Cash and Receivables

1

• Cash and Receivables

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Objectives of this Chapter

• I. Discuss the asset valuation methods.
• II. Identify items to be included in the cash
  account and discuss how cash and related items
  are reported.
• III. Explain accounting issues related to
  valuation of accounts receivables -- volume
  discount, sales discount, sales returns and
  allowance, and uncollectible accounts.

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Objectives of this Chapter (contd.)

• IV. Explain accounting issues related to
  disposition of accounts receivables -- pledge,
  assign and factor.
• V. Discuss the valuation of notes receivable and
  the disposition of notes receivable.

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I. Assets Valuation Methods

• A. Acquisition Cost (Historical Cost)
• Used in the initial recording for all assets
  except for
• 1. Debt securities-held-to-maturity.
• 2. Long-term monetary assets (i.e., Long-term
  N/R).
• B. Current Entry Value (Replacement Cost)
• Applied in the inventory valuation (LCM).

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Assets Valuation Methods (contd.)

• C. Current Exit Value (Net Realizable Value)
• Applied in the valuation of trading securities
  and securities-available-for-sale.
• D. Net Present Value
• Applied in the valuation of debt
  securities-held-to-maturity and long-term
  monetary assets.

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Cash and Receivables

• Liquidity The amount of time expected to elapse
  until an asset is converted into cash.
• Liquid assets Assets are available for
  conversion into cash quickly (i.e., cash,
  receivables, trading securities, etc..).
• Liquidity is an indication of a companys ability
  to meet its obligation.

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II. Cash

• What are included in the cash account?
• A. Cash on hand in the forms of coins,
  currency, personal checks, travelers checks,
  money order, etc. These can be in the cash
  register, in the petty cash fund or in the change
  fund.
• B. Cash in bank including demand deposits
  (checking account) and time deposits (savings
  account) or money market fund account.

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Cash (contd.)

• What are excluded from the cash account (source
  FRR No. 1)
• Foreign currency with severe restrictions -
  separate cash account.
• Certificates of deposits (CDs) - Temporary
  Investments.
• Bank overdrafts - current liabilities (i.e., A/P)
  unless available cash is present in another
  account in the same bank (offsetting is required
  in this case).

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Cash (contd.)

• What are excluded from the cash account (source
  FRR No. 1)
• Postdated checks- Receivables.
• IOUs - Receivables.
• Travel Advances - Prepaids.
• Employees Advances - Receivables.
• Postage stamps -Office supplies.
• Special purpose funds - Investments.
• Compensating balances - Restricted cash.
• Short-term papera (i.e., commercial paper) - S-T
  investments.
• a. Investments with maturity of 3 to 12 months.

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Restricted Cash

• Compensating balances are examples of restricted
  cash which may require separate reporting.
• Other restricted cash petty cash, cash for
  payroll, cash for dividends. If the amount is
  material, separate reporting is required. When
  separate reporting is required and the restricted
  cash is to be used in short run, reported as
  current assets, otherwise, reported as long-term
  assets.

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CashCompensating Balances (CB)

• CB The portion of any deposit maintained by a
  corporation to support an existing borrowing
  arrangements (ASR No. 148).
• CB will increase the effective interest rate.
• CB may also be payment for bank services rendered
  to the company for which there is no direct fee
  (i.e., free checking account, free lockbox
  management).

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CashCompensating Balances (contd.)

• If the CB is significant and is to support
  short-term borrowing, the CB should be stated
  separately among the cash and cash equivalent
  item in current assets..
• If the CB is significant and is to support
  long-term borrowing, the CB should be classified
  as noncurrent assets in either Investments or
  Other Assets using a caption such as Deposit
  Maintained as Compensating Balance.

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CashCompensating Balances (contd.)

• The following two situations only require a
  footnote disclosure of the CB, not a separate
  reporting
• 1) CB arrangement exists without agreements that
  restrict the use of cash amount shown on the
  balance sheet statement
• 2) CB arrangement is to assure future credit
  availability.
• CB may also be payment for bank services rendered
  to the company for which there is no direct fee
  (i.e., free checking account, free lockbox
  management).

