kieso

weygandt
warfield
INTERMEDIATE team for success
F I F T E E N T H E D I T I O N

Intermediate
Intermediate
ACCOUNTING
Accounting
Accounting

Prepared by
Prepared by
Harsono
Coby Harmon Prepared by
University of California, Santa Coby
BarbaraHarmon
University of California, Santa Barbara
7-1 Westmont College
 PREVIEW OF CHAPTER 7

Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
7-2
 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-3
 Cash

What is Cash?
 Most liquid asset.

 Standard medium of exchange.

 Basis for measuring and accounting for all items.

 Current asset.

 Examples: coin, currency, available funds on deposit at

the bank, money orders, certified checks, cashier’s checks,
personal checks, bank drafts and savings accounts.

7-4 LO 1 Identify items considered cash.

 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-5
 Cash

Reporting Cash
Cash Equivalents
Short-term, highly liquid investments that are both

a) readily convertible to cash, and

b) so near their maturity that they present insignificant
risk of changes in value.

Examples: Treasury bills, Commercial paper, and Money

market funds.

7-6 LO 2 Indicate how to report cash and related items.

 Reporting Cash

Restricted Cash
Companies segregate restricted cash from “regular” cash.
Examples, restricted for:
(1) plant expansion, (2) retirement of long-term debt, and
(3) compensating balances.

Illustration 7-1

7-7 LO 2
 Reporting Cash

Bank Overdrafts
Company writes a check for more than the amount in its
cash account.

 Generally reported as a current liability.

 Offset against other cash accounts only when
accounts are with the same bank.

7-8 LO 2 Indicate how to report cash and related items.

 Cash-Related Items
Illustration 7-2

7-9 LO 2
 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-10
 Accounts Receivable

Receivables - Claims held against customers and

others for money, goods, or services.

Oral promises of the Written promises to pay a

purchaser to pay for goods sum of money on a
and services sold. specified future date.

Accounts Notes
Receivable Receivable

7-11 LO 3 Define receivables and identify the different types of receivables.

 Accounts Receivable

Nontrade Receivables
1. Advances to officers and employees.
2. Advances to subsidiaries.
3. Deposits paid to cover potential damages or losses.
4. Deposits paid as a guarantee of performance or payment.
5. Dividends and interest receivable.
6. Claims against: Insurance companies for casualties sustained;
defendants under suit; governmental bodies for tax refunds;
common carriers for damaged or lost goods; creditors for returned,
damaged, or lost goods; customers for returnable items (crates,
containers, etc.).

7-12 LO 3 Define receivables and identify the different types of receivables.

 Accounts Receivable

Nontrade Receivables
Illustration 7-3
Receivables Balance
Sheet Presentations

7-13 LO 3 Define receivables and identify the different types of receivables.

 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-14
 Recognition of Accounts Receivables

Trade Discounts
 Reductions from the list
price. 10 %
 Not recognized in the Discount for
accounting records. new Retail
Store
 Customers are billed net Customers
of discounts.

7-15 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Recognition of Accounts Receivables

Cash Discounts (Sales Discounts)

 Offered to induce prompt
payment.

 Gross Method vs. Net

Method.
Payment
terms are
2/10, n/30

7-16 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Recognition of Accounts Receivables

Cash Discounts (Sales Discounts) Illustration 7-4

7-17 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Recognition of Accounts Receivables

Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.
shipping point. On June 12, the company received a check for the
balance due from Arquette Company. Prepare the journal entries on
Bolton Company books to record the sale assuming Bolton records sales
using the gross method.

June 3 Accounts Receivable 2,000

Sales 2,000

June 12 Cash ($2,000 x 98%) 1,960

Sales Discounts 40
Accounts Receivable 2,000

7-18 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Recognition of Accounts Receivables

Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.
shipping point. On June 12, the company received a check for the
balance due from Arquette Company. Prepare the journal entries on
Bolton Company books to record the sale assuming Bolton records sales
using the net method.

