Lecture 5

Time Value of Money /

Current Assets

ACC 2707
Corporate Accounting & Reporting I
Semester 1, 19/20

Hojun Seo

I can accept failure. Everyone fails at something. But I cannot accept not
trying. -- Michael Jordan
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 Today’s Topic
• Time Value of Money
• Current Assets
– Cash and Receivable
– Note receivable in combination with time value of money
– Derecognition of Receivables
 Today’s Topic
• Time Value of Money
• Current Assets
– Cash and Receivable
– Note receivable in combination with time value of money
– Derecognition of Receivables
 Present Values
• What is a present value?
– The current value of an amount to be receive in the future; a future
amount discounted for compound interest
– Based on the time value of money
• Would you rather have $1,000 today or $1,000 in three
years? Why?
– The current value of an amount to be received in the future; a
future amount discounted for compound interest
– Based on the time value of money
 Present Values
• Why do we care about Present Values (PV) and Future
Values (FV)?
– We want to know how much we have to pay today to satisfy a given
liability in the future (present value)
– We want to know how much we will have in the future if we invest
a specific amount today (future value)
 Present Values
• What information do you need to calculate Present Values
(PV) and Future Values (FV)?
– Number of periods
– Interest rate per period
– Amount (either the present or future value)

• Types of cash flows (amounts)

– Single Sum
Annuity (def) – a series of periodic cash
– Annuity receipts or payments that are equal in
amount each interest period

Today
Present Value Examples
What is the PV of $100,000 to be received in 5 periods (i = 8%)?
0 1 2 3 4 5

100,000
Inputs
Amount = 100,000 Lump Sum PV of Lump
x PV Factor =
Interest = 8% Amount Sum

Periods =5 100,000 x 0.6806 = 68,060

PV Factor =?
Present Value Examples
What is the PV of $100,000 to be received in 10 periods (i = 8%)?
0 1 2 3 4 5 6 7 8 9 10

100,000
Inputs
Amount = 100,000 Lump Sum PV of Lump
x PV Factor =
Interest = 8% Amount Sum

Periods = 10 100,000 x 0.4632 = 46,320

PV Factor =?
Present Values (Single Sum) Example
• If the annual interest rate is 6%. Which has the highest present
value?
1. $100,000 in 6 years? 100,000 x 0.7050 = 70,500

2. $80,000 today? 80,000

3. $40,000 today and $45,000 in two years? 40,000 + 40,050 = 80,050

45,000 x 0.8900 = 40,050

Present Values (Single Sum) Example
• What is the interest rate if:
– Future Value (FV) = $50,000
– Present Value (PV) = $25,660
Interest Rate # of Periods
– # of Periods = 7 periods

FV x PV Factor = PV

PV Factor = PV
FV

0.5132 = 25,660
50,000
Present Value of Annuities
What is the PV of a $100 annuity for 3 periods (i = 8%)? 1st Method
0 1 2 3

100 100 100

100 x 0.9259 = 92.59 100 x 0.8573 = 85.73 100 x 0.7938 = 79.38

92.59 + 85.73 + 79.38 = 257.70

FV x PV Factor = PV
Present Value of Annuities
What is the PV of a $100 annuity for 3 periods (i = 8%)? 2nd Method
0 1 2 3

100 100 100

Inputs
Amount = 100 Annuity PV of
x PV Factor =
Interest = 8% Amount Annuity

Periods =3 100 x 2.5771 = 257.71

PV Factor =?

SAME Answer as using

the first method
Future Values – Single Sum
If you invest 10,000 today and expect to earn 8% interest (annual) for 2 years, how much will you
have in 2 years? Assume that the interest is compounded quarterly.
0 1 2 3 4 5 6 7 8

10,000
Inputs
Amount = 10,000 Single Sum FV of
x FV Factor =
Interest = 2% Amount Single Sum

Periods =8 10,000 x 1.1717 = 11,717

FV Factor =?
Future Values – Annuity
If you invest 1,000 every quarter for the next two years and expect to earn 8% per year, how
much will you have in 2 years? Assume that the interest is compounded quarterly.
0 1 2 3 4 5 6 7 8

1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000

Inputs
Amount = 1,000 Annuity FV of
x FV Factor =
Interest = 2% Amount Annuity

Periods =8 1,000 x 8.5830 = 8,583

FV Factor =?
Present Value of Annuities - Practice
You are going to buy a car that cost $12,000. You can . . .
1. Borrow $12,000 from the bank. The principal is due in 10 months.
Interest payments of $500 are due at the end of each month. The
current annual interest rate is 12%.

