Chapter 7 Cash and Receivables 1 Question 7-1 Cash equivalents usually include negotiable instruments as well as highly liquid investments that have a maturity date no longer than three months from date of purchase. Question 7-2 Internal control procedures involving accounting functions are intended to improve the accuracy and reliability of accounting information and to safeguard the company’s assets. The separation of duties means that employees involved in recordkeeping should not also have physical responsibility for assets. Question 7-3 Management must document the company’s internal controls and assess their adequacy. The auditors must provide an opinion on management’s assessment. The Public Company Accounting Oversight Board’s Auditing Standard No. 2 further requires the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting Question 7-4 A compensating balance is an amount of cash a depositor (debtor) must leave on deposit in an account at a bank (creditor) as security for a loan or a commitment to lend. The classification and disclosure of a compensating balance depends on the nature of the restriction and the classification of the related debt. If the restriction is legally binding, then the cash will be classified as either current or noncurrent depending on the classification of the related debt. In either case, note disclosure is appropriate. If the compensating balance arrangement is informal and no contractual agreement restricts the use of cash, note disclosure of the arrangement including amounts involved is appropriate. The compensating balance can be included in the cash and cash equivalents category of current assets. Question 7-5 Trade discounts are reductions below a list price and are used to establish a final price for a transaction. The reduced price is the starting point for initial valuation of the transaction. A cash discount is a reduction, not in the selling price of a good or service, but in the amount to be paid by a credit customer if the receivable is paid within a specified period of time. Chapter 7 Cash and Receivables QUESTIONS FOR REVIEW OF KEY TOPICS 2 Question 7-6 The gross method of accounting for cash discounts considers discounts not taken as part of sales revenue. The net method considers discounts not taken as interest revenue, because they are viewed as compensation to the seller for allowing the buyer to defer payment. 3 Answers to Questions (continued) Question 7-7 When returns are material and a company can make reasonable estimates of future returns, an allowance for sales returns is established. At a financial reporting date, this provides an estimate of the amount of future returns for prior sales, and involves a debit to sales returns and a credit to allowance for sales returns for the estimated amount. Allowance for sales returns is a contra account to accounts receivable. When returns actually occur in the future reporting period, the allowance for sales returns is debited. Question 7-8 Even when specific customer accounts haven’t been proven uncollectible by the end of the reporting period, bad debt expense properly should be matched with sales revenue on the income statement for that period. Likewise, since it’s not expected that all accounts receivable will be collected, the balance sheet should report only the expected net realizable value of that asset. So, to record the bad debt expense and the related reduction of accounts receivable when the amount hasn’t been determined, an estimate is needed. In an adjusting entry, we record bad debt expense and reduce accounts receivable for an estimate of the amount that eventually will prove uncollectible. If uncollectible accounts are immaterial or not anticipated, or it’s not possible to reliably estimate uncollectible accounts, an allowance for uncollectible accounts is not appropriate. In these few cases, any bad debts that do arise simply are written off as bad debt expense. Question 7-9 The income statement approach to estimating bad debts determines bad debt expense directly by relating uncollectible amounts to credit sales. The balance sheet approach to estimating future bad debts indirectly determines bad debt expense by estimating the net realizable value for accounts receivable that exist at the end of the period. In other words, the allowance for uncollectible accounts at the end of the period is estimated and then bad debt expense is determined by adjusting the allowance account to reflect net realizable value. Question 7-10 The assignment of all accounts receivable in general as collateral for debt requires no special accounting treatment other than note disclosure of the agreement. Question 7-11 Accounts receivable factored without recourse are accounted for as the sale of an asset. The difference between the book value and the proceeds received is recognized as a gain or a loss. The accounting treatment of receivables factored with recourse depends on whether certain criteria are met. If the criteria are met, the factoring is accounted for as a sale. If they are not met, the factoring is accounted for as a loan. In addition, note disclosure may be required. 4 Answers to Questions (concluded) Question 7-12 When a note is discounted, a financial institution, usually a bank, accepts the note and gives the seller cash equal to the maturity value of the note reduced by a discount. The discount is computed by applying a discount rate to the maturity value and represents the financing fee the bank charges for the transaction. The four-step process used to account for a discounted note receivable is as follows: 1. Accrue any interest revenue earned since the last payment date (or date of the note). 2. Compute the maturity value. 3. Subtract the discount the bank requires (discount rate times maturity value times the length of time from date of discounting to maturity date) from the maturity value to compute the proceeds to be received from the bank (maturity value less discount). 4. Compute the difference between the proceeds and the book value of the note and related interest receivable. The treatment of the difference will depend on whether the discounting is accounted for as a sale or as a loan. If it’s a sale the difference is recorded as a loss or gain on the sale; if it’s a loan the difference is viewed as interest expense or interest revenue. Question 7-13 A company’s investment in receivables is influenced by several related variables, to include the level of sales, the nature of the product or service, and credit and collection policies. The receivables turnover and average collection period ratios are designed to monitor receivables. Question 7-14 The items necessary to adjust the bank balance might include deposits outstanding (including undeposited cash), outstanding checks, and any bank errors discovered during the reconciliation process. The items necessary to adjust the book balance might include collections made by the bank on the company’s behalf, service and other charges made by the bank, NSF (nonsufficient funds) check charges, and any company errors discovered during the reconciliation process. Question 7-15 A petty cash fund is established by transferring a specified amount of cash from the company’s general checking account to an employee designated as the petty cash custodian. The fund is replenished by writing a check to the petty cash custodian for the sum of the bills paid with petty cash. The appropriate expense accounts are recorded from petty cash vouchers at the time the fund is replenished. 