notes – Stated rate of interest payable with face value.
 Zero-Interest-Bearing Notes – Includes interest equal to difference between borrowed
(proceeds) and the higher face amount paid back.
  Accepted from customers who must extend payment period of AR or for high-risk or new
customers.
 Interest Bearing Notes
 Substitution of Note Receivable for AR - Debit Notes Receivable and Credit Accounts
Receivable.
 Payment of Note - Debit Cash and Credit Notes Receivable and Interest Income (Note
amount x interest rate x amount of years).
 Zero-Interest-Bearing Notes
 Substitution of Notes Receivable for AR: Debit Notes Receivable and Credit Cash.
 Payment of Note - Debit Cash and Credit Notes Receivable and Interest Income (The
difference between what is agreed to be repaid and the actual note amount).

1. Account for and explain the accounting issues related to the recognition and measurement
of long-term notes and loans receivable.

Long-Term Notes and Loans Receivable

 Recognition of loans receivable

 Recognize the loan receivable when the entity becomes a party to the contractual
provisions of the financial instrument.
 When recognized initially, measure the LR at fair value.
 After initial recognition, measure LR at amortized cost.
 Recognize bad debt losses on the loans receivable when they are deemed to be impaired.
 Fair Value – Present value of the cash amounts expected to be collected in the future,
with amounts discounted at the market rate of interest appropriate for a loan with similar
credit risk and other characteristics.
 Fair Value → Face Value if the interest is the same as market rate. (Stated Interest rate is
part of the note contract)
 Effective Interest Rate – Rate used in the market to determine the note’s value: the
discount rate used to determine its present value.
 If stated rate does not equal market rate, then fair value does not equal face value.
 The difference between price and maturity value (discount or premium) is amortized over
the note’s life and affects the interest income reported.
 IFRS: Effective interest method of amortization is required.
 ASPE: Amortization Method is not specified.
 Transaction Costs incurred in acquiring a loan/note receivable may be treated in 2 ways:
 They can be recognized as an expense when the yare incurred.
 They can be added to fair value of the instrument, increasing original amount
recognized at its cost at acquisition.
 Transaction costs are an adjustment to the discount/premium amortized over the loan’s
life.
 Recalculate effective rate of interest.
 Amortized Cost – Amount recognized when the instrument was acquired, reduced by
any principal payments received, and adjusted for the amortization of any discount or
premium, if appropriate, and write-downs for impairment.
  IFRS - Contains Basic Loan Features – contractual terms that result in cash flows that are
principal and interest payments.
 IFRS - Managed on a Contractual Yield Basis – company’s business model of holding
instruments for these principal/interest flows.

Notes Issued at Face Value

 i.e. Bigelow Corp. lends Scandinavian Imports $10 000 in exchange for a $10 000 three-
year note bearing interest at 10% paying annually.
 Identify the amounts and timing of cash flows.

 I = 10%, n = 3
 Calculation: We must add two components:
 Present Value of Lump Sum Principal ($10 000 x PV at n=3, I =10)
 Present Value of the Ordinary Interest Annuity ($1000 x PV at n=3, I = 10)
 The difference between face value and present value must be amortized – in this case
they are both $10 000 so the acquisition and interest earned are recorded as normal.

Notes Issued at Other Than Face Value

 Sometimes companies issue different types of notes to encourage sales or facilitate

intercompany transactions.

Zero-Interest-Bearing Notes

 Present value is usually the cash paid to the issuer. (We know both future amount and
present value)
 Implicit Interest Rate – The rate that equals cash paid with amounts receivable in the
future.
 Difference between these is a discount – Amortize it to interest income over the life of
the note.
 Usually the implicit rate is the market rate.
 Calculation →
 We are given Present Value, Number of years, and the initial principal. We must solve
for implicit interest rate.
  The Holy Trinity: Maturity Value (Face value), Present Value Factor (I and n), and
Present Value of the note.
 If you have two of these, you can calculate the last one.
 Recording: Debit Note Receivable and Credit Cash for the present value of future cash
flows.

Effective Interest Method of Amortization (Zero-Interest Bearing Notes)

 IFRS method that recognizes interest income by calculating the effective interest rate at
the time of investment.
 Use this rate to calculate interest income by applying it to carrying amount each period.
(Carrying amount changes as it is increased by amortized discount)
 Net Carrying Amount = Present Value of the Note’s Remaining Cash Flows
(principal and interest payments) discounted at market rate at acquisition.
 Calculation: Interest Income = Carrying amount x the interest rate calculated.
 Discount Amortized = the interest income.
 New Carrying Amount = Old carrying amount + the interest income.

 Proceed to record the interest income:

 Debit Notes Receivable and credit interest income the amount.
  Note Due at the end of the year:
 Debit Cash and credit notes receivable the balance at the end.

