PART II: Corporate Accounting Concepts and Issues

Lecture 09

Practical Issues in Cash and

Receivable: Disposition and
Recognitions

Instructor
Adnan Shoaib
1

Learning
Learning Objectives
Objectives

1.

Explain accounting issues related to recognition and valuation of notes

receivable.

2.

Explain the fair value option.

3.

Explain accounting issues related to disposition of accounts and notes

receivable.

4.

Describe how to report and analyze receivables.

Cash
Cash and
and Receivables
Receivables

Cash
What is cash?
Reporting cash
Summary of
cash-related
items

Accounts
Receivable

Notes
Receivable

Recognition of
accounts
receivable

Recognition of
notes
receivable

Valuation of
accounts
receivable

Valuation of
notes
receivable

Special
Issues
Fair value
option
Disposition of
accounts and
notes
receivable
Presentation
and analysis

Recognition
Recognition of
of Notes
Notes Receivable
Receivable
Notes Receivable
Supported by a formal promissory note.

A negotiable instrument.

Maker signs in favor of a Payee.

Interest-bearing (has a stated rate of interest) OR

Zero-interest-bearing (interest included in face amount).

LO 1 Explain accounting issues related to recognition of notes receivable.

Recognition
Recognition of
of Notes
Notes Receivable
Receivable
Generally originate from:

Customers who need to extend payment period of

an outstanding receivable.

High-risk or new customers.

Loans to employees and subsidiaries.

Sales of property, plant, and equipment.

Lending transactions (the majority of notes).

LO 1 Explain accounting issues related to recognition of notes receivable.

Recognition
Recognition of
of Notes
Notes Receivable
Receivable

Short-Term

Long-Term

Record at
Face Value,
less allowance

Record at
Present Value
of cash expected to
be collected

Interest Rates

Note Issued at

Stated rate = Market rate

Face Value

Stated rate > Market rate

Premium

Stated rate < Market rate

Discount

LO 1 Explain accounting issues related to recognition of notes receivable.

Note
Note Issued
Issued at
at Face
Face Value
Value
Illustration: Bigelow Corp. lends Scandinavian Imports
$10,000 in exchange for a $10,000, three-year note bearing
interest at 10 percent annually. The market rate of interest for a
note of similar risk is also 10 percent. How does Bigelow record
the receipt of the note?
i = 10%
$10,000 Principal

$1,000

1,000

n=3

1,000 Interest

LO 1 Explain accounting issues related to recognition of notes receivable.

Note
Note Issued
Issued at
at Face
Face Value
Value
PV of Interest

$1,000

Interest Received
8

2.48685
Factor

$2,487
Present Value

LO 1 Explain accounting issues related to recognition of notes receivable.

Note
Note Issued
Issued at
at Face
Face Value
Value
PV of Principal

$10,000
Principal
9

.75132
Factor

$7,513
Present Value

LO 1 Explain accounting issues related to recognition of notes receivable.

Note
Note Issued
Issued at
at Face
Face Value
Value
Summary

Present value of interest

$ 2,487

Present value of principal

7,513

Note current market value

$10,000

Notes receivable

10,000

Cash
Cash
Interest revenue

10

10,000
1,000
1,000

LO 1 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing
Zero-Interest-Bearing Note
Note
Illustration: Jeremiah Company receives a three-year, $10,000
zero-interest-bearing note. The market rate of interest for a
note of similar risk is 9 percent. How does Jeremiah record the
receipt of the note?
i = 9%
$10,000 Principal

11

$0

$0

n=3

$0 Interest

LO 1 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing
Zero-Interest-Bearing Note
Note
PV of Principal

$10,000
Principal
12

.77218
Factor

$7,721.80
Present Value

LO 1 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing
Zero-Interest-Bearing Note
Note
Illustration 7-12

13

LO 1 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing
Zero-Interest-Bearing Note
Note
Journal Entries for Zero-Interest-Bearing note
Present value of Principal