5 Brief Exercise 7-1 The company could improve its internal control procedure for cash receipts by segregating the duties of recordkeeping and the handling of cash. Jim Seymour, responsible for recordkeeping, should not also be responsible for depositing customer checks. Brief Exercise 7-2 All of these items would be included as cash and cash equivalents except the U.S. Treasury bills, which would be included in the current asset section of the balance sheet as short-term investments. Brief Exercise 7-3 Income before tax in 2007 will be reduced by $2,500, the amount of the cash discounts. $25,000 x 10 = $250,000 x 1% = $2,500 Brief Exercise 7-4 Income before tax in 2006 will be reduced by $2,500, the anticipated amount of cash discounts. $25,000 x 10 = $250,000 x 1% = $2,500 BRIEF EXERCISES 6 Brief Exercise 7-5 Estimated returns = $10,600,000 x 8% = $848,000 Less: Actual returns (720,000) Remaining estimated returns $128,000 Sales returns .................................................................... 128,000 Allowance for sales returns ....................................... 128,000 Inventory ........................................................................ 76,800 Cost of goods sold ($128,000 x 60%) ........................... 76,800 Brief Exercise 7-6 (1) Bad debt expense = $1,500,000 x 2% = $30,000 (2) Allowance for uncollectible accounts: Beginning balance $25,000 Add: Bad debt expense 30,000 Deduct: Write-offs (16,000) Ending balance $39,000 7 Brief Exercise 7-7 (1) Allowance for uncollectible accounts: Beginning balance $ 25,000 Deduct: Write-offs (16,000) Required allowance (33,400)* Bad debt expense $24,400 (2) Required allowance = $334,000** x 10% = $33,400* Accounts receivable: Beginning balance $ 300,000 Add: Credit sales 1,500,000 Deduct: Cash collections (1,450,000) Write-offs (16,000) Ending balance $ 334,000** Brief Exercise 7-8 Allowance for uncollectible accounts: Beginning balance $30,000 Add: Bad debt expense 40,000 Deduct: Required allowance (38,000) Write-offs $32,000 8 Brief Exercise 7-9 Credit sales $8,200,000 Deduct: Cash collections (7,950,000) Write-offs (32,000)* Year-end balance in A/R (2,000,000) Beginning balance in A/R $1,782,000 *Allowance for uncollectible accounts: Beginning balance $30,000 Add: Bad debt expense 40,000 Deduct: Required allowance (38,000) Write-offs $32,000 Brief Exercise 7-10 2006 interest revenue: $20,000 x 6% x 1/12 = $100 2007 interest revenue: $20,000 x 6% x 2/12 = $200 9 Brief Exercise 7-11 Assets decrease by $3,000: Cash increases by $100,000 x 85% = $ 85,000 Receivable from factor increases by ([15% x $100,000] – $3,000 fee) 12,000 Accounts receivable decrease (100,000) Net decrease in assets $ (3,000) Liabilities would not change as a result of this transaction. Income before income taxes decreases by $3,000, the amount of the factor’s fee. ($100,000 x 3%) The journal entry to record the transaction is as follows: Cash (85% x $100,000) ...................................................... 85,000 Loss on sale of receivables (3% x $100,000) ..................... 3,000 Receivable from factor ([15% x $100,000] – $3,000 fee) ..... 12,000 Accounts receivable (balance sold) ............................... 100,000 Brief Exercise 7-12 Logitech would account for the transfer as a secured borrowing. The receivables would remain on the company’s books and a liability is recorded for the amount borrowed plus the bank’s fee. 10 Brief Exercise 7-13 $30,000 Face amount 450 Interest to maturity ($30,000 x 6% x 3/12) 30,450 Maturity value (406) Discount ($30,450 x 8% x 2/12) $30,044 Cash proceeds Brief Exercise 7-14 Receivables turnover = $320,000 = 5.33 $60,000* ($50,000 + 70,000) ÷ 2 = $60,000* Average collection = 365 = 68 days period 5.33 11 Exercise 7-1 Requirement 1 Cash and cash equivalents includes: a. Balance in checking account $13,500 Balance in savings account 22,100 b. Undeposited customer checks 5,200 c. Currency and coins on hand 580 f. U.S. treasury bills with 2-month maturity 15,000 Total $56,380 Requirement 2 d. The $400,000 savings account will be used for future plant expansion and therefore should be classified as a noncurrent asset, either in other assets or investments. e. The $20,000 in the checking account is a compensating balance for a long-term loan and should be classified as a noncurrent asset, either in other assets or investments. f. The $20,000 in 7-month treasury bills should be classified as a current asset along with other temporary investments. EXERCISES 12 Exercise 7-2 Requirement 1 Cash and cash equivalents includes: Cash in bank – checking account $22,500 U.S. treasury bills 5,000 Cash on hand 1,350 Undeposited customer checks 1,840 Total $30,690 Requirement 2 The $10,000 in 6-month treasury bills should be classified as a current asset along with other temporary investments. 13 Exercise 7-3 Requirement 1 Sales price = 100 units x $600 = $60,000 x 70% = $42,000 November 17, 2006 Accounts receivable ........................................................ 42,000 Sales revenue .............................................................. 42,000 November 26, 2006 Cash (98% x $42,000) ........................................................ 41,160 Sales discounts (2% x $42,000) ......................................... 840 Accounts receivable .................................................... 42,000 Requirement 2 November 17, 2006 Accounts receivable ........................................................ 42,000 Sales revenue .............................................................. 42,000 December 15, 2006 Cash ................................................................................ 42,000 Accounts receivable .................................................... 42,000 14 Exercise 7-3 (concluded) Requirement 3 Requirement 1: November 17, 2006 Accounts receivable ........................................................ 41,160 Sales revenue (98% x $42,000) ...................................... 41,160 November 26, 2006 Cash ................................................................................ 41,160 Accounts receivable .................................................... 41,160 Requirement 2: November 17, 2006 Accounts receivable ........................................................ 41,160 Sales revenue (98% x $35,000) ...................................... 41,160 December 15, 2006 Cash ................................................................................ 42,000 Accounts receivable .................................................... 41,160 Interest revenue ........................................................... 840 15 Exercise 7-4 Requirement 1 Sales price = 1,000 units x $50 = $50,000 July 15, 2006 Accounts receivable ........................................................ 50,000 Sales revenue .............................................................. 50,000 July 23, 2006 Cash (98% x $50,000) ........................................................ 49,000 Sales discounts (2% x $50,000) ......................................... 1,000 Accounts receivable .................................................... 50,000 Requirement 2 July 15, 2006 Accounts receivable ........................................................ 50,000 Sales revenue .............................................................. 50,000 Aug. 15, 2006 Cash ................................................................................ 50,000 Accounts receivable .................................................... 50,000 16 Exercise 7-5 Requirement 1 July 15, 2006 Accounts receivable ........................................................ 49,000 Sales revenue (98% x $50,000) ...................................... 49,000 July 23, 2006 Cash ................................................................................ 49,000 Accounts receivable .................................................... 49,000 Requirement 2 July 15, 2006 Accounts receivable ........................................................ 