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Other Cash Related Topics

• Electronic Fund Transfer (EFT) any fund
  transfer without using paper (i.e., wire,
  telephone, telegraph, computer, ATM).
• Cash Equivalents short-term, highly liquid
  investments that are both 1) readily convertible
  to known amount of cash, and 2) so near their
  maturity that they present insignificant risk of
  change in value.
• In general, only investments with original
  maturity of three months or less qualify under
  these definitions.
• Examples Treasury bills, Commercial paper, and
  Money Market Funds.

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CashUsing Bank Account

• General checking accounts
• Imprest bank accounts
• Lockbox accounts

16
Cash Imprest bank accounts

• These accounts are used to make a specific amount
  of cash available for a large volume of checks or
  for a specific type of checks (i.e., for payroll
  checks, dividends checks, etc.)

17
Cash Lockbox accounts

• Company rents a local post office box and
  authorizes a local bank to pick up the checks
  mailed to that box number. The bank will empty
  the box at lease once a day and makes immediate
  credit to the company accounts. This arrangement
  is used for corporation to make collection in
  cities within areas of heaviest customer
  billings. The bank will provide the company with
  a deposit slip, a list of collections and any
  customer correspondence.

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Cash Management and Control

• Cash Management
• 1) to maintain sufficient balance of cash on hand
  for day-to-day operation
• 2) to prevent large amount of idle cash on hand.
• Cash Control to prevent losses of cash by theft
  of fraud
• 1. Immediate deposit of cash.
• 2. Cash payment by checks except for small
  amounts.
• 3. Separation of duties.
• 4. Bank account reconciliation.

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III.Receivables

• Receivables claims held against customers and
  others for money, goods or services.
• Current Receivables expected to be collected
  within one year or one operating cycle, whichever
  is longer.

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Receivables (contd.)

• Trade Receivables amount owed by customers for
  goods sold and services rendered as part of
  normal business operations (i.e., accounts
  receivables and notes receivables).
• Nontrade Receivables all others (i.e., interest
  receivable, advances to employees, deposits to
  cover potential damages, etc.)

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Receivables (contd.)

• Accounts Receivable oral promises of the
  purchasers to pay for goods sold and services
  rendered. They are usually collected in 30-60
  days. Thus, A/R is always reported as a current
  asset with the net realizable value (i.e.,
  subtract allowance for doubtful accounts,
  allowance for sales returns and allowances (if
  significant)). There is no valuation problem
  association with A/R due to the short-term nature
  of the account.

22
Receivables (contd.)

• Notes Receivable written promises to pay a
  certain sum of money on a specific future date.
  N/R can be long-term or short-term and can be
  interesting-bearing or noninterest bearing.
  Short-term N/R is reported at net realizable
  value (face amount - allowances) but long-term
  N/R is reported at present value.

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Valuation of A/R N/R
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Adjustments Related to Sales

• 1. Volume Dis. (Trade Discounts)
• 2. Cash Discounts (Sales Discounts)
• 3. Sales Returns and Allowances
• 4. Uncollectible Accounts

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1. Volume Discount

• When to Recognize the Adjustments Not reflected
  on the J.E.
• Unit price 10
• Volume Dis. 5 if purchase 100 or more units
• Sale 200 units
• J.E.
• Cash 1,900
• Sales 1,900

OR A/R 1,900 Sales 1,900
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2. Cash Discount

• When to Recognize the Adjustments All Methods
  are acceptable.
• A. Recognized at time of sale (Net Price Method)
• B. Recognized at time of occurrence (Gross price
  Method)
• C. Recognized at time of sale (Allowance method)

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2A. Recognized at Time of Sale(Net Price Method)

• Sales 100, terms 2/10, n/30
• 12/26/x1 A/R 98
• Sales 98
• a. 1/2/x2 Cash 98
• A/R 98

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2A. Recognized at Time of Sale(Net Price Method)
(contd.)

• If Dis. not taken
• b. 1/31/x2 Cash 100
• A/R 98
• Cash Dis. not taken 2
• ? ?
• Finance charge or Cash Dis.
  Forteited
• (interest revenue)
• Note If the discount period post on 12/31,
  adjustment is required to bring the A/R to the
  gross amount.

