Intermediate Accounting

Part I

CH7: Cash and Receivables

BU387 Spring 2023

Instructor: Xiaoran (Jason) Jia, PhD, CFA

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 Cash and Receivables
The Basics

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How do companies manage and control cash?

•Minimizing “idle” cash

• Opportunity cost: ‘idle’ cash does not earn interests
• E.g., banks with idle cash lend cash out overnight, earn an
overnight rate.

•Cash flow budgets

• i.e., manage cash to achieve the budgeted cash flow

•Internal controls or bank reconciliations

• Physical protection of cash
• Make sure cash is reconciled with bank balances

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Types of Accounts Receivable

• Trade accounts receivable—related to sales

• Manufacturers, wholesalers, retailers
• Loans receivable
• Non-trade receivables

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Manage Accounts Receivable

Credit Policy
• If credit policy too loose – higher credit risk
• If credit policy too tight – lower sales
• Credit policy should be dependent on credit risk assessments
Collection of AR
• The outstanding amount of accounts receivable should be monitored
constantly, because:
• Encourage customer payments (for overdue amounts) – e.g., consider
using the ‘collection agency’.
• Minimize stress on working capital, bank debt
Payment incentives
• Early payment discounts / Late payment charges
Selling AR (i.e., risk transfer)
• Factoring (sells accounts receivable at a discount)
• Securitization (package receivables and sell to investors)
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What is Included in Cash?
• Meets the definition of a financial asset
• Classified as a current asset

• Consists of coins, currency, available funds on deposit at a

bank, and petty cash

• Also includes money orders, certified cheques, cashier’s

cheques, personal cheques, bank drafts, usually savings
accounts, and money-market funds with chequing
privileges
Post-dated cheques and travel advances are
not classified as cash.
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Restricted Cash
Definition: Cash that is segregated from “regular” cash for
reporting purposes because it needs to be set aside for a particular
purpose.
• Set aside because there are restrictions that prevent it from
being used for current purposes, for example:
• Petty cash, special payroll
• compensating balances: Minimum cash balances required by creditors
• legally restricted balances: Cash balance required by regulators

• If the restricted cash balance is material, it must be segregated

• Classified as current or non-current assets depending on date of
availability or expected disbursement

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Foreign Currencies

• E.g., If a company’s functional currency is Canadian

dollars (CAD), then other currencies held (such as USD)
are foreign currencies

• Value is recorded in functional currency by applying the

exchange rate at the date of SFP

• Either current or non-current

Some Canadian companies identify US funds as

their functional currency.

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Bank Overdrafts

• Occur when cheques are written in excess of the cash

account balance
• Reported as current liabilities (sometimes included with
accounts payable)
• Should not be offset against the Cash account
• May be offset against available cash in another account
at the same bank (special case)

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Cash Equivalents

“short-term, highly liquid investments that are readily

convertible to known amounts of cash and which are
subject to an insignificant risk of changes in value.”
CPA Canada Handbook Part II, Section 1540.06(b) and IAS 7.6

• Original maturity of three months or less-–such as

treasury bills, money-market funds, commercial paper
• ASPE exclude equity securities
• Under IFRS, some equity instruments can be classified
as cash equivalents (for example, preferred shares
close to maturity)
• Cash equivalents are reported at fair value
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Concept check

1. Which of the following is considered “cash” for reporting purposes?

a) money-market chequing accounts
b) certificates of deposit (CDs)
c) travel advances to employees
d) postdated cheques

2. Bank overdrafts are generally reported as

a) a current asset.
b) a contra account.
c) a non-current asset.
d) a current liability.

3. Which of the following is the reason(s) why companies should monitor accounts
receivable levels carefully?
a) to maximize costs of collection
b) to encourage prompt payment from their customers
c) to minimize the stress on working capital and related bank debt
d) B and C only
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 Receivables

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Definition and Types of Receivables

… claims that a company has against customers and others,

usually for the unconditional right to specific cash receipts in
the future.