June 3 Accounts Receivable 1,960

Sales 1,960

June 12 Cash ($2,000 x 98%) 1,960

Accounts Receivable 1,960

7-19 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Recognition of Accounts Receivables

Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.
shipping point. Prepare the journal entries on Bolton Company books to
record the sale assuming Bolton records sales using the net method,
and Arquette did not remit payment until July 29.

June 3 Accounts Receivable 1,960

Sales 1,960

June 12 Account Receivable 40

Sales Discount Forfeited 40

7-20 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Recognition of Accounts Receivables

Non-Recognition of Interest Element

A company should measure receivables in terms of their
present value.

In practice, companies ignore

interest revenue related to accounts
receivable because the discount is
not usually material in relation to
the net income for the period.

7-21 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables

How are these accounts presented on the Balance Sheet?

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.

End. 500 25 End.

7-22 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables

ABC Corporation
Balance Sheet (partial)
Current Assets:
Cash $ 330
Accounts receivable 500
Less: Allowance for doubtful accounts (25) 475
Inventory 812
Prepaid expense 40
Total current assets 1,657

7-23 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Alternate
ABC Corporation Presentation
Balance Sheet (partial)
Current Assets:
Cash $ 330
Accounts receivable, net of $25 allowance 475
Inventory 812
Prepaid expense 40
Total current assets 1,657

7-24 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Journal entry for credit sale of $100?
Accounts Receivable 100
Sales 100

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.

End. 500 25 End.

7-25 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Journal entry for credit sale of $100?
Accounts Receivable 100
Sales 100

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100

End. 600 25 End.

7-26 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Collected $333 on account?
Cash 333
Accounts Receivable 333

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100

End. 600 25 End.

7-27 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Collected $333 on account?
Cash 333
Accounts Receivable 333

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll.

End. 267 25 End.

7-28 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Adjustment of $15 for estimated bad debts?
Bad Debt Expense 15
Allowance for Doubtful Accounts 15

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll.

End. 267 25 End.

7-29 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Adjustment of $15 for estimated bad debts?
Bad Debt Expense 15
Allowance for Doubtful Accounts 15

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll. 15 Est.

End. 267 40 End.

7-30 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Write-off of uncollectible accounts for $10?
Allowance for Doubtful accounts 10
Accounts Receivable 10

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll. 15 Est.

End. 267 40 End.

7-31 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables
Write-off of uncollectible accounts for $10?
Allowance for Doubtful accounts 10
Accounts Receivable 10

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll. 15 Est.
10 W/O W/O 10

End. 257 30 End.

7-32 LO 4 Explain accounting issues related to recognition of accounts receivable.

 Accounts Receivables

ABC Corporation
Balance Sheet (partial)
Current Assets:
Cash $ 330
Accounts receivable, net of $30 allowance 227
Merchandise inventory 812
Prepaid expense 40
Total current assets 1,409

7-33 LO 4 Explain accounting issues related to recognition of accounts receivable.

 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-34
 Accounts Receivable

Valuation of Accounts Receivable

 Reporting of receivables involves
1) classification and

2) valuation on the balance sheet.

 Classification involves determining the length of time each

receivable will be outstanding.
 Value and report short-term receivables at net realizable
value.

7-35 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Uncollectible Accounts Receivable

 Record credit losses as debits to Bad Debt Expense (or
Uncollectible Accounts Expense).

 Normal and necessary risk of doing business on credit.

 Two methods to account for uncollectible accounts:
1) the direct write-off method and

2) the allowance method.

7-36 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Methods of Accounting for Uncollectible Accounts

Direct Write-Off Allowance Method

Theoretically deficient: Losses are estimated:
 No matching.  Percentage-of-sales.
 Receivable not stated at  Percentage-of-receivables.
cash realizable value.  GAAP requires when
 Not GAAP when material in material in amount.
amount.