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2B. Recognized at time of occurrence (Gross price
Method)

• Sales 100, terms 2/10, n/30
• 12/26/x1 A/R 100
• Sales 100
• a. 1/2/x2 Cash 98
• Cash Dis. 2
• AR 100
• If Dis. not taken
• b. 1/31/x2 Cash 100
• A/R 100

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2C. Recognized at Time of Sale(Allowance method)

• Sales 100, terms 2/10, n/30
• 12/26/x1 A/R 100
• Allowance for Cash Dis. 2
• Sales 98
• a. 1/2/x2 Cash 98
• Allowance 2
• AR 100
• If Dis. not taken
• b. 1/31/x2 Cash 100
• A/R 100
• Allowance 2
• Cash Dis. not taken 2

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3. Sales Returns Allowances (FASB 48)

• A. The amount of sales RA is not significant.
• B. The amount of sales RA is significant
• and six conditions are not met.
• C. The amount of sales RA is significant and six
  conditions are met.

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3A. The amount of Sales RA Is Not Significant

• If the amount of sales RA is not significant,
  sales RA are recognized at time of occurrence
• Sales Returns Allowances xxx
• A/R (or cash) xxx

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3B. The Amount of Sales RA Is Significant and
Six Conditions Are Not Met

• If the amount of sales RA is significant, and
  the following six conditions are not met,
  postpone the revenue recognition until all six
  conditions are met or the return period expired.

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Six Conditions (SFAS No. 48)

• 1. Sales price is determinable or fixed
• 2. Buyers have paid or have the obligation to pay
  the sales price
• 3. The buyers obligation would not be changed
  due to theft or damage of the product after
  purchase
• 4. Sellers are not responsible for the
  performance of the product

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Six Conditions (SFAS No. 48)

• 5. Buyers and sellers are two separate economic
  entities
• 6. The amount of returns can be estimated.
• If the amount of returns is significant and these
  conditions are not met, revenue cannot be
  recognized.

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3C. The Amount of Sales RA Is Significant and
Six Conditions Are Met

• Sales can be recognized in the period in which
  the sales are made.
• Also, at the end of the same period, the amount
  of sales returns would be estimated and
  recognized.
• 10/5/x1 A/R 10,000
• Sales 10,000
• 12/31/x1 Sales RA 1,000
• Allow. for sale R A 1,000
• (estimate 10 returns)
• 1/10/x2 Allowance for sales RA 900
• A/R 900

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4. Uncollectible Accounts

• Current practice Estimate the B/D exp. at the
  end of the period and recognize the expense (SFAS
  No. 5).
• Adjusting entry for B/D expense
• Estimated B/D expense 2,000
• 12/31 B/D Expense 2,000
• Allowance for
• Doubtful accounts 2,000
• When B/D actually occurred (200 B/D)
• Allowance for doubtful Accounts 200
• A/R 200

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4. Uncollectible Accounts (contd.)

• If 100 of the B/D recovered
• A/R 100
• Allow. for Doubtful Acct. 100
• Cash 100
• A/R 100
• The current practice is complied with the
  matching principle.
• The direct write-off method (recognize the B/D
  expense when it occurs) is not recommended.

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Estimation of B/D Expense

• 1. Percentage of net credit sales (I/S approach).
• 2. Percentage of accounts receivable (B/S
  approach).
• 3. Aging of accounts receivable (B/S approach
  using individual account information).

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1. Percentage of Net Credit Sales (I/S Approach)

• Example
• Net credit sales 20,000
• Estimated B/D exp. 2 of net credit sales
• Adjusting Entry
• 12/31 B/D Expense 400
• Allow. for Doubtful accounts 400

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2. Percentage of A/R (B/S Approach)

• A/R Balance 50,000
• Estimated B/D 1 of A/R
• Beginning balance of the allowance for doubtful
  accounts 300
• The new balance of the allowance for doubtful
  accounts 50,000 x 1 500
• Bad Debt Expense 500 - 300 200
• Adjusting Entry
• B/D expense 200
• Allowance for Doubtful accounts 200

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3. Aging-of-A/R

• The beginning balance of the allow. acct. 100
• B/D expense 440 - 100 340
• 12/31 adjusting entry
• B/D Exp. 340
• Allowance for Doubtful Accounts 340

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Interest on Receivables

• Most of the A/R does not bear interest if the
  customers pay the amount within the term period.
  However, if payment is not made within the term
  period, the customer may have to pay interest on
  the unpaid balance.

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Interest on Receivables Example A

• Credit sale of 1,000 was made on 3/1/x1, terms
  2/10 and n/30. Financial change is 1 per month
  on the unpaid balance. The customer paid the
  first half of the A/R on 5/1/x1 and the second
  half on 6/1/x1.