49,000 Sales revenue (98% x $50,000) ...................................... 49,000 August 15, 2006 Cash ................................................................................ 50,000 Accounts receivable .................................................... 49,000 Interest revenue ........................................................... 1,000 17 Exercise 7-6 Requirement 1 $67,500 (1.5% x $4,500,000) Requirement 2 Allowance for uncollectible accounts Balance, beginning of year $42,000 Add: Bad debt expense for 2006 (1.5% x $4,500,000) 67,500 Less: End-of-year balance (40,000) Accounts receivable written off $69,500 Requirement 3 $69,500 — the amount of accounts receivable written off. 18 Exercise 7-7 Requirement 1 To record the write-off of receivables. Allowance for uncollectible accounts ............................. 21,000 Accounts receivable .................................................... 21,000 To record the collection of a receivable previously written off. Accounts receivable ........................................................ 1,200 Allowance for uncollectible accounts ......................... 1,200 Cash ................................................................................ 1,200 Accounts receivable .................................................... 1,200 Allowance for uncollectible accounts: Balance, beginning of year $32,000 Deduct: Receivables written off (21,000) Add: Collection of receivable previously written off 1,200 Balance, before adjusting entry for 2006 bad debts 12,200 Required allowance: 10% x $625,000 (62,500) Bad debt expense $50,300 To record bad debt expense for the year. Bad debt expense ............................................................ 50,300 Allowance for uncollectible accounts ......................... 50,300 Requirement 2 Current assets: Accounts receivable, net of $62,500 in allowance for uncollectible accounts $562,500 19 Exercise 7-8 Using the direct write-off method, bad debt expense is equal to actual write- offs. Collections of previously written-off receivables are recorded as revenue. Allowance for uncollectible accounts: Balance, beginning of year $17,280 Deduct: Receivables written off (17,100) Add: Collection of receivables previously written off 2,200 Less: End of year balance (22,410) Bad debt expense for the year 2006 $20,030 Exercise 7-9 ($ in millions) Allowance for uncollectible accounts: Balance, beginning of year $242 Add: Bad debt expense 44 Less: End of year balance (166) Write-offs during the year $120* Accounts receivable analysis: Balance, beginning of year ($5,196 + 242) $ 5,438 Add: Credit sales 36,835 Less:Write-offs* (120) Less: Balance end of year ($5,890 + 166) (6,056) Cash collections $36,097 20 Exercise 7-10 Requirement 1 June 30, 2006 Note receivable ............................................................... 30,000 Sales revenue .............................................................. 30,000 December 31, 2006 Interest receivable ........................................................... 900 Interest revenue ($30,000 x 6% x 6/12) ........................... 900 March 31, 2007 Cash [$30,000 + ($30,000 x 6% x 9/12)] ................................ 31,350 Interest revenue ($30,000 x 6% x 3/12) ........................... 450 Interest receivable (accrued at December 31) .................. 900 Note receivable .......................................................... 30,000 Requirement 2 2006 income before income taxes would be understated by $900 2007 income before income taxes would be overstated by $900. 21 Exercise 7-11 Requirement 1 June 30, 2006 Note receivable (face amount) ........................................... 30,000 Discount on note receivable ($30,000 x 8% x 9/12) ........ 1,800 Sales revenue (difference) ............................................. 28,200 December 31, 2006 Discount on note receivable .......................................... 1,200 Interest revenue ($30,000 x 8% x 6/12) ............................ 1,200 March 31, 2007 Discount on note receivable .......................................... 600 Interest revenue ($30,000 x 8% x 3/12) ............................ 600 Cash ................................................................................ 30,000 Note receivable (face amount) ....................................... 30,000 Requirement 2 $ 1,800 interest for 9 months ÷ $28,200 sales price = 6.38% rate for 9 months x 12/9 to annualize the rate _______ = 8.51% effective interest rate 22 Exercise 7-12 Requirement 1 Book value of stock $16,000 Plus gain on sale of stock 6,000 = Note receivable $22,000 Interest reported for the year $ 2,200 = 10% rate Divided by value of note $ 22,000 Requirement 2 To record sale of stock in exchange for note receivable. January 1, 2006 Note receivable ............................................................... 22,000 Investments ................................................................. 16,000 Gain on sale of investments ........................................ 6,000 To accrue interest on note receivable for twelve months. December 31, 2006 Interest receivable ........................................................... 2,200 Interest revenue ($22,000 x 10%) .................................. 2,200 Exercise 7-13 1. a 2. a 3. a 4. a 23 Exercise 7-14 Cash (difference) ............................................................... 439,200 Finance charge expense (1.8% x $600,000) ....................... 10,800 Liability – financing arrangement ............................. 450,000 Exercise 7-15 Cash (90% x $60,000) ........................................................ 54,000 Loss on sale of receivables (2% x $60,000) ....................... 1,200 Receivable from factor ([10% x $60,000] – $1,200 fee) ....... 4,800 Accounts receivable (balance sold) ............................... 60,000 Exercise 7-16 Cash (90% x $60,000) ........................................................ 54,000 Loss on sale of receivables ([2% x $60,000] + $3,000) ....... 4,200 Receivable from factor ([10% x $60,000] – $1,200 fee) ...... 4,800 Recourse liability ....................................................... 3,000 Accounts receivable (balance sold) ............................... 60,000 24 Exercise 7-17 Step 1: Accrue interest earned. February 28, 2006 Interest receivable ........................................................... 250 Interest revenue ($15,000 x 10% x 2/12) .......................... 250 Step 2: Add interest to maturity to calculate maturity value. Step 3: Deduct discount to calculate cash proceeds. $15,000 Face amount 750 Interest to maturity ($15,000 x 10% x 6/12) 15,750 Maturity value (630) Discount ($15,750 x 12% x 4/12) $15,120 Cash proceeds Step 4: To record a loss for the difference between the cash proceeds and the note’s book value. February 28, 2006 Cash (proceeds determined above) ........................................ 15,120 Loss on sale of note receivable (difference) ...................... 130 Note receivable (face amount) ....................................... 15,000 Interest receivable (accrued interest determined above) .... 250 Exercise 7-18 1. d 2. c 25 Exercise 7-19 List A List B c 1. Internal control a. Restriction on cash. j 2. Trade discount b. Cash discount not taken is sales revenue. g 3. Cash equivalents c. Includes separation of duties. h 4. Allowance for uncollectibles d. Bad debt expense a % of credit sales. i 5. Cash discount e. Recognizes bad debts as they occur. l 6. Balance sheet approach f. Sale of receivables to a financial institution. d 7. Income statement approach g. Include highly liquid investments. k 8. Net method h. Estimate of bad debts. a 9. Compensating balance i. Reduction in amount paid by credit customer. m 10. Discounting j. Reduction below list price. b 11. Gross method k. Cash discount not taken is interest revenue. e 12. Direct write-off method l. Bad debt expense determined by estimating realizable value. f 13. Factoring m. Sale of note receivable to a financial institution. 