CHAPTER 8 – Accounting for Receivables

Accounts Receivable:

- “receivables” refers to amounts due to a company from individuals and other companies.
o They are claims that are expected to be collected in cash
- it is important because they are usually one of a company’s largest assets and the most significant
type of claim held by a company
- 2 approaches to revenue recognition:
o The contract-based approach: used when a company follows IFRS
o The earnings approach: used when a company follows ASPE
- Accounting for revenue is different depending on which approach is being used, however there
are no significant differences between IFRS and ASPE when accounting for receivables
o Since a sole proprietorship will follow ASPE, the earnings approach is used in the
chapter and the end-of-chapter material for receivable transactions that also require
revenue recognition

Types of Receivables:

Accounts receivable:

- They are amounts owed by customers on account

- Result from the sale of goods and services
- Usually expected to be collected within 30 days or so and are classified as current assets

Notes receivable:

- Claims for which formal instruments of credit (a written note) are issued as proof of the debt
- Normally requires the debtor to pay interest and extends for longer than the company’s normal
credit terms

Trade receivable:

- Accounts and notes receivable that result from sale transactions

Recognizing Accounts Receivable:

- In chapter 2, for a service company, an AR (an asset) is recorded when a service performance
obligation is completed, and the revenue is recognized, and the customer is given credit terms
o This asset has the potential to provide future economic benefit from the receiving of cash
in the future
- in chapter 5, for a merchandising company, a receivable is recorded when the performance
obligation is complete – when the goods have transferred to the customer
- we also saw how a/r are reduced when goods are returned by a customer. The asset is reduced
because the returns will result in less cash being received from the customer

Subsidiary A/R Ledger

 - a subsidiary ledger gives supporting detail to the general ledger
- the company’s A/R account in the general ledger is the control account that provides the balance
in a/r reported on the balance sheet

Credit Card Receivables:

- some companies have their own financial divisions that will process the billings to and
collections from customers
- sometimes reported as loans receivable or other receivables

Interest Revenue

- at the end of each month, the company can use the subsidiary ledger to easily determine the
transactions that occurred in each customer’s account during the month and then send the
customer a statement of transactions for the month. If the customer doesn’t pay in full within a
specified period (usually 30 days), most retailers add an interest (financing) charge to the balance
due
- always stated per annum (on an annual basis)
- when financing charges are added, the seller increases the a/r and recognizes interest revenue

Valuing A/R

- recall at the end of a period, before financial statements are prepared, adjusting journal entries are
required to ensure revenues and expenses are recorded in the proper period and that assets,
liabilities, and owner’s equity are correct on the balance sheet. Receivables are assets, but
determining the amount to report as an asset is sometimes difficult because some receivables will
become uncollectible.
o A receivable can only be reported as an asset only IF it will give a future benefit
o This means that only collectible receivables can be reported as assets in the financial
statements
 This collectible amount is called the receivables’ carrying amount, which is the
value reported for a/r in the statement of financial position (balance sheet). It’s
the total amount of a/r – allowance for doubtful accounts
- The key issue in valuing a/r is to estimate the amount of a/r that will not be collected. If a
company waits until it knows for sure that a specific amount will not be collected, it could end up
overstating the asset a/r on the balance sheet and understating expenses

Effect of overstating accounts receivable and understating expenses:

 - Since we don’t know which specific a/r will need to be written off, we use what is known as the
allowance method in which we estimate uncollectible accounts at the end of each accounting
period.
- In this method, the estimated uncollectible accounts are recorded as a credit balance in a contra
asset account, Allowance for Doubtful Accounts. The allowance is deducted from a/r on the
balance sheet to report the carrying amount of the receivables
- The allowance method also ensures better matching of expenses with revenues on the income
statement because credit losses that are expected to happen from sales or service revenue in that
accounting period are recorded in the same accounting period as the revenue recognized.
- Has 3 essential features:
1. Recording estimated uncollectible: the amount of uncollectible a/r is estimated at the end
of an accounting period and an adjusting entry is recorded
 First step is to estimate the AFDA – it is estimated by 2 approaches: percentage
of receivables and percentage of sales
 Percentage of receivables approach: easiest way to do this is to multiply the total
amount of a/r by management’s estimate of the percentage of accounts that will
be uncollectible. The problem with this approach is that it doesn’t take into
consideration that the longer a receivable is past due or outstanding, the less
likely it is to be collected.
 Formula for calculating carrying amount: gross a/r – AFDA = carrying amount
2. Writing off uncollectible accounts: in the next accounting period, actual uncollectible
accounts ae written off when the specific account is determined to be uncollectible
3. Collection of a previously written-off account: if an account that was previously written
off is later collected, the original write off is reversed and the collection is recorded.