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Example A (contd.)

• Journal Entries
• 3/1/x1 A/R 1,000
• Sales 1,000
• 5/1/x1 Cash 510
• A/R 500
• Interest Revenue 10 a
• 6/1/x1 Cash 505
• A/R 500
• Interest Revenue 5 b
• a. 1 x 1000
• b. (1,000-500) x 1

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Interest on Receivables Example B

• Installment Sales (with Interest)
• Sales Price 1,200
• CGS 900
• Sales were made on 5/1/x1, four equal payments of
  322.83 were made on 8/1/x1, 11/1/x1, 2/1/x2 and
  5/1/x2 with 3 of quarterly interest rate.
• 1,200 X ? 3.7171
• X 322.83

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Example B (contd.)

• Accrual Method
• Journal Entries
• 5/1/x1 A/R 1,200
• Sales Revenue 1,200
• 8/1/x1 Cash 322.83
• A/R 286.83
• Interest Revenue 36 1
• 11/1/x1 Cash 322.83
• A/R 295.43
• Interest Revenue 27.40 2
• 1. 3 ? 1,200
• 2. (1,200 - 286.83) ? 3

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Example B (contd.)

• 2/1/x2 Cash 322.83
• A/R 304.30
• Interest Revenue 18.53 1
• 5/1/x2 Cash 322.83
• A/R 313.43
• Interest Revenue 9.40 2
• 1. (1,200 - 286.83 - 295.43) ? 3
• 2. (1,200 - 286.83 - 295.43 - 304.30) ? 3
• A/R
• 1,200 286.43 - 5/1/x1
• 295.43 - 8/1/x1
• 304.30 - 2/1/x2
• 313.43 - 5/1/x2

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IV. Disposition of Accounts Receivable (Using
A/R as a financial Instrument)

• Advantages
• 1) Immediate use of cash (i.e., pledge, assign
  and factor)
• 2) Avoid the cost of billing and collection
  (i.e., factor).
• Disadvantages
• 1) Service charge (i.e., assign and factor)
• 2) Interest charge (i.e., pledge, assign and
  factor with recourse).

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Pledge of A/R(General assignment of A/R)

• Pledge of A/R
• Use A/R as a security (collateral) to borrow
  money from financial institutions.
• No journal entries are required for the pledge.
  Information related to the pledge is disclosed in
  the footnote.

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Pledge of A/RExample

• Borrow 100,000 by pledging all receivables for
  the borrowing
• Journal Entry
• Cash 100,000
• Notes Payable 100,000
• Notes The companys trade accounts are pledged
  as collateral for the 100,000 notes payable

52
Pledge of A/RExample (contd.)

• When the note is due and paid, the following
  entry will be recorded
• Notes Payable 100,000
• Interest Expense 3,000
• Cash 103,000
• Assume a 12 interest and a 3-month duration.

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Pledge of A/RExample (contd.)

• If the note is not paid on the maturity date, the
  lending institution can seize and collect the
  pledged A/R.
• The borrower (the company) continues to have the
  control of the A/R. Cash used to pay off the
  note can be from any sources including proceeds
  received from the pledged A/R.

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Assignment of Accounts Receivable(specific)

• Use A/R as a mean to borrow money from banks or
  financial institutions. Specific A/R are
  assigned as collateral for the borrowing.
  Companies (the borrowers) continue to have the
  control of the A/R assigned and continue to
  collect assigned A/R from the customers.

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Assignment of Accounts Receivable(contd.)

• The amount collected from the assigned A/R must
  be remitted to the lending institution
  periodically. The proceeds collected from the
  assigned A/R cannot be used for any other
  purposes until all loans are paid off.
• The lender usually charges 1) a service charge
  (i.e., 5 of the loan amount), 2) interest on the
  loan.

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Example of (Specific) Assignment

• (Illustration 7-14 of textbook with little
  modification for April collections.)
• On March 1, 20x2, Howat Mills Inc. (HM), assigns
  700,000 of its accounts receivable to Citizens
  Bank as collateral for a 500,000 borrowing. HM
  continues to collect the A/R the account debtors
  are not notified of the assignment (a
  non-notification assignment). Citizens Bank
  charges a finance charge of 1 of the A/R
  assigned. The annual interest on the note is
  12. Settlement by HM to the bank is made
  monthly for all cash collection on the assigned
  receivable.

