MGAC01 Intermediate Accounting I

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1 MGAC01 Intermediate Accounting I S. Daga TOPIC: CASH & RECEIVABLES TEXT: Chapter 7 (exclude Appendix) CLASS Q s: E7-2, E7-19, P7-2, P7-13, Case IC7-1 LEARNING GOALS: 1. Cash know how to PRESENT cash on financial statements 2. Receivables understand RECOGNITION & MEASUREMENT issues 3. Receivables know how to record their sale and derecognition CLASS OUTLINE: LEARNING GOAL 1: Cash know how to PRESENT cash on financial statements Cash is a financial asset. A financial asset is cash or a contractual right to receive cash or another financial asset from another party; a contractual right to exchange financial instruments with another party under conditions that are potentially favourable; or an equity instrument of another entity.(cica Handbook) Reporting Cash some PRESENTATION issues include how to report the following: 1. Restricted Cash 2. Cash in Foreign Currencies 3. Bank Overdrafts 4. Cash Equivalents - do class exercise E7-2 1

2 LEARNING GOAL 2: Receivables understand RECOGNITION & MEASUREMENT issues Receivables These are claims that a company has against customers and others. They can be current or noncurrent, trade or nontrade (e.g. advances to employees). Types: A. Accounts Receivable Recognition and Measurement issues include accounting for: 1. Sales discounts gross & net methods. 2. Impairment issues need to account for bad debts (2 methods Allowance procedure and a mix of procedures using percentage-of-sales method) - see Illustration 1 - do Problem 7-2 B. Notes Receivable - The interest element is ignored for short-term notes and therefore they are carried at face value. However, long-term notes are recorded at the present value of the cash expected to be collected. For zero interest or unreasonable interest-bearing notes, an appropriate rate of interest must be determined in order to compute the present value of the note. - see Illustration 2 2

3 LEARNING GOAL 3: Receivables know how to record their sale and derecognition In order to accelerate the receipt of cash from receivables, they may be transferred to a third party for cash. 1. Secured Borrowing (Assigning or Pledging) - The owner of the receivables borrows cash from a bank or another company by designating the accounts receivable as collateral. 2. Sale (factoring) These transfers of receivables may be with or without recourse. a. Transfer without recourse The purchaser assumes the risk of collectability and absorbs the credit losses. b. Transfer with recourse The seller guarantees payment to the purchaser for those receivables that become uncollectible. - see Illustration 3 - do Exercise 7-19, P7-13 3

4 ILLUSTRATION 1 ACCOUNTING FOR UNCOLLECTIBLE ACCOUNTS/BAD DEBT EXPENSE Data Charge sales $ 500,000 Estimated % of credit sales not collectible 1 % Accounts receivable balance $ 72,500 Estimated % of accounts receivable not collectible 8% Case I Allowance for Doubtful Accounts $ 150 (Credit balance) Case II Allowance for Doubtful Accounts $ 150 (Debit balance) Mix of Procedures Step 1: Determine relationship between bad debts (1% in our example) Credit sales = $500,000 Allowance Approach Only Step 1: Determine balance in the credit sales and Accounts Receivable account. Accounts Receivable balance = $72,500. Step 2: Calculate estimated Step 2: Calculate required balance for expense. the Allowance for Doubtful.01 $500,000 = $5,000 Accounts..08 $72,500 = $5,800 Step 3: Not necessary. Step 3: Calculate estimated bad debt expense. Step 4: Interim entry. Case I Bad Debt Expense 5,000 Desired balance $5,800 Cr. Allowance for Actual balance 150 Cr. Doubtful Accounts 5,000 Amount of new expense $5,650 Step 5: Make adjusting entry. See Step 3 Allowance method for required balance Case II Desired balance $5,800 Cr. Actual balance 150 Dr. Amount of new expense $5,950 Step 4: Make entry 4

5 Case I (5, ,000 = $650) Case I Bad Debt Expense 650 Bad Debt Expense 5,650 Allowance for Allowance for Doubtful Accounts 650 Doubtful Accounts 5,650 Case II (5, ,000 = $950) Case II Bad Debt Expense 950 Bad Debt Expense 5,950 Allowance for Allowance for Doubtful Accounts 950 Doubtful Accounts 5,950 5

