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Intermediate Financial Reporting I

Chapter 7
Cash and Receivables

Topic: Cash and Cash Equivalents

1. Cash includes (1) currency and coins, (2) balance in checking accounts, and (3) checks and money
orders.

c For financial reporting, we make no distinction between cash in the form of currency or bank
account balances and amounts held in cash equivalent investments.

2. Cash equivalents include (1) money market funds, (2) treasury bills, and (3) commercial paper. To
be classified as cash equivalents, these investments must have a maturity date no longer than three
months from the date of purchase.

c Companies are permitted flexibility in designating cash equivalents and must establish
individual policies regarding which short-term, highly liquid investments are classified as cash
equivalents.

Topic: Restricted Cash and Bank Overdraft

1. Companies segregate ³restricted" cash from ³regular´ cash for reporting purposes.

c For example, cash restricted for plant expansion, retirement of long-term debt, and (3)
compensating balances.

2. Bank overdrafts occur when a company writes a check for more than the amount in its cash account.

c ^enerally reported as a current liability.

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Topic: Recognition of Accounts Receivables

1. Trade Discount
- Trade discounts are commonly quoted in %
- Reductions from the list price
- Not recognized in the accounting records
- Customers are billed net of discounts
Example: Our product has a list price of $100, and we sell it to a local retailer at a 30% discount. Make
journal entries to record this transaction.

Dr. Accounts Receivable $70


Cr. Sales Revenue $70

Dr. Cash $70


Cr. Accounts Receivable $70

2. Cash Discount (Sales Discount)


- Firms offer cash discount to induce prompt payment.
- Presented in terms such as 2/10, n/30 (2% discount if paid within 10 days, gross amount due in 30
days)

(1) ^ross Method

Sales of $10,000, terms 2/10, n/30


Dr. Accounts Receivable 10,000
Cr. Sales 10,000

Receipt of $4,000 within 10 days


Dr. Cash 3,920
Dr. Sales Discount 80
Cr. Accounts Receivable 4,000

Payment of $6,000 after 10 days


Dr. Cash 6,000
Cr. Accounts Receivable 6,000

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(2) Net Method

Sales of $10,000, terms 2/10, n/30


Dr. Accounts Receivable 9,800
Cr. Sales 9,800

Receipt of $4,000 within 10 days


Dr. Cash 3,920
Cr. Accounts Receivable 3,920

Receipt of $6,000 after 10 days


Dr. Cash 6,000
Cr. Sales Discount Forfeited 120
Cr. Accounts Receivable 5,880

Topic: Valuation of Accounts Receivables

1. Firms value and report short-term receivables at net realizable value ± the net amount they expect to
receive in cash.

2. Allowance Method
(1) Percentage-of-Sales (Income Statement) Approach
- Suppose that Pitt Corp. estimates from past experience that approximately 2 percent of credit sales
become uncollectible. Pitt Corp. has credit sales of $400,000 in 2010. How does this company record
bad debt expense?

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(2) Percentage-of-Receivable (Balance Sheet) Approach
- Raintree Co. sells its product to customers on a credit basis. An aging of accounts receivable at
12/31/2010 reveals the following:

Age ^roups Amount Percent Uncollectible


0-60 days $900,000 2%
61-90 days $50,000 3%
91-120 days $45,000 5%
Over 120 days $120,000 10%

Suppose that the balance of ³allowance for doubtful accounts´ was $23,000 before making the year-
end adjusting entry. What is the ending balance of ³allowance for doubtful accounts´ after the year-end
adjustments?