14

$7,721.80

LO 1 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing
Interest-Bearing Note
Note
Illustration: Morgan Corp. makes a loan to Marie Co. and
receives in exchange a three-year, $10,000 note bearing interest
at 10 percent annually. The market rate of interest for a note of
similar risk is 12 percent. How does Morgan record the receipt of
the note?
i = 12%
$10,000 Principal

15

$1,000

1,000

n=3

1,000 Interest

LO 1 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing
Interest-Bearing Note
Note
PV of Interest

$1,000

Interest Received
16

2.40183
Factor

$2,402
Present Value

LO 1 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing
Interest-Bearing Note
Note
PV of Principal

$10,000
Principal
17

.71178
Factor

$7,118
Present Value

LO 1 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing
Interest-Bearing Note
Note
Illustration: How does Morgan record the receipt of the note?
Illustration 7-14

Notes Receivable
Discount on Notes Receivable
Cash
18

10,000
480
9,520

LO 1 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing
Interest-Bearing Note
Note
Illustration 7-15

19

LO 1 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing
Interest-Bearing Note
Note
Journal Entries for Interest-Bearing Note

Cash
Discount on notes receivable
Interest revenue

20

1,000
142
1,142

LO 1 Explain accounting issues related to recognition of notes receivable.

U.S.
U.S. GAAP
GAAP vs.
vs. IFRS
IFRS
In general, IFRS and U.S. GAAP are very similar with respect to
accounts receivable and notes receivable. Differences are
highlighted below.

21

U.S. GAAP allows a fair value

option for accounting for
receivables.
U.S. GAAP does not allow
receivables to be accounted
for as available for sale
investments.
U.S. GAAP requires more
disaggregation of accounts
and notes receivable in the
balance sheet or notes.

IFRS restricts the

circumstances in which a fair
value option for accounting
for receivables is allowed.
In the years between 2010 and
2012, companies may account
for receivables as available
for sale investments if the
approach is elected initially.
After January 1, 2013, this
treatment is no longer
allowed.

Recognition
Recognition of
of Notes
Notes Receivable
Receivable
Notes Received for Property, Goods, or Services
In a bargained transaction entered into at arms length, the
stated interest rate is presumed to be fair unless:
1. No interest rate is stated, or
2. Stated interest rate is unreasonable, or
3. Face amount of the note is materially different from the
current cash sales price.

22

LO 1 Explain accounting issues related to recognition of notes receivable.

Recognition
Recognition of
of Notes
Notes Receivable
Receivable
Illustration: Oasis Development Co. sold a corner lot to Rusty
Pelican as a restaurant site. Oasis accepted in exchange a fiveyear note having a maturity value of $35,247 and no stated interest
rate. The land originally cost Oasis $14,000. At the date of sale
the land had a fair market value of $20,000. Oasis uses the fair
market value of the land, $20,000, as the present value of the
note. Oasis therefore records the sale as:
($35,247 - $20,000) = $15,247

Notes Receivable
Discount on Notes Receivable
Land
Gain on Sale of Land
23

35,247
15,247
14,000
6,000

LO 1 Explain accounting issues related to recognition of notes receivable.

Valuation
Valuation of
of Notes
Notes Receivable
Receivable

Short-Term reported at Net Realizable Value (same as

accounting for accounts receivable).

Long-Term - FASB requires companies disclose not only

their cost but also their fair value in the notes to the
financial statements.

24

Fair Value Option. Companies have the option to use

fair value as the basis of measurement in the financial
statements.

LO 2 Explain the fair value option.

Valuation
Valuation of
of Notes
Notes Receivable
Receivable
Illustration (recording fair value option): Assume that
Escobar Company has notes receivable that have a fair value of
$810,000 and a carrying amount of $620,000. Escobar decides
on December 31, 2012, to use the fair value option for these
receivables. This is the first valuation of these recently acquired
receivables. At December 31, 2012, Escobar makes an
adjusting entry to record the increase in value of Notes
Receivable and to record the unrealized holding gain, as follows.
Notes Receivable

190,000

Unrealized Holding Gain or LossIncome

25

190,000

LO 2 Explain the fair value option.

