Cash
The most liquid asset, the basis for measuring and accounting for all other items.
What items can be considered cash?
Coin, currency, and available funds on deposit at the bank.
What negotiable instruments can be considered cash?
Money orders, certified checks, and cashiers checks, personal checks, and savings accounts
What can be considered temporary investments?
Money market funds, money market savings certificates, CD's, and similar types of deposits and short term paper.
How is a money market account that the funds provide checking account privileges treated?
These would be treated as cash
How are post-dated checks and IOU's treated?
As receivables
How are travel advances treated?
As a receivable if collected from employees or deducted from salaries. Otherwise, will be a prepaid expense.
How are postage stamps on hand treated?
Classified as part of office supplies inventory or as a prepaid expense.
How should be petty cash be treated?
Petty cash funds and change funds are treated as cash.
Reporting issues with cash
1-Cash equivalents
2-Restricted Cash
3-Bank overdrafts
Cash equivalents
Short term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rate.
What is an example of a cash equivalent?
Treasury bills, commercial paper, and money market funds
What will cash equivalents fall under if the FASB chooses to eliminate this category?
If an asset is not cash and it is short term in nature it will be reported as a temporary investment.
What are examples of restricted cash?
Perry cash, payroll, dividend funds
When must a company report restricted cash separately on the balance sheet?
When the restricted amount is material in nature.
How can restricted cash classified if material in nature?
Classified in current or long-term assets section depending on the date of availability or disbursement. If less than a year classified as current otherwise long term.
What are some examples of long term assets?
1-Money set aside for plant expansion
2-Retirement of long term debt
Compensating balances
A minimum balance in a bank account allowed
Legally restricted deposits
SEC recommends that companies state separately legally restricted deposits held as compensating balances against short term borrowing arrangements amount the cash and cash equivalents.
Separately restricted deposits
Companies should classify separately restricted deposits held as a compensating balance against long term borrowing as non current assets in either investments or other assets.
Bank overdrafts
Occur when a company writes a check for more than the amount in its cash account.
Where should bank overdrafts be reported on the balance sheet?
Under current liabilities, adding them to the total amount of accounts payable.
How should bank overdrafts that are material in nature be treated?
If material, companies should disclose these items separately, either on the face of the balance sheet or in related notes.
What are receivables?
Claims held against customers and others for money, goods, or services.
What are the classifications of receivables?
Current or noncurrent
What are current receivables?
Receivables that are expected to be collected within a year of the current operating cycle, whichever is longer.
What are noncurrent receivables?
All other receivables that cannot be considered current.
What other classification is given to receivables after determining whether current or noncurrent?
Trade or nontrade
Trade receivables
Amounts owed to the company for goods bought or services rendered.
What are some common trade receivables seen on balance sheet?
Accounts receivable
Notes receivable
Accounts receivable
Oral promises of the purchaser to pay for goods or services sold.
Notes receivable
Written promise to pay certain sum of money on a specified future date. Can be short term or long term.
Nontrade receivables
Can arise from a variety of transactions other than those for payment of goods or services. Such as advance to officers, dividend and interest receivable
What are the basic issues in accounting for accounts and notes receivable?
1-Recognition
2-Valuation
3-Disposition
What is the exchange price?
The amount due from the debtor.
What two factors can complicate the measurement of the exchange price?
1-The availability of discounts (trade and cash discounts)
2-The length of time between the sale and the due date of payments
Cash discounts
Offered to encourage prompt payment
How are accounts receivable classified?
Classified by the length of time each receivable will be outstanding.
How are short term receivables valued and reported?
Valued and reported at net realizable value-the amount that they expect to receive in cash
What two methods are used in accounting for uncollectible accounts?
1-Direct write off
2-Allowance method
Direct write off method
When a company determines that an account is uncollectible it charges the losses to Bad Debt Expense
Which losses will be shown in Bad Debt Expense if using the direct write off method?
Actual losses from uncollectibles
Why is the direct write off method not considered appropriate for most cases?
1-Fails to record the expenses in the same period as associated revenues.
2-Does not result in receivables being stated at their net realizable value on the statement of financial position.
When is is considered appropriate to use the direct write off method?
When the amount of the uncollectible is immaterial.
What is the allowance method of accounting for uncollectible receivables?
Estimate of uncollectibles done at the end of each period, this ensures that the receivables are stated at net realizable value.
Net realizable value
The net amount the company expects to receive in cash from receivables.
When does the FASB require the allowance method for bad debts?
The allowance method is required when the amounts are material
What are the three essential features of the allowance method?
1-Companies estimate uncollectible accounts receivable
2-Companies debit estimated uncollectibles to Bad Debt Expense and credit them to the Allowance for Doubtful Accounts
3-When companies write off a specific account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit the amount to Accounts Receivable.
How is Bad Debt recognized when writing off under the allowance method?
Companies debit bad debt write offs to the allowance account rather than to bad debt expense. The bad debt expense account does not increase when a write off occurs.
What two entries are made to record the recovery of bad debt?
