Unit 6 Receivables. Receivables - Claims resulting from credit sales to customers and others goods or services for money,.

Transcription

1 Unit 6 Receivables 7-1 Receivables - Claims resulting from credit sales to customers and others goods or services for money,. Oral promises of the purchaser to pay for goods and services sold (credit sale; trade). Accounts Receivable Written promises to pay a sum of money on a specified future date (trade or nontrade). Notes Receivable

2 Accounts Receivable Transactions for Nontrade Receivables (Other Receivables) Advances to officers, directors, 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, interest receivable, rent, or royalties accrued. 6. Claims against: Insurance companies for casualties sustained; amounts arising from litigation; 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. Claims for subscriptions for the entity s securities.

3 7-3 Receivables Trade & Nontrade Receivables (report as separate items)

4 7-4 Recognition of Accounts Receivables Trade Discounts Reductions from the list price Not recognized in the accounting records Customers are billed net of discounts e.g., 10 % Discount for new Retail Store Customers

5 7-5 Cash Discounts 2/10,n/30 Discount percent Number of days discount is available Otherwise, net (or all) is due Credit period

6 7-6 Cash Discounts Gross Method Net Method Sales are recorded at the invoice amounts. Sales discounts taken: reduction of revenue. Sales are recorded at the invoice amount less the cash discount. Sales discounts forfeited: interest revenue.

7 Cash Discounts On October 5, Hawthorne sold merchandise for $20,000 with terms 2/10, n/30. On October 14, the customer sent a check for $13,720 taking advantage of the discount to settle $14,000 of the amount. On November 4, the customer paid the remaining $6, October 5, 2013 October 5, 2013 October 14, 2013 October 14, 2013 November 4, 2013 November 4, 2013

8 Sales Returns Merchandise may be returned by a customer to a supplier. A special price reduction, called an allowance, may be given as an incentive to keep the merchandise. To avoid misstating the financial statements, sales revenue and accounts receivable should be reduced by the amount of returns in the period of sale if the amount of returns is anticipated to be material. 7-8

9 Sales Returns 7-9 During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). Industry experience indicates a10% return rate. During the year $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment. Actual Returns Sales returns 130,000 Accounts receivable 130,000 Inventory 78,000 Cost of goods sold (60%) 78,000 Adjusting Entries (estimated remaining) Sales returns 70,000 Allowance for sales returns 70,000 Inventory estimated returns 42,000 Cost of goods sold (60%) 42, , ,000 = 200,000 (10% of 2,000,000)

10 7-10 Uncollectible Accounts Receivable Bad debts result from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts. In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in which the sales related to the uncollectible account were recorded.

11 7-11 Uncollectible Accounts Receivable Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period. Normally classified as a selling expense and closed at year-end. Contra asset account to accounts receivable. Bad debt expense Allowance for uncollectible accounts xxx xxx

12 7-12 Allowance for Uncollectible Accounts Accounts Receivable Less: Allowance for Uncollectible Accounts Net Realizable Value Net realizable value is the amount of the accounts receivable that the business expects to collect. Income Statement Approach Balance Sheet Approach Composite Rate Aging of Receivables

13 Income Statement Approach 7-13 Focuses on past credit sales to make estimate of bad debt expense. Emphasizes the matching principle by estimating the bad debt expense associated with the current period s credit sales. Bad debt expense is computed as follows: Current Period Credit Sales Estimated Bad Debt % = Estimated Bad Debt Expense

14 Income Statement Approach 7-14 In 2014, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit sales are uncollectible. What is Bad Debt Expense for 2014? MusicLand computes estimated Bad Debt Expense of $2,400. $ 400, % = $ 2,400 Bad debt expense 2,400 Allowance for uncollectible accounts 2,400

15 Balance Sheet Approach 7-15 Focuses on the collectability of accounts receivable to make the estimate of uncollectible accounts. Involves the direct computation of the desired balance in the allowance for uncollectible accounts. Compute the desired balance in the allowance for uncollectible accounts. Bad debt expense is computed as: Desired Balance in Allowance for Uncollectible Accounts Existing Year-End Balance in Allowance for - Uncollectible Accounts = Estimated Bad Debt Expense

16 Balance Sheet Approach Composite Rate 7-16 On Dec. 31, 2014, MusicLand has $50,000 in accounts receivable and a $200 credit balance in allowance for uncollectible accounts. Past experience suggests that 5% of receivables are uncollectible. What is MusicLand s bad debt expense for 2014?

