ACCT 3000: Chapter 7 - Financial Assets: Cash & Receivables

Financial Assets

Either cash or a contractual right to receive a determinable amount of cash from another entity.
Includes: cash, accounts and notes receivable, derivatives, and many investments

Financial assets, by their nature, are :

Monetary Items

What 2 key aspects do Monetary Items have?

1. Cash must be involved
2. The amount of cash must be fixed (or determinable) by contract or agreement

What value are financial assets initially recognized at?

The Transaction Value (aka the fair value on that date)

What are the 3 financial asset classifications?

1. amortized cost
2. FVTOCI
3. FVTPL

What 2 conditions must be met to classify a financial asset at amortized cost?

1. The objective is to hold financial asset to collect cash flows
2.Contractual cash flows are solely principal and interest

What 2 conditions must be met to classify a financial asset as FVOCI?

1. Objective is to hold financial asset to collect contractual cash flows and eventually sell
2. Contractual cash flows are solely principal and interest

What 2 conditions must be met to classify a financial asset as FVTPL?

1. Loans and receivables will be sold in the short term
2. Management wishes to avoid an accounting mismatch

How is cash measured in the FVTPL category ?

Cash is measured at FV, and if FV changes, and gain or loss is included in earnings

Cash Equivalents

Items that can be readily converted into cash
-Includes:investments that are highly liquid, little risk of price changes, maturing in 90 days or less
-Usually classified as FVTPL
-Includes money market investments, but not investments in common shares

Examples of Cash Equivalents

-treasury bills
-guaranteed investment certificates (GICs)
-commercial paper (short-term notes receivable from other companies)

Overdraft

a negative bank account balance
-Reported as a separate current liability

What may happen If an account is overdrawn but company has other accounts with the same bank ?

The bank may offset with cash and cash equivalents provided:
-Bank has the legal right to offset, and
-Company plans to settle the overdraft in this way

Compensating Balance/ Restricted Balance

A minimum balance that must be maintained in a depositor's account as support for loan borrowed by the depositor
-May be included in cash, with note disclosure on the restricted amount; or
-May be shown separately as long term

What is the purpose of bank reconciliation?

To compare the bank to the books and determine reason for differences for the following:
-Deposits made in the bank to books;
-Cheques and charges;
-Make journal entries for all adjustments to the book balance; and
-Inform the bank of any errors made by the bank.

Bank Reconciliation: Adjustments required to the Bank Balance

-ADD Outstanding deposits
-DEDUCT Outstanding cheques
-ADD or DEDUCT Bank errors

Bank Reconciliation: Adjustments required to the book value

-ADD Direct deposits to the bank not yet recorded
-DEDUCT Charges recorded by the bank (bank charges, NSF cheques)
-ADD or DEDUCT Correct company errors in recording transactions

Internal Control System

A planned organizational design meant to protect all assets and the integrity of the information system.

What is are receivables most commonly classified as ?

Amortized Cost
-Initially recorded at fair value - transaction value + any transaction costs
-Subsequently, measured at amortized cost, less any valuation allowances

When may receivables be classified as FVTPL?

If they are going to be sold or are part of hedging arrangement.

When may receivables by classified as FVOCI?

If the company has a business model of collecting contractual cash flows and eventually selling rather than holding.

Trade Accounts receivable

Amounts owed by customers for goods and services sold in the firm's normal course of business.

Where do non trade-receivables arise from?

Many sources including:
-tax refunds
-contracts
-investments
-finance receivables
-installment notes
-sale of assets
-and advances to employees

Valuation allowance

The receivables are meant to be an approximate cash that will be collected
Adjusts for items such as:
-cash discounts;
-sales returns and allowances; and
-allowances for uncollectible accounts.

Why are cash discounts used?

-increase sales;
-encourage early payment by customers;
-increase the likelihood of collections of accounts receivable.

Cash Discounts

Recorded as a contra account to sales called Sales Discounts
-reduces sales to a net amount

Sales returns

merchandise is returned by the customer
-If returns are material and unestimatable, sales revenue cannot be recorded until after the uncertainty is resolved
-If returns can be estimated, the company does not recognize revenue for the items it estimates will be returned.

