CHAPTER

7
Cash and Receivables

Chapter Overview
1. Financial asset 2. Cash and cash-like items
Recognition Measurement Presentation

3. Receivables
Recognition/De-recognition Measurement Presentation

4. IFRS/GAAP comparison
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Cash and Receivables

Cash What is cash? Reporting cash Summary of cashrelated items Receivables Recognition and measurement of accounts receivable Impairment of accounts receivable Recognition and measurement of shortterm notes and loans receivable Recognition and measurement of longterm notes and loans receivable Derecognition of receivables Presentation, Disclosure, and Analysis of Receivables Presentation and disclosure Analysis IFRS / Private Entity GAAP Comparison Comparison of IFRS and private entity GAAP Looking ahead

1. Financial Asset
Any asset that is: (i) cash; (ii) a contractual right to receive cash or another financial asset from another party; (iii) a contractual right to exchange financial instruments with another party under conditions that are potentially favourable to the entity; or (iv) an equity instrument of another entity
(private entity GAAP CICA Handbook, Section 3856)

Financial assets and financial liabilities collectively called financial instruments.

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WA 7-1: Indicate whether the item is a financial asset

1. Accounts receivable, trade 2. Accounts receivable, related company 3. Accounts receivable, to be exchanged for shares in another company 4. Note receivable, receivable in grams of a precious metal 5. Cash 6. Investment in Royal Bank common shares (long-term investment) 7. Income taxes receivable 8. Interest rate swap: contract to receive fixed rate (at 8%) and to pay variable rate (current rates are 6%) on debenture debt 9. U.S. dollar cash holdings in a U.S. subsidiary's bank account
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WA7-1 Solution
Item 4: No. The consideration to be received is not cash or other financial assets Item 7: No. It is a legal right not a contractual right Item 8: Yes. (not required for exam) Other items: Yes

Note:
Financial instruments often involve complex issues and examples that is beyond the scope of the text Exam tests only examples that have been covered in assignments
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2. Cash and Cash-Like Items

Recognition
Cash vs. Cash equivalents vs. short-term investments Restricted cash Other cash-like items Bank overdrafts, foreign currencies,

Measurement and presentation

Bank overdrafts Cash in foreign currencies Restricted cash Cash equivalents
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More details from publishers slides

Recognition (Classification)
Cash
e.g. coins, deposits in bank, most cheques, money orders etc.; Must be immediately available and free of restrictions

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 IFRSs definition slightly differs (more principle-based)

Short-term investments
Other short-term investments that are not classified as cash equivalents Original maturity is generally more than three months

Measurement and Presentation

Cash vs. cash equivalents
At fair value, report as current

Restricted cash
If immaterial, include with cash. If material, report separately as restricted cash, either current or long term, and/or disclose in the notes.

Cash in foreign currencies

At equivalent Canadian dollars @ exchange rate on B/S date

Bank overdrafts
Often report as current liabilities, unless both accounts are from the same bank; in such case, overdraft can be offset against cash account

Plus sufficient disclosure (e.g. restricted cash; cash equivalents how they are defined; etc.)
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Cash, Cash Equivalent, or Other?

Coins on hand Checking or savings accounts (no restriction) Certificate of deposits: 60 days Short-term commercial papers: 180 days 3 month treasury bills Money market funds with checking privileges Postdated checks from customers IOUs from customers NSF Check received from customer Short-term equity securities, 4 months U.S. dollar account on hold for long-term loans Compensating balances Bank overdrafts * Can be classified as cash equivalents under IFRS in certain scenarios Cash Cash Cash equivalent Short-term investment Cash equivalent Cash Receiv. or non-asset Receivables Receivables S-T investments* Long-tem asset S-T or L-T asset Depends, liability if no another bank account to offset
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3. Receivables
3.1 Recognition (classification) 3.2 Initial and subsequent measurement
3.2.1 Accounts Receivable 3.2.2 Notes Receivable

3.3 Presentation 3.4 De-recognition 3.5 Ratio Analysis

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3.1 Receivables: Recognition (Classification)