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Example of Assignment (contd.)
58
Example of Assignment (contd.)
59
Example of Assignment (contd.)
60
Example of Assignment (contd.)

• The balance sheet statement of HM on 4/1 after
  the remittance of 434,000 cash collected from
  A/R Assigned in March, the balance of the A/R
  assigned account is 246,000 (700,000 -
  454,000) and the balance of the Notes Payable
  account is 66,000 (500,000-434,000). These
  two accounts will be presented on the balance
  sheet statement as
• Current Assets
• Accounts Receivable Assigned 246,000
• Notes Payable (66,000)
• Equity in Assigned A/R 180,000

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Sale (Factor) of Accounts Receivable

• A common type of sale of A/R is a sale to a
  factor. Factors are finance companies or banks
  that buy receivables from businesses for a fee
  and then collect the receivables directly from
  the customers.
• In the case of factor, A/R would be transferred
  to the purchaser. The purchaser would collect
  the accounts, not the seller. The seller
  relinquishes all rights pertaining to the future
  collection of A/R.

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Sale (Factor) of A/R (contd.)

• Sale of A/R is a common practice in some
  industries such as textile, apparel, footwear,
  furniture, etc. Credit card transaction (like
  VISA charges) is also a type of factoring
  arrangement in which the purchaser (the card
  issuer) of the receivable charges a 0.75 to 1.5
  commission of the receivables purchased.

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Types of Factor

• Factor without recourse
• Factor with recourse
• Recourse is a right of a purchaser of receivables
  to receive payments from the seller of those
  receivables for failure of the debtors to pay
  when due.

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Factor without Recourse

• In the case of factor without recourse, the
  purchaser assumes the risk of collectibility and
  absorbs any credit losses (i.e., bad debts).
  Thus, factor without recourse is a sale of
  receivables both in form (the transfer of the
  title of the receivable) and in substance
  (transfer of the risk).

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Example of Factor without Recourse

• (Illustration 7-16 of textbook with some
  modifications.)
• Crest Textiles factors 500,000 of A/R with ABC
  Bank on a without recourse basis. The
  receivables are transferred to ABC bank on 5/1.
  ABC bank charges 3 of financial charge for
  factor without recourse and retain an amount
  equals to 5 of the A/R to cover sales returns
  and discounts. Credit losses (bad debts) are
  absorbed by ABC bank due to factor without
  recourse. The ABC bank expects 4,100 of
  uncollectible accounts from the receivables
  purchased.

66
Example of Factor without Recourse(contd.)

• Crest Textiles
• 5/1
• Cash 460,000
• Due from
• Factor 25,000
• Loss on Sale
• of Rec. 15,000
• A/R 500,000

• ABC Bank
• A/R 500,000
• Due to
• Crest Texti. 25,000
• Financing Rev. 15,000
• Cash 460,000
• Recognition of Bad Debt Exp.
• Bad Debt Exp. 4,100
• Allow. For
• Doub. Acct. 4,100

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Example of Factor without Recourse(contd.)

• Crest Textiles
• .
• Sales RA 9,500
• Sales Dis. 2,600
• Due from
• Factor 12,100

• ABC Bank
• Cash 483,800
• Due to
• Crest Texti. 12,100
• A/R 495,900
• Allow. for
• Doub. Acct. 4,100
• A/R 4,100

Transactions in May and June collects of
483,800 by ABC bank sales RA of 9,500 sales
discounts taken of 2,600 and 4,100 bad debts
written off by ABC bank.
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Example of Factor without Recourse(contd.)

• Crest Textiles
• Cash 12,900
• Due from
• Factor 12,900

• ABC Bank
• Due to
• Crest Texi 12,900
• Cash 12,900

Final settlement between Crest Text and ABC Bank
Note The factors (ABC Bank) income from this
factor is 15,000 - 4,100 (finance revenue -
uncollectible receivables).
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Factor with Recourse

• When receivables are sold with recourse, the
  seller guarantees payment to the purchaser in the
  event the debtor fails to pay (or the payment of
  the debtor is less than expected by the
  purchaser). Thus, the seller retains the same
  risk of collection after the deal as before.
  SFAS No. 77 requires that a sale of receivables
  with recourse be recognized as a sale if all
  three conditions are met

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Factor with RecourseThree Conditions

• 1. The seller surrenders control of the future
  economic benefits of the receivables.
• 2. The sellers obligation under the recourse
  provisions can be reasonable estimated.
• 3. The purchaser cannot require the seller to
  repurchase the receivable.

