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CHAPTER 7
Cash and Receivables
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions
Brief Exercises Exercises Problems
Concepts for Analysis
- Accounting for cash. 1, 2, 3, 4, 23 1 1, 2 1
- Accounting for accounts receivable, bad debts, other allowances.
- Accounting for notes receivable.
- Assignment and factoring of accounts receivable.
- Analysis of receivables.
*6. Petty cash and bank reconciliations.
*7. Allowance estimate using expected cash flow.
*This material is covered in an Appendix to the chapter.
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives Questions
Brief Exercises Exercises Problems
Concepts for Analysis
- Indicate how to report cash and related items.
- Define receivables and understand accounting issues related to their recognition.
- Explain accounting issues related to valuation of accounts receivable.
- Explain accounting issues related to recognition and valuation of notes receivable.
- Explain the fair value option. 17
- Explain accounting issues related to disposition of accounts and notes receivable.
- Describe how to report and analyze receivables.
*8. Explain common techniques employed to control cash.
*9. Describe the estimation of the allowance based on expected cash flows.
ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Item Description
Level of Difficulty
Time (minutes)
CA7-1 Bad-debt accounting. Simple 10–
CA7-2 Various receivable accounting issues. Simple 15–
CA7-3 Bad-debt reporting issues. Moderate 25–
CA7-4 Basic note and accounts receivable transactions. Moderate 25–
CA7-5 Sale of notes receivable. Moderate 20–
CA7-6 Zero-interest-bearing note receivable. Moderate 20–
CA7-7 Reporting of notes receivable, interest, and sale
of receivables.
Moderate 25–
CA7-8 Accounting for zero-interest-bearing note. Moderate 25–
CA7-9 Receivables management. Moderate 25–
CA7-10 Bad-debt reporting, ethics. Moderate 25–
ANSWERS TO QUESTIONS
- Cash normally consists of coins and currency on hand, bank deposits, and various kinds of orders for cash such as bank checks, money orders, travelers’ checks, demand bills of exchange, bank drafts, and cashiers’ checks. Balances on deposit in banks which are subject to immediate with- drawal are properly included in cash. Money market funds that provide checking account privileges may be classified as cash. There is some question as to whether deposits not subject to immediate withdrawal are properly included in cash or whether they should be set out separately. Savings accounts, certificates of deposit, and time deposits fall in this latter category. Unless restrictions on these kinds of deposits are such that they cannot be converted (withdrawn) within one year or the operating cycle of the entity, whichever is longer, they are properly classified as current assets. At the same time, they may well be presented separately from other cash and the restrictions as to convertibility reported.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- (a) Cash (h) Investments, possibly other assets. (b) Investments (i) Cash. (c) Temporary investments. (j) Trading securities. (d) Accounts receivable. (k) Cash. (e) Accounts receivable, a loss if uncollectible. (l) Cash. (f) Other assets if not expendable, cash if ex- (m) Postage expense, or prepaid ex- pendable for goods and services in the for- pense, or supplies inventory. eign country. (n) Receivable from employee if the (g) Receivable if collection expected within one company is to be reimbursed; year; otherwise, other asset. otherwise, prepaid expense.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- A compensating balance is that portion of any demand deposit maintained by a corporation which constitutes support for existing borrowing arrangements of a corporation with a lending institution.
A compensating balance representing a legally restricted deposit held against short-term borrowing arrangements should be stated separately among the cash and cash equivalent items. A restricted deposit held as a compensating balance against long-term borrowing arrangements should be separately classified as a noncurrent asset in either the investments or other assets section.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- Restricted cash for debt redemption would be reported in the long-term asset section, probably in the investments section. Another alternative is the other assets section. Given that the debt is long term, the restricted cash should also be reported as long term.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- The seller normally uses trade discounts to avoid frequent changes in its catalogs, to quote different prices for different quantities purchased, and to hide the true invoice price from competitors. Trade discounts are not recorded in the accounts because the price finally quoted is generally an accurate statement of the fair market value of the product on that date. In addition, no subsequent changes can occur to affect this value from an accounting standpoint. With a cash discount, the buyer receives a choice and events subsequent to the original transaction dictate that additional entries may be needed.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 7 (Continued)
This method of providing for uncollectible accounts is quite accurate for purposes of reporting accounts receivable at their estimated net realizable value in the balance sheet. From the stand- point of the income statement, however, the aging method may not match accurately bad debt expenses with the sales which caused them because the charge to bad debt expense is not based on sales. The accuracy of both the charge to bad debt expense and the reported value of receiv- ables depends on the current estimate of uncollectible accounts. The accuracy of the expense charge, however, is additionally dependent upon the timing of actual write-offs.