Receivable or not? If classified as receivable
Current vs. Non-current receivables Trade vs. Non-trade receivables

Trade receivables: receivables from sales

e.g. Accounts Receivable; Notes Receivable

Non-trade receivables (other receivables)

E.g. Interest receivable, dividend receivable, advances to employees, etc.
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3.2 Receivables: Measurement

Initial measurement (on transaction date): At fair value
Current: time value of money is often ignored e.g. Accounts Receivable Non-current: time value of money should be considered e.g. Long-term notes receivable

Subsequent measurement (on B/S date)

Depending on the type of receivables Accounts receivable Notes receivable

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3.2.1 Accounts Receivable

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Initial Measurement
Trade discounts (30% off, 50% off)
e.g. sold 3000 shirts on account at 30% off, original price @$10

Cash discounts (2/10, 1/15, n/30)

Gross method
sales price recorded at gross amt Most common method in real world Use Sales Discount to capture discount actually taken by customers; its a contra account to Sales Revenue

Net method
Sales price recorded at net amount
Assume every customer will take cash discount

Theoretically preferred but rarely used Discount not taken by customers are recognized as other 15 revenue - Sales Discount Forfeited

Sales Returns and Allowance (SR&A)

To capture actual sales returns and expected material returns and allowance to incur after B/S date Example of sales allowance include estimated cash discounts to be taken by customers, estimated deduction from sales due to unexpected problems such as breakage, quality deficiency, incorrect quantity, and product call back The journal entry involve a debit to SR&A, and a credit to Allowance for SR&A (a contra account to Accounts Receivable)
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SR&A vs. Allowance for SR&A

Sales (Balance of Sales Revenue) -): Cash Discount (Balance of Sales Discount)* -): Sales returns & allowance (Balance of SR&A) = Net Sales Accounts Receivable $ XXX Less: Allowance on Doubtful Accounts XXX Less: Allowance on SR&A XXX Net Realizable Value $ XXX
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Subsequent Measurement
Theoretically, accounting receivable on B/S date should be amortized cost using the effective interest method In practice, for short-term A/R, the interest is often IGNORED materiality

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Uncollectible A/R (Impairment of A/R)

When the uncollectible amount should be recorded?
Two options

At the time the receivable is reasonably estimated to be uncollectible (i.e. When A/R is impaired) => Allowance method
Required by IFRS/PE GAAP Must be followed if amounts are material

At the time the receivable is determined to be uncollectible => Direct write-off method
Appropriate only for immaterial amt or small business
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Direct Write-off Method

Sales date:
Acc. Receiv. is initially recognized

Balance sheet date

No entry

Write-off date
Actual uncollectible amount is recorded as a debit to Bad Debt Expense account and a credit to Acc. Rec.

Recovery date (uncollectible amount is collected)

First entry to reverse the entry on write-off date Second entry to record the collection
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Allowance Method
Sales date:
Acc. Receiv. is initially recognized

Balance sheet date

Uncollectible amount is estimated and recorded under Allowance for Doubtful Accounts, a contra asset account. Bad Debt Expense is recognized

Write-off date
Actual uncollectible amount is recorded as a debit to Allowance account and a credit to Acc. Rec.

Recovery date (uncollectible amount is collected)

First entry to reverse the entry on write-off date Second entry to record the collection
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Allowance Method - Two procedures

Allowance Procedure Only
Estimation of uncollectible amount is based on % of A/R A Balance sheet approach (A/R is a B/S account)

Mix of Procedures

During the year use % of sales; at year-end adjust the Allowance for Doubtful Accounts using the Allowance Procedure A mix of I/S approach and B/S approach Assume a better match between bad debt expense and sales revenue during the year; and a better match between bad debt expense and outstanding A/R at year end

Both approach will result in

The SAME ending balance in Bad Debt Expense The SAME ending balance in the Allowance for Doubtful Accounts
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Allowance Procedure Only

Wilson & Co. Aging Schedule
Customer Balance < 60 Days
$ 80,000 320,000 $55,000 60,000 $ 18,000 15% $14,000 $ 14,000 20% $ 55,000 25%