Straight-Line Method of Amortization (Zero-Interest-Bearing Notes)

 Simple way of amortizing discounts and premiums used by ASPE.

 Calculation - Divide the total discount by the amount of periods.
 i.e. 1000 over 3 years = 100 straight-line a year.
 Does not reflect the economic reality of a loan.

Interest Bearing Notes

 Given - Principal amount, number of periods, and interest rate, as well as market rate of
interest.
 i.e. Morgan Corp. makes a loan to Marie Co. and receives $10 000, three-year note
bearing interest at 10% annually. Market rate of interest for a similar risk is 12%.
 Interest Cash Flows dictated by the stated rate (10%).
 Cash Flows are Discounted at the market rate (12%).
 Calculate the 2 parts:
 Present Value of the Principal = $10 000 (PVF with n=3 and i=12)
 Present Value of the Interest = $10 000 (PVF of an Ordinary Annuity with n = 3 and I
= 12)
 There is a difference in present value and face value (due to different rates) so the note is
exchanged at a discount.
 Exchange - Debit Note Receivable and credit cash.

Effective Interest Method of Amortization (Interest Bearing Notes)

 Morgan receives the $1000 interest each year at the stated rate 10% and at maturity,
receives the discount of $480 so that the return of the investment raises to market rate
(12%).
 Cash Received = the interest, or principle x stated rate
 Interest Income = carrying amount x market rate.
 Discount Amortized = the difference between cash received and interest income.
 New Carrying Amount = old amount + discount amortized.
Straight-Line Method (Interest Bearing Notes)

 For ASPE, the initial discount of $480 will be amortized at the same even amount every
year.
 Premium – If the note’s fair value > face value.
 Recognized by recording the note receivable at its higher initial present value.
 Excess is amortized over the life of the note by crediting Notes Receivable and debiting
or reducing the amount of interest income that is recognized.

Notes Received for Property, Goods, or Services

 If a long-term note is received for sale of property, goods, or services, there may be an
issue.
 If appropriate market rate of interest is known there is no problem.
 Sale amount = present value of the cash flows promised by the note discounted at market
rate.
 If stated = market, then face value = fair value.
 If we don’t know the market rate, we use 1 of 2 approaches:

1. Use the fair value of the property, goods, or services given up as an estimate of the fair
value of the note received.
2. We have an estimate of PV, cash flow amounts, and timing of cash flows – so we can
calculate interest rate for effective interest method.
3. Use Imputation.
4. Determining an appropriate interest rate “Imputed Interest Rate” based on what could
have been agreed on if an independent borrower/lender had negotiated something similar.
5. Affected by factors such as rates for similar issuers’ instruments, restrictive covenants,
collateral, payment schedule, existing prime interest rates.

Examples
 1. Market rate of interest is given, and the proceeds from sale = present value.
2. Non-interest-bearing note, so cash flow is the amount received in all periods.
3. Unknown market rate of interest, but land has an appraised value and the future cash flow
is known.
4. Property’s fair value determines the amount of the proceeds and note’s fair value
5. Find the implicit interest rate by taking present value factor by dividing the future cash
flow amount by present value and identifying the interest rate.
6. Now we can amortize the discount using effective-interest method.
7. Neither market rate not land’s fair value is known.
8. Impute a market rate based on prevailing interest rates.
9. If the estimated rate is the same as the land’s purchasing rates, then use that interest rate.

 If they are different, the note receivable and gain on sale will both be different.

Fair Value Not Equal to Cash Consideration

 If cash exchanged does not equal fair value of the loan, the substance of the transaction
must be determined and accounted for.
 Recognize the difference as additional compensation to be recognized immediately as
an expense (unless otherwise qualified).
 Account for and explain the basic accounting issues related to the derecognition of
receivables.

Derecognition of Receivables

 Accounts and Notes Receivables are collected when due and then derecognized (removed
from the books)
 To receive cash more quickly from receivables, owners now transfer accounts/loans
receivable to another company for cash.
 For competitive reasons – major companies create wholly owned subsidiaries that
specialize in financing the purchase until the buyer can pay it off.
 For money reasons – holder wants to accelerate cash inflows.
 Purchasers of receivables want to obtain the legal protection of ownership rights vs.
unsecured creditors.
 Asset-Backed Financing - Receivables can be used to generate immediate cash for a
company in 2 ways:

1. Secured Borrowings
2. Sales of Receivables
Secured Borrowings

 Receivables are used as collateral in borrowing transactions. (Debtor pledges receivables

as security for the loan, but receivables are under the control of the borrowing
companies)
 Note or loan payable is a liability reported on statement of financial position.
 If it isn’t paid in time, the creditor can convert the collateral to cash (collect the
receivables).
 Company accounts for the liability according to accounting policies for similar liabilities.
(Same way as it did before the borrowing)
 Debtor recognizes interest expense on the borrowed amount and may have to pay an
additional finance charge which is expensed.
 Collecting accounts receivable proceeds retires the loan obligation.