Total Cash Paid

12,000 + (500 * 10) = 17,000

2. Promise to pay the dealer $1,700 (which includes principal plus

interest) at the end of each month for 10 months. The current
annual interest rate is 12%.
Total Cash Paid
1,700 * 10 = 17,000
Present Value of Annuities - Practice
You are going to buy a car that cost $12,000. You can . . .
1. Borrow $12,000 from the bank. The principal is due in 10 months. Interest payments of
$500 are due at the end of each month. The current annual interest rate is 12%.

Single Sum = 12,000

Amt * Rate = PV
12,000 * 0.9053 = 10,863.6

Annuity = 500
Amt * Rate = PV
500 * 9.4713 = 4,735.65

10,863.6 + 4,735.65 = 15,599.25

Present Value of Annuities - Practice
You are going to buy a car that cost $12,000. You can . . .
2. Promise to pay the dealer $1,700 (which includes principal plus interest) at the end of each
month for 10 months. The current annual interest rate is 12%.

Annuity = 1,700
Amt * Rate = PV
1,700 * 9.4713 = 16,101.21
Present Value of Annuities - Practice
You are going to buy a car that cost $12,000. You can . . .
1. Borrow $12,000 from the bank. The principal is due in 10 months.
Interest payments of $500 are due at the end of each month. The
current interest rate is 12%.

$15,599.25

2. Promise to pay the dealer $1,700 (which includes principal plus

interest) at the end of each month for 10 months. The current
annual interest rate is 12%.

$16,101.21
 Today’s Topic
• Time Value of Money
• Current Assets
– Cash and Receivable
– Note receivable in combination with time value of money
– Derecognition of Receivables
 Cash
• What is the definition of cash equivalents?
– Short-term, highly liquid investments that are both
 Readily convertible to known amounts of cash
 So near their maturity that they present insignificant risk of changes in
value because of changes in interest rates
– Generally, only investments with original maturities of 3 months or
less qualify

• E.g., treasury bills, commercial paper, money market funds

 Receivables
• What is an account receivable?
– Oral promise to pay
– Typically collected in 30 to 60 days (current asset)

• What is a note receivable?

– Written promise to pay
– Could result from a sales, financing, or other transaction
– Could be a current or non-current asset
 Receivables
• What are trade receivables?
– Customers owe money to the company
– Can be an account or note receivable; however, most likely is an
account receivable

• What are non-trade receivables?

– Could arise from a variety of transactions, such as
1. Advances to officers and employees
2. Dividend and interest receivable
3. Deposits paid as a guarantee of performance or payment
4. Claims against various parties (e.g., insurance companies)
Likely trade
receivables
 Recognition of Accounts Receivables
• Recognition of accounts receivable generally occurs when
the revenue is recognized
• Revenue is recognized when the selling company satisfies
the performance obligation, which occurs when the good or
service is transferred to the customer (i.e., control is
transferred)
– Will be discussed more in revenue recognition
• What is the journal entry?

Accounts Receivable XXX

Sales Revenue YYY
 Bad Debt Expense
• What activity is recorded in the bad debt expense account?
– An expense that is associated with estimated uncollectible accounts
receivable
– When customers pay with credit, the company later ascertains that
the customer will not pay the amount they owe regardless of
collection efforts

• When is the bad debt expense recognized on the income

statement?
– The same period in which the sales are recognized
– Application of the matching principle
 Bad Debt Expense
PROBLEM
Much of the time, the company does not know which customers
will not be paying (uncollectible) until next period

End of period 1
Period 1 Period 2

Sale is recognized Account is

deemed to be
uncollectible

In what period should the bad debt expense be recognized?

• During Period 1 (Matching Principle)
• Bad debts are estimated and recorded during period 1
 Bad Debt Expense
• What is the journal entry that is recorded when bad debts
are estimated to be uncollectible?