61 90 Days
$ 18,000

91 120 Days

> 120 Days

Western Brockville Freeport Manitoba

$ 98,000 320,000 55,000 74,000

$547,000 $460,000 Estimated Uncollectible 4%

Assume Allowance for Doubtful accounts has a credit balance of $800 immediately before adjustment
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Allowance Procedure Only

1 Calculate the impairment and bad debts expense: 460,000 x .04 $18,400 18,000 x .15 2,700 14,000 x .20 2,800 55,000 x .25 13,750 Required balance in Allowance $37,650 Cr. less: current balance in Allowance 800 Cr. Write-down amount for period $36,850*

2 To record the write-down for the period: Bad Debts Expense *36,850 Allowance for Doubtful Accounts

36,850

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Mix of Procedures: Example

Example: Dockrill Corp. estimates from past experience that about 2% of net credit sales will become uncollectible. The firm has net credit sales of $400,000 in 2010 At year end, management determines that 3% of $330,000 accounts receivable will not be collectible. Balance of Allowance account immediately before any allowance adjustment is a debit of $500. Make necessary adjusting entries for 2011 related to Allowance for Doubtful Accounts
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Mix of Procedures: Example

1 Estimated Bad Debts Expense: $400,000 x 2% = $8,000 2 To record Bad Debts Expense: Bad Debts Expense $8,000 Allowance for Doubtful Accounts

$8,000

At year end, management determines that $9,900 3 will not be collectible. The balance of Allowance account year-end before adjustments is $7,500 (= -500 + 8000): Bad Debt Expense $2,400 Allowance for Doubtful Accounts $2,400 ($9,900 - $7,500 = $2,400)

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3.2.2 Notes Receivable

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Short-Term Notes Receivable

All notes contain some interest However, depending on whether notes have a stated rate of interest, notes are either:
Interest bearing (interest is stated) e.g. a $1,000, 6% six-month note is issued in exchange for an Account Receivable Non-interest bearing (interest is implicit) e.g. a $5,000 nine-month note issued for $4,717. No interest rate is stated. Interest amount is the difference between purchase price and maturity value

Accounting entries involve issue date and expiration date

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Interest Bearing Short-Term Notes Receivable

Example: On March 14, 2011, Accounts Receivable of $1,000 is exchanged for a 6% six-month note March 14, 2011(when note is issued): Notes Receivable 1,000 Accounts Receivable 1,000 September 14, 2011 (on collection of note): Cash 1,030 Notes Receivable 1,000 Interest Income 30 Interest = $1,000 x 6% x 6/12
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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 at 4,717. Calculate implicit interest and record journal entries.

On issuance of note: Notes Receivable Cash

On collection of note: Cash Notes Receivable Interest Income

4,717 4,717

*4,717*(1+i%) = 5,000 => i=6% (for 9 months) => APR = 8%

5,000 4,717 283

= 283
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Interest = $4,717 x 8% x 9/12

Long-Term Loans Receivable

Interest-bearing notes
Stated interest May be issued at face value, or at discount (when market rate > promised rate) At premium (when market rate < promised rate)

Non-interest bearing Notes (also called Zerointerest-bearing notes)

Implicit interest In essence such notes must be issued at discount

Accounting entries involve issue date, interest date, year-end date, and expiration date
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L-T Loans Issued at Face Value

Example: Invested in a $10,000, 3 year, 10% note issued on Jan 1 at face value. Interest paid annually on Dec 31.