71
Factor with RecourseThree Conditions (contd.)

• The purchaser usually charges a higher financial
  fee in the case of factor without recourse than
  in the case of factor with recourse.

72
Example of Factor with Recourse

• Crest Textiles factors 500,000 of A/R with ABC
  Bank on a with recourse basis. The receivables
  are transferred to ABC Bank on 5/1. ABC Bank
  charges 2 of financial charge for factor with
  recourse and retains an amount equals to 5 of
  the A/R to cover sales returns and discounts.
  Credit losses (bad debts) are absorbed by Crest
  Textiles, Inc. due to factor with recourse. The
  Crest Textiles, Inc. expects 4,100 of
  uncollectible accounts from the receivables
  factored.

73
Example of Factor with Recourse(contd.)

• Crest Textile
• (Treated as a Sale)
• 5/1 Cash 465,000
• Due from
• Factor 25,000
• Loss on Sale
• of Rec. 10,000
• A/R 500,000

• Crest Textile
• (Treated as a Borrowing)
• Cash 465,000
• Due from
• Factor 25,000
• Int. Exp. 10,000
• Liability on
• Transferred
• A/R 500,000

74
Example of Factor with Recourse(contd.)

• Crest Textile
• (Treated as a Sale)
• B/D Exp. 4,100
• Due
• from Factor 4,100

• Crest Textile
• (Treated as a Borrowing)
• B/D Exp. 4,100
• Allow. for
• Doub. Acct. 4,100

Recognition of Bad Debts
75
Example of Factor with Recourse(contd.)

• Crest Textile
• (Treated as a Sale)
• Sales RA 9,500
• Sales Dis. 2,600
• Due
• from Factor 12,100

• Crest Textile
• (Treated as a Borrowing)
• Sales RA 9,500
• Sales Dis. 2,600
• Allow. for
• Doub. Acct 4,100
• Due
• from Factor 16,200
• Liability on
• Tran. A/R 500,000
• A/R 500,000

Transactions in May and June (same as in without
recourse example)
76
Example of Factor with Recourse(contd.)

• Crest Textile
• (Treated as a Sale)
• Cash 8,800a
• Due
• from Factor 8,800

• Crest Textile
• (Treated as a Borrowing)
• Cash 8,800a
• Due
• from Factor 8,800

(Settlement between Crest and ABC)
a. 4,100 less than in the case of factor without
recourse. This is due to the bad debt amount
4,100 is absorbed by the seller (Crest Textile)
in the case of factor with recourse.
77
Example of Factor with Recourse(contd.)

• ABC Bank
• (Treated as a Sale)
• 5/1
• A/R 500,000
• Cash 465,000
• Due to Crest 25,000
• Financing Rev. 10,000

• ABC Bank
• (Treated as a Loan)
• 5/1
• Receivables 500,000
• Cash 465,000
• Due to Crest 25,000
• Financing Rev. 10,000

78
Example of Factor with Recourse(contd.)

• ABC Bank
• (Treated as a Sale)
• Cash 483,800
• Due
• to Crest 12,100
• A/R 495,900

• ABC Bank
• (Treated as a Loan)
• Cash 483,800
• Due
• to Crest 12,100
• Receivable 495,900

Transactions in May and June collects of
483,800 by ABC bank sales RA of 9,500 sales
discounts taken of 2,600 and bad debt of 4,100
materialized.
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Example of Factor with Recourse(contd.)

