ACC 313 Chapter 6 Part 2

Knight, Creigton

receivables

claims held against customers and others for money, goods, or services

how are receivables classified?

• short-term or long-term

• trade or non-trade

short-term receivables

expected to be collected within 1 year or current operating cycle, whichever is longer

trade receivables

assets owed from customers for goods bought or services rendered

non-trade receivables

assets owed to an entity that arise from transactions outside the normal course of business

accounts receivable

oral promises of a purchaser to pay for goods and services received; arise from short-term extensions of credit; collected w/in 30-60 days

notes receivable

written promises of a purchaser to pay a certain sum of money on a specified future date; can be short or long-term; usually include interest

all trade receivables are called…

“accounts receivable”

*all others are non-trade receivables

how are short-term receivables reported?

on the balance sheet under “current assets”

what short-term receivables should not be shown as a “current asset”?

• loans to related-party individuals or companies

  • (officers or board members, relatives of owners, subsidiaries, parent companies)

• short-term receivables that are restricted for payment of a long-term liability

  • “restricted receivables”

how are related-party receivables and restricted receivables reported?

on the balance sheet under “other assets”

installment receivables

receivables that are due in more than 1 year

how are installment receivables reported?

• installment sales are a major portion of business → under “current assets”

  • (this is bc the firm’s operating cycle is greater than 1 year)

• installment sales are not a major portion of business → under “long-term investments”

how are receivables with a credit balance reported?

on the balance sheet as a liability (bc this indicates an overpayment by a customer)

trade discount

an arbitrary reduction in the sales price of an item

how are trade discounts handled in accounting?

they are disregarded

sales discounts

reductions in amount owed that are offered to customers to induce prompt payment

computation for the annual interest rate being paid if a sales discount is not taken

[(% discount / (1 - % discount)] x [365 / (day gross amount must be paid - day discount period ends)]

sales discounts are usually accounted for using the _____ method

gross

entry to record the sale of goods to a customer (on account)

Db. A/R

Cr. sales rev.

entry to record collection of a customer’s payment within the discount period:

Db. cash

Db. sales discounts

Cr. A/R

entry to record collection of a customer’s payment after the discount period:

Db. cash

Cr. A/R

gross method

A/R and its related revenue is recognized at the invoice price; sales discounts are a separate account

sales returns and allowances are accounting for when…

they occur

entry to record returns and allowances":

Db. sales returns & allowances

Cr. cash or A/R

if a company maintains a perpetual inventory system, what entries have to be made for returns and allowances?

Db. sales returns & allowances

Cr. cash or A/R

Db. inventory

Cr. COGS

what are financial statement disclosures pertain to accounts receivable?

companies should…

• segregate different receivable types

• ensure contra accounts are offset against the proper receivable accounts

• ensure that receivables classified as current will actually be converted to cash within one year/operating cycle

• disclose any existing loss contingencies

• disclose any receivables pledged as collateral

• disclose all significant credit risks arising from receivables

accounts receivable turnover

equation: net sales / average A/R

measured in: times

measures: operating efficiency

days in accounts receivable

equation: 365 days / accounts receivable turnover

measured in: days

measures: operating efficiency

any receivable being collected at a later date has…

imputed interest

*this is included in the face amount of the payment, as long as there’s no stated interest rate

how is imputed interest handled for receivables due in one year or less?

imputed interest is overlooked → no “interest income” is recorded

direct write-off method

theoretically unacceptable because expenses are not matched to revenues → violation of matching principle

can only be used for immaterial amounts and tax purposes

entry to record end-of-period adjustment under direct write-off method:

no entry

c

Db. bad debt expense

Cr. A/R

entry to record the recovery of a specific receivable previously written-off as uncollectible under the direct write-off method:

Db. A/R

Cr. bad debt expense

Db. cash

Cr. A/R

allowance method

theoretically correct → follows matching principle

entry to record end-of-period adjustment under allowance method:

Db. bad debt expense

Cr. allowance for uncollectibles

allowance for uncollectible is what type of account?

contra-account

income statement approach for computing allowance method adjusting entry:

taken when bad debts are based on a % of “sales” (income statement account)

• “bad debt expense” is to be adjusted to this amount

  • “BDE” always has a zero balance before adjustment

balance sheet approach for computing allowance method adjusting entry:

taken when bad debts are based on a % of A/R (balance sheet account)

• “allowance for uncollectibles” is to be adjusted to this amount

entry to record end-of-period adjustment under allowance method:

Db. allowance for uncollectibles

Cr. A/R

entry to record the recovery of a specific receivable previously written-off as uncollectible under allowance method:

Db. A/R

Cr. allowance for uncollectibles

Db. cash

Cr. A/R

pledging of accounts receivable

• A/R is used as general collateral wen obtaining a loan and assigning a note

• no specific A/Rs are designated as being pledged

• companies retain the receivables on their books and make collections (treat them as normal)

assignment of accounts receivable

• company designates specific A/R as collateral for a loan; legally required to make principal and interest payments for the loan after collecting A/R