17 Balance Sheet Approach Composite Rate 7-17 Determine the desired balance in allowance for uncollectible accounts $ 50, % = $ 2,500 Allowance for Uncollectible Accounts 200 2,300 2,500 Bad debt expense 2,300 Allowance for uncollectible accounts 2,300

18 Balance Sheet Approach Aging of Receivables 7-18 Year-end accounts receivable is broken down into age classifications. Each age grouping has a different likelihood of being uncollectible. Compute required uncollectible amount. Compare required uncollectible amount with the existing balance in the allowance account.

19 Balance Sheet Approach Aging of Receivables 7-19 At December 31, 2014, the receivables for EastCo, Inc., were categorized as follows: Days Past Due EastCo, Inc. Schedule of Accounts Receivable by Age December 31, 2014 Accounts Estimated Receivable Percent Balance Uncollectible Estimated Allowance Current $ 45,000 1% $ ,000 3% ,000 5% 250 Over 60 2,000 10% 200 $ 67,000 $ 1,350

20 Balance Sheet Approach Aging of Receivables 7-20 EastCo s unadjusted balance in the allowance account is $500. Per the previous computation, the required balance is $1,350. Allowance for Uncollectible Accounts ,350 Bad debt expense 850 Allowance for uncollectible accounts 850

21 When Uncollectible Accounts Incur: 7-21 As accounts are deemed to be uncollectible, a journal entry is made to record the actual write-off. Allowance for uncollectible accounts 500 Accounts receivable 500 If a customer makes a payment after an account has been written off, two journal entries are required. Accounts receivable 500 Allowance for uncollectible accounts 500 Cash 500 Accounts receivable 500

22 7-22 Direct Write-off Method If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account; not permitted by GAAP). Bad debts expense Accounts receivable xxx xxx

23 Summary of Measurement and Reporting Issues for Accounts Receivable Recognition Depends on the earnings process; for most credit sales, revenue and the related receivables are recognized at the point of delivery. Initial valuation Initially recorded at the exchange price agreed upon by the buyer and seller. Subsequent valuation Initial valuation reduced to net realizable value by: 1. Allowance for sales returns 2. Allowance for uncollectible accounts: The income statement approach The balance sheet approach Classification Almost always classified as a current asset. 7-23

24 Accounts Receivable Presentation Illustrated 7-24 Current Assets: Cash $ 346 Accounts receivable, net of $25 allowance 475 Inventory 812 Prepaids 40 Total current assets 1,673 Fixed Assets: Assets Office equipment 5,679 Furniture & fixtures 6,600 Less: Accumulated depreciation (3,735) Total fixed assets 8,544 Total Assets $ 10,217

25 7-25 Recognition of Notes Receivable Notes Receivable Supported by a formal promissory note. 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).

26 7-26 Notes Receivable Reasons for Accepting a Note: to extend payment period of an outstanding receivable (from an overdue customer). to sell products or services to High-risk or new customers. to make a loan to employees and subsidiaries. to sell property, plant, and equipment. to lend money to borrowers (the majority of notes).

27 7-27 Notes Receivable A written promise to pay a specific amount at a specific future date. Face amount of the note Annual interest rate Fraction of the annual period = Interest Even for maturities less than 1 year, the rate is annualized.

28 Recognizing Notes Receivable Short-Term Record at Face Value, less allowance (similar to Accounts Receivable) Long-Term Record at Present Value of expected cash flows (loss is treated the same with shortterm receivables Interest Rates Stated rate = Market rate Stated rate > Market rate Stated rate < Market rate Note Issued at Face Value Premium Discount

29 Interest-Bearing Notes 7-29 On November 1, 2014, West, Inc., loans $25,000 to Winn Co. The note bears interest at 12% and is due on November 1, Prepare the journal entry on November 1, 2014, December 31, 2014, (year-end) and November 1, 2015, for West. November 1, 2014 Notes receivable 25,000 Cash 25,000 December 31, 2014 Interest receivable 500 Interest revenue 500 November 1, 2015 Cash 28,000 Note receivable 25,000 Interest receivable 500 Interest revenue 2,500

30 Present Value Table $1,000 x = $3,170 Interest Received Factor Present Value PV of An Annuity Due At 10% = $10,000 x = $6,830 Principal Factor Present Value.90909x1.1=

31 Note Not Issued at Face Value Interest-Bearing Note - Example Illustration: January 1, 2012, Good Neighbor Corp. makes a loan to Needy Co. and receives in exchange a four-year, $10,000 note at stated interest of 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. How does Good Neighbor record the receipt of the note? N (period) = 4 i = 12% $10,000 Principal $1,000 1,000 1,000 1,000 Interest