7-37 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable
Illustration 7-6

The percentage-of-sales basis The percentage-of-receivables

results in a better matching of basis produces the better estimate of
expenses with revenues net realizable value

7-38 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Percentage-of-Sales Approach
 Percentage based upon past experience and anticipate
credit policy.
 Achieves better matching of expenses with revenues.
 Any balance in Allowance for Doubtful Accounts is
ignored.

7-39 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Illustration: Gonzalez Company estimates that about 1% of net

credit sales become uncollectible. If net credit sales for are
$800,000 for the year, it records bad debt expense as follows.

Bad Debt Expense 8,000

Allowance for Doubtful Accounts 8,000

Illustration 7-7

7-40 LO 5
 Valuation of Accounts Receivable

Percentage-of-Receivables Approach
 Not matching.
 Reports estimate of receivables at realizable value.

Companies may apply this method using

 one composite rate, or
 an aging schedule using different rates.

7-41 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Illustration 7-8
Accounts Receivable
Aging Schedule

What entry
would Wilson
make assuming
that the
allowance
account had a
zero balance?

Bad Debt Expense 37,650

Allowance for Doubtful Accounts 37,650

7-42 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Illustration 7-8
Accounts Receivable
Aging Schedule

What entry
would Wilson
make assuming
the allowance
account had a
credit balance
of $800 before
adjustment?

Bad Debt Expense ($37,650 – $800) 36,850

Allowance for Doubtful Accounts 36,850

7-43 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Illustration: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry to record bad debt

expense assuming Sandel Company estimates bad debts
at (a) 1% of net sales and (b) 5% of accounts receivable.

7-44 LO 5 Explain accounting issues related to valuation of accounts receivable.

 Valuation of Accounts Receivable

Illustration: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry assuming Sandel

estimates bad debts at (b) 1% of net sales.

Bad Debt Expense 7,500

Allowance for Doubtful Accounts 7,500
($800,000 – $50,000) x 1% = $7,500

7-45 LO 5
 Valuation of Accounts Receivable

Illustration: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry assuming Sandel

estimates bad debts at (b) 5% of accounts receivable.

Bad Debt Expense 6,000

Allowance for Doubtful Accounts 6,000
($160,000 x 5%) – $2,000) = $6,000

7-46 LO 5
 Write-Off of Uncollectible Accounts

Illustration: The financial vice president of Brown Furniture

authorizes a write-off of the $1,000 balance owed by Randall Co. in
March 1. The entry to record the write-off is:

Allowance for Doubtful Accounts 1,000

Accounts Receivable 1,000

Assume that on July 1, Randall Co. pays the $1,000 amount that
Brown had written off on March 1. These are the entries:
Accounts Receivable 1,000
Allowance for Doubtful Accounts 1,000
Cash 1,000
Accounts Receivable 1,000
7-47 LO 5
 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-48
 Notes Receivable

Supported by a formal promissory note.

 Written promise to pay a certain sum of money at a specific
future date.

 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 6 Explain accounting issues related to recognition

7-49 and valuation of notes receivable.
 Notes 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 (majority of notes).

LO 6 Explain accounting issues related to recognition

7-50 and valuation of notes receivable.
 Recognition of Notes Receivable

Short-Term Long-Term
Record at Record at
Face Value, Present Value
less allowance 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

7-51 LO 6
 Note Issued at Face 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 1,000 Interest

0 1 2 3 4
n=3
LO 6 Explain accounting issues related to recognition
7-52 and valuation of notes receivable.
 Note Issued at Face Value

PV of Interest

$1,000 x 2.48685 = $2,487

Interest Received Factor Present Value

LO 6 Explain accounting issues related to recognition

7-53 and valuation of notes receivable.
 Note Issued at Face Value

PV of Principal

$10,000 x .75132 = $7,513

Principal Factor Present Value

LO 6 Explain accounting issues related to recognition

7-54 and valuation of notes receivable.
 Note Issued at Face Value

Summary Present value of interest $ 2,487

Present value of principal 7,513
Note current market value $10,000

Journal Entries

Jan. yr. 1 Notes Receivable 10,000

Cash 10,000

Dec. yr. 1 Cash 1,000

Interest Revenue 1,000

LO 6 Explain accounting issues related to recognition

7-55 and valuation of notes receivable.
 Zero-Interest-Bearing 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