• Current (short-term) or non-current (long-term)

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Types of Receivables
Trade receivables
• Amounts that result from operating transactions
• Accounts receivable (verbal promise to pay, normally within 30 to 60 days)
• Notes receivable (written promises with specified terms)

Loans receivable; notes receivable

Nontrade receivables
• Advances (i.e., ST loans) to employees or officers
• Receivables from government
• Dividends/Interest receivable
• Insurance claims

Government debt, corporate bonds, convertible debt, and commercial paper

are not receivables.
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Recognition and Measurement of Accounts Receivables

When the party has a legal claim to

Recognition receive cash or other financial assets
(“becomes a party to the contractual
provisions of the financial instrument”)

Initial
Measurement Fair Value

Subsequent Net Realizable Value

Measurement
= Amortized Cost – impairment
(est. uncollectible accounts)
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Accounts Receivable-Initial Measurement

Two complicating factors:

1. Availability of discounts
• Trade discounts
• Normally: deduct the trade discount
• Cash discounts/sales discounts
• 2/10, n/30; 2/10 E.O.M. n/30 E.O.M.
• Sales returns and allowances
• Under IFRS: Refund Liability
• Under ASPE: Allowance for Sales Returns and Allowances
2. Interest element
• If the receivables are short-term, the time value of money is
usually considered immaterial

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Accounts Receivable-Subsequent Measurement

• No interest element: amortized cost = cost

• Loans and notes receivable: carrying amount is

amortized

• A/R is carried at Net Realizable Value, which is the

amortized cost (or cost) – impairment losses (the
estimated uncollectable accounts)

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Accounts Receivable-Impairment

IFRS 9: Expected Credit Loss (ECL) Model

• If credit risk has increased significantly since recognition, loss
allowance is based on ‘lifetime expected credit losses”.
• If no indication of the significant credit risk increase, loss
allowance is based on 12-month expected credit losses.

ASPE: Incurred Credit Loss (ICL) Model

• Impaired if there is “significant adverse change” in expected
timing of future cash flows or the amount expected to be repaid.
• I.e., losses are only recognized when they are incurred (as
opposed to expected)
• ‘incurred’ here means ‘likely’ – you need to have sufficient
evidence.
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Accounts Receivable Impairment: Methods
We can use two methods for the
impairment of accounts receivables:

Method 1: Allowance method Dr. Loss on Impairment (or bad debt

• Used in most cases expense)
Cr. Allowance for Expected Credit
• Management estimates the Losses (or Allowance for Doubtful
percentage of uncollectible amount Accounts)
based on two methods:
• Percentage-of-receivables, or This allowance account is a contra-asset
• Percentage-of-credit sales account to reduce the net amount of A/R

Method 2: Direct write-off method

Dr. Loss on Impairment (or bad debt
• Only used when ‘bad debt’ are not expense)
material Cr. Accounts Receivable

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Allowance Method:
Estimating Uncollectible Accounts
• An estimate of the amounts unlikely to be collected, recognized in
an allowance account, which is a contra A/R account on SFP
• Naming under IFRS:
• “Allowance for Expected Credit Losses” on SFP
• “Loss on Impairment” or something similar on statement of income
• Naming under ASPE:
• “Allowance for Doubtful Accounts” on B/S
• “Bad Debt Expense” on income statement
• Allowance based on
• Age of the accounts Two estimation methods:
• Past loss experience
• Current economic conditions
1. % of receivables
• Geography 2. % of credit sales
• Industry

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Estimating Uncollectible Trade A/R:
Percentage-of-receivables method (using aging schedule)

• Idea: the higher the number of days accounts are

outstanding, the less likely they will be collected.
• i.e., the higher the ‘age’ of A/R, the less likelihood of
collection.

In practice:
• For each ‘age’, estimate a percentage of collectible
accounts
• This estimation is based on historical observed default
rates, or other judgments by managers.