6 ILLUSTRATION 2 INTEREST INCOME ON INTEREST-BEARING AND NON-INTEREST- BEARING NOTES RECEIVABLE COMPANY A: Lends Company C $20,000 July 1, 2014 in exchange for a 2 year note that pays interest at a stated rate of 10% semi-annually on Jan. 1 and July 1. The market rate of interest for a similar note is also 10%. Company B has a December 31 year end. COMPANY B: purchases a six-month $20,000 note for $19,231 on March 15. The note matures on Sept 15 and was purchased to yield an 8% return. COMPANY A COMPANY B July 1, 2014 March 15 DR Note receivable $20,000 DR Note receivable $19,231 CR Cash $20,000 CR Cash $19,231 To record purchase To record purchase December 31, 2014 Sept 15 DR Interest receivable $1,000 DR Cash $20,000 CR Interest Revenue $1,000 CR Note receivable $19,231 Accrue semi-annual interest CR Interest revenue $769 [$20,000 10% ½] To record proceeds on maturity Jan 1, 2015 DR Cash $1,000 CR Interest receivable $1,000 To record payment of accrued interest To record payment of note at maturity: July 1, 2016 DR Cash $21,000 CR Notes receivable $20,000 CR interest revenue $1,000 6

7 ILLUSTRATION 3 SALE (FACTORING) OF RECEIVABLES Accounts Receivable Are Transferred Transfer without Recourse Transfer with Recourse Report as Sale Reduce Receivable Record Gain or Loss Does it meet three conditions? a. Transferor surrenders benefits. b. Transferor's obligation can be reasonably estimated 3. Transferee cannot require repurchase. YES NO Report as Sale Report as Secured Borrowing Reduce Receivable Record Gain or Loss Expense Increase Liability Record Interest Source: Paul Munter and Tommy Moores, "Transfers of Receivables with Recourse."The CPA Journal, July, 1984, pp

8 Class Discussion Questions E7-2, E7-19, P7-2, P7-13, Case IC7-1 E7-2 Several independent situations follow. 1. Chequing account balance $625,000; certificate of deposit $1.1 million; cash advance to subsidiary $980,000; utility deposit paid to gas company $ Chequing account balance $500,000; overdraft in special chequing account at same bank as normal chequing account $17,000; cash held in bond sinking fund $200,000; petty cash fund $300; cash on hand $1, Chequing account balance $540,000; postdated cheque from customer $11,000; cash restricted to maintain compensating balance requirement $100,000; certified cheque from customer $9,800; postage stamps on hand $ Chequing account balance at bank $57,000; money-market balance at mutual fund (has chequing privileges) $38,000; NSF cheque received from customer $ Chequing account balance $700,000; cash restricted for future plant expansion $500,000; shortterm (60-day) treasury bills $180,000; cash advance received from customer $900 (not included in chequing account balance); cash advance of $7,000 to company executive, payable on demand; refundable deposit of $26,000 paid to federal government to guarantee performance on construction contract. Instructions For each situation above, determine the amount that should be reported as cash. If the item(s) is (are) not reported as cash, explain why. E7-19 (Transfer of Receivables with Recourse) Chessman Corporation factors $600,000 of accounts receivable with Liquidity Financing, Inc. on a with recourse basis. Liquidity Financing will collect the receivables. The receivable records are transferred to Liquidity Financing on August 15, Liquidity Financing assesses a finance charge of 2.5% of the amount of accounts receivable and also reserves an amount equal to 5.25% of accounts receivable to cover probable adjustments. Chessman prepares financial statements under ASPE. Instructions (a) According to ASPE, what conditions must be met for a transfer of receivables to be accounted for as a sale? (b) Assume the conditions from part (a) are met. Prepare the journal entry on August 15, 2014, for Chessman to record the sale of receivables, assuming the recourse obligation has a fair value of $6,000. (c) What effect will the factoring of receivables have on calculating the accounts receivable turnover for Chessman? Comment briefly. (d) Assume that Chessman is a private enterprise and prepares financial statements under IFRS. What conditions must be met for the transfer of receivables to be accounted for as a sale? 8