$0 $0 $0 Interest

0 1 2 3 4
n=3

LO 6 Explain accounting issues related to recognition

7-56 and valuation of notes receivable.
 Zero-Interest-Bearing Note

PV of Principal

$10,000 x .77218 = $7,721.80

Principal Factor Present Value

LO 6 Explain accounting issues related to recognition

7-57 and valuation of notes receivable.
 Zero-Interest-Bearing Note
Illustration 7-12

LO 6 Explain accounting issues related to recognition

7-58 and valuation of notes receivable.
 Zero-Interest-Bearing Note
Illustration 7-12

Prepare the
journal entry to
record the receipt
of the note.

Notes Receivable 10,000.00

Discount on Notes Receivable 2,278.20
Cash 7,721.80

LO 6 Explain accounting issues related to recognition

7-59 and valuation of notes receivable.
 Zero-Interest-Bearing Note
Illustration 7-12

Prepare the
journal entry to
record interest
revenue at the
end of the first
year.

Discount on Notes Receivable 694.96

Interest Revenue 694.96

LO 6 Explain accounting issues related to recognition

7-60 and valuation of notes receivable.
 Interest-Bearing 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. Prepare the journal entry to record the
receipt of the note?

i = 12%
$10,000 Principal

$1,000 1,000 1,000 Interest

0 1 2 3 4
n=3

LO 6 Explain accounting issues related to recognition

7-61 and valuation of notes receivable.
 Interest-Bearing Note

PV of Interest

$1,000 x 2.40183 = $2,402

Interest Received Factor Present Value

LO 6 Explain accounting issues related to recognition

7-62 and valuation of notes receivable.
 Interest-Bearing Note

PV of Principal

$10,000 x .71178 = $7,118

Principal Factor Present Value

LO 6 Explain accounting issues related to recognition

7-63 and valuation of notes receivable.
 Interest-Bearing Note

Illustration: Record the receipt of the note?

Illustration 7-14

Notes Receivable 10,000

Discount on Notes Receivable 480
Cash 9,520

LO 6 Explain accounting issues related to recognition

7-64 and valuation of notes receivable.
 Interest-Bearing Note
Illustration 7-15

LO 6 Explain accounting issues related to recognition

7-65 and valuation of notes receivable.
 Interest-Bearing Note
Illustration 7-15

Prepare the journal

entry to record
interest revenue at
the end of the first
year.

Cash 1,000
Discount on Notes Receivable 142
Interest Revenue 1,142

LO 6 Explain accounting issues related to recognition

7-66 and valuation of notes receivable.
 Recognition of Notes Receivable

Notes Received for Property, Goods, or Services

In a bargained transaction entered into at arm’s 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.

LO 6 Explain accounting issues related to recognition

7-67 and valuation of notes receivable.
 Recognition of Notes Receivable

Illustration: Oasis Development Co. sold a corner lot to Rusty

Pelican as a restaurant site. Oasis accepted in exchange a five-year
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 35,247

Discount on Notes Receivable 15,247
Land 14,000
Gain on Disposal of Land 6,000

LO 6 Explain accounting issues related to recognition

7-68 and valuation of notes receivable.
 Notes Receivable

Valuation of Notes 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.

LO 6 Explain accounting issues related to recognition

7-69 and valuation of notes receivable.
 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-70
 Special Issues

Fair Value Option

 Companies have the option to use fair value as the basis
of measurement in the financial statements.

 If companies choose the fair value option

► Receivables are recorded at fair value.

► Unrealized holding gains or losses reported as part of

net income.

 Company reports the receivable at fair value each

reporting date.

7-71 LO 7 Explain the fair value option.

 Special Issues

Fair Value Option

 Companies may elect at time the financial instrument is

► originally recognized or

► when some event triggers a new basis of accounting.