26 Exercise 7-20 Requirement 1 March 17, 2006 Allowance for uncollectible accounts ............................. 1,700 Accounts receivable .................................................... 1,700 March 30, 2006 Note receivable ............................................................... 20,000 Cash ............................................................................ 20,000 Step 1: To accrue interest earned for two months on note receivable May 30, 2006 Interest receivable ........................................................... 233 Interest revenue ($20,000 x 7% x 2/12) ............................ 233 Step 2: Add interest to maturity to calculate maturity value. Step 3: Deduct discount to calculate cash proceeds. $20,000 Face amount 1,400 Interest to maturity ($20,000 x 7%) 21,400 Maturity value (1,427) Discount ($21,400 x 8% x 10/12) $19,973 Cash proceeds 27 Exercise 7-20 (continued) Step 4: To record a loss for the difference between the cash proceeds and the note’s book value. May 30, 2006 Cash (proceeds determined above) ....................................... 19,973 Loss on sale of note receivable (difference) ...................... 260 Interest receivable (from adjusting entry) ....................... 233 Note receivable (face amount) ....................................... 20,000 June 30, 2006 Accounts receivable ........................................................ 12,000 Sales revenue .............................................................. 12,000 July 8, 2006 Cash ($12,000 x 98%) ........................................................ 11,760 Sales discounts ($12,000 x 2%) ......................................... 240 Accounts receivable .................................................... 12,000 August 31, 2006 Notes receivable (face amount) .......................................... 6,000 Discount on note receivable ($6,000 x 8% x 6/12) .......... 240 Investments (book value) ............................................... 5,000 Gain on sale of investments (difference) ....................... 760 December 31, 2006 Bad debt expense ($700,000 x 2%) .................................... 14,000 Allowance for uncollectible accounts ......................... 14,000 28 Exercise 7-20 (concluded) Requirement 2 To accrue interest earned on note receivable. December 31, 2006 Discount on note receivable ........................................... 160 Interest revenue ($6,000 x 8% x 4/12) ............................. 160 Exercise 7-21 Second quarter: Receivables turnover = 5,398 = 3.15 1,714 Average collection = 91 = 29 days period 3.15 Third quarter: Receivables turnover = 5,620 = 3.14 1,790 Average collection = 91 = 29 days period 3.14 29 Exercise 7-22 Average collection period = 365 ÷ Accounts receivable turnover = 50 days Accounts receivable turnover = 365 ÷ 50 = 7.3 Average accounts receivable = ($400,000 + 300,000) ÷ 2 = $350,000 Accounts receivable turnover = Net sales ÷ Average accounts receivable 7.3 = Net sales ÷ $350,000 Net sales = 7.3 x $350,000 = $2,555,000 Exercise 7-23 1. c. The allowance method records bad debt expense systematically as a percentage of either sales or the level of accounts receivable. The latter calculation considers the amount already existing in the allowance account. The credit is to a contra asset or allowance account. As accounts receivable are written off, they are charged to the allowance account. 2. d. If a company uses the allowance method, the write-off of a receivable has no effect on total assets. The journal entry involves a debit to the allowance account and a credit to accounts receivable. The net effect is that the asset section is both debited and credited for the same amount. Thus, there will be no effect on either total assets or net income. 3. c. The entry is to debit bad debt expense and credit the allowance account. Net credit sales were $1,500,000 ($1,800,000 - $125,000 of discounts - $175,000 of returns). Thus, the expected bad debt expense is $22,500 (1.5% x $1,500,000). This amount is recorded regardless of the balance remaining in the allowance account from previous periods. The net effect is that the allowance account is increased by $22,500. 30 Exercise 7-24 To establish the petty cash fund. October 2, 2006 Petty Cash .......................................................... 200 Cash (checking account) ................................ 200 To replenish the petty cash fund. October 31, 2006 Office supplies expense ..................................... 76 Entertainment expense ....................................... 48 Postage expense ................................................. 20 Miscellaneous expense ...................................... 19 Cash (checking account) ................................ 163 31 Exercise 7-25 Compute balance per bank statement: Balance per books $23,820 Deduct: Deposits outstanding (2,340) Add: Checks outstanding 1,890 Deduct: Bank service charges (38) Balance per bank $23,332 Step 1: Bank Balance to Corrected Balance Balance per bank statement $23,332 Add: Deposits outstanding 2,340 Deduct: Checks outstanding (1,890) Corrected cash balance $23,782 Step 2: Book Balance to Corrected Balance Balance per books $23,820 Deduct: Service charges (38) Corrected cash balance $23,782 32 Exercise 7-26 Requirement 1 Requirement 2 To correct error in recording cash receipt from credit customer. Cash ................................................................... 1,800 Accounts receivable ....................................... 1,800 To record credits to cash revealed by the bank reconciliation. Miscellaneous expense (bank service charges) . 30 Accounts receivable (NSF checks) .................... 1,200 Interest expense ................................................. 320 Note payable ...................................................... 3,000 Cash ............................................................... 4,550 Note: Each of the adjustments to the book balance required journal entries. None of the adjustments to the bank balance require entries. Step 1: Bank Balance to Corrected Balance Balance per bank statement $38,018 Add: Deposits outstanding 6,300 Deduct: Checks outstanding (8,420) Add: Bank error in recording check 270 Corrected cash balance $36,168 Step 2: Book Balance to Corrected Balance Balance per books $38,918 Add: Error in recording cash receipt ($2,000 - 200) 1,800 Deduct: Service charges (30) NSF checks (1,200) Automatic monthly loan payment (3,320) Corrected cash balance $36,168 33 Problem 7-1 Requirement 1 Monthly bad debt expense accrual summary. Bad debt expense (3% x $2,620,000) ................................. 78,600 Allowance for uncollectible accounts ......................... 78,600 To record year 2006 accounts receivable write-offs. Allowance for uncollectible accounts ............................. 68,000 Accounts receivable .................................................... 68,000 Requirement 2 Bad debt expense ........................................................... 4,300 Allowance for uncollectible accounts (below) ............. 