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Estimating Uncollectible Trade A/R:
Percentage-of-receivables method (using aging schedule)
PiP 7.3: Wilson & Co. Aging Schedule
Assume that Wilson & Co. has prepared the following aging of its accounts receivable. The
company’s collection history suggests that the probability of collection for its accounts
receivable is 96% for balances under 61 days, 85% for balances 61–90 days old, 80% for
balances 91–120 days old, and 75% for balances over 120 days.
Age (number of days accounts are outstanding)
Customer Name Balance Under 61 – 90 91 – 120 Over
Dec. 31 61 days days days 120 days

Atlantic Stainless Steel Corp. $ 9,800 $ 7,000 $ 2,800

Brockville Steel Company 34,000 34,000
Cambridge Sheet & Tube Co. 4,500 $ 4,500
Eastern Iron Works Ltd. 7,200 6,000 $ 1,200
Other individual customers 491,500 413,000 15,200 12,800 50,500
$547,000 $460,000 $18,000 $14,000 $55,000

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Estimating Uncollectible Trade A/R:
Percentage-of-receivables method (using aging schedule)
PiP 7.3: Wilson & Co. Aging Schedule - Solution
Customer Name Balance Under 61 – 90 91 – 120 Over
Dec. 31 61 days days days 120 days

Atlantic Stainless Steel Corp. $ 9,800 $ 7,000 $ 2,800

Brockville Steel Company 34,000 34,000
Cambridge Sheet & Tube Co. 4,500 $ 4,500
Eastern Iron Works Ltd. 7,200 6,000 $ 1,200
Other individual customers 491,500 413,000 15,200 12,800 50,500
$547,000 $460,000 $18,000 $14,000 $55,000
Estimation of uncollectible Trade A/R
Collection Percentage Estimated 96% 85% 80% 75%
Uncollectible Percentage 4% 15% 20% 25%
Estimate of Uncollectible Accounts 18,400 2,700 2,800 13,750

Total = $37,650

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The Allowance Method using the percentage-of-
receivables aging schedule Balance Sheet Presentation

Wilson & Co.

Statement of Financial Position
December 31
Current assets
Accounts receivable $547,000
Less: Allowance for expected credit losses 37,650
$509,350

This is the NRV

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The Allowance Method using the percentage-of-
receivables aging schedule Journal Entries

PiP 7.4(b): Assume the allowance account already had a credit balance of
$18,800 before adjustment. What journal entry would Wilson & Co. prepare?
Description Debit Credit
Loss on Impairment 18,850
Allowance for Expected Credit Losses 18,850
($37,650 − $18,800 = $18,850)

PiP 7.4(b): Assume the allowance account already had a debit balance of
$200 before adjustment. What journal entry would Wilson & Co. prepare?

Description Debit Credit

Loss on Impairment 37,850
Allowance for Expected Credit Losses 37,850
($37,650 + $200 = $37,850)

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Estimating Uncollectible Trade A/R:
Percentage-of-credit sales method

Idea: at month end, management estimates the loss on

impairment as a percentage of current month’s sales

• This is considered a fast and simple approach

• At year end, receivables still must be analyzed to ensure
the balance in the allowance account is correct

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Estimating Uncollectible Trade A/R:
Percentage-of-credit sales method - Example

PiP 7.5(a): Dockrill Corp. estimates 2% of every month’s net credit sales will be
uncollectible. What journal entries would be required during the year if net
credit sales are $400,000 annually?
Step 1: recognize the estimated losses as a percentage of credit sales
Description Debit Credit
Loss on Impairment 8,000
Allowance for Expected Credit Losses 8,000

Management estimates the uncollectible accounts at year end are $29,900.

What journal entry should Dockrill make if the balance in the Allowance for
Expected Credit Losses is $27,500 before adjustment?

