Chapter 7
Cash: What is it? Coins, currency, funds on deposit (checking and savings), money orders, cashiers’ checks, personal checks, bank drafts, petty cash Cash Equivalents: Very short term investments, highly liquid, maturities of 3 months or less Reporting Cash: 3 Issues 1. Restricted Cash If restricted to support short-term borrowing (this could be a compensating balance), then that amount must be reported separately among the “cash and cash equivalents” item in current assets If compensating balance supports long-term borrowing, then it’s separately classified as non-current asset in either investments or other assets Other types of restrictions – if restricted for a long time (outside of current period), then it’s classified as non-current Subject to materiality constraint •
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2. Bank Overdrafts – when a check is written for more than the amount a mount in cash account -reported as a current liability – usually added to accounts payable -usually not offset against cash unless there is another account ac count in the same bank 3. Cash Equivalents – highly liquid (1) readily convertible to cash (2) so close to maturity that they have insignificant risk of change in interest rates – i.e. 3 month maturity or less – T Bills, commercial paper, money market Receivables – claims against customers for money, goods or services Trade Receivables A/R – oral promises N/R – written, often with interest Non-Trade loans to officers, deposits, advances to subsidiary dividends receivable and interest receivable generally classified and reported as separate items on Balance Sheet • •
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Because they’re short term, we do not record at their present value (i.e., discount the receivable to its present value) or recognize interest on them
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Recognition Issues A) Trade Discounts or Quantity Discounts – These are deductions from Gross
Billing amount Ex. HP sells a server for Offers Trade Discount of 10%
$12,000 -1,200 $10,800 HP would record receivable of $10,800, not $12,000
B) Cash Discounts – used to encourage prompt payment. Most common method of recording is Gross method, but a company may also use Net method. 9/1/2009 Sales $1,000 2/10, n/30 9/10/2009 Paid
10/1/2009 Paid Outside Discount Period
Gross A/R 1,000 Sales 1,000 Cash 980 Sales Disc. 20 A/R 1,000 Cash 1,000 A/R 1,000
A/R Cash
Cash
Net 980 Sales 980 A/R
980 980
1,000 A/R Sales Disc. Not Taken
980 20
Valuation of A/R -reported at NRV -Uncollectible A/R: 2 methods (1) Direct Write-Off – simple, doesn’t match, not allowable under GAAP (2) Allowance Method (1) % Sales (Income Stmt) approach -focuses on Bad Debt Expense Ex. Estimates 2% of credit sales is uncollectible Credit Sales = 100,000 100,000 (.02) = 2,000 Bad Debt Exp 2,000 Allowance for Bad Debt
2,000
(2) % Receivables (Balance Sheet) approach -uses either % of receivables or aging -focuses on the balance in the allowance account Writing off account: Determine Jones can’t pay $500 account Allowance for Bad Debt 500 A/R
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500
If Jones subsequently pays, 1) Reestablish Receivable A/R 500 Allowance for Bad Debt 2) Show it paid Cash 500 A/R 500
500
If a company generally has material sales returns, it may be necessary to have allowance accounts for SR&A Assume that ABC Corp generally has sales returns of 8% of sales during a period Sales = $100,000 On Income Stmt Sales Less: SR&A Net Sales
$100,000 (8,000) 92,000
Sales Returns & Allowances Allowances for SR&A On Balance Sheet A/R Less: Allow. for SR&A Net Receivables
8,000 8,000
100,000 (8,000) 92,000
Recognition of N/R •
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May be interest bearing or non-interest bearing Short-term notes are recorded at face value Long-term notes are recorded at present value of cash to be collected Notes issued at Face – these typically have interest rates which are equivalent to market rates
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These are recorded at Face Value Notes Receivable Cash
XX XX
Notes not issued at Face – these can either have no stated interest rate – called Zero-Interest Bearing - or the interest rate is different from market rates
Notes with No Interest or Interest Different than Market No Interest – Interest is computed •
Assume the company has a $1,000 A/R that the customer wants to turn into a note and take 3 years to pay. So, the company agrees to accept $1,200 in payment for the receivable 3 years from now
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PV | | 1,000
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FV | 1,200
1000 = 1200 (PVss, n=3, i=?) (1000/1200) = .833 or approximately 6.2% They would record this note N/R 1200 (recorded at FV) A/R 1000 Disc. on N/R 200 (represents the interest to be earned) (reported on BS as a contra-asset to N/R) Thus: N/R 1200 Less: Disc (200) Net N/R 1000 The discount is amortized using the Effective Interest Method YR 1: Disc. on N/R 62 Int. Rev. 62 Cash Received