Sale of Receivables

 Factor – Financial intermediaries (i.e. finance companies) that buy receivables from
businesses for a fee and collect the amounts owed directly from customers.

 Securitize – Process of transferring receivables by which interests in financial assets are

sold to a third party.
 Transforms financial assets into asset-backed securities.
 Takes a pool of assets that generate interest/principal payments and issues debt and
equity interests in these pools.
 These securities are backed by pools of assets – they have payment streams and a long-
term payment history.
 Special Purpose Entity (SPE) holds the securities.
 Differences between factoring and securitization:
  Factoring usually involves a sale to only one company, fees are relatively high, quality
of receivables is lower, and the seller doesn’t service receivables after.
 Securitization – Many investors are involved, margins are tight, receivables are higher
quality, and the seller continues to service receivables.

Underlying Principles

1. IFRS Focus → An entity should derecognize the financial asset from the statements only
when it transfers substantially all of the risks and rewards of ownership.
2. If it cannot be determined whether they have been transferred, it considers control.

 If the transferee can sell the entire asset and make that decision on its own, then control
has shifted so it should be derecognized.
 IFRS focuses on the first principle and ASPE focuses on the second one.

Criteria for Treatment as a Sale

 Must identify a transfer of receivables as qualified for being treated as a sale

(Derecognition) or if it is only a secured borrowing.
 There is debate over how to interpret situations where the company selling the
receivables still has involvement with the asset.
 In IFRS, there are conditions of transfer:
 Entity transfers the contractual rights to receive cash flows from the AR
 Entity retains contractual rights to receive cash flows from AR but must pay the cash
flows to one or more recipients.
 The entity has no obligation to pay amounts to eventual recipient unless it collects the
same amount from the OG receivable.
 The entity is prohibited by the terms of the contract to sell or pledge the original asset
unless it’s a security.
 The entity has an obligation to remit cash flows it collects without delay.
 In ASPE, there are 3 conditions that must be met.
Sale with No Continuing Involvement by Transferor

 Most straightforward → receivables are sold outright to another unrelated party and sold
without recourse.
 Risks and rewards are transferred.
 Without recourse – Purchaser assumes the risk of collection and absorbs the credit
losses.
 To record the sale:
 Debit Cash for the proceeds, due from factor (and possibly loss on sale of receivables)
and credit the accounts receivable (and possibly gain on sale of receivables.)
 To record the purchase on journal:
 Debit Accounts Receivable and credit due to the company, finance revenue (the loss for
the other company), and cash.

Sale with Continuing Involvement by Transferor → Recourse Component Retained

 Receivables are sold with recourse – Seller or transferor guarantees payment to

purchaser if the customer fails to pay.
 Financial Components Approach is used to record this transaction because seller has
continued involvement. (Both parties recognize assets and liabilities)
  Example → Crest Textiles estimates a recourse obligation (liability) of fair value $6000.
This is the estimate of the cost of its agreement.
 Loss on sale of receivables is determined by calculating net proceeds from sale and
comparing it to the carrying amount of sold assets.

 Journal entries are the same as non-recourse, but with these numbers instead.
 Credit an additional liability - Recourse Liability to indicate the probable payment for
uncollectibles.
 Servicing – transferor in the securitization retains service responsibility (i.e. collecting
principal and interest, monitoring accounts, and remitting cash for those who hold
beneficial interests).
 A Service Liability/Asset Component is recognized depending on if the service
activities cost is less than or greater than estimated cost.

Disclosure

 Transparency requires significant disclosures for securitized receivables accounted for

as sales.
 Inform readers about fair value measurements and key assumptions, securitization
characteristics, cash flows between special purpose entity and transferor, and
balances/risk of service.

1. Explain how receivables and loans are reported and analyzed.

Presentation and Disclosure

 The objective is to allow users to evaluate the significance of the financial assets and the
nature/extent of associated risks.
 More info is required under IFRS (go figure…)
 Separation of the reporting of ordinary trade accounts, amounts owing by related
parties, prepayments, and other significant amounts.
 An indication of amounts and maturity dates of accounts with maturity > 1 year.
 Separate reporting of receivables that are current assets from those that are non-current.
  Separate reporting of any impaired balances, and the amount of any allowance for
credit losses with reconciliation of changes in allowance.
 Major disclosures are required about securitization or transfers of receivables, whether
derecognized or not.
 Credit Risk is a major concern due to associated risks.
 Balance Sheet: Record cash and receivables under current assets.’
 Notes: Specify disclosure of the specifics behind trade and other receivables as well as
other non-current assets.
 Also include details on financial management, derivative instruments, and credit risk.