Accounting journal entries

Issue date Notes Receivable Cash Interest date (annually) Cash Interest Revenue Expiration date Cash Notes Receivable 10,000 10,000 1,000 1,000 10,000 10,000
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L-T Notes Issued at Discount: Implicit Rate

Example: Invested in a 3-year note with face value $10,000. The note was issued at $7721.8 on Jan 1. The note has no stated interest rate. Implicit interest rate 7721.80* (1+ i)3 = 10000 => i=9%
Issue date (indirect method) Notes Receivable Cash

7721.8 7721.8

Note that the discount is indeed implicit 3-year interest revenue and should be amortized over 3-years.
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L-T Notes Issued at Discount: Implicit Rate

Implicit interest rate:
7721.80* (1+ i)3 = 10000
7721.8 0.77218 10, 000

Look up PV table => i=9%

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Amortization of Discounts
In this example, $10,000 $7721.8 = 2278.2 represents interest income that would be recognized on the firms books over 3 years. How much is interest income for each year? Depending on the amortization method:
Effective Interest Method: 7721.8 x 9% (7721.8 + 694.96)x 9% (7721.8 + 694.96 + 757.51) x 9%

Each year Dr. Notes Receivable and Cr. Interest income

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- Straight Line Method: 2278.2 / 3 = 795.4

= 694.96 = 757.51 = 825.73 2278.2

L-T Notes Issued at Discount: Accounting Treatment

Amortization methods (1) Straight-line method (PE GAAP only) (2) Effective interest method (PE GAAP and IFRS) (1) Effective interest method

Interest Date (Annually)

Notes Receivable Interest Revenue Expiration date Cash Notes Receivable 10,000 10,000
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Year 1 Year 2 Year 3 695.0 757.5 825.7 695.0 757.5 825.7

L-T Notes Issued at Discount: Accounting Treatment

(2) Straight line method Annual amortization: 2278.2 / 3 = 759.4 Interest Date Notes Receivable 759.4 Interest Revenue 759.4 Expiration date Cash Notes Receivable 10,000 10,000
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L-T Notes Issued at Discount: Stated Rate

Example: Morgan Corp. issues a $10,000, 10% three-year note on Jan 1; 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* PV (3, 12%) + $1,000 * Annuity (3, 12%) =($10,000 x .71178) + ($1,000 x 2.40183) = $9,520

The note is issued at a discount (as proceeds < face)

Issue Date: Dr. Notes Receivable Cr. Cash 9,520 9,520
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Present Value Tables single amount

1 PVn , i (1 i ) n
1 PV (3, 12%) 0.7118 3 (1 12%)

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Present Value Tables ordinary annuity

1 1 1 1 3 n (1 12%) 2.40183 PV OAn, i 1 i PV OA(3, 12%) 12% i

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L-T Notes Issued at Discount: Stated Rate

(2) Effective interest method

Stated Interest: 10%; Market Interest: 12% Year 1 interest $9520*12%=$1142 Year 2 interest ($9520+$142)*12%=$9662*12%=$1159 Year 3 interest ($9662+$159)*12%=$9821*12%=$1179 Interest Date
Cash Notes Receivable Interest Revenue Expiration date Year 1 Year 2 Year 3 1000 1000 1000 142 159 179 1142 1159 1179

Cash 10,000 Notes Receivable 10,000

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Other Issues
Notes Received for property, goods and services (p.402)
Not required

Fair value not equal to cash consideration (p.403)

Conceptual understanding only

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3.3 De-recognition of Receivable

The holder of accounts or notes receivable may transfer them to another company for cash The transfer may be:
A secured borrowing: holder retains ownership, I.e. A/R is indeed the collateral A sale of receivables: holder transfers ownership

No firm standards exist in IFRS yet, therefore, our discussion will focus on the general approach that is widely accepted.
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Secured Borrowing vs. Sale : Pre-2011 GAAP

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?
Yes

Sale Secured Borrowing

No

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Secured Borrowing vs. Sale

Secured borrowing:

Sale of A/R Two types Factoring:

A/R is accounted the same way as if the collateral is not made. Disclosure of collateral is required.

Securitization (p.405): not required Substantial disclosure is required for both secured borrowing and sale of A/R Why is there a concern?