Disposition
Disposition of
of Accounts
Accounts and
and Notes
Notes Receivable
Receivable
Owner may transfer accounts or notes receivables to
another company for cash.
Reasons:

Competition.

Sell receivables because money is tight.

Billing / collection are time-consuming and costly.

Transfer accomplished by:

1. Secured borrowing
2. Sale of receivables
26

LO 3 Explain accounting issues related to disposition

of accounts and notes receivable.

Factoring
Factoring Arrangements
Arrangements
2. Accounts Receivable

SUPPLIER
(Transferor)

RETAILER

as

ou

nt
sR
ec

ei
va

C
as
h

4.

Ac
c

1. Merchandise

5.

3.

bl
e

FACTOR
(Transferee)

27

A
Afactor
factor is
is aa financial
financial institution
institution that
that buys
buys receivables
receivables
for
for cash,
cash, handles
handles the
the billing
billing and
and collection
collection of
of the
the
receivables
receivables and
and charges
charges aa fee
fee for
for the
the service.
service.

Disposition
Disposition of
of Accounts
Accounts and
and Notes
Notes Receivable
Receivable
Secured Borrowing
Illustration: March 1, 2012, Howat Mills, Inc. provides
(assigns) $700,000 of its accounts receivable to Citizens Bank
as collateral for a $500,000 note. Howat Mills continues to
collect the accounts receivable; the account debtors are not
notified of the arrangement. Citizens Bank assesses a finance
charge of 1 percent of the accounts receivable and interest on
the note of 12 percent. Howat Mills makes monthly payments to
the bank for all cash it collects on the receivables.

28

LO 3 Explain accounting issues related to disposition

of accounts and notes receivable.

Secured
Secured Borrowing
Borrowing -- Illustration
Illustration
Illustration 7-16

29

LO 8

Secured
Secured Borrowing
Borrowing -- Exercise
Exercise
E7-13: On April 1, 2012, Prince Company assigns $500,000 of its
accounts receivable to the Third National Bank as collateral for a $300,000
loan due July 1, 2012. The assignment agreement calls for Prince Company
to continue to collect the receivables. Third National Bank assesses a
finance charge of 2% of the accounts receivable, and interest on the loan is
10% (a realistic rate of interest for a note of this type).

Instructions:

30

a)

Prepare the April 1, 2012, journal entry for Prince Company.

b)

Prepare the journal entry for Princes collection of $350,000 of the

accounts receivable during the period from April 1, 2012, through
June 30, 2012.

c)

On July 1, 2012, Prince paid Third National all that was due from the
loan it secured on April 1, 2012.
LO 3 Explain accounting issues related to disposition
of accounts and notes receivable.

Secured
Secured Borrowing
Borrowing -- Exercise
Exercise
Exercise 7-13 continued

31

LO 8

Sales
Sales of
of Receivables
Receivables
Factors are finance companies or banks that buy receivables
from businesses for a fee.
Illustration 7-17

32

LO 3 Explain accounting issues related to disposition

of accounts and notes receivable.

Sales
Sales of
of Receivables
Receivables
Sale Without Recourse

Purchaser assumes risk of collection

Transfer is outright sale of receivable

Seller records loss on sale

Seller use Due from Factor (receivable) account to

cover discounts, returns, and allowances

Sale With Recourse

33

Seller guarantees payment to purchaser

Financial components approach used to record transfer

LO 3 Explain accounting issues related to disposition
of accounts and notes receivable.

Sales
Sales of
of Receivables
Receivables
Illustration: Crest Textiles, Inc. factors $500,000 of accounts
receivable with Commercial Factors, Inc., on a without recourse
basis. Commercial Factors assesses a finance charge of 3 percent of
the amount of accounts receivable and retains an amount equal to 5
percent of the accounts receivable (for probable adjustments). Crest
Textiles and Commercial Factors make the following journal entries
for the receivables transferred without recourse.
Illustration 7-18

34

LO 3 Explain accounting issues related to disposition

of accounts and notes receivable.