 Must continue to use fair value measurement for the specific

instrument until the company no longer owns this
instrument.

 If not elected at date of recognition, company may never

use fair value option on that specific instrument.

7-72 LO 7 Explain the fair value option.

 Valuation of Notes Receivable

Illustration: 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, of the current year, to use the fair value
option for these receivables. This is the first valuation of these
recently acquired receivables. At December 31, 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 Loss—Income 190,000

7-73 LO 7 Explain the fair value option.

 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-74
 Disposition of Accounts and Notes Receivable

Owner may transfer accounts or notes receivables to

another company for cash. Reasons:

 Competition.

 Sell receivables because money is tight.

 Billing and collection are time-consuming and costly.

Transfer accomplished by:

 Secured borrowing.

 Sale of receivables.

LO 8 Explain accounting issues related to disposition

7-75 of accounts and notes receivable.
 Disposition of Accounts and Notes Receivable

Secured Borrowing
Illustration: March 1, 2014, 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.

LO 8 Explain accounting issues related to disposition

7-76 of accounts and notes receivable.
 Secured Borrowing
Illustration 7-16

7-77 LO 8
 Secured Borrowing
Illustration: On April 1, 2014, Prince Company assigns $500,000 of its
accounts receivable to the Third National Bank as collateral for a $300,000
loan due July 1, 2014. 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:
a) Prepare the April 1, 2014, journal entry for Prince Company.
b) Prepare the journal entry for Prince’s collection of $350,000 of the
accounts receivable during the period from April 1, 2014, through
June 30, 2014.
c) On July 1, 2014, Prince paid Third National all that was due from the
loan it secured on April 1, 2014.

LO 8 Explain accounting issues related to disposition

7-78 of accounts and notes receivable.
 Secured Borrowing
Instructions:
a) Prepare the April 1, 2014, journal entry for Prince Company.
b) Prepare the journal entry for Prince’s collection of $350,000.
c) On July 1, 2014, Prince paid Third National all that was.

a) Cash 290,000
Finance Charge ($500,000 x 2%) 10,000
Notes Payable 300,000

b) Cash 350,000
Accounts Receivable 350,000

c) Notes Payable 300,000

Interest Expense (10% x $300,000 x 3/12) 7,500
Cash 307,500
7-79 LO 8
 Disposition of Accounts and Notes Receivable

Sales of Receivables
Sale Without Recourse
 Purchaser assumes risk of collection.

 Transfer is outright sale of receivable.

 Seller records loss on sale.

Sale With Recourse

 Seller guarantees payment to purchaser.

 Financial components approach used to record transfer.

LO 8 Explain accounting issues related to disposition

7-80 of accounts and notes receivable.
 Sales of Receivables

Factors are finance companies or banks that buy receivables

from businesses for a fee.
Illustration 7-17

7-81 LO 8
 Sales of 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

LO 8 Explain accounting issues related to disposition

7-82 of accounts and notes receivable.
 Sales of 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

7-83 LO 8
 Sales of Receivables

Illustration: Prepare the journal entries for both Crest Textiles and
Commercial Factors for the receivables sold with recourse.

Crest Cash 460,000

Textiles, Inc. Due from Factor 25,000
Loss on Sale of Receivables 21,000
Accounts (Notes) Receivable 500,000
Recourse Liability 6,000

Commercial Accounts Receivable 500,000

Factors, Inc. Due to Customer (Crest Textiles) 25,000
Interest Revenue 15,000
Cash 460,000

7-84 LO 8
 Secured Borrowing versus 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.

7-85 LO 8
 7 Cash and Receivables

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify items considered cash. 6. Explain accounting issues related to

recognition and valuation of notes
2. Indicate how to report cash and related
receivable.
items.
7. Explain the fair value option.
3. Define receivables and identify the
different types of receivables. 8. Explain accounting issues related to
disposition of accounts and notes
4. Explain accounting issues related to
receivable.
recognition of accounts receivable.
9. Describe how to report and analyze
5. Explain accounting issues related to
receivables.
valuation of accounts receivable.