32 Note Not Issued at Face Value Interest-Bearing Notes - Example (continued) $1,000 x = $3,037 Interest Received Factor Present Value $10,000 x = $6,355 Principal Factor Present Value 9,392 = 3, ,355 PV or Note Carrying Amount

33 Note Not Issued at Face Value Interest-Bearing Note - Example (continued) Amortization Schedule of Note Discount Effective-Interest Method 10% Note and Discounted at 12% Cash Received (10%) Interest Revenue (12%) Discount Amortized Note Carrying Amount 1/1/12 9,392 1/1/13 1,000 a 1,127 b 127 9,519 1/1/14 1,000 1, ,661 1/1/15 1,000 1, ,820 1/1/16 1,000 1, ,000 4,000 4, a $1,000 = $10,000 x 10% b $9,392 x 12% = $1,127 c $9,392 + $127 = $9,519 c

34 7-34 Note Not Issued at Face Value Interest-Bearing Note - Example (cont d) Illustration: Calculation Presentation 1/1/12 Face value of the note $10,000 Present value of the principal: $10,000 (PVF 4, 12%) = $10,000 x $6,355 Present value of the interest: $10,000 (PVF - OA 4, 12%) = $10,000 x $3,037 Present value of the note 9,392 Discount (Difference) $608

35 Note Not Issued at Face Value Interest-Bearing Note (continued) - Example Journal Entries for Interest-Bearing note Date Account Title Debit Credit 1/1/2012 Notes Receivable 10,000 Discount on Notes Receivable 608 Cash 9,392 12/31/2012 Cash 1,000 Discount on Notes Receivable 127 Interest Revenue 1,127 (9,392 x 12% = 1,127) Present value of the note: $9,392

36 Noninterest-Bearing Notes (Zero Interest) 7-36 Actually do bear interest. Interest is deducted (discounted) from the face value of the note Cash proceeds = face value of note - discount, because interest is included in face amount.

37 Present Value Table $1,000 x = $3,170 Interest Received Factor Present Value $10,000 x = $6,830 Principal Factor Present Value (See slide 30)

38 Note Not Issued at Face Value Zero Interest-Bearing Note - Example Illustration: January 1, 2012, Big Help Company made a loan and receives a four-year, $10,000 zero-interest-bearing note. The market rate of interest (implicit interest rate or discount rate) for a note of similar risk is 10 percent. How does Big Help record the receipt of the note? N (period) = 4 i = 10% $10,000 Principal $1,000 1,000 1,000 1,000 Interest

39 Note Not Issued at Face Value Zero Interest-Bearing Note - Example (cont d) Amortization Schedule of Note Discount Effective-Interest Method 0% Note and Discounted at 10% Cash Received Interest Revenue Discount Amortized Note Carrying Amount 1/1/12 6,830 1/1/ ,513 1/1/ ,264 1/1/ ,093 1/1/ , ,170 3,170 6,830 = 10,000 x (see slide 30) 683 = 6,830 x 10% 910 = 9,093 x 10% + 1 adjustment

40 Note Not Issued at Face Value Zero Interest-Bearing Note - Example (continued) Journal Entries for Zero-Interest-Bearing note Principal (Present value): $6,830 Interest: deducted (discounted) from the face amount to determine the cash proceeds made available to the borrower. Date Account Title Debit Credit 1/1/2012 Notes Receivable 10,000 Discount on Notes Receivable 3,170 Cash 6,830 12/31/2012 Discount on Notes Receivable 683 Interest Revenue 683 (6,830 x 10%)

41 Noninterest-Bearing Notes Example 2 On Jan. 1, 2014, West, Inc., accepted a $25,000 noninterestbearing note from Winn Co. as payment for a sale. The note is discounted at 12% (Market Rate) and is due on Dec. 31, Prepare the journal entries on Jan. 1, 2014, and Dec. 31, January 1, 2014 Notes receivable 25,000 Discount on notes receivable 3,000 Sales revenue 22,000 ($25,000 * 12% = $3,000) December 31, 2014 Cash 25,000 Discount on notes receivable 3,000 Interest revenue 3,000 Note receivable 25,000

42 Reporting Notes Receivable Example for Illustration (Cost basis): 9/30/12 Notes Receivable (Loans) 800,000 Allowance for Note (Loan) Losses 100,000 Net Notes Receivable (carrying amount) 700,000