• immediate financing fee upon loan signing

• companies normally retain A/R and make collections on it

securitization of accounts receivable

• receivables are combined and securitized into a financial instrument → sold to investors

• an agent for investors collects receivables and makes payments to the group of investors

• if any receivables are never collected → company selling them is not liable

• securitized receivables are higher quality and lower cost than assigned receivables

  • this is bc the company is dealing with investors, not a financial institution

factoring of accounts receivable

the selling of A/R to a bank or factor

A/R factored without recourse

• A/R is sold (at a loss)

• bank or factor is the entity that collects the receivable

• if the creditor fails to pay the receivable to bank/factor, the bank/factor incurs a loss

how is A/R factored without recourse reported?

there are no disclosure requirements → A/R sold is no longer presented, and there is no contingent liability

A/R factored with recourse

• A/R is not actually sold → bank/factor is not paid

• bank/factor has to collect receivable

• often a financing fee charged by bank/factor

what are the ways a company raises capital through accounts receivable?

• pledging

• assignment of accounts receivable

• securitization of accounts receivable

• factoring (with and without recourse)

when are notes receivable accounted for at face value only (no discount or premium)?

when the note’s stated interest rate is equal to the current market interest rate

entry to record issuance of notes receivable at face value:

Db. N/R

Cr. cash (sales rev., A/R, etc.)

entry recorded at interest payment dates for notes receivable at face value (assuming no accruals):

Db. cash

Cr. interest income

entry recorded at interest payment dates for notes receivable at face value (assuming accruals, but no reversing entries):

Db. cash

Cr. accrued interest payable

Cr. interest income

entry recorded at interest payment dates for notes receivable at face value (assuming accruals and reversing entries):

Db. cash

Cr. interest income

entry to record period-ending adjustments for notes receivable at face value:

Db. accrued interest receivable

Cr. interest income

entry recorded at maturity date of notes receivable at face value:

Db. cash

Cr. N/R

+ entry for last interest payment

how is a note that is a cash transaction but has no stated interest rate or one that is “clearly unreasonable” treated?

• cash paid will not equal the note’s face value → there will be a discount/premium

• discount/premium is amortized using the effective-interest-rate method

• have to compute market interest rate since present value of note is known

how is a note that is a non-cash transaction but has no stated interest rate or one that is “clearly unreasonable” treated?

• maturity date is less than 1 year → any present value considerations are overlooked; notes are accounted for at face value only

• maturity date is greater than 1 year → notes are issued at a discount/premium

entry to record issuance of a notes receivable with no stated interest rate or one that is “clearly unreasonable”:

Db. N/R [face value of note]

Cr. sales rev. [present value of note]

→ balance with “discount on N/R” or “premium on N/R”

fair value = _________

present value

what is done to find the market interest rate on a note if the fair value of a transaction is known?

since the fair value of the transaction is known → the present value of the note is known

• market interest rate is computed

what is done to find the market interest rate on a note if the fair value of a transaction is not known?

the market interest rate must be imputed so that the present value of the note can be computed

• present value of the note must be equal to the fair value of the transaction

straight-line amortization

theoretically incorrect → does not follow matching principle; can only use for immaterial amounts

effective-interest-rate amortization method

a method of amortizing discounts and premiums; recognizes interest expense over a note’s life based on its carrying value and the market interest rate

• an effective-interest-rate amortization schedule is prepared

what are the columns of an effective-interest-rate amortization schedule, left to right?

1. date

2. cash interest

3. interest income

4. amortization of discount/premium

5. book value N/R

entry to record amortization without combining accrued interest and amortization:

Db. discount on N/R

Cr. interest income

or

Db. interest income

Cr. premium on N/R

entry recorded on an interest-payment date using effective-interest rate method

Db. cash

Cr. interest income

→ balance with “discount on N/R” or “premium on N/R”

what may notes receivable be reported at?

• historical cost

• amortized cost

• net realizable value

• fair value

• impaired vale

reporting notes receivable at historical cost

N/R would be reported at face value only

ex. N/R   50,000

reporting notes receivable at amortized cost

N/R would be reported at its face value ± premium/discount

ex.

N/R (50,000) + premium on N/R (2,000)

→ N/R = 52,000

reporting notes receivable at net realizable value

• an “allowance for uncollectibles” account is created for a collection of several N/R

ex.

N/R (600,000) - allowance for uncollectible notes (18,000) = N/R 582,000

reporting notes receivable at fair value

this method is considered GAAP, but is optional

*if used, it must be followed consistently

entry to record receipt of a note from a customer at fair value:

Db. N/R

Cr. sales rev.

*separate transaction for amortization is not used → premium/discount combined with amount reported in this entry

entry to record the amortization of a discount/premium at fair value:

no entry

entry to record a period-ending adjustment at fair value:

Db. unrealized holding loss from valuing N/R at fair value

Cr. N/R

reporting notes receivable at impaired value

if a book value inc.s./dec.s  → receivable with the changed value is written up/down and an “unrealized holding loss” is recorded