Bad Debt Expense (+E, -SE) XXX

Allowance for Doubtful Accounts (-A) XXX

Contra accounts receivable account

Bad Debt Expense is normally classified as a selling expense and is

closed at year-end.
 Bad Debt Estimation
What are the two main ways that bad debt expense is
estimated?
• Percentage of credit sales method
– Bad debt expense is based on the historical percentage of credit
sales that result in bad debts (bad debt loss rate)

Previous Bad Debt Losses

Bad Debt Loss Rate =
Previous Credit Sales

• Aging of accounts receivables

– Estimate uncollectible accounts based on the age (days
outstanding) of each account receivable
– As accounts receivable become older and more overdue, it is less
likely that they will be collectible
Aging of Accounts Receivable
Microsoft had $400,000 of credit sales during the fiscal year ending December 31,
2012. Of the credit sales, $50,000 remains uncollected at the end of the year. An aging
schedule as of December 31, 2012 is provided below. Calculate the ending balance for
the Allowance for Doubtful Accounts.

Estimated
Amount Estimated % Amount
Age Group Receivable Uncollectible Uncollectible
Not yet due 30,000 1% 300

0-30 days past due 10,000 3% 300

31-60 days past due 7,000 5% 350

More than 60 days past due 3,000 10% 300

Total 50,000 1,250

December 31, 2012 Allowance for

Doubtful Accounts balance
Aging of Accounts Receivable
Microsoft had $400,000 of credit sales during the fiscal year ending December 31, 2012.
Of the credit sales, $50,000 remains uncollected at the end of the year. An aging schedule
as of December 31, 2012 is provided below. Calculate the ending balance for the
Allowance for Doubtful Accounts.

What is the December 31, 2012 adjusting entry if the Allowance for Doubtful Accounts’
balance is equal to a $350 credit immediately prior to booking the adjusting entry?

Start with the T-account Journal Entry

Allowance for DA Bad Debt Expense 900

350 Allowance for Doubtful Accounts 900
900
1,250

To balance the account we must credit the

Allowance for Doubtful Accounts
 Write-offs
• When it is clear that a specific customer’s account
receivable will be uncollectible, the amount should be
removed from the Accounts Receivable and the Allowance
for Doubtful Accounts balances.
• What is the journal entry that is recorded when accounts
are written-off?

Allowance for Doubtful Accounts (+A) XXX

Accounts Receivable (-A) XXX
 Write-offs
Allowance for Doubtful Accounts (+A) XXX
Accounts Receivable (-A) XXX

• Why is bad debt expense not debited when the account is

written-off?
– We previously estimated the percentage of accounts receivable that
will be uncollectible and was expensed through the bad debt
expense account
• How is the income statement affected by the write-off?
– Unchanged
• How are total assets affected by the write-off?
– Unchanged
Write-offs

Lululemon’s Allowance for Doubtful Accounts balance is $4,000 on December 31, 2010. On
May 2, 2011, Lululemon wrote off $5,500 of accounts receivable. Lululemon has the
following accounts receivable aging schedule as of December 31, 2011.

Amount Estimated %
Age Group
Receivable Uncollectible
Not yet due 79,000 1%
0-30 days past due 54,000 3%
31-60 days past due 30,000 5%
More than 60 days past due 4,000 10%
Total 167,000

Record the write-off of the accounts receivable on May 2 and the adjusting journal entry
associated with recording the bad debt expense for 2011 on December 31, 2011.
Write-offs
Lululemon’s Allowance for Doubtful Accounts balance is $4,000 on December 31, 2010. On
May 2, 2011, Lululemon wrote off $5,500 of accounts receivable. Lululemon has the
following accounts receivable aging schedule as of December 31, 2011.

T-account Journal Entry – Write-off

Allowance for DA Allowance for Doubtful Accounts 5,500
4,000 Accounts Receivable 5,500
5,500
Write-offs
Lululemon’s Allowance for Doubtful Accounts balance is $4,000 on December 31, 2010. On
May 2, 2011, Lululemon wrote off $5,500 of accounts receivable. Lululemon has the
following accounts receivable aging schedule as of December 31, 2011.

Amount Estimated %
Age Group
Receivable Uncollectible
Not yet due 79,000 1%
0-30 days past due 54,000 3%
31-60 days past due 30,000 5%
More than 60 days past due 4,000 10%
Total 167,000
Write-offs
Lululemon’s Allowance for Doubtful Accounts balance is $4,000 on December 31, 2010.
On May 2, 2011, Lululemon wrote off $5,500 of accounts receivable. Lululemon has the
following accounts receivable aging schedule as of December 31, 2011.