• ABC Bank
• (Treated as a Sale)
• Due
• to Crest 12,900
• Cash 8,8001,a
• A/R 4,100

• ABC Bank
• (Treated as a Loan)
• Due
• to Crest 12,900
• Cash 8,800
• Receivable 4,100

(Settlement between Crest and ABC)
1. equal to 25,000 - 12,100 - 4,100(Bad Debt)
8,800 a. also equal to 483,800 - 475,000 8,800
80
V. Notes Receivable

• Note receivable A written promissory note can
  be interest bearing or non-interest bearing.
• Short-term N/R Recorded at the amount expected
  to be collected.
• Interest bearing Accrued interest recognized at
  the end of a period.
• Non-interest bearing

81
Notes Receivable (contd.)

• Long-term N/R
• 1. Recorded at net present value
• 2. End of period valuation --NPV
• (Source APB No. 21)

82
Notes ReceivableCase I Non-Interesting Bearing
Example

• Receiving a 3 month non-interest bearing note on
  11/1/x1 with a face amount of 10,000.
• 11/1/x1 N/R 10,000
• Sales 10,000
• 12/31/x1 No adjusting entry for accrued interest
  because the note is a non-interest bearing note.
• 1/31 Cash 10,000
• N/R 10,000
• If the note is dishonored on 1/31
• A/R 10,000
• N/R 10,000

83
Notes ReceivableCase II Interesting Bearing
Example

• Short-term note with interest bearing annual
  interest rate 12.
• Receiving a 3-month interest bearing note on
  11/1/x1. Face amount is 10,000 and the annual
  interest rate is 12

84
Case II (contd.)

• 11/1/x1 N/R 10,000
• Sales 10,000
• 12/31/x1 Interest Receivable 200
• Interest Revenue 200
• 1/1/x2 Reversing Entry
• Interest Revenue 200
• Interest Receivable 200
• 1/31/x2 Cash 10,300
• N/R 10,000
• Interest Revenue 300

85
Discount of Notes (to a bank or to any finance
institution)

• Example A 3-month note with a face amount of
  10,000 (received on 11/1/x1) is discounted on
  12/1/x1.
• Interest rate of the note 12 (annual)
• Int. rate charged by the bank 18 (annual)

86
Discount of Notes (contd.)

• 1. Maturity value of the note
• 10,000 10,000 ? 12 ? 3/12
• 10,300
• 2. Interest charged by the bank (discount)
• 10,300 x 18 x 2/12 309

87
Discount of Notes (contd.)

• Proceeds received by the firm from discounting
  the note (the bank will deduct the interest
  charge from the proceeds)
• 10,300 - 309 9,991

88
Discount of Notes (contd.)

• J.E. on 12/1
• Cash 9,991
• Loss on Dis. of Note 109
• N/R Discounted 10,000
• Interest Revenuea 100
• a.Interest earned by the firm from holding the
  note for one month (11/1 12/1) 10,000 ? 12
  ? 1/12 100
• Footnote (FASB) Contingent liability of
  discounted note of 10,000

89
Discount of Notes (contd.)

• On 1/31/x2, the note is paid, the following entry
  will be recorded
• N/R discounted 10,000
• N/R 10,000
• If on 1/31/x2, the note is dishonored, the
  following entry will be recorded
• (Assuming the bank charge 10 fee)
• N/R Discounted 10,000
• Loss on Dishonored Note 10,310
• N/R 10,000
• Cash 10,310

90
Long-Term Notes Receivable

• Initial Recording Net present value
• End of Period Net present value

91
Long-Term N/RExample A

• Receiving a 2-year note on sales of goods on
  1/1/x1. The face amount of this note is 100,000
  and the annual interest of the note is 10. The
  interests are paid annually and the market
  interest rate is 12. Present value of the note
• 100,000 ? 0.79719 10,000 ? 1.69005
• 96,620

92
Long-Term N/RExample A (contd.)

• 1/1/x1
• Notes Receivable 100,000
• Sales Revenue 96,620
• Discounts on N/R 3,380
• Effective Interest of 20x1
• PV of note on 1/1/x1 ? 12
• (100,000 - 3,380) ? 12
• 11,594.4

93
Long-Term N/RExample A (contd.)

• 12/31/x1 (recording receiving of 10,000
  interest)
• Cash 10,000
• Discount on N/R 1,594.4
• Interest Revenue 11,594.4
• P.V. of the note on 1/1/x2
• 100,000 - (3,380 - 1594.4) 98,214.4
• Effective Interest of 20x2 PV on 1/1/x2 ? 12
• 98,214.4 ? 12 11,785.7

94
Long-Term N/RExample A (contd.)

• 12/31/x2 (recording int. received on 12/31/x2)
• Cash 10,000
• Discount on N/R 1,785.7
• Int. Revenue 11,785.7
• 12/31/x1 (recording face amount of N/R received
  on maturity date)
• Cash 100,000
• N/R 100,000
• Discount on N/R has been amortized to zero after
  two years of amortization using the effective
  interest method.