Sales
Sales of
of Receivables
Receivables
Illustration: Assume Crest Textiles sold the receivables on a with
recourse basis. Crest Textiles determines that this recourse
obligation has a fair value of $6,000. To determine the loss on the
sale of the receivables, Crest Textiles computes
the net proceeds from the sale as follows.
Illustration 7-19
Net Proceeds
Computation

Illustration 7-20
Loss on Sale Computation

35

LO 8

Sales
Sales of
of Receivables
Receivables
Illustration: Prepare the journal entries for both Crest Textiles and
Commercial Factors for the receivables sold with recourse.
Crest
Textiles, Inc.

Commercial
Factors, Inc.

36

Cash
Due from Factor
Loss on Sale of Receivables
Accounts (Notes) Receivable
Recourse Liability

460,000
25,000
21,000

Accounts Receivable
Due to Crest Textiles
Financing Revenue
Cash

500,000

500,000
6,000

25,000
15,000
460,000

LO 3 Explain accounting issues related to disposition

of accounts and notes receivable.

Transfers
Transfers of
of Notes
Notes Receivable
Receivable
On December 31, Stridewell accepted a nine-month 10
percent note for $200,000 from a customer. Three months
later on March 31, Stridewell discounted the note at its
local bank. The banks discount rate is 12 percent.

Before preparing the journal entry to record the discounting,

Stridewell must record the accrued interest on the note
from December 31 until March 31.
Interest receivable
Interest revenue

37

$200,000 10% 3/12

5,000
5,000

Transfers
Transfers of
of Notes
Notes Receivable
Receivable

Cash
Loss on sale of note receivable
Notes receivable
Interest receivable
$205,000 - $202,100
38

202,100
2,900
200,000
5,000

Deciding
Deciding Whether
Whether to
to Account
Account for
for aa Transfer
Transfer as
as
aa Sale
Sale or
or aa Secured
Secured Borrowing
Borrowing

39

U.S.
U.S. GAAP
GAAP vs.
vs. IFRS
IFRS
The U.S. GAAP and the IFRS approaches often lead to
similar accounting treatment for transfers of
receivables.

40

U.S. GAAP focuses on

whether control of assets
has shifted from the
transferor to the transferee.

IFRS requires a more complex

decision process. The
company has to have
transferred the rights to
receive the cash flows from
the receivable, and then
considers whether the
company has transferred
substantially all of the risks
and rewards of ownership, as
well as whether the company
has transferred control.

Secured
Secured Borrowing
Borrowing versus
versus Sale
Sale
Illustration 7-22

The FASB
concluded that a
sale occurs only if
the seller surrenders
control of the
receivables to the
buyer.
Three conditions
must be met.

41

LO 3 Explain accounting issues related to disposition

of accounts and notes receivable.

Presentation
Presentation and
and Analysis
Analysis
Presentation of Receivables
1. Segregate the different types of receivables that a company
possesses, if material.
2. Appropriately offset the valuation accounts against the proper
receivable accounts.
3. Determine that receivables classified in the current assets
section will be converted into cash within the year or the
operating cycle, whichever is longer.
4. Disclose any loss contingencies that exist on the receivables.
5. Disclose any receivables designated or pledged as collateral.
6. Disclose the nature of credit risk inherent in the receivables.
42

LO 4 Describe how to report and analyze receivables.

Presentation
Presentation and
and Analysis
Analysis
Analysis of Receivables
Illustration 7-24

This Ratio used to:

43

Assess the liquidity of the receivables.

Measure the number of times, on average, a company

collects receivables during the period.

LO 4 Describe how to report and analyze receivables.

CASH CONTROLS

Management faces two problems in accounting for cash

transactions:
1. Establish proper controls to prevent any unauthorized
transactions by officers or employees.
2. Provide information necessary to properly manage cash
on hand and cash transactions.

44

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

Using Bank Accounts

To obtain desired control objectives, a company can vary the
number and location of banks and the types of accounts.

45

General checking account

Collection float.

Lockbox accounts

Imprest bank accounts

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

The Imprest Petty Cash System

To pay small amounts for miscellaneous expenses.