Step 2: year-end adjusting entry to reflect management estimates at year end

Description Debit Credit
Loss on Impairment 2,400
Allowance for Expected Credit Losses 2,400
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Accounts Receivable Written Off

• When a specific customer’s account is determined to

be uncollectible, the following entry is made:

Description Debit Credit

Allowance for Expected Credit Losses x,xxx
Accounts Receivable x,xxx

• There is no effect on the income statement or A/R

• Loss on impairment was recognized when the
allowance was recorded

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Collection of Account that Has been Written Off

• If payment is received after write-off of account, the

account is reinstated, and payment is recorded:

Description Debit Credit

Accounts Receivable x,xxx
Allowance for Expected Credit Losses x,xxx
To reinstate account written off

Cash x,xxx
Accounts Receivable x,xxx
To record payment of account

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Direct Write-off Method
• Used if A/R balances are very small; no allowance account is
used
• Record bad debt expense only when a specific account is
determined to be uncollectible:
Description Debit Credit
Bad Debt Expense x,xxx
Accounts Receivable x,xxx

• If amounts are collected for accounts previously written off:

Description Debit Credit
Cash x,xxx
Uncollectible Amounts Recovered x,xxx

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In Class Practice – E7.7
At January 1, 2023, the credit balance of Andy Corp.’s Allowance for Expected
Credit Losses was $400,000.
During 2023, the related loss on impairment entry was based on a percentage of
net credit sales.
Net sales for 2023 were $80 million, of which 90% were on account. Based on
the information available at the time, the 2023 loss on impairment was
estimated to be 0.8% of net credit sales.
During 2023, uncollectible receivables amounting to $500,000 were written off
against the allowance for expected credit losses.
The company has estimated that at December 31, 2023, based on a review of
the aged accounts receivable, the allowance for expected credit losses would be
properly measured at $525,000.
Instruction: Prepare a schedule calculating the balance in Andy’s Allowance for
Expected Credit Losses at December 31, 2023. Prepare any journal entry
needed at year end to adjust the allowance for expected credit losses to the
required balance. Andy follows IFRS.
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Notes and Loans Receivable

• Notes receivable differ from accounts receivable as they are

supported by a promissory note (with specific terms)
• All notes contain some interest element and maturity date
—short term notes mature within one year
• Notes are either
• Interest bearing: Have a stated rate of interest or
• Zero-interest bearing (or non-interest bearing): Interest
amount is the difference between the amount borrowed and
the face amount paid back

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Interest Bearing Short-Term Notes Receivable

PiP 7.7: On March 14 an accounts receivable of $1,000 is

exchanged for a 6%, six-month note. What journal entries would
Prime Corporation make to record the substitution and payment
of the note?
Date Description Debit Credit
14-Mar Notes Receivable 1,000
Accounts Receivable 1,000
14-Sep Cash 1,030
Notes Receivable 1,000
Interest Income 30
($1,000
 × 6% × 6 over
6  12)
 $1,000  6%  
 12 

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Non-Interest Bearing Short-Term Notes Receivable

PiP 7.8: On February 23 a $5,000, nine-month non-

interest bearing note is issued; 8% is the implied
interest rate.
Date Description Debit Credit
23-Feb Notes Receivable 4,717
Cash 4,717
23-Nov Cash 5,000
Notes Receivable 4,717
Interest Income 283

 9 
 $4,717  8%  
 12 

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Long-term Notes and Loans Receivable

• Long-term notes and loans receivable are recognized at the

present value of the future cash flows discounted at market rate
(i.e., fair value)
• Face rate: stated interest rate
• Effective interest rate: PV discount rate
• If stated rate = market rate, fair value = face value
• If stated rate < or > market rate, loan issued at a premium or
discount (the premium or discount will be amortized)
• IFRS requires effective interest method of amortization; ASPE
does not specify
• Transaction costs:
• Added to the fair value (preferred by IFRS and ASPE)
• or expensed
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Interest-bearing Notes Issued at Face Value
PiP 7.9: Assume that firm A lends firm B $10,000 in exchange for a $10,000,
three-year note bearing interest at 10% payable annually. The market rate of
interest for a note of similar risk is also 10%.
A) Calculate the note’s present value
Face value of the note $10,000
Present value of the lump sum principal = $10,000 / (1+10%)^3 $7,513
Present value of the ordinary interest annuity
= 1000/1.1 + 1000/1.1^2 + 1000/1.1^3 2,487
Present value of the note 10,000

Present value = face value, because stated interest rate = effective interest rate

B) Provide journal entries at the date of issue and for related interest
Description Debit Credit
Notes Receivable 10,000
Cash (Issuance of the note) 10,000
Cash 1,000
Interest
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Zero-interest Bearing Notes: Implicit Interest Rate
Example