7-86
 Presentation and 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.

7-87 LO 9 Describe how to report and analyze receivables.

 Presentation and Analysis

Analysis of Receivables
Accounts Receivable Turnover Ratio:
 Use to evaluate the liquidity of accounts receivable.

 Measures the number of times, on average, a company

collects receivables during the period.
Illustration 7-24

7-88 LO 9 Describe how to report and analyze receivables.

 APPENDIX 7A 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.

7-89 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A 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 300

Cash 300

2. The petty cash custodian obtains signed receipts from

each individual to whom he or she pays cash.

7-90 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A CASH CONTROLS

The Imprest Petty Cash System

Steps:

3. Custodian receives a company check to replenish the

fund.
Supplies Expense 42
Postage Expense 53
Miscellaneous Expense 76
Cash Over and Short 2
Cash 173

7-91 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A 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 50

7-92 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A CASH CONTROLS

Physical Protection of Cash Balances

Company should
 Minimize the cash on hand.

 Only have on hand petty cash and current day’s receipts.

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

 Transmit each day’s receipts to the bank as soon as practicable.

 Periodically prove (reconcile) the balance shown in the general

ledger.

7-93 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A CASH CONTROLS

Reconciliation of Bank Balances

Schedule explaining any differences between the bank’s
and the company’s records of cash.
Reconciling Items:
1. Deposits in transit.

2. Outstanding checks.
Time Lags
3. Bank charges and credits.

4. Bank or Depositor errors.

7-94 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A CASH CONTROLS

Reconciliation of Bank Balances Illustration 7A-1

Bank Reconciliation
Form and Content

7-95 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A CASH CONTROLS

7-96 LO 10
 APPENDIX 7A CASH CONTROLS

Illustration 7A-2

7-97 Advance slide in presentation mode to reveal answer.

 APPENDIX 7A CASH CONTROLS

Illustration: Journalize the adjusting entry on the books of

Nugget Mining Company.

Nov. 30 Cash 542

Office Expense 18
Accounts Receivable 220
Accounts Payable 180
Interest Revenue 600

7-98 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7A CASH CONTROLS

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.

7-99 LO 10 Explain common techniques employed to control cash.

 APPENDIX 7B 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.

7-100 LO 11 Describe the accounting for a loan impairment.

 APPENDIX 7B IMPAIRMENT OF RECEIVABLES

Impairment Measurement and Reporting

Impairment loss is calculated as the difference between
 the investment in the loan (generally the principal plus
accrued interest) and

 the expected future cash flows discounted at the loan’s

historical effective-interest rate.

7-101 LO 11 Describe the accounting for a loan impairment.

 APPENDIX 7B IMPAIRMENT OF RECEIVABLES

Illustration: At December 31, 2013, 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 loan’s expected future cash flow and utilizes
the present value method for measuring the required impairment loss.
Illustration 7B-1

7-102 LO 11 Describe the accounting for a loan impairment.

 APPENDIX 7B IMPAIRMENT OF RECEIVABLES

Illustration: Computation of impairment loss.

Illustration 7B-2

Recording Impairment Loss

Bad Debt Expense 12,434

Allowance for Doubtful Accounts 12,434

7-103 LO 11 Describe the accounting for a loan impairment.