(3) Write-off of Accounts Receivable


- When a firm determines a particular account receivable ($800) to be uncollectible, it removes the
balance from the books by
Dr. Allowance for Doubtful Accounts $800
Cr. Accounts Receivable $800

Modified Accounting Equation:


(EB of A/R) = (BB of A/R) + (Credit Sales) - (Cash Collected from Customers) ± (A/R Written Off)

(4) Collection of A/R Previously Written Off

Step 1:
Dr. Accounts Receivable $800
Cr. Allowance for Doubtful Accounts $800

Step 2:
Dr. Cash $800
Cr. Accounts Receivable $800

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Topic: Recognition of Notes Receivables

1. Note Issued at Face Value


- Suppose that Pitt Corp. lends CMU Corp. $10,000 in exchange for a $10,000, three-year note bearing
interest at 10% annually. Pitt Corp. records the receipt of the note as follows:

Dr. Notes Receivable $10,000


Cr. Cash $10,000

Pitt Corp. recognizes the interest earned each year as follows:

Dr. Cash $1,000


Cr. Interest Revenue $1,000

2. Zero-Interest-Bearing Notes
- Pitt Corp. receives a three-year, $10,000 zero-interest-bearing note, the present value of which is
$7,721.80. Pitt Corp. records the transaction as follows:

Dr. Notes Receivable $10,000


Cr. Discount on Notes Receivable $2,278.20
Cr. Cash $7,721.80

What is the implicit interest rate? 9%

Pitt Corp. records interest revenue at the end of the first year as follows:

Dr. Discount on Notes Receivables $694.96


Cr. Interest Revenue $694.96

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3. Notes Received for Property, Plant and Equipment
- Suppose that Pitt Corp. sold equipment to CMU Corp. for a $10,000, two-year note bearing interest at
10% annually. The equipment originally cost Pitt Corp. $15,000, and its accumulated depreciation is
$6,000.

Pitt Corp. records the transaction as follows:

Dr. Notes Receivable $10,000


Dr. Accumulated Depreciation $6,000
Cr. Equipment $15,000
Cr. ^ain on Sale of Equipment $1,000

If Pitt Corp. receives a three-year, $10,000 zero-interest-bearing note, the present value of which is
$7,722. Pitt Corp. records the transaction as follows:

Dr. Notes Receivable $10,000


Dr. Accumulated Depreciation $6,000
Dr. Loss on Sale of Equipment $1,278
Cr. Equipment $15,000
Cr. Discount on Notes Receivable $2,278

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Topic: Sale of Receivables

1. Sale without Recourse


- When buying receivables without recourse, the purchaser assumes the risk of uncollectibility and
absorbs any credit losses. The seller simply accounts for the transaction as a sale of an asset.
- Pitt Corp. sells $500,000 of accounts receivable to BNY Mellon on a without recourse basis. Pitt
Corp. transfers the receivable records to BNY Mellon, which will receive the collections. BNY Mellon
assesses a finance charge of 3% of $500,000 and retains an amount equal to 5% of $500,000. When
BNY Mellon collects the receivables, it remits to Pitt Corp. the retained amount.

<Pitt Corp.>
Dr. Cash $460,000
Dr. Due from BNY Mellon $25,000
Dr. Loss on Sale of Receivables $15,000
Cr. Accounts Receivables $500,000

<BNY Mellon>
Dr. Accounts Receivables $500,000
Cr. Due to Pitt Corp. $25,000
Cr. Financing Revenue $15,000
Cr. Cash $460,000

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2. Sale with Recourse
- When a company sells accounts receivable with recourse, the seller retains the risk of uncollectibility.
In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be
uncollectible.
- The seller still accounts for the transaction as a sale of an asset. The only difference would be
additional requirement that the seller record the estimates fair value of the recourse obligations as a
liability. The recourse obligation is the estimated amount that the seller will have to pay the buyer as a
reimbursement for uncollectible receivables.
- Pitt Corp. sells $500,000 of accounts receivable to BNY Mellon with recourse. BNY Mellon assesses
a finance charge of 3% of $500,000 and retains at $6,000.

<Pitt Corp.>
Dr. Cash $460,000
Dr. Due from BNY Mellon $25,000
Dr. Loss on Sale of Receivables $21,000
Cr. Accounts Receivables $500,000
Cr. Recourse Liability $6,000

<BNY Mellon>
Dr. Accounts Receivables $500,000
Cr. Due to Pitt Corp. $25,000
Cr. Financing Revenue $15,000
Cr. Cash $460,000

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