PiP 7.10 Jeremiah Company receives a three-year, $10,000, zero-interest-bearing

note, and the present value is known to be $7,721.80
A) Determine the implicit interest rate
Present value = future value / (1 + implied interest rate)3
 7,721.80 = 10,000 / (1 + implied interest rate) 3
 (1+Implied interest rate)3 = 10,000/7,721.80
 Implied interest rate = (10,000/7,721.80)1/3 – 1 = 9%

The interest component = 10,000 – 7,721.80 = 2,278.20

B) Prepare the journal entry to record the transaction

Description Debit Credit
Notes Receivable 7,721.80
Cash 7.721.80

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 Zero-interest Bearing Notes: Implicit Interest Rate
Amortization Schedule with effective interest rate method
PiP 7.11 Jeremiah Company receives a three-year, $10,000, zero-interest-bearing
note, and the present value is known to be $7,721.80. The market rate is 9%.

Schedule of Note Discount Amortization

Effective Interest Method
0% Note Discounted at 9%
Cash Interest Income Discount Carrying
Received (= Beginning carrying amount X Amortized Amount of Note
implied interest rate)
Date of issue $ 7,721.80
End of year 1 $−0− $ 694.96 $ 694.96 8,416.76
End of year 2 −0− 757.51 757.51 9,174.27
End of year 3 −0− 825.73 825.73 10,000.00
$−0− $2,278.20 $2,278.20

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 Zero-interest Bearing Notes: Implicit Interest Rate
Effective interest rate method – Journal entries
Cash Interest Income Discount Carrying
Received (= Beginning carrying amount X Amortized Amount of Note
implied interest rate)
Date of issue $ 7,721.80
End of year 1 $−0− $ 694.96 $ 694.96 8,416.76
End of year 2 −0− 757.51 757.51 9,174.27
End of year 3 −0− 825.73 825.73 10,000.00
$−0− $2,278.20 $2,278.20

Record journal entry for first year using effective interest method for
amortization
Date Description Debit Credit
Notes Receivable 694.96
Interest Income 694.96

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Zero-interest Bearing Notes: Implicit Interest Rate
Straight-line method of amortization

PiP 7.12 Compare straight-line and effective interest

methods, Years 1 and 2
Straight-line Effective
interest
Date Description Debit Credit Debit Credit
Year 1 Notes Receivable 759.40 694.96
Interest Income 759.40 694.96
Year 2 Notes Receivable 759.40 757.51
Interest Income 759.40 757.51

Straight-line = $2,278.20 divided by 3 = $759.40 each year for 3 years

Effective interest = $7,721.80 × 9% = $694.96 (year 1)
($7,721.80 + 694.96) × 9% = $757.51 (year 2)

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In-class practice: Interest-bearing Note Issued at Discount

PiP 7.13 Assume that Morgan Corp. makes a loan to

Marie Co. and receives in exchange a $10,000, three-year
note bearing interest at 10% annually. The market rate of
interest for a note of similar risk is 12%.
(a) Determine the discount and
(b) prepare the journal entries.

(Use both the effective interest method and the straight-

line method)

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Interest-bearing Note Issued at Premium

• Stated rate of interest is higher than the effective rate of

interest: note is issued at a premium
• PV of the note at issuance will be higher than the face
value
• Note is recorded at the higher value
• Excess is amortized by crediting Notes Receivable and
debiting (reducing) interest income

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Notes for Property, Goods, or Services

• The issue is determining the selling price

• Known market rate: use it to determine PV of future cash
flows discounted at the market rate
• Unknown market rate:
• Use the fair value of the property, goods and services to
estimate the value
• Use an imputed (estimated) interest rate
• Required to record effective interest income and amortize the
discount
• Loan to officer with no interest: difference between fair
value and cash received is expensed to salary

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Derecognition of Receivables