Calculation of bad debt expense using percentage receivables approach – unadjusted credit balance
in the allowance:
Calculation of bad debt expense using the percentage of receivables approach – unadjusted debit
balance in the allowance

Percentage of Sales Approach

- Estimates the amount of bad debt expense as a percentage of net credit sales. This amount is also
recorded in the AFDA. Management determines the percentage based on experience and the
company’s credit policy
 - When calculating the amount in the adjusting entry ($24,000), the existing balance in AFDA is
ignored when using the percentage of sales approach
- Because the income statement is emphasized in the percentage of sales approach, the balance in
the allowance account isn’t involved in calculating the bad debt expense in the adjusting entry

Calculation of bad debt expense using the percentage of sales approach

- This approach is estimating uncollectible results in better matching of expenses with revenues
because the bad debt expense is related to the sales recorded in the same period. Because an
income statement account (sales) is used to calculate another income statement account (bad debt
expense), and because any balance in the balance sheet account (AFDA) is ignored, this approach
is often called the income statement approach
- Current accounting standards emphasize the balance sheet the valuation of assets, liabilities, and
equity as primary measurements. Therefore, the percentage of a/r approach is most appropriate
for reporting a/r assets at a reporting date.
- The percentage of sales approach is quick and easy to use so companies will often use a mix of
the 2 approaches. The percentage of sales approach can be used monthly to estimate uncollectible
amounts and the percentage of a/r can then be used as the final period-end adjustment for
financial reporting purposes.
Writing Off Uncollectible Accounts

- Note that the journal entries required to write off specific a/r will be the same whether the
company uses the percentage of receivables or percentage of sales approach to estimate
uncollectible amounts

- Bad debt expense isn’t increased (debited) when the write off occurs. Under the allowance
method, every account write off is debited to the allowance account rather than to bad debt
expense. A debit to bad debt expense would be incorrect because the expense was already
recognized when the adjusting entry was made for uncollectible accounts at the end of the
previous year.
- Instead, the entry to record the write off of an uncollectible account reduces both a/r and AFDA.

- The allowance account can sometimes end up in a debit balance position after the write off of an
uncollectible account. This can happen if the write offs during the period are more than the
opening balance of the allowance. It means the actual credit losses were greater than the
 estimated credit losses. The balance in AFDA will be corrected when the adjusting entry for
estimated uncollectible accounts is made at the end of the period.

Collection of a Previously Written-Off Uncollectible Account

- Sometimes, a company collects cash from a customer after its account has been written off. Two
entries are required to record the collection of a previously written-off account:
1. The entry previously made when the account was written off is reversed to restore the
customer’s account
2. The collection is recorded in the usual way. The journal entries required for a previously
written-off uncollectible account demonstrated below will be the same when using the
percentage of receivables approach or the percentage of sales approach
 - Note that the collection of a previously written-off account, like the write off of a bad debt,
affects only balance sheet accounts. The net effect of the 2 entries is a debit to cash and a credit to
AFDA.

Summary of Allowance Method

Notes Receivable

- Credit may also be granted in exchange from a formal credit instrument known as a promissory
note.
- Promissory note: defined as a written promise to pay a specified amount of money on demand or
at a definite time. Promissory notes may be used (1) when individuals and companies lend or
borrow money, (2) when the amount of the transaction and the credit period are longer than
normal limits, or (3) in the settlement of a/r

Promissory note:

- Might also contain other details such as whether any security is pledged as collateral for the loan
and what happens if the maker defaults
- A note receivable is a formal promise to pay an amount that bears interest from the time it is
issued until it is due. An a/r is an informal promise to pay that bears interest only after its due
date. Because it’s less formal, it doesn’t not have as strong a legal claim as a note receivable.
- There are also similarities between notes and a/r. both extend credit to customers, can be sold to
another party, and are reported on the balance sheet at their carrying amount.

Recognizing Notes Receivable

- If a note is exchanged for cash instead of an a/r, the entry is a debit to notes receivable and a
credit to cash for the amount of the loan
- The note receivable is recorded at its principal amount (the value shown on the face of the note)

Recording Interest
 - Recall that the principal amount is the amount borrowed, or the amount still outstanding on a
loan, separate from interest. This is also the balance in the notes receivable account in wolder’s
accounting records.
- The interest rate specified in a note is an annual rate of interest. There are many factors that affect
the interest rate. Interest rates may also be fixed for the term of the notes or may change over the
term.