1-Reverses the entry made in writing off the account
2-Journalize the collection like normal
What are the two bases used to determine the amount of bad debt?
Percentage of Sales
Percentage of receivables
Percentage of Sales
Results in a better matching of expenses with revenues.
Estimates what percentage of credit sales will be uncollectible. This is based on past experience and anticipated credit policy.
Applies to total credit sales or net credit sales
Percentage of Receivables
Using past experience a company can estimate the percentage of its outstanding receivables that will be uncollectible without identifying specific accounts.
Does not follow the matching principle
What are two options for companies applying the percentage of receivables?
1-Using one composite rate
2-Set up an aging schedule
What is an aging schedule?
Applies different percentage rates for bad debt experience to each category based on past experience to the different aging categories.
Notes receivable
A formal promissory note, a written promise to pay a certain sum of money at a specific future date.
Interest-bearing notes
Have a stated rate of interest
Zero-interest bearing notes
Non-interest bearing, includes interest as part of the face amount of the note.
How should companies record and report long term notes receivable?
Record and report at the present value of the cash that they expect to collect.
Implicit interest rate
Because the company knows both the future and the present value of an zero interest bearing note they can compute the implicit interest rate.
How is the interest rate determined when a note is received in exchange for property, goods, or services?
The interest rate is presumed to be the fair value unless it meets other criteria
What things will cause a notes receivables to be estimated at something other than fair value when issued in exchange for property, goods, or services?
1-No interest rate is stated
2-The stated interest rate is unreasonable
3-The face amount of the note is materially different from the current cash sales price of the same or similar items or from the current market value of debt instruments.
Imputation
The process of interest-rate approximation which results in an imputed interest rate
Impairment
When it is probable that the creditor will be unable to collect all the amounts due, both principal and interest, according to the contractual terms of the receivable.
Special Issues for the accounting of receivables
1-Fair Value Option
2-Disposition of receivables
3-Presentation and disclosure
Fair Value option for receivables
The receivable is recorded at fair value with unrealized holding gains and losses reported as part of net income.
Unrealized holding gain or loss
The net change in the fair value of the receivable from one period to another, exclusive of interest revenue
After electing to use the fair value for reporting how must subsequent periods be treated?
After the first valuation of accounts receivables is reported at fair value all subsequent periods must also be reported at fair value.
Unrealized holding gain or loss
The difference between the fair value and the carrying value
Why do companies transfer accounts or notes receivables to other companies?
In order to accelerate the receipt of cash from receivables
What are the two ways in which receivables are transferred to a third party?
1-Secured borrowing
2-Sales of receivables
Secured borrowing on receivables
A company uses receivables as collateral in a borrowing transaction. Must assign or pledge receivables as security for the loan. If the loan is not paid the creditor can collect the receivables for payment.
Sales of receivables
Commonly sold to factor
Factors
Finance companies or banks that buy receivables from businesses for a fee and then collect the remittances directly from the customer.
Securitization
Takes a pool of assets such as credit card receivables and sells shares of these pools of interest and principal payments. Creates securities backed by pools of assets.
What are the two basis on which receivables can be sold?
Without recourse
With recourse
Without recourse
The purchaser assumes the risk of collectibility and absorbs any credit losses. This is an outright sale of the receivables both in form (transfer of title) and substance (transfer of control)
Due from Factor account
Seller uses this to account for the proceeds retained by the factor to cover probable sales discounts, sales returns, and sales allowances.
With recourse
The seller guarantees payment to the purchaser in the event the debtor fails to pay. The seller has a continued involvement with receivable.
In which basis of receivable sale does each party to the sale only recognize the assets and liabilities that it controls after the sale?
With recourse
Before recording the sale of receivables what three things must occur?
1-The transferred asset has been isolated from the transferor (put beyond the reach of the transferor and their creditors).
2-The transferors have obtained the right to pledge or exchange either the transferred assets or beneficial interests in the transferred assets.
3-The transferor does not maintain effective control over the transferred assets thru an agreement to repurchase or redeem them before maturity.
Accounts receivable turnover ratio
Measures the number of times, on average, a company collects receivables during the period. Shows how successful the company is in collecting outstanding receivables.
How is accounts receivable turnover ratio calculated?
Net Sales/Average net receivables outstanding during the year
Days to collect accounts receivables
Often the accounts receivable turnover ratio is converted to days to collect
What is the general rule for the average collection period?
The collection period should not be longer than the credit term period.
Presentation of receivables
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How is a concentration of risk typically determined?
If a customer produces more than 10% of your revenues.
When is a loan considered impaired?
When it is probable, based on current information and events, that it will not collect all amounts due (both principal and interest).
How is the impairment loss calculated?
The difference between the investment in the loan (principal plus accrued interest)and the expected future cash flows.
How is the impairment loss measured?
Loss must be measured at the present value amount, not an undiscounted amount.
How is an impairment loss journalized?
Debit Bad Debt Expense for the expected loss and credit the Allowance for Doubtful Accounts.