Holder sold receivables to a third party (often called factor) Factors are finance companies or banks that buy receivables from companies for a fee and then collect the remittances directly from the customers Mastercard, Visa Accounting journal entries depend on whether the sale is with or without recourse

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Illustration (Simplified) - Real world deals are more complex

ABC Co. want to dispose its $40,000 accounts receivable to XYZ Co. with three options Option 1: assign it to XYZ as collateral for a 8%, $30,000 note. Option 2: sell it to XYZ without recourse. XYZ retains an amount equal to 5% of accounts receivable Option 3: sell it to XYZ with recourse. XYZ retains an amount equal to 5% of accounts receivable. ABC estimates that recourse obligation has a fair value of $900. Finance charge is 4% on accounts receivable for option 1. 1% for option 2 &3 Prepare journal entries for both ABC and XYZ under each option.

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Option 1 (Secured Borrowing): Assign $40,000 A/R to XYZ as collateral for a 8%, $30,000 note with 4% finance charge
Finance charge =40,000*4%=1,600

ABC
Cash Finance Expense Notes Payable 28,400 1,600 30,000

XYZ
Notes Receivable 30,000 Cash 28,400 Finance Revenue 1,600

Disclose $40,000 receivable as collateral; Note A/R is still on ABCs books

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Option 2 (Sale without recourse): Sell $40,000 A/R to XYZ without recourse. XYZ retains an amount equal to 5% of accounts receivable and deducts 1% finance charge before remitting cash to ABC.
Amount retained by XYZ=40,000*5%=2,000 Finance charge =40,000*1%=400

ABC
Cash 37,600 Due from XYZ 2,000 Loss on Sale of A/R 400 Accounts Receivable 40,000

XYZ
Accounts Receivable 40,000 Cash 37,600 Due to ABC 2,000 Financing revenue 400 Due to ABC Cash 2,000 2,000
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Cash Due from XYZ

2,000 2,000

Option 3 (Sale with recourse): Sell $40,000 A/R to XYZ. Fair value of recourse obligation is $900. XYZ retains an amount equal to 5% of accounts receivable. Finance charge is 1% of accounts receivable. Cash was remitted to ABC.
Finance charge =40,000*1% = 400 Loss on sale of A/R =400+900=1,300

ABC
Cash 37,600 Due from XYZ 2,000 Loss on Sale of A/R 1,300 Accounts Receivable 40,000 Recourse Liability 900 Cash Due from XYZ 2,000 2,000

XYZ
Accounts Receivable 40,000 Cash 37,600 Due to ABC 2,000 Financing revenue 400 Due to ABC Cash 2,000 2,000
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Summary
Receivables
Initial measurement
is always at fair value (not face value, although sometimes the two can be the same)
deduct for sales return & allowance, impairment, adjust for discounts/premium Remove completely from balance sheet only if risks and rewards of ownership has been transferred.

Subsequent measurement Derecognition

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3.4 Presentation of Receivables

Segregate types of receivables
i.e. accounts receivable, notes receivable, due from related parties, etc.

If > 1 year, report amount and maturity date If < 1 year, report in current assets Use allowance account to record impairments
IFRS also requires a reconciliation of changes in the allowance account during accounting period

Income statement disclosure of interest income, impairment losses, and any reversals of such losses

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3.5 Ratio Analysis

(1) Accounts Receivable Turnover Net Credit Sales Average Trade Receivables (Net) (2) Days Sales Uncollectible 365 Days A/R Turnover
Measures average days to collect receivable during the period
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Measures the number of times, on average, receivables are collected during the period

Illustration
Accounts Receivable Turnover (Firm A vs. Firm B) Net credit sales 100,000 = 4.0 Average Trade receivables 25,000 Net credit sales Average Trade receivables 100,000 = 10.0 10,000

Days Sales Uncollectible (Firm A) 365 Days A/R Turnover

(365/4) = 91.25

Days Sales Uncollectible (Firm B) 365 Days (365/10) = 36.5 A/R Turnover
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4. PE GAAP vs. IFRS - Loans and Receivables

Canadian and international GAAP are substantially converged Some differences still exist, for example
Definition of cash equivalents Accounting for interests of long-term notes Disclosure of allowance for doubtful accounts IFRS Requires reconciliation schedule IFRS generally requires more extensive disclosures
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Mid Term Information

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