4,300 Year-end required allowance for uncollectible accounts: PROBLEMS Summary Percent Estimated Age Group Amount Uncollectible Allowance 0-60 days $430,000 4% $17,200 61-90 days 98,000 15% 14,700 91-120 days 60,000 25% 15,000 Over 120 days 55,000 40% 22,000 Totals $643,000 $68,900 34 Problem 7-1 (concluded) Allowance for uncollectible accounts: Beginning balance $54,000 Add: Monthly bad debt accruals 78,600 Deduct: Write-offs (68,000) Balance before year-end adjustment 64,600 Required allowance (determined above) 68,900 Required year-end increase in allowance $ 4,300 Requirement 3 Bad debt expense for 2006: Monthly accruals $78,600 Year-end adjustment 4,300 Total $82,900 Balance sheet: Current assets: Accounts receivable, net of $68,900 in allowance for uncollectible accounts $574,100 35 Problem 7-2 Requirement 1 (a) Accounts receivable analysis: Balance, beginning of year ($580,640 + 6,590) $ 587,230 Add: Credit sales 2,158,755 Less: Cash collections (2,230,065) Less: Balance end of year ($504,944 + 5,042) (509,986) Accounts receivable written off during year $ 5,934 (b) Allowance for uncollectible accounts analysis: Beginning balance $6,590 Less: Write-offs (from above) (5,934) Less: Year-end balance (5,042) Bad debt expense for the current year $4,386 (c) $4,386 of bad debt expense divided by $2,158,755 in credit sales equals .2% (.002). Requirement 2 (a) Current year Previous year Current assets: Receivables $509,986 $587,230 (b) Bad debt expense would be equal to actual receivables written off of $5,934. 36 Problem 7-3 Requirement 1 To record accounts receivable written off during the year 2006. Allowance for uncollectible accounts ............................. 35,000 Accounts receivable .................................................... 35,000 To record collection of account receivable previously written off. Accounts receivable ........................................................ 3,000 Allowance for uncollectible accounts ......................... 3,000 Cash ................................................................................ 3,000 Accounts receivable .................................................... 3,000 Requirement 2 (a) December 31, 2006 Bad debt expense (3% x $1,750,000) ................................. 52,500 Allowance for uncollectible accounts ......................... 52,500 (b) December 31, 2006 Bad debt expense ............................................................ 36,700 Allowance for uncollectible accounts (below) ............. 36,700 37 Problem 7-3 (continued) Accounts receivable analysis: Beginning balance $ 462,000 Add: Credit sales 1,750,000 Less: Write-offs (35,000) Less: Cash collections (1,830,000) Ending balance $ 347,000 $347,000 x 10% = $34,700 = Required allowance for uncollectible accounts Allowance for uncollectible accounts analysis: Beginning balance $30,000 Add: Collection of receivable previously written off 3,000 Less: Write-offs (35,000) Balance before adjustment (2,000) debit balance Required allowance (determined above) 34,700 Bad debt expense adjustment $36,700 (c) December 31, 2006 Bad debt expense ............................................................ 37,047 Allowance for uncollectible accounts (below) ............. 37,047 Required allowance: Age Group Amount Percent uncollectible Estimated allowance 0-60 days $225,550 4% $ 9,022 61-90 days 69,400 15% 10,410 91-120 days 34,700 25% 8,675 Over 120 days 17,350 40% 6,940 Totals $347,000 $35,047 38 Problem 7-3 (concluded) Allowance for uncollectible accounts analysis: Beginning balance $30,000 Add: Collection of receivable previously written off 3,000 Less: Write-offs (35,000) Balance before adjustment (2,000) debit balance Required allowance 35,047 Bad debt expense adjustment $37,047 Requirement 3 Accounts receivable - Year-end allowance (a) $347,000 - [$(2,000) + 52,500] = $296,500 (b) $347,000 - 34,700 = $312,300 (c) $347,000 - 35,047 = $311,953 39 Problem 7-4 Requirement 1 Total face value of notes = $300,000 + 150,000 + 200,000 = $650,000 Balance sheet carrying value = 645,000 Difference is the remaining discount on note 3 $ 5,000 Note 3 is a 6-month note, with three months remaining. Therefore, $5,000 represents one-half of the total discount of $10,000. $10,000 ÷ $200,000 = 5% x 12/6 = 10% discount rate. Requirement 2 Total accrued interest receivable $16,000 Less: Interest accrued on note 1: $300,000 x 10% x 4/12 = (10,000) Interest accrued on note 2 $ 6,000 $6,000 ÷ $150,000 = 4% x 12/6 = 8% Requirement 3 Note 1 $10,000 Note 2 6,000 Note 3 ($200,000 x 10% x 3/12) 5,000 Total interest revenue $21,000 40 Problem 7-5 Requirement 1 Alternative a: To record the borrowing of $500,000 and signing of a note payable. July 1, 2006 Cash ................................................................................ 500,000 Note payable ............................................................... 500,000 Alternative b: To record the transfer of receivables. July 1, 2006 Cash ($550,000 x 98%) ...................................................... 539,000 Loss on transfer of receivables (2% x $550,000) ............... 11,000 Accounts receivable .................................................... 550,000 Requirement 2 Alternative a: July, 2006 Cash (80% x $780,000) ...................................................... 624,000 Accounts receivable .................................................... 624,000 July 31, 2006 Interest expense ($500,000 x 12% x 1/12) ............................ 5,000 Note payable ................................................................... 500,000 Cash ............................................................................ 505,000 41 Problem 7-5 (concluded) Alternative b: The amount collected by the bank in excess of the receivables transferred is remitted to Lonergan. July 31, 2006 Cash [(80% x $780,000) - $550,000] .................................... 74,000 Accounts receivable .................................................... 74,000 Requirement 3 Alternative a. – Note disclosure is required for the assignment of accounts receivable as collateral for the $500,000 note. Alternative b. – No disclosure is required since the transfer of receivables was made without recourse. Problem 7-6 Cash (90% x $800,000) ...................................................... 720,000 Loss on sale of receivables (4% x $800,000) ..................... 32,000 Receivable from factor ([10% x $800,000] – $32,000 fee) .. 48,000 Accounts receivable (balance sold) ............................... 800,000 42 Problem 7-7 Requirement 1 February 28, 2006 Note receivable ............................................................... 10,000 Sales revenue .............................................................. 10,000 March 31, 2006 Note receivable (face amount) ........................................... 8,000 Discount ($8,000 x 10%) ............................................... 800 Sales revenue (difference) ............................................. 7,200 April 3, 2006 Accounts receivable ........................................................ 7,000 Sales revenue .............................................................. 7,000 April 11, 2006 Cash (98% x $7,000) .......................................................... $6,860 Sales discounts (2% x $7,000) ........................................... 140 Accounts receivable .................................................... 7,000 April 17, 2006 Sales returns .................................................................... 5,000 Accounts receivable .................................................... 5,000 Inventory ......................................................................... 3,200 Cost of goods sold ...................................................... 3,200 43 Problem 7-7 (continued) April 30, 2006 Cash (99% x $50,000) ........................................................ 49,500 Loss on sale of receivables (1% x $50,000) ....................... 500 Accounts receivable .................................................... 50,000 To accrue interest on note receivable for four months. June 30, 2006 Interest receivable ........................................................... 