- Notice that interest on a note receivable is not debited to the notes receivable account. Instead, a
separate asset account for the interest receivable is used. The notes receivable account balance
must be equal to the amount still outstanding on the note, in order to correctly calculate interest.

Valuing Notes Receivable

 - Like a/r, notes receivable are reported at their carrying amount. Each note must be analyzed to
determine how likely it is to be collected. If eventual collection is doubtful, bad debt expense and
an allowance for doubtful notes must be recorded using the allowance method in the same way as
for a/r. some companies use only one allowance account for both accounts and notes, and call it
AFDA.

Disposing of Notes Receivable

Honouring of Notes Receivable

Dishonouring of Notes Receivable

- A dishonoured note is a note that isn’t paid in full at maturity. Since a dishonoured note
receivable is no longer negotiable, the notes receivable account must be reduced to 0. The payee
still has a claim against the maker of the note for both the principal and any unpaid interest. The
payee will transfer the amount owing to an a/r account if there is hope that the amount will
eventually be collected.
Chapter 9: Long-Lived Assets
Property, Plant, and Equipment

- Long-lived assets that the company owns and uses for the production and sale of goods or
services to consumers
- They have 3 characteristics:
1. They have a physical substance (a definite size and shape)
2. Are held for use in the production or supply of goods or services, for rental to others or for
administrative purposes
3. Aren’t intended for sale to customers.
- Unlike current assets, these assets are expected to provide services to a company for a # of years
- Known as fixed assets; land, building, and equipment; or capital assets

Determining the Cost of Property, Plant, and Equipment

1. the purchase price, + any non-refundable taxes, less any discounts or rebates;
2. the expenditures necessary to bring the asset to the required location and make it ready for its
intended use; and
3. any obligations to dismantle, remove, or restore the asset when it’s retired. An estimate of these
costs is also included in the cost of the long-lived asset. We will assume that these costs, known
as asset retirement costs, are equal to zero in the examples in this text.

- PPE are often subdivided into 4 classes:

1. Land, such as a building site
2. Land improvements, such as driveways, parking lots, fences, and underground sprinkler
systems
3. Buildings, such as stores, offices, factories, and warehouses
4. Equipment, such as store checkout counters, cash registers, office furniture, computer
equipment, factory equipment, and delivery equipment

Land:

- Cost of land includes:

1. Purchase price
2. Closing costs such as surveying and legal fees
3. The costs of preparing the land for its intended use, such as the removal of old buildings,
clearing, draining, fillings and grading.
o All these costs (less any proceeds from salvaged materials) are debited to the Land
account
 - When recording the acquisition, land is debited for $209,000 and cash is credited for $209,000
(assuming the costs were paid in cash). Land is a unique long-lived asset. Its costs isn’t
depreciated because land has an unlimited useful life.

Land Improvements:

- Structural additions made to land, such as driveways, sidewalks, fences, and parking lots
- Land improvements, unlike land, decline in service potential over time, and require maintenance
and replacement. Because of this, land improvements are recorded separately from land are
depreciated over their useful lives
- When classifying costs, its important to remember that one-time costs required for getting the
land ready to use are always charged to the land account, not the land improvements account

Buildings:

- all costs that are directly related to the purchase or construction of a building are debited to the
buildings account.
- When a building is purchased, these costs include the purchase price and closing costs (such as
legal fees). The costs of making a building ready to be used as intended can include expenditures
for remodelling, and for replacing or repairing the roof, floors, electrical wiring, and plumbing.
These costs are also debited to buildings
- As noted above, any costs incurred to remove or demolish existing buildings are debited to the
Land account and shouldn’t be included in the Building account
- When a new building is built, its costs includes the contract price + payments for architects’ fees,
building permits, and excavations costs. The interest costs of financing the construction project
are also included in the asset’s cost but only the interest costs incurred during the construction
 phase. In this situation, interest costs are considered to be as necessary as materials and labour
are.
- When the building is ready for use, interest costs are once again included in interest expense

Equipment:

- The costs of these assets includes the purchase price; freight charges and insurance during transit
paid by the purchaser; and the costs of assembling, installing, and testing the equipment. These
costs are treated as capital expenditures because they benefit future periods and are necessary to
bring the asset to its required location and make it ready for use
Allocating Cost to Multiple Assets or Significant Components