9 P7-2 A series of unrelated situations follow: 1. Atlantic Inc.'s unadjusted trial balance at December 31, 2014, included the following accounts: Debit Credit Allowance for doubtful accounts $ 8,000 Sales revenue $1,980,000 Sales returns and allowances 60,000 Sales discounts 4, An analysis and aging of Central Corp.'s accounts receivable at December 31, 2014, disclosed the following: Amounts estimated to be uncollectible $ 160,000 Accounts receivable 1,790,000 Allowance for doubtful accounts (per books) 125, Western Co. provides for doubtful accounts based on 4.5% of credit sales. The following data are available for 2014: Credit sales during 2014 $3,200,000 Allowance for doubtful accounts 1/1/14 37,000 Collection of accounts written off in prior years (customer credit was re-established) 18,000 Customer accounts written off as uncollectible during , At the end of its first year of operations, on December 31, 2014, Pacific Inc. reported the following information: Accounts receivable, net of allowance for doubtful accounts $950,000 Customer accounts written off as uncollectible during ,000 Bad debt expense for , The following accounts were taken from Northern Inc.'s unadjusted trial balance at December 31, 2014: Debit Credit Sales revenue (all on credit) $950,000 Sales discounts $ 21,400 Allowance for doubtful accounts 34,000 Accounts receivable 610,000 Instructions (a) For situation 1, Atlantic estimates its bad debt expense to be 1.5% of net sales. Determine its bad debt expense for (b) For situation 2, what is the net realizable value of Central Corp.'s receivables at December 31, 2014? (c) For situation 3, what is the balance in Allowance for Doubtful Accounts at December 31, 2014? (d) For situation 4, what is the balance in accounts receivable at December 31, 2014, before subtracting the allowance for doubtful accounts? (e) For situation 5, if doubtful accounts are 7% of accounts receivable, what is the bad 9

10 debt expense amount to be reported for 2014? P7-13 The Patchwork Corporation manufactures sweaters for sale to athletic-wear retailers. The following information was available on Patchwork for the years ended December 31, 2013, and 2014: 12/31/13 12/31/14 Cash $ 20,000 $ 15,000 Accounts receivable 90,000? Allowance for doubtful accounts 8,500? Inventory 85,000 80,000 Current liabilities 80,000 86,000 Total credit sales 600, ,000 Collections on accounts receivable 440, ,000 During 2014, Patchwork had the following transactions: 1. On June 1, 2014, sales of $80,000 to a major customer were settled, with Patchwork accepting an $80,000, one-year note bearing 7% interest that is payable at maturity. The $80,000 is not included in the total credit sales amount above. 2. Patchwork factors some accounts receivable at the end of the year. Accounts totalling $60,000 are transferred to Primary Factors Inc., with recourse. Primary Factors retains 5% of the balances, and will receive the collections directly from Patchwork's customers. Patchwork is assessed a finance charge of 6% on this transfer. The fair value of the recourse obligation is $7, Patchwork wrote off $3,200 of accounts receivable during Based on the latest available information, the 2014 allowance for doubtful accounts should have a balance of $12,000 at December 31, Additional information: Included in the cash balance at December 31, 2014, are the following: a chequing account with a balance of $9,600, postage stamps of $100, petty cash of $300, coins and currency on hand of $3,000, and postdated cheques from customers of $2,000. Patchwork is a private company that follows ASPE. Instructions (a) Prepare the journal entry for the factoring of the accounts receivable to Primary Factors Inc. (b) Based on the above transactions and additional information, determine the balances of Accounts Receivable and Bad Debt Expense at December 31, (c) Prepare the current assets section of Patchwork's statement of financial position at December 31, (d) Calculate the current ratios for Patchwork for 2013 and (e) Calculate the receivables turnover ratio for Patchwork for Patchwork's receivables turnover ratio for 2013 was 3.8 times. 10

11 IC7-1 Fritz's Furniture (FF) is a mid-sized owner-operated business that was started 25 years ago by Fred Fritz. The retail furniture business is cyclical, with business dropping off in times of economic downturn, as is the case currently. In order to encourage sales, the store offers its own credit cards to good customers. FF has run into a bit of a cash crunch and is planning to go to the bank to obtain an increase in its line of credit in order to replenish and expand the furniture stock. At present, the line of credit is limited to 70% of the credit card receivables and inventory. The receivables and inventory have been pledged as security for the loan. Fred has identified two possible sources of the cash shortage: outstanding credit card receivables and a buildup in old inventory. He has come up with two strategies to deal with the problem: 1. Credit card receivables: For the existing receivables, Fred has found the company Factors Inc., which will buy the receivables for 93% of their face value. The two companies are currently negotiating the terms of the deal. So far, FF has agreed to transfer legal title to the receivables to Factors Inc., and FF will maintain and collect the receivables. The one term that is still being discussed is whether Factors Inc. will have any recourse to FF if the amounts become uncollectible. 2. Excess inventory: A new sales promotion has been advertised in the newspaper for the past two months. Under the terms of the promotion, customers do not pay anything up front and will be able to take the furniture home and begin payments the following year. Response to the advertisement has been very good and a significant amount of inventory has been moved to date, leaving room for new inventory once the bank financing comes through. Instructions Assume the role of FF's bookkeeper and advise Fred about the impact of the strategies on the company's financial reporting. The company follows ASPE. 11

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