 WHAT’S YOUR PRINCIPLE
LOST IN TRANSLATION

Floyd Norris, noted financial writer for the New Translation: The U.S. has caused a financial
York Times, recently wrote in his blog that he crisis as a result of poor lending practices,
attended a conference to discuss the financial and many financial institutions are fighting to
crisis in subprime lending. He highlighted, and survive.
provided “translations” of, some of the statements • “I’m glad that this time we did not cause it.”
he heard at that conference: Translation: Other countries realized they had
• “There is a problem of misaligned incentives.” caused financial crises in the past but were
Translation: Many parties in the lending not to blame for the current U.S. financial
process were complicit in not performing due situation.
diligence on loans because there were lots of • “What you see is what you get. If you don’t
fees to be had if the loans were made, good see it, it will get you.”
loans or bad. Translation: A large number of financial
• “It is pretty clear that there was a failure in institutions have to take losses on assets that
some key assumptions that were supporting are not reported on their balance sheet. Their
our analytics and our models.” continuing interest in some of the loans that
Translation: The rating agencies that they supposedly sold is now coming back to
evaluated the risk level of these securities them and they will have to report losses.
made many miscalculations. Some structured Source: Floyd Norris blog,
finance products that were given superior http://www.norris.blogs.nytimes.com/
ratings are no longer worth much.
(accessed June 2008).
• “The plumbing of the U.S. economy has been
deeply damaged. It is a long window of
vulnerability.”
7-104 LO 11
 RELEVANT FACTS - Similarities
 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.
 Like GAAP, cash and receivables are generally reported in the current
assets section of the balance sheet under IFRS.
 Similar to GAAP, IFRS requires that loans and receivables be accounted
for at amortized cost, adjusted for allowances for doubtful accounts.

LO 12 Compare the accounting procedures for cash

7-105 and receivables under GAAP and IFRS.
 RELEVANT FACTS - Differences
 Under IFRS, companies may report cash and receivables as the last
items in current assets under IFRS. Under GAAP, these items are
reported in order of liquidity.
 While IFRS implies that receivables with different characteristics should
be reported separately, there is no standard that mandates this
segregation. GAAP has explicit guidance in the area.
 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. In addition, there is
some difference in the financial instruments covered.

LO 12 Compare the accounting procedures for cash

7-106 and receivables under GAAP and IFRS.
 RELEVANT FACTS - Differences
 Under IFRS, bank overdrafts are generally reported as cash. Under
GAAP, such balances are reported as liabilities.
 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.

LO 12 Compare the accounting procedures for cash

7-107 and receivables under GAAP and IFRS.
 ON THE HORIZON
Both the IASB and the FASB have indicated that they believe that financial
statements would be more transparent and understandable if companies recorded
and reported all financial instruments at fair value. That said, in IFRS 9, which was
issued in 2009, the IASB created a split model, where some financial instruments
are recorded at fair value but other financial assets, such as loans and receivables,
can be accounted for at amortized cost if certain criteria are met. Critics say that
this can result in two companies with identical securities accounting for those
securities in different ways. A proposal by the FASB would require that nearly all
financial instruments, including loans and receivables, be accounted for at fair
value. It has been suggested that IFRS 9 will likely be changed or replaced as the
FASB and IASB continue to deliberate the best treatment for financial instruments.
In fact, one member of the IASB said that companies should ignore IFRS 9 and
continue to report under the old standard, because in his opinion, it is extremely
likely that it would be changed before the mandatory adoption date of this standard
in 2013.

7-108 LO 12
 IFRS SELF-TEST QUESTION
Under IFRS, receivables are to be reported on the balance sheet at:
a. amortized cost.
b. amortized cost adjusted for estimated loss provisions.
c. historical cost.
d. replacement cost.

LO 12 Compare the accounting procedures for cash

7-109 and receivables under GAAP and IFRS.
 IFRS SELF-TEST QUESTION
Which of the following statements is false?
a. Receivables include equity securities purchased by the
company.
b. Receivables include credit card receivables.
c. Receivables include amounts owed by employees as result of
company loans to employees.
d. Receivables include amounts resulting from transactions with
customers.

LO 12 Compare the accounting procedures for cash

7-110 and receivables under GAAP and IFRS.
 IFRS SELF-TEST QUESTION
Under IFRS:
a. the entry to record estimated uncollected accounts is the same
as GAAP.
b. loans and receivables should only be tested for impairment as a
group.
c. it is always acceptable to use the direct write-off method.
d. all financial instruments are recorded at fair value.

LO 12 Compare the accounting procedures for cash

7-111 and receivables under GAAP and IFRS.
 Copyright

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7-112