Multiple Assets

- PPE are often purchased for a single price. Known as a basket purchase
- When a basket purchase occurs, we determine individual asset costs by allocating the total price
paid for the group of assets to each individual asset based on its relative fair value

Significant Components

- When an item of PPE includes individual components that have different useful lives, the cost of
the item should be allocated to each of its significant components. This allows each component to
be depreciated separately over the different useful lives or possibly by using different
depreciation methods.
o Ex. An aircraft and its engine may need to be treated as separate depreciable assets if they
have different useful lives
Cost of Plant Assets
Depreciation

- In chapter 3, depreciation is the systematic allocation of the cost of a long-lived asset, such as
PPE, over the asset’s useful life. The cost is allocated to expense over the asset’s useful life to
recognize the cost that has been used up (the expense) during the period, and report the unused
cost (the asset) at the end of the period
- Depreciation expense is an operating expense on the income statement. Accumulated depreciation
appears on the balance sheet as a contra account to the related long-lived asset account. The
resulting balance, cost less accumulated depreciation, is the carrying amount of the depreciable
asset.
- It’s important to understand the depreciation is a process of a cost allocation, not a process of
determining an asset’s real value.
o Under the cost model, an increase in an asset’s fair value isn’t relevant because PPE are
not for resale. As a result, the carrying amount of PPE (cost less accumulated
depreciation) may be very different from its fair value
- It’s also important to understand that depreciation neither uses up nor provides cash to replace the
asset. The balance is accumulated depreciation only represents the total amount of the asset’s cost
that has been allocated to expense so far. It’s not cash fund. Cash is neither increased nor
decreased by the adjusting entry to record depreciation

Factors in Calculating Depreciation

Cost:

o Remember that the cost of PPE includes the purchase price plus all costs necessary to get
the asset ready for use. Cost includes an initial estimate of the retirement costs, if there
are any.
Useful life:
o It is either 1) the period of time over which an asset is expected to be available for use or
2) the number of units of production (such as machine hours) or units of output that are
expected to be obtained from an asset.
o It’s estimated based on such factors as the asset’s intended use, its expected need for
repair and maintenance, and how vulnerable it’s to wearing out or becoming obsolete.
The company’s past experience with similar assets often helps in estimating the expected
useful life.
Residual Value:
 o It is the estimated amount that a company would obtain from disposing of the asset at the
end of its useful life. Residual value isn’t depreciated, because the amount is expected to
be recovered at the end of the asset’s useful life.

Depreciation Methods:

- How do companies decide which of the 3 depreciation methods to use?

o management must choose the method that best matches the estimated pattern in which the
asset’s future economic benefits are expected to be consumed. The depreciation method
must be reviewed at least once a year. If the expected pattern of consumption of the
future economic benefits has changed, the depreciation method must be changed, and the
change disclosed in the notes to the financial statements
1. Straight-line
o Used by the majority
o Has 2 steps – 1st, residual value is deducted from the asset’s cost to determine an asset’s
depreciable amount. 2nd, the depreciable amount is divided by the asset’s useful life to
calculate the annual depreciation expense
o Most appropriate method of depreciation when the asset is used quite uniformly
throughout its useful life
2. Diminishing-balance
o Produces decreasing annual depreciation expense over the asset’s useful life.
o This method is so named because the periodic depreciation is based on a diminishing
carrying amount (cost less accumulated depreciation) of the asset.
o Annual depreciation expense is calculated by multiplying the carrying amount at the
beginning of the year by the depreciation rate.
o The depreciation rate remains constant from year to year, but the rate is applied to a
carrying amount that declines each year.
3. Units-of-production
o Useful life is either the estimated total units of production or total expected use of the
asset, not the # of years that the asset is expected to be used.
o It is ideal for equipment whose activity can be measured in units of output, such as kms
driven or hours in use.
o Generally, not suitable for buildings or furniture because depreciation of these assets is
more a result of time than of use
o In this method, the total units of production for the entire useful life are estimated.
Units-of-Production Depreciation in a Partial Year

- Easy to apply when assets are purchased during the year

- The actual units of production already show how much the asset was used during the year.
Therefore, the depreciation calculations don’t need to be adjusted for partial periods, as is done in
the straight-line and diminishing-balance methods
 - Therefore, the depreciation calculations don’t need to be adjusted for partial periods as is done in
the straight-line and diminishing-balance methods