Other methods that companies may use employ estimates based on historical loss ratios for customers with different credit ratings as a basis for estimating uncollectible accounts. Or a company may utilize a probability-weighted discounted cash flow model (as illustrated in Chapter
- to estimate expected credit losses.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- A major part of accounting is the measurement of financial data. Estimates of uncollectibility should be recognized so that receivables are reported at net realizable value and in order for accounting to provide useful information on a periodic basis.
The very existence of accounts receivable is based on the decision that a credit sale is an objec- tive indication that revenue should be recognized. The alternative is to wait until the debt is paid in cash. If revenue is to be recognized and an asset recorded at the time of a credit sale, the need for fairness in the statements requires that both expenses and the asset be adjusted for the estimated amounts of the asset that experience indicates will not be collected.
The argument may be persuasive that the evidence supporting write-offs permits a more accurate decision than that which supports the allowance method. The latter method, however, is “objective” in the sense in which accountants use the term and is justified by the need for fair presentation of receivables and income. The direct write-off method is not wholly objective; it requires the use of judgment in determining when an account has become uncollectible.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- Because estimation of the allowance account balance requires judgment, management could either over-estimate or under-estimate the amount of uncollectible accounts depending on whether a higher or lower earnings number is desired. For example, Sun Trust bank (referred to in the chapter) was having a very profitable year. By over-estimating the amount of bad debts, Sun Trust could record a higher allowance and expense, thereby reducing income in the current year. In a subsequent year, when earnings are low, they could under-estimate the allowance, record less expense and get a boost to earnings.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- The receivable due from Bernstein Company should be written off to an appropriately named loss account and reported in the income statement as part of income from operations. In this case, classification as an unusual item would seem appropriate. The loss may properly be reduced by the portion of the allowance for doubtful accounts at the end of the preceding year that was allocable to the Bernstein Company account.
Estimates for doubtful accounts are based on a firm’s prior bad debt experience with due consideration given to changes in credit policy and forecasted general or industry business conditions.
The purpose of the allowance method is to anticipate only that amount of bad debt expense which can be reasonably forecasted in the normal course of events.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 7 (Continued)
- If the direct write-off method is used, the only alternative is to debit Cash and credit a revenue account entitled Uncollectible Amounts Recovered. If the allowance method is used, then the accountant would debit Accounts Receivable and credit the Allowance for Doubtful Accounts. An entry is then made to credit the customer’s account and debit Cash upon receipt of the remittance.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- The journal entry on Lombard’s books would be: Notes Receivable ............................................................................. 1,000, Discount on Notes Receivable .................................................... 360, Sales Revenue............................................................................ 640,000*
*Assumes that seller is a dealer in this property. If not, the property might be credited, and a loss on sale of $50,000 would be recognized.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- Imputed interest is the interest ascribed or attributed to a situation or circumstance which is void of a stated or otherwise appropriate interest factor. Imputed interest is the result of a process of interest rate estimation called imputation.
An interest rate is imputed for notes receivable when (1) no interest rate is stated for the transaction, or (2) the stated interest rate is unreasonable, or (3) the stated face amount of the note is materially different from the current cash price for the same or similar items or from the current market value of the debt instrument.