333 Interest revenue ($10,000 x 10% x 4/12) .......................... 333 To record discounting of note receivable. June 30, 2006 Cash (proceeds determined below) ....................................... 10,266 Loss on sale of note receivable (difference) ...................... 67 Interest receivable (from adjusting entry) ........................ 333 Note receivable (face amount) ....................................... 10,000 $10,000 Face amount 583 Interest to maturity ($10,000 x 10% x 7/12) 10,583 Maturity value (317) Discount ($10,583 x 12% x 3/12) $10,266 Cash proceeds August 31, 2006 — NO ENTRY REQUIRED 44 Problem 7-7 (concluded) Requirement 2 To accrue nine months' interest on the Maddox Co. note receivable. Discount ......................................................................... 600 Interest revenue ($8,000 x 10% x 9/12) ........................... 600 Requirement 3 Income Date increase (decrease) February 28 $10,000 March 31 7,200 April 3 7,000 April 11 (140) April 17 (5,000) April 17 3,200 April 30 (500) June 30 333 June 30 (67) December 31 600 Total effect $22,626 45 Problem 7-8 Note Note Face Value Date of Note Interest Rate Date Discounted Discount Rate Proceeds Received 1 $50,000 3-31-06 8% 6-30-06 10% $50,350 (1) 2 50,000 3-31-06 8% 9-30-06 10% 51,675 (2) 3 50,000 3-31-06 8% 9-30-06 12% 51,410 (3) 4 80,000 6-30-06 6% 10-31-06 10% 81,027 (4) 5 80,000 6-30-06 6% 10-31-06 12% 80,752 (5) 6 80,000 6-30-06 6% 11-30-06 10% 81,713 (6) (1) $50,000 Face amount 3,000 Interest to maturity ($50,000 x 8% x 9/12) 53,000 Maturity value (2,650) Discount ($53,000 x 10% x 6/12) $50,350 Cash proceeds (2) $50,000 Face amount 3,000 Interest to maturity ($50,000 x 8% x 9/12) 53,000 Maturity value (1,325) Discount ($53,000 x 10% x 3/12) $51,675 Cash proceeds 46 Problem 7-8 (concluded) (3) $50,000 Face amount 3,000 Interest to maturity ($50,000 x 8% x 9/12) 53,000 Maturity value (1,590) Discount ($53,000 x 12% x 3/12) $51,410 Cash proceeds (4) $80,000 Face amount 2,400 Interest to maturity ($80,000 x 6% x 6/12) 82,400 Maturity value (1,373) Discount ($82,400 x 10% x 2/12) $81,027 Cash proceeds (5) $80,000 Face amount 2,400 Interest to maturity ($80,000 x 6% x 6/12) 82,400 Maturity value (1,648) Discount ($82,400 x 12% x 2/12) $80,752 Cash proceeds (6) $80,000 Face amount 2,400 Interest to maturity ($80,000 x 6% x 6/12) 82,400 Maturity value (687) Discount ($82,400 x 10% x 1/12) $81,713 Cash proceeds 47 Problem 7-9 Requirement 1 Computation of balance per books: Balance per bank statement $14,632.12 Add: Deposits outstanding 575.00 Deduct: Checks outstanding (1,320.25) Error in recording rent check (18.00) Add: Automatic mortgage payment 450.00 Add: Bank service charges 14.00 Deduct: Deposit credit to company’s account in error (875.00) Add: NSF check charge 85.00 Balance per books $13,542.87 Step 1: Bank Balance to Corrected Balance Balance per bank statement $14,632.12 Add: Deposits outstanding 575.00 Deduct: Bank error - deposit incorrectly credited to company account (875.00) Checks outstanding (1,320.25) Corrected cash balance $13,011.87 Step 2: Book Balance to Corrected Balance Balance per books $13,542.87 Add: Error in recording rent check 18.00 Deduct: Automatic mortgage note payment (450.00) Service charges (14.00) NSF checks (85.00) Corrected cash balance $13,011.87 48 Problem 7-9 (concluded) Requirement 2 To correct error in recording cash disbursement for rent. Cash ................................................................... 18 Rent expense .................................................. 18 To record credits to cash revealed by the bank reconciliation. Interest expense ................................................. 350 Mortgage note payable ...................................... 100 Miscellaneous expense (bank service charges) . 14 Accounts receivable (NSF checks) .................... 85 Cash ............................................................... 549 Requirement 3 Checking account balance $13,011.87 Petty cash 200.00 U.S. treasury bills 5,000.00 Total cash and cash equivalents $18,211.87 49 Problem 7-10 Requirement 1 Step 1: Bank Balance to Corrected Balance Balance per bank statement $3,851 Add: Deposits outstanding 2,150 (1) Deduct: Bank error - deposit incorrectly credited to company account (1,300) Outstanding checks (831) (2) Corrected cash balance $3,870 Step 2: Book Balance to Corrected Balance Balance per books $4,422 Deduct: Error in recording check #411 (90) Service charges (22) NSF checks (440) Corrected book balance $3,870 (1) Receipts $42,650 Less: December receipts deposited: Bank deposits $43,000 Less: Deposit error (1,300) Less: Prior month's deposits outstanding (1,200) 40,500 Deposits outstanding, Dec. 31 $ 2,150 (2) Dec. disbursements $41,853 Error in recording check #411 90 Less: December checks cleared: Total checks cleared $41,918 Prior month's checks: #363 $123 #380 56 #381 86 #382 340 (605) (41,313) December checks outstanding 630 Add: check # 365 201 Total checks outstanding, Dec. 31 $ 831 50 Problem 7-10 (concluded) Requirement 2 To record credits to cash revealed by the bank reconciliation. Advertising expense ........................................... 90 Miscellaneous expense (bank service charges) . 22 Accounts receivable (NSF checks) .................... 440 Cash ............................................................... 552 51 Judgment Case 7-1 Requirement 1 To account for the accounts receivable factored on April 1, 2006, Magrath should decrease accounts receivable by the amount of accounts receivable factored, increase cash by the amount received from the factor, and record a loss equal to the difference. The loss should be reported in the income statement. Factoring of accounts receivable without recourse is equivalent to a sale. Requirement 2 Magrath should account for the collection of the accounts previously written off as uncollectible as follows: l Increase both accounts receivable and the allowance for uncollectible accounts. l Increase cash and decrease accounts receivable. Requirement 3 One approach estimates uncollectible accounts based on credit sales. This approach focuses on income determination by attempting to match uncollectible accounts expense with the revenues generated. The other approach estimates uncollectible accounts based on the balance in receivables or on an aging of receivables. The approach focuses on asset valuation by attempting to report receivables at realizable value. CASES 52 Communication Case 7-2 Suggested Grading Concepts and Grading Scheme: Content (70%) _____ 40 Explains the difference between the allowance method and the direct write-off method. ____ Direct write-off more objective. ____ Direct write-off has potential to violate the matching principle. _____ 15 Even if uncollectibles are fairly stable, when significant variations do occur, profit will be overstated in one period and understated in another period. _____ 15 Even if uncollectibles remain constant, the direct write-off method will result in an overstatement of accounts receivable on the balance sheet. ____ _____ 70 points Writing (30%) _____ 6 Terminology and tone appropriate to the audience of a company president. _____ 12 Organization permits ease of understanding. ____ Introduction that states purpose. ____ Paragraphs that separate main points. _____ 12 English ____ Sentences grammatically clear and well organized, concise. ____ Word selection. ____ Spelling. ____ Grammar and punctuation. ____ _____ 30 points 53 Judgment Case 7-3 Requirement 1 a. Hogan should account for the sales discounts at the date of sale using the net method by recording accounts receivable and sales revenue at the amount of sales less the sales discounts available. Revenues should be