43 Valuation of Notes Receivable (continued) 7-43 Illustration (using fair value option): At December 31, 2012, Gracious Lady Company has notes receivable that have a fair value of $500,000 and a carrying amount of $700,000, Gracious Lady decides to use the fair value option for these receivables. This is the first valuation (the original year the instrument is recognized) of these recently acquired receivables. At December 31, 2012, Gracious Lady makes an adjusting entry to record the decrease in value of Notes Receivable and to record the unrealized holding loss, as follows: Unrealized Holding Gain or Loss (UHGL) - Income 200,000 Notes Receivable (or Fair Value Adjustment) 200,000 (If not electing FV option & your holding is less than 20%, and if it is a trading security, UHGL is reported in Income Statement; if it is available for sale security, UHGL is reported as Other Comprehensive Income.

44 Comprehensive Income 7-44 Important Notes: If companies choose the fair value option, the receivables are recorded at fair value, with unrealized holding gains or losses reported as part of net income instead of Comprehensive Income or Losses. Reporting requirements for Other Comprehensive Income: FASB ASC This Subtopic requires an entity to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements A An entity reporting comprehensive income in a single continuous financial statement shall present its components in two sections, net income and other comprehensive income. If applicable, an entity shall present the following in that financial statement: a. A total amount for net income together with the components that make up net income. b. A total amount for other comprehensive income together with the components that make up other comprehensive income. As indicated in paragraph , an entity that has no items of other comprehensive income in any period presented is not required to report comprehensive income. 45-1B c. Total comprehensive income. An entity reporting comprehensive income in two separate but consecutive statements shall present the following: a. Components of and the total for net income in the statement of net income b. Components of and the total for other comprehensive income as well as a total for comprehensive income in the statement of other comprehensive income, which shall be presented immediately after the statement of net income. A reporting entity may begin the second statement with net income.

45 7-45 Valuating 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. Fair Value Option. Recently, the FASB has given companies the option to use fair value as the basis of measurement for financial instruments including receivables, in the financial statements.

46 7-46 U.S. GAAP vs. IFRS In general, IFRS and U.S. GAAP are very similar with respect to accounts receivable and notes receivable. Differences are highlighted below. U.S. GAAP allows a fair value option for accounting for receivables. U.S. GAAP does not allow receivables to be accounted for as available for sale investments. U.S. GAAP requires more disaggregation of accounts and notes receivable in the balance sheet or notes, e.g., A/R from customers, from related parties, & from others. IFRS restricts the circumstances in which a fair value option for accounting for receivables is allowed. Until 2015, companies may account for receivables as available for sale investments if the approach is elected initially. After January 1, 2015, this treatment is no longer allowed.

47 7-47 Financing with Receivables Companies may use their receivables to obtain immediate cash.

48 Factoring Arrangements Selling Receivables to a Factor 7-48 SUPPLIER (Transferor) 2. Accounts Receivable 1. Merchandise RETAILER FACTOR (Transferee) A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables from retailer, and charges a fee to Retailer for the service.

49 Sale of Receivables Meet All 3 Conditions to Be Classified as a Sale 7-49 Treat as a sale if all of these conditions are met: receivables are isolated from transferor (A/R owner). transferee (Factor) has right to pledge or exchange receivables. transferor does not have control over the receivables. Transferor cannot repurchase receivable before maturity. Transferor cannot require return of specific receivables.

50 Sale of Receivables 7-50 Without recourse An ordinary sale of receivables to the factor. 1. Factor assumes all risk of uncollectibility. 2. Control of receivable passes to the factor. 3. Receivables are removed from the books, fair value of cash and other assets received is recorded, and a financing expense or loss is recognized. With recourse Transferor (seller) retains risk of uncollectibility. If the transaction fails to meet the 3 conditions necessary to be classified as a sale, it will be treated as a secured borrowing, i.e., as if it is Using receivables as collateral for loans

51 Sale of Receivables (with recourse & without recourse) In December 2013, the Santa Teresa Glass Company factored accounts receivable that had a book value of $600,000 to Factor Bank. The transfer was made without recourse. Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor, and Factor immediately remits to Santa Teresa cash equal to 90% of the factored amount (90% $600,000 = $540,000). Factor retains the remaining 10% (estimated to have a fair value of $50,000) to cover its factoring fee (equal to 4% of the total factored amount; 4% $600,000 = $24,000) and to provide a cushion against potential sales returns and allowances ,000 = 10,000 (ie.,60,000 50,000 FV) + 24,000 factoring fee Assume the same facts as above, except that Santa Teresa Glass sold the receivables to Factor with recourse and estimates the fair value of the recourse obligation (liability) to be $5,000.