In imputing an appropriate interest rate, consideration should be given to the prevailing interest rates for similar instruments of issuers with similar credit ratings, the collateral, and restrictive covenants.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- The fair value option gives companies the option of using fair value as the measurement basis for financial instruments. The Board believes that fair value measurement for financial instruments provides more relevant and understandable information than historical cost. If companies choose the fair value option, the receivables are recorded at fair value, with unrealized gains or losses reported as part of net income.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- A company might sell receivables because money is tight and access to normal credit is not available or prohibitively expensive. Also, a company may have to sell its receivables, instead of borrowing, to avoid violating existing lending arrangements. In addition, billing and collection of receivables are often time-consuming and costly.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- The financial components approach is used when receivables are sold but there is continuing involvement by the seller in the receivable. Examples of continuing involvement are recourse provisions or continuing rights to service the receivable. A transfer of receivables should be recorded as a sale when the following three conditions are met:
(a) The transferred asset has been isolated from the transferor (put beyond reach of the trans- feror and its creditors). (b) The transferees have obtained the right to pledge or exchange either the transferred assets or beneficial interests in the transferred assets. (c) The transferor does not maintain effective control over the transferred assets through an agreement to repurchase or redeem them before their maturity.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Questions Chapter 7 (Continued)
*25. A loan is considered impaired when it is probable that the creditor will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan. If a loan is considered impaired, the loss due to impairment should be measured as the difference between the investment in the loan and the expected future cash flows discounted at the loan’s historical effective-interest rate. The loss is recorded on the books of the creditor. The debtor would not be aware of the entry made by the creditor and would not make an entry until settlement or if a modification of terms resulted.
LO: 9, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*26. Companies commonly evaluate loans (long-term notes receivable) for collectability based on an analysis of the expected contractual cash flows. They then apply discounted expected cash flow methods, to measure the allowance to report the loan at net realizable value. The allowance for doubtful accounts and related bad debt expense on a loan or note receivable can be estimated as the difference between the investment in the loan (generally the principal plus accrued interest or amortized cost) and the expected future cash flows discounted at the loan’s historical effective- interest rate.
LO: 9, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 7-
Cash in bank—savings account ................................ $68,
Cash on hand .............................................................. 9,
Checking account balance ......................................... 17,
Cash to be reported .................................................... $94,
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
June 1 Accounts Receivable ........................... 50,
Sales Revenue ............................. 50,
June 12 Cash ...................................................... 48,500*
Sales Discounts ................................... 1,
Accounts Receivable .................. 50,
*$50,000 – ($50,000 X .03) = $48,
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
June 1 Accounts Receivable ........................... 48,500*
Sales Revenue ............................. 48,
June 12 Cash ...................................................... 48,
Accounts Receivable .................. 48,
*$50,000 – ($50,000 X .03) = $48,
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
(a)
Accounts Receivable ........................... 9,
Sales Revenue ............................. 9,
BRIEF EXERCISE 7-7 (Continued)
5/1/ 18 Cash......................................................... 30,
Notes Receivable ........................... 30,
Interest Receivable ........................ 300
Interest Revenue
($30,000 X 6% X 4/12) ................... 600
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
Notes Receivable ..................................................... 20,
Discount on Notes Receivable....................... 3,
Cash ................................................................. 16,
Discount on Notes Receivable ................................ 1,
Interest Revenue
$16,529 X 10% .............................................. 1,
Discount on Notes Receivable ................................ 1,
Interest Revenue
($16,529 + $1,653) X 10% ............................. 1,
Cash .......................................................................... 20,
Notes Receivable ............................................ 20,
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
Chung, Inc.
Cash ........................................................................ 730,
Interest Expense ($1,000,000 X 2%) ...................... 20,
Notes Payable ............................................... 750,
Seneca National Bank
Notes Receivable ................................................... 750,
Cash ............................................................... 730,
Interest Revenue ($1,000,000 X 2%) ............ 20,
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
Wood
Cash ........................................................................ 138,
Due from Factor ..................................................... 9,000*
Loss on Sale of Receivables ................................. 3,000**
Accounts Receivable .................................... 150,
*6% X $150,000 = $9,
**2% X $150,000 = $3,
Engram
Accounts Receivable ............................................. 150,
Due to Customer (Wood) .............................. 9,
Interest Revenue ........................................... 3,
Cash ............................................................... 138,
LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
Wood
Cash ........................................................................ 138,
Due from Factor ..................................................... 9,000*
Loss on Sale of Receivables ................................. 10,500**
Accounts Receivable .................................... 150,
Recourse Liability ......................................... 7,
*6% X $150,000 = $9,
**2% X $150,000 = $3,000 + $7,500 = $10,
LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 7-
Cash $250,000 – [$250,000 X (.05 + .04)] ............... 227,
Due from Factor ($250,000 X .04) .......................... 10,
Loss on Sale of Receivables ................................. 20,500*
Accounts Receivable .................................... 250,
Recourse Liability ......................................... 8,
*($250,000 X .05) + $8,
LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
*BRIEF EXERCISE 7-
Petty Cash ....................................................................... 200
Cash ........................................................................ 200
Supplies ........................................................................... 94
Miscellaneous Expense .................................................. 87
Cash Over and Short ...................................................... 4
Cash ($200 – $15) ................................................... 185
LO: 8, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
*BRIEF EXERCISE 7-
(a) Added to balance per bank statement (1)
(b) Deducted from balance per books (4)
(c) Added to balance per books (3)
(d) Deducted from balance per bank statement (2)
(e) Deducted from balance per books (4)
LO: 8, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
*BRIEF EXERCISE 7-
(b) Office Expense ........................................................ 25
Cash ................................................................ 25
(c) Cash ......................................................................... 31
Interest Revenue ............................................ 31
(e) Accounts Receivable .............................................. 377
Cash ................................................................ 377
Thus, all “Balance per books” adjustments in the reconciliation require a
journal entry.