Allowance for Doubtful accounts

-If uncollectible receivables are likely and estimable - recognize so that receivables are not overstated
-Write-down made to an allowance account called - Allowance for doubtful accounts (a contra account to receivables)

Allowance for Doubtful Accounts - Aging Method

Examine accounts for aging , by item or statistically to estimate the net realizable amount and the appropriate allowance
-Adjust allowance to this amount

When might receivables be classified to FVOCI?

If a business model is not to hold receivables to maturity(not usually the case)

When might receivables be classified to FVTPL?

Ex) If hedging strategies are in place

What 2 events must be considered when dealing with Write-offs and Recovery?

1. the write off of a specific receivable
2. The collection of an account previously written off

Credit Card Transactions

Allows retailers to get their money up front, and let the customers owe the credit card company

What are the advantages of credit card transactions?

-avoid bad debts
-no delay in receiving cash, and
-customer may spend more

What is the primary difference between debit card and credit card transactions?

The Point of View of the customer:
-A debit card removes the amount immediately from the customer's bank account
For merchant - similar to credit card transaction

Loans Secured by Accounts Receivable

-May borrow from the bank and use the accounts receivable as security for the loan
-not usually done for one specific receivable
-usually the overall balance is security
-"working capital loans" that are relatively permanent form of financing

Derecognition

the accounts receivable come off the books of the selling company, and a financing fee is recognized
-nets off a loan against the receivables
-implications for ratios

Factoring

individual account transferred to financial institution for collection;

Securitization

bundle of receivables sold as a portfolio

Recourse

the finance company can come back to company for payment if sold receivable is not collectible.

How can a transfer of receivables be recorded?

1) A sale (Derecognition)
2) Borrowing

Transfer of receivables- Borrowing

the accounts receivable are left on the books of the selling company, and the amount received from the finance company is recorded as a loan payable until the customer actually pays

What 2 tests must be met to qualify for derecognition?

1. The account receivable has been transferred; and
2. The risks and rewards of ownership are passed to the other party.

The risks and rewards of ownership of an accounts receivable are passed to another party if:

1. The company's exposure to variability in the amounts and timing of cash flow are different before and after the transfer.
2. Control over the receivables has not been retained

Special Purpose Entity (SPE)

a separate entity, carrying on a specific part of the business, and not legally controlled by the company.

What does a SPE do?

-Holds account receivables which are security for loans issued to outside investors
-May be a cost effective way to raise capital
-May have to be consolidated in certain circumstances

When is consolidation required in an SPE?

-"parent" has power over the SPE
-has the right (or exposure to) variable returns from the SPE activities
-the ability to use its power over SPE to affect its returns.

note receivable

a written promise to pay a specified amount at a specified future date (or a series of amounts over a series of payment dates)

What are some common characteristics of a note receivable ?

-extended payments
-more security (collateralized security)
-formal basis to charge interest
-negotiability

How are notes receivable initially recorded?

at fair value using effective interest rate method
-Present value methods are used to initially value these financial instruments if stated rates and market rates are different; and if maturity date is longer than one year.

Face value or maturity value

stated dollar amount of note

specify the interest rate to be applied to the face amount in computing interest payments.

Non-interest-bearing

do not state an interest rate but command interest through the difference between cash lent and (higher) cash repaid.

Effective interest rate method

-Requires that the market rate is used to value the not and the transaction
-The market rate is also used to measure interest revenue or expense
-The stated rate is used to determine the cash interest payments

Where are foreign exchange gains/losses reported?

net earnings

Notes receivable may be an ________activity

investing

When is extensive disclosure required?

-the carrying amounts for financial instruments in each category;
-the fair value and methods used to determine fair value;
-detail of any changes in fair values and maturity values;
-Important components of each category;
-collateral pledged as security.
-reconciliation of changes in the allowance for credit losses and an analysis of past due accounts not written down
-effect of netting arrangements;
-various income statement amounts - interest income
-information on credit risk, liquidity risk and interest rate risk including objectives, policies and processes for managing risk