Study Notes for Cash and Receivables
Cash Equivalents
Cash equivalents usually include negotiable instruments and highly liquid investments with a maturity date of no longer than three months from purchase.
Internal Control Procedures
Internal control procedures in accounting improve the accuracy and reliability of information while safeguarding a company's assets.
Separation of Duties: Employees involved in recordkeeping should not have physical responsibility for assets.
Documentation and Auditing of Internal Controls
Management is required to document the adequacy of the company’s internal controls.
Auditors give an opinion on management’s assessment.
Public Company Accounting Oversight Board’s Auditing Standard No. 5: Supersedes Auditing Standard No. 2 requiring auditors to express their own opinion on the effectiveness of internal controls over financial reporting.
Treatment of Restricted Cash
Restricted cash is included in the reconciliation of cash balances on the statement of cash flows.
Both restricted cash and restricted cash equivalents should be included in the cash and cash equivalents category during reconciliation of cash balances at the beginning and end of the period.
Compensating Balances
A compensating balance is cash an account holder must maintain in their bank account for a loan.
The classification depends on the nature of the restriction and related debt:
Legally Binding: Classified as current or noncurrent based on related debt.
Informal Arrangements: Should be disclosed, along with amounts, and included in cash and cash equivalents as current assets.
Bank Overdrafts
IFRS vs. U.S. GAAP:
Under IFRS, overdrafts can be offset against other cash accounts.
Under U.S. GAAP, overdrafts must be treated as liabilities.
Discounts in Pricing
Trade Discounts: Reductions below the list price to establish a final transaction price.
Cash Discounts: Offer a reduction on the amount due if paid within a specific time, not affecting the selling price of goods or services.
Cash Discounts Accounting Methods
Gross Method: Records accounts receivable at gross value; discounts taken later adjust sales revenue.
Net Method: Records accounts receivable at net value; discounts not taken increase sales revenue later.
Estimation of Sales Returns
Companies estimate sales returns reducing revenue to account for them.
Typically, this is done through actual returns throughout the period followed by an adjusting entry at period-end.
Adjusting Entry:
Debit: Sales Returns (contra revenue account).
Credit: Refund Liability (amount expected to be refunded).
Adjusting entries increase inventory for returned items and reduce cost of goods sold accordingly.
Allowance for Uncollectible Accounts
Companies estimate the amount for accounts receivable expected to be collected, adjusting the allowance for uncollectible accounts accordingly.
Bad Debt Expense: Reflects corresponding entry for increase in allowance.
Uncollectible Accounts: Immaterial amounts can be written off directly as they prove uncollectible.
CECL Model
CECL stands for “Current Expected Credit Loss” allowing flexibility in estimating credit losses using various methods.
Must consider all relevant information including historical and projected conditions.
ECL in IFRS
Expected Credit Loss (ECL): Requires reporting a 12-month ECL unless credit quality significantly deteriorates, which then leads to the reporting of a lifetime ECL.
Expected credit losses generally will be lower and occur later in IFRS compared to CECL under U.S. GAAP.
Approaches to Estimating Expected Credit Losses
Balance Sheet Approach: Adjusts allowance for uncollectible accounts to reflect appropriate carrying value at period's end.
Income Statement Approach: Uses a percentage of current period’s credit sales to adjust the allowance for uncollectible accounts and bad debt expense.
Disclosure of Receivables
Under U.S. GAAP, trade receivables and related party receivables must be disclosed separately, differing from IFRS guidelines.
Factoring of Receivables
Treatment of factored receivables with or without recourse influences accounting; if criteria for sale are met, recognize accordingly, otherwise treat as a loan.
Requires note disclosures.
Discounted Notes Receivable Accounting
When a note is discounted, the seller receives cash less the discount calculated.
Four-Step Process:
Accrue Interest Revenue: Since the last payment.
Compute Maturity Value.
Calculate Proceeds: Subtract discount from maturity value.
Difference Treatment: Depending on accounting for it as a sale or loan, treat the difference as loss/gain or interest expense/revenue.
Variables Affecting Investment in Receivables
Factors include sales levels, nature of products/services, credit policies, and collection policies.
Metrics to assess include receivables turnover and average collection period ratios.
Bank Reconciliation Items
Items needed to adjust bank balance include outstanding deposits and checks, and any errors.
Items needed to adjust book balance are collections, service charges, NSF check charges, and company errors.
Petty Cash Fund Management
Established by transferring cash to a custodian, replenished with checks equivalent to expenses incurred.
Brief Exercises
Exercise 7–1
Improvement in internal control can be achieved by segregating duties (e.g., recordkeeping vs. cash handling).
Exercise 7–2
Under IFRS: Cash balance equals $245,000 due to offsets.
Under U.S. GAAP: Balance is $250,000, with $5,000 overdraft as liability.
Exercise 7–3
All items included as cash/cash equivalents except U.S. Treasury bills maturing in six months, classified as short-term investments.
Exercise 7–4
Income before tax reduced by $2,500 due to cash discounts recognized.
Adjustments for Estimated Returns
Brief Exercise 7–6
Estimated returns adjusted as follows:
Estimated Returns:
Less: Actual Returns:
Remaining Estimated Returns: .
Adjustments include sales returns, refund liability, inventory for estimated returns, and cost of goods sold.
Brief Exercise 7–10
For allowance accounts, adjustments made for collectability evaluations.
For example: Write-offs and adjustments to various balance estimates documented in journal entries.
Receivables Measurement and Journal Entries
Include accruals for interest revenue and collection entries with specific reference to dates and amounts.
Financial Reporting
Procedures for financial reports with journal entries reflecting cash flow impact from transactions involving sales, expenses, collections, and adjustments.
Notes Summary
Each transaction systematically lays out the entries needed to accurately portray financial status, ensuring compliance with accounting principles and clarity in reports.