Interest Rev
0 0 0
=CV*Effective Int. Rate 62 66 70
At Issue YR 1 YR 2 YR 3
Disc. Amortized =Int. Rev. – Cash Received 62 66 70
Carrying Value 1000 1,062 1,128 1,198 = 1,200
Interest Bearing Notes Different from Market Assume Smith Co. loans $5,000 to Jones Co. The note has an 8% interest rate. Market rates are currently 10%. N=4. To determine how much to loan, Smith takes PV of interest and return of principal. N=5 i=10
PV of principal = 5000 (PVss, i=10, n=5) =5000 (.62092) =
5000(.08) = 400
PV of interest= 400 (PVordann, n=5, i=10) 400 (3.79079) =
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3104.60
1516.32 $4620.92
So, Smith records N/R 5,000 Cash 4,620.92 (only loans this much to make up for underlying interest) Disc. on N/R 379.08 Then amortize Disc. using Effective Interest Method PMT # 0 1 2 3 4 5
Cash Received 400 400 400 400 400
At first interest receipt YR 1 Cash Disc. on N/R Int. Rev
Int Rev Mkt i*CV 462.09 468.30 475.13 482.64 490.91
Discount Amortized Int Rev – $ Rec’d 62.09 68.30 75.13 82.64 90.91
Carrying Value 4620.92 4683.01 4751.31 4826.44 4909.08 5000
400 62.09 462.09
Valuation of N/R Short-term N/R should be valued at their NRV, just like trade A/R Note: Companies can elect to report Long-term N/R at their fair value each period o The FASB has given this option for most financial instruments, including receivables LT N/R would first be recorded at fair value (either cash equivalent or fair value of the asset given up) Unrealized holding gains or losses would be reported each period as part o of income If a company elects to use fair value for a fin instrument, then it must continue to use it until it no longer owns the instrument If a N/R becomes impaired, then the co. recognizes a loss in the period it recognizes the impairment • •
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Transferring A/R or N/R
Can be accomplished in 2 ways: 1) Secured borrowing -Rec. used as collateral for borrowings Assume ABC borrows 10,000 from XYZ on Sept. 1. ABC pledges 13,000 of Receivables to cover. XYZ charges 1% of receivables plus 10% interest on the loan ABC XYZ 9/1
Cash Financing Exp N/P
9870 130
9/1
N/R
10,000 Cash Financing Rev
10,000
9870 130
ABC collected $7000 of receivables less $200 in discounts and 500 in returns 10/1 Cash 6300 No entry Sales Disc 200 SR&A 500 A/R 7000 Remits to XYZ plus interest 10/3 Interest Exp 83.33 (10000*.1*1/12) 10/3 N/P 6300 Cash 6383.33 Collects Balance 11/1 Cash 6000 A/R 6000 Remits to XYZ 11/3 N/P 3700 Int. Exp 30.83 (3700*.1*1/12) Cash 3730.83
Cash
6383.33 N/R 6300 Int. Rev. 83.33
No entry
11/3
Cash
3730.83 Int. Rev 30.83 N/R 3700
Factoring Receivables – Factoring receivables = selling the receivables
1) Factored without recourse – purchaser assumes risk of collectability and absorbs losses -This is an outright sale in both form and substance Basic form of entry: Loss on Sale of A/R Cash Due from Factor A/R
xx (amount of factoring charge, non-collection estimates, discounts, etc.) xx (amount received – less than A/R value) xx (amount withheld by factor to cover extra discounts, returns, etc.) xx
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Assume Bugs Bunny Co. factors $100,000 in receivables to Yogi Bear Bank. Yogi charges 2% of amount factored (A/R) and retains 5% of A/R Bugs Yogi Cash 93,000 A/R 100,000 Loss on Sale Cash 93,000 of A/R 2,000 Financing Rev 2,000 Due from Factor 5,000 Due to Bugs 5,000 A/R 100,000
2) Factored with recourse -seller guarantees payment and purchases if the A/R proves uncollectible -in this case, the seller has to recognize a liability estimating its obligation under the recourse agreement Suppose same facts except that Bugs determines its obligation under the recourse agreement is $4500. Bugs A/R 100,000 Less: Charge (2,000) Less: Due from Factor (5,000) Resource Obligation (4,500) 88,500 Net proceeds = cash received + due from factor – recourse obligation = 93000 + 5000 – 4500 Cash Received Add: Due from factor Less: Resource Obligation Net proceeds
93,000 5,000 (4,500) 93,500
Loss = Carrying Value Less: (Net Proceeds) Loss on sale
100,000 (93,500) (6,500)
Note: A much easier way to determine the loss on the sale is to calculate it as the $2000 finance charge + recourse obligation of $4500 (2000 + 4500 = 6500) Bugs Cash Due from Factor Loss on Sale A/R Recourse liability
93,000 5,000 6,500 100,000 4,500
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Yogi A/R Cash Fin. Rev. Due to Bugs
100,000 93,000 2,000 5,000
To be a sale, rather than a secured borrowing, 3 conditions must be met: 1) Transferred asset is isolated from the transferor 2) Buyer has the right to dispose of (transfer or exchange) the assets 3) Transferor doesn’t maintain control through a repurchase agreement If it doesn’t meet the 3 criteria, then it’s a secured borrowing
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