52 Secured Borrowing Using receivables as collateral for loans On December 1, 2013, the Santa Teresa Glass Company borrowed $500,000 (liability) from Finance Bank and signed a promissory note. Interest at 12% is payable monthly. The company assigned $620,000 of its receivables (current asset) as collateral for the loan. Finance Bank charges a finance fee equal to 1.5% of the accounts receivable assigned. Cash (difference) 490,700 Finance charge expense (1.5% * $620,000) 9,300 Liability financing arrangement 500,000 Santa Teresa Glass (Borrower) will continue to collect the receivables, and will record any discounts, sales returns, and bad debt write-offs, but will remit the cash to Finance Bank (lender), usually on a monthly basis. When $400,000 of the receivables assigned are collected in December, Santa Teresa Glass records the following entries. Receivable: Cash 400,000 Accounts receivable 400,000 Loan: Interest expense ($500,000 * 12% * 1/12) 5,000 Liability financing arrangement 400,000 Cash 405,

53 7-53 Securitization: The process of transforming financial assets into securities. It involves: 1. the transfer of a portfolio of financial assets (such as trade receivables, mortgage loans notes receivables, auto loans) to a trust or other entity such as SPE Special Purpose Entity (SPE) or Qualifying Special Purpose Entity (QSPE). And 2. the sale of beneficial interests in that entity to investors. New rules eliminate QSPE and require consolidation!

54 Transfers of Financial Assets Sales It includes transfers of: 1. an entire financial assets 2. a group of entire financial assets, and 3. a participating interest in an entire financial asset A transfer of financial assets is a sale when the transferor relinquishes control. Continuing involvement is the right to receive benefits from the assets or an obligation to provide additional assets to a party related to the transfer; e.g., servicing agreement, recourse provisions. Participating Interests: A participating interest exists if: 1. It is a proportionate ownership interest, 2. Cash receipts are proportionate to shares of ownership 3. Each holder has the same priority, & 4. The entire asset cannot be pledged or exchanged without the agreement of all holders. It is a transfer of portion of a receivable or partial transfer. Example: transfer right to interest, but retain right to principal New rules require a partial transfer be treated as a secured borrowing, unless specific conditions are met! 7-54

55 Transfers (Discounts) of Notes Receivable 7-55 On December 31, Stridewell accepted a nine-month 10 percent note for $200,000 from a customer. 3 months later on March 31, Stridewell discounted the note at its local bank. The bank s discount rate is 12 percent. Before preparing the journal entry to record the discounting, Stridewell must record the accrued interest on the note from December 31 until March 31. Interest receivable 5,000 Interest revenue 5,000 $200,000 10% 3/12

56 7-56 Transfers of Notes Receivable Face amount of note receivable $ 200,000 Interest to maturity ($200,000 10% 9/12) 15,000 Maturity value of note receivable 215,000 Discount fee ($215,000 12% 6/12) (12,900) Cash proceeds $ 202,100 Cash 202,100 Loss on sale of note receivable 2,900 Notes receivable 200,000 Interest receivable 5,000 $205,000 $202,100

57 7-57 Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowing Pledge: An arrangement for a co. transfer the receivables for custodial purpose. Secured: a co. assigns its receivables as collateral to borrow money; the a/c debtors are not notified.

58 U.S. GAAP vs. IFRS Treatment for Transfers of Receivables The U.S. GAAP and the IFRS approaches often lead to similar accounting treatment for transfers of receivables U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee. IFRS requires a more complex decision process. The company has to: 1. have transferred the rights to receive the cash flows from the receivable, and 2. considers whether the company has transferred substantially all of the risks and rewards of ownership, and 3. whether the company has transferred control.

59 7-59 Receivables Management Receivables Turnover Ratio = Net Sales Average Accounts Receivable This ratio measures how many times a company converts its receivables into cash each year. Average Collection Period = 365 Receivables Turnover Ratio This ratio is an approximation of the number of days the average accounts receivable balance is outstanding.

60 7-60 Receivables Management Symantec Corp. vs. CA, Inc., comparison (All dollar amounts in millions) Symantec Corp. CA, Inc Accounts receivable (net) $ 1,013 $ 856 $ 849 $ 931 Net sales 6,190 4,429 Symantec Corp CA, Inc Industry Average Receivables turnover Average collection period days days 61.3 days