Revising Periodic Depreciation

- During the useful life of a long-lived asset, the annual depreciation expense needs to be revised if
there are changes to the 3 factors that affect the calculation of depreciation: the asset’s cost,
useful life, or residual value
- Therefore, depreciation needs to be revised if there are:
1. Capital expenditures during the asset’s useful life
2. Impairments in the value of an asset
3. Changes in the asset’s fair value when using the revaluation model, and/or
4. Changes in the appropriate depreciation method, or in the asset’s estimated useful life or
residual value

Capital Expenditures During Useful Life:

- Ordinary repairs:
o Are costs to maintain the asset’s operating efficiency and expected productive life.
o Ex. Oil changes, repainting a building, or replacing worn-out gears on equipment
o These costs are frequently fairly small amounts that occur regularly. They may also be
larger, infrequent amounts, but if they simply restore an asset to its prior condition, they
are considered an ordinary repair.
o Such repairs are debited to Repairs Expense as they occur. Ordinary repairs are operating
expenditures
- Additions and improvements:
o Are costs that are incurred to increase the asset’s operating efficiency, productive
capacity, or expected useful life.
o These costs are usually large and happen less often.
o Additions and improvements that add to the future cash flows associated with that asset
aren’t expensed as they occur – they are capitalized.
 As capital expenditures, they are generally debited to the appropriate PPE
account.
 The capital expenditure will be depreciated over the remaining life of the original
structure or the useful life of the addition.
o It can also increase the useful life of the original structure. The depreciation calculations
need to be revised when a company makes an addition or improvement.

Impairments:

- PPE is considered impaired if the asset’s carrying amount exceeds its recoverable amount
o Recoverable amount: it is defined as the greater of the asset’s fair value less costs to sell
or its value in use, which is determined by discounting future estimated cash flows.
- When an asset is impaired, an impairment loss is recorded that is the amount by which the asset’s
carrying amount exceeds its recoverable amount.
- Companies are required to determine on a regular basis if there is any indication of impairment.
Some factors that would indicate an impairment of an asset include:
o Obsolescene or physical damage of the asset
o Equipment used in the manufacture of a product where there is dramatically reduced
demand or the market has become highly competitive
o Bankruptcy of a supplier of replacement parts for equipment
Revised Depreciation Calculations:
Disposal of PPE:

Steps in Recording Disposals of PPE:

Step 1: Update Depreciation

- Depreciation must be recorded over the entire period of time an asset is available for use.
Therefore, if the disposal occurs in the middle of an accounting period, depreciation must be
updated for the fraction of the year since the last time adjusting entries were recorded up to the
date of disposal
Step 2: Calculate the Carrying Amount

- Calculate the carrying amount at the date of disposal after updating the accumulated depreciation
for any partial year depreciation calculated in Step 1

Step 3: Calculate the Gain or Loss

- Determine the amount of the gain or loss on disposal, if any, by comparing the proceeds received
from the disposal with the carrying amount at the date of disposal

- Gain and losses are similar to revenues and expenses except that gains and losses arise from
activities that are peripheral to (outside of) a company’s normal operating activities.
- If the proceeds of the sale are more than the carrying amount of the PPE, there is a gain on
disposal. If the proceeds of the sale are less than the carrying amount of the asset sold, there’s a
loss on disposal.

Step 4: Record the Disposal

- The journal entry to record the disposal always involves removing the asset’s cost and the
accumulated depreciation from the accounts. These are the same amounts used to calculate the
carrying amount in Step 2. The journal entry may also include recording the proceeds and the
gain or loss on disposal. Gains on disposal are recorded as credits because, like revenue, gains
increase owner’s equity; losses on disposal are recorded as debits because, like expenses, losses
decrease owner’s equity.
- Gain and losses are reported in the operating section of a multiple-step income statement
o Why? Depreciation expense is an estimate. A loss results when the annual depreciation
expense hasn’t been high enough, so the carrying amount at the date of disposal is greater
than the proceeds. Gains are caused because the annual depreciation expense has been too
high, so the carrying amount at the date of disposal is less than the proceeds. Thus, gain
and losses are adjustments to depreciation expense and should be recorded in the same
section of the income statement

Retirement of PPE:

- Some productive assets used in manufacturing may have highly specializing uses and
consequently have no market when the company no longer needs the asset – the asset is retired
- when an asset is retired, there are often no proceeds on disposal. The accumulated depreciation
account is decreased (debited) for the full amount of depreciation recorded over the life of the
asset.
o The asset account is reduced (credited) for the asset’s original cost. Even the carrying
amount equals zero, a journal entry is still required to remove the asset and its related
depreciation account from the accounting records.
What happens if a company is still using a fully depreciated asset?