*Due to sizing issues, refer to Illustration 7-17 on Page 371-373 for an example of disclosures.*

Analysis

 Calculate financial ratios to evaluate the liquidity of a company’s accounts receivable.

 Receivables Turnover ratio = Net Sales/Revenue / Average Trade Receivables (net)
 Measures the receivables’ liquidity by measuring the number of times on average that
receivables are collected during the period.

 Results give info on quality of receivables and how successful collection will be
compared to prior periods, industry standards, credit terms, or internal targets.
 Aging Schedule – Used to reveal patterns of how long the receivables have been
outstanding.
 If allowance grows faster than receivables – there may be deterioration in credit quality
or the company is trying to cushion for poorer performing years ahead.
 Consider:
 Not appropriate to compare turnover ratio of a company that securitizes or factors
receivables with a company that does not.
 Growth in sales and receivables are positively correlative UNLESS a company sells
receivables.
 Securitization is “off balance sheet” because receivables are removed from current assets
and because the amount borrowed is not in liabilities. (Affects the liquidity ratios)
 Identify differences in accounting between IFRS and accounting standards for private
enterprises (ASPE), and what changes are expected in the near future.

Refer to Illustration 7-19 on Page 374-375 for exact changes.

 Looking Ahead →
  IFRS → simplification of forward-looking impairment is expected - credit losses in the
future will be based on reasonable and supportable info.
 ASPE → Not likely to change in the short term. One area open to change is
derecognition.
 Explain common techniques for controlling cash. (APPENDIX 7A)

Management and Control of Cash

 Cash is at risk of being diverted/used improperly → so 2 problems must be overcome.

 It must establish proper controls to ensure that no unauthorized transactions are entered.
 It must ensure that the info needed to properly manage cash on hand and cash
transactions is available.
 Internal Control – Must be effective to maintain the control.

Bank Accounts

 Collection Centres reduce the size of collection float – difference between amount on
deposit according to records and amount of collected cash according to the bank record.
 General Chequing Account – Main bank account for businesses.
 Lockbox Accounts – Used by large companies with multiple locations to make
collections in cities where billing occurs.
 Accelerates availability of collected cash.

Imprest Petty Cash System

 The Petty Cash System

 The custodian is given a small amount of currency to make small payments.
 Debit Petty cash and credit cash
 As payments are made out of the fund, the custodian gets signed receipts from each
individual who receives cash from the fund.
 When the cash in the fund runs low, the custodian presents a request for reimbursement.
 If the fund’s balance is too high, deposit the surplus amount back into the account.
 Examples of uses: Office expense, postage expense, entertainment expense, cash over
and short.
 Cash Over and Short – When the cash in the petty cash fund + dollar amount of the
receipts doesn’t equal the imprest petty cash amount.
 Left open until the end of the year and counted as other expense or revenue.
 The Petty Cash Custodian is responsible for the fund, and there are 2 additional checks.
 Surprise counts.
 Petty cash receipts are cancelled or mutilated to prevent repeated use.

Physical Protection of Cash Balances

  Cash on hand and in banks must be protected by reducing the actual cash held on hand or
in the office.
 Only funds on hand: petty cash, current day’s receipts, or funds for making change.
 Cash should be locked in a vault, safe, or locked cash drawer.
 Each day’s receipts should be transmitted to the bank to prevent errors or omissions.
 Cash on deposit is not available for count, so a bank reconciliation is prepared.

Reconciliation of Bank Balances

 At the end of the month a bank sends the customer a bank statement, but there may be
differences between customers’ records and bank records.
 Differences are reconciled by a schedule that explains differences between the bank and
company’s cash records.

Reconciling Items →

1. Deposits in Transit – End of month deposits of cash are recorded next month by the
bank.
2. Outstanding Cheques – Cheques written by the depositor are recorded when written but
not recorded by the bank until next month.
3. Bank Charges – Charges are recorded by the bank against depositor’s balance for items
– the depositor may not be aware of these charges until the bank statement is received.
4. Bank Credits – Collections or deposits by the bank for the depositor’s benefit may not
be known by the depositor until the bank statement is received.
5. Bank or Depositor Errors – Errors by either the bank or depositor.

 It safeguards cash by ensuring accurate accounting records.

 Typically the popular format is to reconcile both the bank balance and book balance to a
correct cash balance.
 The two sections: Balance per bank statement and Balance per company’s books end
with the same correct cash balance.
 Adjusting journal entries are prepared for the addition/deduction items in the Balance
Per Company’s Books section.