recorded at the cash equivalent price at the date of sale. Under the net method, the sale is recorded at an amount that represents the cash equivalent price at the date of exchange (sale). b. There is no effect on Hogan’s sales revenues when customers do not take the sales discounts. Hogan’s net income is increased by the amount of interest earned when customers do not take the sales discounts. Requirement 2 Trade discounts are neither recorded in the accounts nor reported in the financial statements. Therefore, the amount recorded as sales revenues and accounts receivable is net of trade discounts and represents the cash equivalent price of the asset sold. Requirement 3 To account for the accounts receivable factored on August 1, 2006, Hogan should decrease accounts receivable by the amount of the accounts receivable factored, increase cash by the amount received from the factor, and record a loss. Factoring of accounts receivable without recourse is equivalent to a sale. The difference between the cash received and the carrying amount of the receivables is a loss. Requirement 4 Hogan should report the face amount of the interest-bearing notes receivable and the related interest receivable for the period from October 1 through December 31 on its balance sheet as current assets. Both assets are due on September 30, 2007, which is less than one year from the date of the balance sheet. Hogan should report interest revenue from the notes receivable on its income statement for the year ended December 31, 2006. Interest revenue is equal to the amount accrued on the notes receivable at the appropriate interest rate. Interest revenue is realized with the passage of time. Accordingly, interest revenue should be accounted for as an element of income over the life of the notes receivable. 54 Ethics Case 7-4 Requirement 1 Required allowance $180,000 Revised allowance 135,000 Increase in income before taxes of proposed change $ 45,000 Requirement 2 Discussion should include these elements. Ethical Dilemma: You as the assistant controller have a responsibility to follow GAAP and make a reasonably accurate estimate of the net realizable value of receivables. Is your responsibility to fairly present Stanton Industries' financial statements to external users greater than your obligation to improve the financial position of your employer? Alternative actions and consequences include: 1. Refuse to comply with the controller's request to change the aging category of the large account. Positive consequences: a. Preservation of your honesty and integrity. b. Fair presentation of the net realizable value of receivables. Negative consequences: a. Possible loss of your job. b. Lower net income for Stanton Industries. c. A devalued stock price for Stanton Industries. 2. Comply with the controller's suggestion to report the allowance for uncollectible accounts at $135,000. Positive consequences: a. Retention of your job. b. A more favorable net income for Stanton Industries. c. A more favorable position with unknowing creditors, financial analysts, current investors, and future investors. Negative consequences: a. Endure guilt feelings. 55 b. A lack of trust in you by other managers and employees. c. Possible litigation from investors and creditors. 56 Case 7-4 (concluded) 3. Report the controller's suggestion to a higher level of management, the audit committee, or the auditors. If one of these parties corrects the controller and compels fair reporting of the allowance account, the consequences would be the same as in alternative 1 when you refuse to make the adjustment. Your job may still be in jeopardy due to the fact that management may consider whistle blowing as indicative of employee disloyalty. If the reportee parties agree with the controller and report the incorrect amount of $135,000, the consequences will be similar to those for the second alternative in 2, except that you run an even greater risk of losing your job. 4. Refuse to comply with the controller's request and resign as assistant controller. If you report the controller's suggestion to higher management, the audit committee, or the auditor, the positive and negative considerations are the same as for alternative 3. If you do not report the controller's request, then the consequences are the same as for alternative 2. In either case your job is not an issue since you have already resigned. 57 Judgment Case 7-5 1. A weakness is created by the fact that John need only submit a list of accounts and amounts to be charged to replenish the petty cash fund. The supporting documentation for the petty cash disbursements also should be submitted with John’s list and reviewed by someone else. Surprise counts of the fund also should be made to ensure that the fund is being maintained on an imprest basis, that is, to ensure that cash and/or receipts equal $200 at all times. 2. The internal control system for disbursements does not contain sufficient separation of duties. Dean Leiser approves the vouchers, signs the checks, maintains the disbursement records, and reconciles the bank account. There should be at least one other person involved in these activities to ensure accuracy and to safeguard cash from expropriation. 3. The internal control system for receipts does not contain sufficient separation of duties. Fran Jones has physical control of the deposits and also maintains the subsidiary ledger for accounts receivable. These duties should be separated. In addition, the company should require that customers pay their bills via check and that cash not be used. 58 Real World Case 7-6 Requirement 1 2004 2003 ($ in thousands) Accounts receivable, net $19,804 $22,712 Add: Allowances 696 977 Accounts receivable, gross $20,500 $23,689 Requirement 2 ($ in thousands) The answers to this question require an analysis of both accounts receivable and the allowance for uncollectible accounts for 2004. First of all, 2004 sales of $196,338 plus the decrease in receivables reported in the statement of cash flows indicates cash received from customers of $199,246 ($196,338 + 2,908). Analysis of accounts receivable ($ in thousands) Beginning accounts receivable $ 23,689 Add: Credit sales 196,338 Less: Cash collections (199,246) Less: Write-offs ? Ending accounts receivable $ 20,500 Therefore, bad debt write-offs must have been $281. ($23,689 + 196,338 – 199,246 – 20,500 = $281) Analysis of allowance for uncollectible accounts Beginning allowance $977 Add: Bad debt expense ? Less: Write-offs (281) Ending allowance $696 Therefore, bad debt expense must have been $0, indicating that the allowance account from prior years’ was sufficient to cover future anticipated write-offs on year-end accounts receivable. ($977 – 281 – 696 = $0) 59 Real World Case 7-7 Requirement 3 Answers will, of course, vary. The following were reported in the financial statements for the year ended December 31, 2003 ($ in millions): a. Net trade accounts receivable + Allowance for doubtful accounts = Gross accounts receivable $599.8 + 63.1 = $662.9 b. The statement of cash flows indicates bad debt expense (provision for doubtful accounts) of $124.8 c. Beginning allowance for doubtful accounts + Bad debt expense - Bad debt write-offs = Ending allowance for doubtful accounts $49.5 + 124.8 - Write-offs = $63.1 Write-offs = $111.2 d. Beginning trade accounts receivable + Credit sales - Bad debt write-offs - Cash collected = Ending trade accounts receivable Beginning trade accounts receivable = $555.4 + 49.5 = $604.9 $604.9 + 6,804.6 – 111.2 – Cash collections = $662.9 Cash collections = $6,635.4 Integrating Case 7-8 McLaughlin's underestimation of bad debts is treated as a change in accounting estimate. Changes in estimates are accounted for prospectively. When a company revises a previous estimate, prior financial statements are not restated. Instead, the company merely incorporates the new estimate in any related accounting determinations from then on. In this case, bad debt expense for 2007 will be higher than it would have been had not the underestimation occurred. A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for 2007. 