- the asset and its accumulated depreciation continue to be reported on the balance sheet, without
further depreciation, until the asset is retired. Reporting the asset and related depreciation on the
balance sheet informs the reader of the financial statements that the asset is still being used by the
company.
 - Once an asset is fully depreciated, even if it is still being used, no additional depreciation should
be taken. Accumulated depreciation on a piece of PPE can never be more than that asset’s cost.

If a PPE is retired before it’s fully depreciated and no proceeds are received, a loss on disposal occurs.

Sale of PPE:

Gain on Disposal
Exchanges of PPE

- An exchange of assets is recorded as the purchase of a new asset and the sale of an old asset.
- Typically, a trade-in allowance on the old asset is given toward the purchase price of the new
asset.
o An additional cash payment is usually also required for the difference between the trade-
in allowance and the stated purchase price (list price) of the new asset.
- The trade-in allowance amount is often just a price concession and doesn’t reflect the fair value of
the asset that is given up.
- Trade-in allowances are only used to determine the remaining cash that must be paid and aren’t
recorded in the accounting records.
- Instead of using the stated purchase price, the new asset is recorded at the fair value of the asset
given up plus any cash paid (or less any cash received) unless the fair value of the asset given up
can’t be determined reliably, in which case the FV of the asset received should be used.
o The FV of the asset given up is used to calculate the gain or loss on the asset being given
up. A loss results if the carrying amount of the asset being given up is more than its FV.
A gain results if the carrying amount is less than its FV
- Procedure to account for exchanges:
Step 1: Update any unrecorded depreciation expense on the asset being given up to the date of the
exchange
Step 2: Calculate the carrying amount of the asset being given up (cost – accumulated
depreciation)
Step 3: Calculate any gain or loss on disposal (FV – carrying amount = gain [loss])
Step 4: Record the exchange as follows:
 Remove the cost and the accumulated depreciation of the asset that is given up
 Record any gain or loss on disposal
 Record the new asset at the FV of the old asset plus any cash paid (or less any
cash received)
 Record the cash paid or received
CHAPTER 10 – Current Liabilities and Payroll
- Liabilities are present obligations resulting from past transactions that will involve future
settlement

Determinable (Certain) Current Liabilities

- Also referred to as certain liabilities or known liabilities

- Liabilities with a known amount, payee, and due date are often referred to as determinable
liabilities

Accounts Payable:

o Referred to as a “trade payable”

Unearned Revenue:

o When a company receives the payment in advance, it debits cash and credits a current
liability account identifying the source of the unearned revenue
o When the company provides the goods or performs the service, the performance
obligation is satisfied, and the company recognizes the revenue as it debits an unearned
revenue account and credits a revenue account
Operating Line of Credit
o Most companies have an operating line of credit at their bank to help them manage
temporary cash shortfalls. This means that the company has been pre-authorized by the
bank to borrow money when it’s needed, up to a pre-set limit
o Security, called collateral, is usually required by the bank as protection in case the
company is unable to repay the loan. Collateral normally includes some, or all, of the
company’s current assets (e.g., a/r or inventories); investments; or PPE
o Money borrowed through a line of credit is normally borrowed on a short-term basis, and
is repayable on demand by the bank.
 In reality, repayment is rarely demanded without notice. A line of credit makes it
very easy for a company to borrow money. It doesn’t have to make a call or visit
its banks to actually arrange the transaction. The bank simply covers any cheques
written in excess of the bank account balance, up to the approved credit limit.
Bank Overdraft
o No special entry or account is required to record the overdrawn account
o The cash account has a credit balance because the $ amount of cheques written exceeded
the $ amount of deposits. The credit balance in Cash is reported as a current liability with
the appropriate note disclosure.
o Prime rate: is the interest rate that banks charge their best customers. This rate is usually
increased by a specified percentage according to the company’s risk profile.

Short-Term Notes Payable

- Notes payable are obligations in the form of written promissory notes. Notes payable are often
used instead of a/p because they give the lender formal proof of the obligation in case legal
remedies are needed to collect the debt. Companies frequently issue notes payable to meet short-
term financing needs. Notes payable usually require the borrower to pay interest.
- Notes payable due for payment within one year of the balance sheet date are classified as current
liabilities.