Steps:
1. Record $300 transfer of funds to petty cash:
Petty Cash
Cash

300
300

2. The petty cash custodian obtains signed receipts from

each individual to whom he or she pays cash.

46

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

The Imprest Petty Cash System

Steps:
3. Custodian receives a company check to replenish the
fund.
Office Supplies Expense

42

Postage Expense

53

Entertainment Expense

76

Cash Over and Short

Cash

47

2
173

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

The Imprest Petty Cash System

Steps:
4. If the company decides that the amount of cash in the
petty cash fund is excessive by $50, it lowers the fund
balance as follows.
Cash

50

Petty cash

48

50

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

Physical Protection of Cash Balances

Company should

49

Minimize the cash on hand.

Only have on hand petty cash and current days receipts.

Keep funds in a vault, safe, or locked cash drawer.

Transmit each days receipts to the bank as soon as

practicable.

Periodically prove (reconcile) the balance shown in the general

ledger.

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

Reconciliation of Bank Balances

Schedule explaining any differences between the banks
and the companys records of cash.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Bank charges and credits.

Time Lags

4. Bank or Depositor errors.

50

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

Reconciliation of Bank Balances

51

Illustration 7A-1
Bank Reconciliation
Form and Content

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

52

LO 10

CASH CONTROLS
Illustration 7A-2

53

CASH CONTROLS

Illustration: Journalize the adjusting entries at November 30 on

the books of Nugget Mining Company.
Nov. 30

Cash

542

Office expense
Accounts receivable

54

18
220

Accounts payable

180

Interest revenue

600

LO 5 Explain common techniques employed to control cash.

CASH CONTROLS

Review Question
The reconciling item in a bank reconciliation that will result
in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.

55

LO 5 Explain common techniques employed to control cash.

IMPAIRMENT OF RECEIVABLES

Companies evaluate their receivables to determine their

ultimate collectibility.
Allowance method is appropriate when:

probable that an asset has been impaired and

amount of the loss can be reasonably estimated.

Long-term receivables such as loans that are identified as

impaired, companies perform an additional impairment
evaluation.

56

LO 6 Describe the accounting for a loan impairment.

IMPAIRMENT OF RECEIVABLES

Impairment Measurement and Reporting

Impairment loss is calculated as the difference between

57

the investment in the loan (generally the principal plus

accrued interest) and

the expected future cash flows discounted at the loans

historical effective interest rate.

LO 6 Describe the accounting for a loan impairment.

IMPAIRMENT OF RECEIVABLES
Illustration: At December 31, 2011, Ogden Bank recorded an
investment of $100,000 in a loan to Carl King. The loan has an
historical effective-interest rate of 10 percent, the principal is due in full
at maturity in three years, and interest is due annually. The loan officer
performs a review of the loans expected future cash flow and utilizes
the present value method for measuring the required impairment loss.
Illustration 7B-1

58

LO 7 Describe the accounting for a loan impairment.

IMPAIRMENT OF RECEIVABLES
Illustration: Computation of Impairment Loss
Illustration 7B-2

Recording Impairment Losses

Bad Debt Expense

12,437

Allowance for Doubtful Accounts

59

12,437

LO 7 Describe the accounting for a loan impairment.

RELEVANT FACTS

60

The accounting and reporting related to cash is essentially the same

under both IFRS and GAAP. In addition, the definition used for cash
equivalents is the same. One difference is that, in general, IFRS
classifies bank overdrafts as cash.

Like GAAP, cash and receivables are generally reported in the

current assets section of the balance sheet under IFRS. However,
companies may report cash and receivables as the last items in
current assets under IFRS.

RELEVANT FACTS

61

The fair value option is similar under GAAP and IFRS but not
identical. The international standard related to the fair value option is
subject to certain qualifying criteria not in the U.S. standard.

IFRS and GAAP differ in the criteria used to account for transfers of
receivables. IFRS is a combination of an approach focused on risks
and rewards and loss of control. GAAP uses loss of control as the
primary criterion. In addition, IFRS generally permits partial transfers;
GAAP does not.

End
End of
of Lecture
Lecture 09
09

62