Amount Estimated % Estimated Amt

Age Group
Receivable Uncollectible Uncollectible
Not yet due 79,000 1% 790
0-30 days past due 54,000 3% 1,620
31-60 days past due 30,000 5% 1,500
More than 60 days past due 4,000 10% 400
Total 167,000 4,310

T-account

Allowance for DA
4,000
5,500
4,310
Example with Write-offs
Write-offs
Lululemon’s Allowance for Doubtful Accounts balance is $4,000 on December 31, 2010.
On May 2, 2011, Lululemon wrote off $5,500 of accounts receivable. Lululemon has the
following accounts receivable aging schedule as of December 31, 2011.

Amount Estimated % Estimated Amt

Age Group
Receivable Uncollectible Uncollectible
Not yet due 79,000 1% 790
0-30 days past due 54,000 3% 1,620
31-60 days past due 30,000 5% 1,500
More than 60 days past due 4,000 10% 400
Total 167,000 4,310

T-account

Allowance for DA
4,000
5,500 4,000 + x – 5,500 = 4,310
4,310
x = 5,810
Write-offs
Lululemon’s Allowance for Doubtful Accounts balance is $4,000 on December 31, 2010.
On May 2, 2011, Lululemon wrote off $5,500 of accounts receivable. Lululemon has the
following accounts receivable aging schedule as of December 31, 2011.

Amount Estimated % Estimated Amt

Age Group
Receivable Uncollectible Uncollectible
Not yet due 79,000 1% 790
0-30 days past due 54,000 3% 1,620
31-60 days past due 30,000 5% 1,500
More than 60 days past due 4,000 10% 400
Total 167,000 4,310

T-account

Allowance for DA
4,000
5,500 5,810 Journal Entry

4,310 Bad Debt Expense 5,810

Allowance for Doubtful Accounts 5,810
Write-offs
On the February 3, 2012, an accounts receivable of $1,200 that was written-off by
Lululemon was unexpectedly collected. What is the journal entry to record the
restoration and collection of the accounts receivable?

Journal Entry Restore the

Accounts
Receivable
Accounts Receivable 1,200
balance
Allowance for Doubtful Accounts 1,200

Cash 1,200
Record
Accounts Receivable 1,200 Collection of the
Receivable
 Notes Receivables
• Notes receivables are typically supported by a promissory
note, a written promise to pay
• A promissory notes typically specify the
– Principal
– Maturity date
– Payment terms
 Recognition of Notes Receivables
• Companies report long-term notes receivable at the present
value of the cash they expect to collect
• Three scenarios
Scenario #1 Loan is issued at par
Stated Interest Rate = Market Interest Rate Face Value = Cash Loaned

Scenario #2 Loan is issued at a premium

Stated Interest Rate > Market Interest Rate Face Value < Cash Loaned

Scenario #3 Loan is issued at a discount

Stated Interest Rate < Market Interest Rate Face Value > Cash Loaned

Cash
Market rate Loaned
Recognition of Notes Receivables

Purchase of Security
Notes Receivable (+A) xx
Cash (-A) xx

Recording Interest Revenue

Cash (+A) xx
Interest Revenue (+R, +SE) xx

Principal Payment at Maturity

Cash (+A) xx
Notes Receivable (-A) xx

Journal Entries when the note is issued at par

Notes Receivable – Interest-Bearing Notes
On the January 1, 2016, Napoleon Corp issues a 3-year note to Pedro Corp (i.e., Napoleon Corp is loaning
the money). The face value of the note is equal to $30,000. The note bears interest at 5% annually. The
market rate of interest for a note of similar risk is 3% annually. Interest is paid annually and the principal is
paid when the loan matures. What journal entry should Napoleon Corp record when the note is issued,
when the interest is paid, and principal is repaid?