LO: 8, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
*BRIEF EXERCISE 7-
National American Bank (Creditor):
Bad Debt Expense ..................................................... 225,
Allowance for Doubtful Accounts...................... 225,
LO: 9, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
SOLUTIONS TO EXERCISES
EXERCISE 7-1 (10–15 minutes)
(a) Cash includes the following:
1. Commercial savings account—
First National Bank of Yojimbo $ 600,
1. Commercial checking account—
First National Bank of Yojimbo 900,
2. Money market fund—Volonte 5,000,
5. Petty cash 1,
11. Commercial Paper (cash equivalent) 2,100,
12. Currency and coin on hand 7,
Cash reported on December 31, 2017, balance sheet $8,608,
(b) Other items classified as follows:
3. Travel advances (reimbursed by employee)* should be reported
as receivable—employee in the amount of $180,000.
4. Cash restricted in the amount of $1,500,000 for the retirement of
long-term debt should be reported as a noncurrent asset
identified as “Cash restricted for retirement of long-term debt.”
6. An IOU from Marianne Koch should be reported as an account
receivable in the amount of $190,000.
7. The bank overdraft of $110,000 should be reported as a current
liability.**
8. Certificates of deposits of $500,000 each should be classified as
temporary investments.
9. Postdated check of $125,000 should be reported as an accounts
receivable.
10. The compensating balance requirement does not affect the
balance in cash. A note disclosure indicating the arrangement
and the amounts involved should be described in the notes.
EXERCISE 7-2 (Continued)
3. Cash balance is $599,800 computed as follows:
Checking account balance $590,
Certified check from customer 9,
The postdated check of $11,000 should be reported as an account
receivable. Cash restricted due to compensating balance should be
described in a note indicating the type of arrangement and amount.
Postage stamps on hand are reported as part of supplies or prepaid
expenses.
4. Cash balance is $85,000 computed as follows:
Checking account balance $37,
Money market mutual fund 48,
The NSF check received from customer should be reported as an
account receivable.
5. Cash balance is $700,900 computed as follows:
Checking account balance $700,
Cash advance received from customer 900
Cash restricted for future plant expansion of $500,000 should be
reported as a noncurrent asset. Short-term Treasury bills of $180,
should be reported as a temporary investment. Cash advance received
from customer of $900 should also be reported as a liability; cash
advance of $7,000 to company executive should be reported as a
receivable; refundable deposit of $26,000 paid to federal government
should be reported as a receivable.
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic , AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 7-3 (10–15 minutes)
Current assets
Accounts receivable
Customers accounts (of which
accounts in the amount of
$40,000 have been pledged as
security for a bank loan) $79,
Installment accounts collectible
due in 2018 23,
Installment accounts collectible
due after December 31, 2018* 34,000 $136,
Other** ($2,640 + $1,500) 4,140 $140,
Non-trade receivables
Advance to subsidiary company 81,
*This classification assumes that these receivables are collectible within
the operating cycle of the business.
**These items could be separately classified, if considered material.
LO: 2, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 7-4 (10–15 minutes)
Computation of cost of goods sold:
Merchandise purchased $320,
Less: Ending inventory 90,
Cost of goods sold $230,