60 Analysis Case 7-9 Requirement 1 These methods can be described by one of two basic arrangements: 1. A secured borrowing, or 2. A sale of receivables. When a company chooses between a borrowing and a sale, the critical element is the extent to which it (the transferor) is willing to surrender control over the assets transferred. Specifically, the transferor is determined to have surrendered control over the receivables if and only if three sale conditions are met. Secured borrowings usually take the form of an assignment of receivables. An assignment of receivables is a promise by the borrower (the owner of the receivables) that any failure to repay debt owed to the lender in accordance with the debt agreement, will cause the proceeds from collecting the receivables to go directly toward repayment of the debt. This arrangement is no different from the use of a building as collateral for a mortgage loan. The assignor (borrower) assigns the assignee (lender) the rights to specific receivables as collateral for a loan. A variation of assigning specific receivables is when trade receivables in general rather than specific receivables are pledged as collateral. The responsibility of collection of the receivables remains solely with the company. This variation is referred to as a pledging of accounts receivable. Two popular arrangements used for the sale of receivables are factoring and securitization. A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables, and charges a fee for this service. Actually, credit cards like VISA and Mastercard are forms of factoring arrangements. The seller relinquishes all rights to the future cash receipts in exchange for cash from the buyer (the factor). Another popular arrangement used to sell receivables is a securitization. In a typical accounts receivable securitization, the company creates a Special Purpose Entity (SPE), usually a trust or a subsidiary. The SPE buys a pool of trade receivables, credit card receivables, or loans from the company, and then sells related securities, for example bonds or commercial paper, that are backed (collateralized) by the receivables. Similar to accounts receivable, a note receivable can be used to obtain immediate cash from a financial institution either by pledging the note as collateral for a loan or by selling the note. The transfer of a note is referred to as discounting. 61 Case 7-9 (concluded) Requirement 2 In an assignment of specific receivables, usually the amount borrowed is less than the amount of receivables assigned. The difference provides some protection for the lender to allow for possible uncollectible accounts. Also, the assignee (transferee) usually charges the assignor an up-front finance charge in addition to stated interest on the collateralized loan. The borrower, assignor, records the loan liability, the finance fee expense, and the cash borrowed. No special accounting treatment is needed for an assignment of receivables in general, and the arrangement is simply described in a disclosure note. The specific accounting treatment for the sale of receivables using factoring and securitization arrangements depends on the amount of risk the factor assumes, in particular whether it buys the receivables without recourse or with recourse. When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer has no recourse to the seller if customers don’t pay the receivables. In that case, the seller simply accounts for the transaction as a sale of an asset. The buyer charges a fee for providing this service, usually a percentage of the book value of receivables. Because the fee reduces the proceeds the seller receives from selling the asset, the seller records a loss on sale of assets. The typical factoring arrangement is made without recourse. When a company sells accounts receivable with recourse, the seller retains the risk of uncollectibility. In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible. Even if receivables are sold with recourse, as long as the three conditions for sale treatment are met, the transferor would still account for the transfer as a sale. The only difference would be the additional requirement that the transferor record the estimated fair value of the recourse obligation as a liability. The recourse obligation is the estimated amount that the transferor will have to pay the transferee as a reimbursement for uncollectible receivables. 62 Research Case 7-10 Requirement 1 When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer has no recourse to the seller if customers don’t pay the receivables. Requirement 3 The transferor is determined to have surrendered control over the receivables if and only if all of the following conditions are met: a. The transferred assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. b. Each transferee has the right to pledge or exchange the assets it received. c. The transferor does not maintain effective control over the transferred assets through either (1) an agreement that the transferor repurchase or redeem them before their maturity or (2) the ability to cause the transferee to return specific assets. Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," provides the authoritative guidance in this area. The above conditions can be found in paragraph 9 of the standard. Requirement 4 Cash (90% x $400,000) ...................................................... 360,000 Loss on sale of receivables (4% x $400,000) ..................... 16,000 Receivable from factor (10% x $400,000 – 16,000 fee) ....... 24,000 Accounts receivable (balance sold) ............................... 400,000 63 Case 7-10 (concluded) Requirement 5 Paragraph 47 of SFAS 140 states lists the following conditions: a. The assets to be repurchased or redeemed are the same or substantially the same as those transferred. b. The transferor is able to repurchase or redeem them on substantially the agreed terms, even in the event of default by the transferee. c. The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price. d. The agreement is entered into concurrently with the transfer. 64 Analysis Case 7-11 Requirement 1 Sara Lee Tyson Foods Receivables turnover = 19,566 = 10.3 26,441 = 21 1,893 1,260 Average collection = 365 = 35 days 365 = 17 days period 10.3 21 Tyson Foods collects its receivables, on average, 18 days faster than does Sara Lee. Assuming similar customer credit policies, this indicates that Tyson does a better job in managing its investment in receivables. Requirement 2 The objective of this requirement is to motivate students to obtain hands-on familiarity with actual annual reports and to apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective. 65 Analysis Case 7-12 Requirement 1 Note 1 indicates that cash equivalents are investments in short-term, interest- bearing instruments with maturities of three months or less at the date of purchase. Requirement 2 ($ in millions) 2004 2003 Net receivables $3,027 $2,627 Add: Allowances 151 149 Gross receivables $3,178 $2,776 Requirement 3 ($ in millions) Allowances: Beginning of year $ 149 Add: Bad debt expense (provision for uncollectible accounts - from statement of cash flows) 106 Less: Ending balance (151) Amount written off as uncollectible $104 Solution Manual for Intermediate Accounting David J. Spiceland, James F. Sepe, Lawrence A. Tomassini 9780072994025, 9780072524482
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