• The holder of accounts or notes receivable may transfer

them to another company for cash

• Use wholly owned subsidiaries that specialize in financing

• Asset-backed financing:
• Secured borrowing—Holder retains control of receivables; the
receivables are used as collateral
• Factoring receivables—Holder transfers ownership of
receivables in a sale to a single company
• Securitization—interests in financial assets are sold to many
investors; lower credit risk = lower financing cost

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Secured Borrowing

• Account for receivable (now collateralized) as before

securing the borrowing:
• Collect accounts receivable
• Record sales returns and sales discounts
• Absorb bad debt expense

• Account for new liability (example: note payable)

• Record a finance charge (if applicable)
• Record interest expense on note payable

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Factoring Without Recourse

• Purchaser buys the receivables for a fee and then collects directly
from the customer
o Purchaser assumes risk of collection and absorbs any credit losses
(without recourse)
o Seller does not service the receivables—derecognition

• Seller does not service the receivables—derecognition

• Journal entry for seller

DR. Cash (receipts)
DR. Due from Factor (withholding for returns and allowances)
DR. Loss or Credit Gain on Disposal of Accounts Receivables
CR. Accounts Receivable (face value of receivables)

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Factoring With Recourse

• Seller guarantees payment to purchaser if customer fails

to pay
o With recourse, purchaser does not have the risk of
collection—not treated as a sale (IFRS 9)
o Under IFRS, apply secured borrowing treatment
o Under ASPE, use the financial components
approach

o Journal entry for seller also recognizes

o Credit Recourse Liability (probable payment for
uncollectible receivables)

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Securitization

• Securitization—interest in financial assets is sold to a

third party
• Transfer receivables through securities (debt and
equity)
• Backed by a pool of financial assets
• Many investors are involved
• Seller continues to service the receivables
• Under IFRS, seller must continue to recognize the
receivables
• Requires significant disclosures

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Selling of Accounts Receivables

• Underlying principles for sale transactions:

o Under IFRS, derecognize when substantially all of the risks and rewards
have been transferred or
o When the transferor has not retained control
o Under ASPE, depends on retention of control

• Under IFRS, with securitization:

o Risks and rewards are not considered transferred
o Receivables no longer qualify for derecognition
o Requires recording additional debt

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Borrowing vs. Sale Treatment: IFRS 9

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Accounting for Transfers of Receivables: ASPE

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In-class practice: E7.18

Lute Retail Ltd. follows ASPE. It transfers $355,000 of its accounts

receivable to an independent trust in a securitization transaction
on July 11, 2023, receiving 96% of the receivables balance as
proceeds.
Lute will continue to manage the customer accounts, including
their collection. Lute estimates this obligation has a liability value
of $12,500.
In addition, the agreement includes a recourse provision with an
estimated value of $9,900. The transaction is to be recorded as a
sale.

Instruction: Prepare the journal entry on July 11, 2023, for Lute Retail Ltd. to
record the securitization of the receivables.

Copyright ©2022 John Wiley & Sons, Canada, Ltd. Copyright ©2023 Xiaoran (Jason) Jia
Presentation and Disclosure Related to
Receivables
• Objective: to allow users to evaluate
o Significance of financial assets to financial position and
performance
o Nature and extent of associated risks

• More information required under IFRS than ASPE

• Extensive qualitative and quantitative information
about entity’s credit situation under IFRS
• Major disclosures about fair value

Copyright ©2022 John Wiley & Sons, Canada, Ltd. Copyright ©2023 Xiaoran (Jason) Jia
Comparison

I F RS A SP E
Cash and cash equivalents Allows preferred shares acquired Does not allow equities to be
close to maturity date considered cash
Recognition and Requires use of the effective Can use either the effective
measurement of receivable interest method for recognizing interest method or the
interest income and amortization straight- line method
Impairment Uses the expected loss model Uses the incurred loss model
Derecognition Considers whether substantial risks Considers who has control of
and rewards of ownership have the asset
been transferred
Disclosures Requires detailed quantitative and Requires basic disclosures
qualitative disclosures
Detailed disclosures for transferred
financial assets that are
derecognized

Copyright ©2022 John Wiley & Sons, Canada, Ltd. Copyright ©2023 Xiaoran (Jason) Jia