Is the note issued at a discount,

PV of the principal pmt 27,453.00 premium, or at par?
+ PV of the interest pmt + 4242.90 Market Rate < Stated Rate => Premium

Cash Loaned 31,695.90

Single Sum PV of
x PV Factor =
Amount Single Sum

30,000 x 0.9151 = 27,453

Annuity PV of Ordinary
x PV Factor =
Amount Annuity
1,500 x 2.8286 = 4242.90
Notes Receivable – Interest-Bearing Notes
On the January 1, 2016, Napoleon Corp issues a 3-year note to Pedro Corp (i.e., Napoleon Corp is loaning
the money). The face value of the note is equal to $30,000. The note bears interest at 5% annually. The
market rate of interest for a note of similar risk is 3% annually. Interest is paid annually and the principal is
paid when the loan matures. What journal entry should Napoleon Corp record when the note is issued,
when the interest is paid, and principal is repaid?

AMORTIZATION SCHEDULE (EFFECTIVE-INTEREST METHOD) Journal Entries

(a) (b) (c) (d)
1/1/16 Notes Receivable 30,000.00
Interest Amortization Book Value Premium on Notes Receivable 1,695.90
Date Payment Interest Revenue (b) - (a) Beg BV + (c)
Cash 31,695.90
1/1/16 31,695.90
31/12/16 1,500 950.88 (549.12) 31,146.78 31/12/16 Cash 1,500.00
Premium on Notes Receivable 549.12
31/12/17 1,500 934.40 (565.60) 30,581.18
Interest Revenue 950.88
31/12/18 1,500 917.44 (582.56) 29,998.62
31/12/17 Cash 1,500.00
Premium on Notes Receivable 565.60
Interest Revenue 934.40

31/12/18 Cash 1,500.00

Difference is Premium on Notes Receivable 582.56
due to rounding Interest Revenue 917.44
Cash 30,000.00
Notes Receivable 30,000
Notes Receivable – Zero-Interest-Bearing Notes
On the January 1, 2016, Napoleon Corp issues a zero-interest-bearing 3-year note to Pedro Corp.
Napoleon Corp is loaning the money. The face value of the note is $30,000. The market rate of interest for
a note of similar risk is 4% annually. Principal is paid when the loan matures. What journal entry should
Napoleon Corp record when the note is issued and principal is repaid?

Is the note issued at a discount,

premium, or at par?
PV of the principal pmt 26,670
Because no interest is paid explicitly paid, the
+ PV of the interest pmt + 0 bond will be issued at a discount

Cash Loaned 26,670 Implicit interest paid is the difference between

the cash loaned and the face value

Single Sum PV of
x PV Factor =
Amount Single Sum

30,000 x 0.8890 = 26,670

Annuity PV of Ordinary
x PV Factor =
Amount Annuity
0
Notes Receivable – Zero-Interest-Bearing Notes
On the January 1, 2016, Napoleon Corp issues a zero-interest-bearing 3-year note to Pedro Corp.
Napoleon Corp is loaning the money. The face value of the note is $30,000. The market rate of interest for
a note of similar risk is 4% annually. Principal is paid when the loan matures. What journal entry should
Napoleon Corp record when the note is issued and principal is repaid?

AMORTIZATION SCHEDULE (EFFECTIVE-INTEREST METHOD) Journal Entries

(a) (b) (c) (d) 1/1/16 Notes Receivable 30,000.00
Interest Amortization Book Value Discount on Notes Receivable 3,330.00
Date Payment Interest Revenue (b) - (a) Beg BV + (c) Cash 26,670.00
1/1/16 26,670.00
31/12/16 Discount on Notes Receivable 1,066.80
31/12/16 0 1,066.80 1,066.80 27,736.80
Interest Revenue 1,066.80
31/12/17 0 1,109.47 1,109.47 28,846.27
31/12/18 0 1,153.85 1,153.85 30,000.12 31/12/17 Discount on Notes Receivable 1,109.47
Interest Revenue 1,109.47

31/12/18 Discount on Notes Receivable 1,153.85

Interest Revenue 1,153.85
Difference is Cash 30,000.00
due to rounding Notes Receivable 30,000.00
Notes Receivable – Exchanges
On the January 1, 2018, Napoleon Corp sells equipment with a fair market value of $33,000 to Pedro
Corp. Pedro Corp agrees to pay Napoleon Corp $40,149.55 in 5 years. On the date of the sale, the book
value of the equipment is equal to $35,000 with accumulated depreciation equal to $54,000. What is the
journal entry that Napoleon Corp records on January 1?

