CHAPTER 7

Cash and
Receivables
1
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.
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.
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.
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.
Receivables
Receivables
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
Recognition of Accounts Receivables
• Accounts receivable generally arise as part of a revenue
arrangement.
• The revenue recognition principle indicates that a
company should recognize revenue when it satisfies its
performance obligation by transferring the good or
service to the customer.
Recognition of Accounts Receivables
Measurement of the Transaction Price
The transaction price is the amount of consideration that a
company expects to receive from a customer in exchange
for transferring goods or services.
Variable Consideration
In some cases the price of a good or service is dependent
on future events. These future events often include such
items as discounts, returns and allowances, rebates,
and performance bonuses.
Recognition of Accounts Receivables
Trade Discounts
• Reductions from the
list price.
• Not recognized in the
accounting records.
• Customers are billed
net of discounts.
Recognition of Accounts Receivables
Cash Discounts (Sales
Discounts)
• Offered to induce prompt
payment.
• Presented in terms such as
o 2/10, n/30
o 2/10, E.O.M.,
o net 30, E.O.M.
• Gross Method vs. Net
Method.
Recognition of Accounts Receivables
Sales Returns and Allowances
• Sales Returns and Allowances is a contra revenue
account to Sales Revenue.
• Allowance for Sales Returns and Allowances is a
contra asset account to Accounts Receivable.
• The use of both Sales Returns and Allowances, and
Allowance for Sales Return and Allowances accounts
is helpful to identify potential problems associated
with inferior merchandise, inefficiencies in filling
orders, or delivery or shipment mistakes.
Recognition of Accounts Receivables
Time Value of Money
• Theoretically, any revenue after the period of sale is
interest revenue.
• Companies ignore interest revenue related to accounts
receivable because the amount of the discount is not
usually material in relation to the net income for the
period.
• The profession specifically excludes from present value
considerations “receivables arising from transactions with
customers in the normal course of business which are due
in customary trade terms not exceeding approximately one
year.”
Time Value of Money
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.

Underlying Concepts
Materiality means it must make a difference to a decision-maker.
The FASB believes that present value concepts can be ignored for
short-term receivables.
Receivables
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.
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.
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 cash • Percentage-of-
realizable value. receivables.
• Not GAAP when material in • GAAP requires when
amount. material in amount.
Valuation of Accounts Receivable
Direct Write-Off Method for Uncollectible Accounts
When a company determines a particular account to be
uncollectible, it charges the loss to Bad Debt Expense.
Assume, for example, that on December 10 Cruz Co. writes off as
uncollectible Yusado’s $8,000 balance. The entry is:

Bad Debt Expense 8,000

Accounts Receivable (Yusado) 8,000

Valuation of Accounts Receivable
Allowance Method for Uncollectible Accounts
• Involves estimating uncollectible accounts at the end
of each period.
• Ensures that companies state receivables on the
balance sheet at their net realizable value.
• Companies estimate uncollectible accounts and net
realizable value using information about past and
current events as well as forecasts of future
collectibility.
Valuation of Accounts Receivable
Recording Estimated Uncollectibles
Illustration: Assume that Brown Furniture in 2017, its first year of
operations, has credit sales of $1,800,000. Of this amount, $150,000
remains uncollected at December 31. The credit manager estimates
that $10,000 of these sales will be uncollectible. The adjusting entry
to record the estimated uncollectibles (assuming a zero balance in
the allowance account) is:

Bad Debt Expense 10,000

Allowance for Doubtful Accounts 10,000

Allowance Method for Uncollectible Accounts
Write-Off of an Uncollectible Account
• When companies have exhausted all means of
collecting a past-due account and collection appears
impossible, the company should write off the account.
• In the credit card industry, for example, it is standard
practice to write off accounts that are 210 days past
due.
Write-Off of an Uncollectible Account
Illustration: The financial vice president of Brown
Furniture authorizes a write-off of the $1,000 balance
owed by Randall Co. on March 1. The entry to record the
write-off is:

Allowance for Doubtful Accounts 1,000

Accounts Receivable 1,000
Write-Off of an Uncollectible Account
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
Valuation of Accounts Receivable
Estimating the Allowance
Percentage-of-Receivables Approach
• Reports estimate of receivables at realizable value.
Companies may apply this method using
• one composite rate, or
• an aging schedule using different rates.
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).
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).
Recognition of Notes Receivable
Short-Term
Record at Face Value, less allowance
Long-Term
Record at Present Value of cash expected to be collecte
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.
Notes Received for Property, Goods, or Services
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
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.
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,
o Receivables are recorded at fair value.
o Unrealized holding gains or losses reported as part of
net income.
• Company reports the receivable at fair value each
reporting date.
Special Issues
Fair Value Option
• Companies may elect at time the financial instrument is
o originally recognized or
o 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.

International Perspective
IFRS also has the fair value option.
Recording Fair Value Option
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

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:
1. Secured borrowing.
2. Sale of receivables.
Sales of Receivables

Factors are finance companies or banks that buy receivables from

businesses for a fee.
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.
Secured Borrowing versus Sale
The FASB
concluded that a sale
occurs only if the
seller surrenders
control of the
receivables to the
buyer.
Three conditions
must be met.
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.
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.