95
Long-Term N/RExample B

• On 12/31/x1 La Tourette Inc. rendered services to
  Husky Corp. at an agreed price of 73,844.10,
  accepting 18,000 down and agreeing to accept the
  balance in four equal installments of 18,000
  receivable each 12/31. An assumed interest rate
  of 11 is imputed. Record the journal entries
  for La Tourette for the sale and for the receipts
  and interest on the following dates
• 1. 12/31/20x1 2. 12/31/20x2
• 3. 12/31/20x3 4. 12/31/20x4
• 5. 12/31/20x5

96
Long-Term N/RExample B (contd.)

• PV of 18,000 annuity _at_11, four payments
• 18,000 ? 3.10245 55,844.10
• Thus, the revenue from the services
• 18,000 55,844.10 73,844.10
• 12/31/x1
• Cash 18,000
• Notes Receivable 72,000
• Discount on N/R 16,155.9a
• Revenue from Services 73,844.10
• a. (18,000 ? 4) - 55,844.10 16,155.9

97
Long-Term N/RExample B (contd.)

• 12/31/x2 (recording install. Payment of 18,000
  and the amortization of discount on N/R)
• Cash 18,000
• N/R 18,000
• Discount on N/R 6,142.85
• Interest Revenue 6,142.85a
• a. Interest Revenue of 20x2
• pv of note on 1/1/x2 (or 12/31/x1) ? 11
• 55,844.1 ? 11 6,142.85

98
Long-Term N/RExample B (contd.)

• 12/31/x3
• Cash 18,000
• N/R 18,000
• Discount on N/R 4,838.56
• Interest Revenue 4,838.56a
• a. Interest Revenue of 20x3
• pv of note on 1/1/x3 ? 11
• (55,844.1 - 18,000 6,142.85) ? 11
• 43,986.95 ? 11 4,838.56

99
Long-Term N/RExample B (contd.)

• 12/31/x4 (recording install. Payment of 18,000
  and the amortization of discount on N/R)
• Cash 18,000
• N/R 18,000
• Discount on N/R 3,390.81
• Interest Revenue 3,390.81a
• a. Interest Revenue of 20x4
• pv of note on 1/1/x4 ? 11
• (43,986.95 - 18,000 4,836.56) ? 11
• 30,825.51 ? 11 3,390.81

100
Long-Term N/RExample B (contd.)

• 12/31/x5
• Cash 18,000
• N/R 18,000
• Discount on N/R 1,783.68
• Interest Revenue 1,783.68a
• a. Interest Revenue of 20x5
• pv of note on 1/1/x5 ? 11
• (30,825.51 - 18,000 3,390.81) ? 11
• 16,216.31 ? 11 1,783.68

101
Notes Received for Cash and Other Rights

• Avon Co. accepts a 3-year, 100,000,
  zero-interest-bearing note from Andrew Co. plus
  the right to purchase 50 machines at a bargain
  price in exchange for 100,000 in cash. Assume
  that the current rate is 10 (for a similar note
  without the right)

102
N/R Received for Cash and Other Rights (contd.)

• J.E. for Greene
• N/R 100,000
• Prepaid Purchase 24,868
• Cash 100,000
• Discount on N/R 24,868
• The 24,868 will be amortized as interest revenue
  in next 3 years. The prepaid purchase will be
  amortized (proportionally to 50 machines) to
  increase the purchase price of machines.

103
Notes Received for Property, Goods and Services

• Example Lenex sold a lot to Impex as an office
  site. Lenex accepted a 3-year note with a
  maturity value of 150,200 and with no stated
  interest rate. The land originally cost Lenex
  30,000 and had an appraised fair value of
  70,000 on the selling date.

104
Notes Received for Property, Goods and Services
(contd.)

• J.E. N/R 150,200
• Dis. on N/R 80,200
• Land 30,000
• Gaina,b 40,000
• a. Use the fair value of the land as the present
  value of the note assuming the discount rate of
  the note is unknown.
• b. The discount of N/R will be amortized in next
  three years. If the effective rate of the note
  is known, the present value of the note can be
  calculated. The gain amount will be the
  difference between the P.V. of the note and the
  cost of the land. The discount amount will be
  the difference between the maturity value and the
  P.V. of the note.