Notes Receivable 40,149.55

89,000 Cost
Accumulated Depreciation 54,000.00 (54,000) (Acc Dep)
Loss on Equipment 2,000.00 35,000 BV

Equipment 89,000.00
Discount on Notes Receivable 7,149.55 40,149.55 – 33,000

33,000 Fair Market Value

(35,000) (Book Value)
(2,000) Gain/(Loss)
Other application - Bonds

12.

Jan 1, 2018: $19,604,145

June 30, 2018: $19,604,145 + ( $19,604,145 × 0.04) – $780,000 = 19,608,311
December 31, 2018: 19,608,311 + [$19,608,311 × 0.04) – $780,000] = $19,612,643
June 30, 2018: $19,612,643 + ( $19,612,643 × 0.04) – $780,000 = 19,617,148
December 31, 2018: 19,617,148 + ($19,617,148 × 0.04) – $780,000 = $19,621,835
 Derecognition of receivables
• Various reasons for transfer of receivables to another party
– Accelerate the receipt of cash.
– Competition.
– Sell receivables because money is tight.
– Billing / collection are time-consuming and costly.
• Transfer of receivables for cash happens in two ways:
1. Sales of receivables.
2. Secured borrowing.
 Sales of receivables

• Factors are finance companies or banks that buy receivables

from businesses for a fee.
 Sales of receivables
Sale without Guarantee
• Purchaser assumes risk of collection and absorbs any credit
losses.
• Transfer is outright sale of receivable.
• Seller records loss on sale.
• Seller uses a Due from Factor (receivable) account to cover
probable sales discounts, sales returns, and sales
allowances.
 Sales of receivables
Illustration: Crest Textiles, Inc. factors €500,000 of accounts
receivable with Commercial Factors, Inc., on a non-guarantee
basis. Commercial Factors assesses a finance charge of 3
percent of the amount of accounts receivable and retains an
amount equal to 5 percent of the accounts receivable (for
probable adjustments). Crest Textiles and Commercial Factors
make the following journal entries for the receivables
transferred without guarantee.
 Sales of receivables
Sale with Guarantee
• Seller guarantees payment to purchaser.
• Transfer is considered a borrowing—sometimes referred to
as a failed sale.

Assume Crest Textiles sold the receivables on a with guarantee

basis.
 Secured borrowing
Illustration: On April 1, 2019, Prince Company assigns $500,000 of
its accounts receivable to the Hibernia Bank as collateral for a
$300,000 loan due July 1, 2019. The assignment agreement calls for
Prince Company to continue to collect the receivables. Hibernia
Bank assesses a finance charge of 2% of the accounts receivable,
and interest on the loan is 10% (a realistic rate of interest for a note
of this type).
Instructions:
a) Prepare the April 1, 2019, journal entry for Prince Company.

Cash 290,000
Finance Charge ($500,000 x 2%) 10,000
Notes Payable 300,000
 Secured borrowing
Illustration: On April 1, 2019, Prince Company assigns $500,000 of
its accounts receivable to the Hibernia Bank as collateral for a
$300,000 loan due July 1, 2019. The assignment agreement calls for
Prince Company to continue to collect the receivables. Hibernia
Bank assesses a finance charge of 2% of the accounts receivable,
and interest on the loan is 10% (a realistic rate of interest for a note
of this type).
Instructions:
b) Prepare the journal entry for Prince’s collection of $350,000 of
the accounts receivable during the period from April 1, 2019,
through June 30, 2019.

Cash 350,000
Accounts Receivable 350,000
 Secured borrowing
Illustration: On April 1, 2019, Prince Company assigns $500,000 of
its accounts receivable to the Hibernia Bank as collateral for a
$300,000 loan due July 1, 2019. The assignment agreement calls for
Prince Company to continue to collect the receivables. Hibernia
Bank assesses a finance charge of 2% of the accounts receivable,
and interest on the loan is 10% (a realistic rate of interest for a note
of this type).
Instructions:
c) On July 1, 2019, Prince paid Hibernia all that was due from the
loan it secured on April 1, 2019.

Notes Payable 300,000

Interest Expense (10% x $300,000 x 3/12) 7,500
Cash 307,500
 Next Time
• Review the slides from today’s class.
• Read Chapter 10
• Any Questions?