Finance: Cash and Receivables PDF

Cash Coins, currency, foreign currency, deposits, bank drafts, money orders Cash equivalents: Money market funds, certificates of deposit, short-term paper Cash and cash equivalents (IFRS and ASPE): – Cash, demand deposits, and short-term, highly liquid investments that are...

Cash Coins, currency, foreign currency, deposits, bank drafts, money orders Cash equivalents: Money market funds, certificates of deposit, short-term paper Cash and cash equivalents (IFRS and ASPE): – Cash, demand deposits, and short-term, highly liquid investments that are readily convertible into known amounts of cash and have an insignificant risk of changing in value Restricted cash: Cash set aside for a particular purpose – Should disclose separately on balance sheet! – Possibly non-current asset as well Separate overdrafts as liabilities unless at same bank 1 Receivables Generally, right to receive cash Trade receivables: owed by customers from revenue Non-trade receivables: other written promises – Loans to employees, dividends receivable, etc. In general, measure receivables initially at fair value – Trade receivables with no significant financing component measured at transaction price (remember IFRS 15?) – Transaction price also okay under ASPE when not material Subsequently, measure receivables at amortized cost – Also take into account impairment 2 Allowance for doubtful accounts* (AFDA) *IFRS calls AFDA “allowance for expected credit losses”. Being proactive about impairing (writing down) the value ASPE calls AFDA “allowance for impairment”. We’ll call it of receivables for amounts we expect we won’t be able to AFDA in these slides because it’s common and easy to collect remember. – Even before people tell us they can’t pay! Also, another name for “bad Be careful of the entries! debts expense” is “loss on impairment”. There are three types of journal entries! In practice, companies will use First, you need to estimate your bad debts every time you variations of these terms. report: – DR Bad debts expense (BDE) – CR Allowance for doubtful accounts (AFDA) (contra-asset) – Allowance approach, sales approach, combined approach 3 Allowance for doubtful accounts (AFDA) Be careful of the entries! Second, when individual accounts are deemed uncollectible (“write-off”): – DR Allowance for doubtful accounts – CR Receivables Third, if a written off account is actually collected: – DR Receivables, CR Allowance for doubtful accounts – DR Cash, CR Receivables 4 Allowance for doubtful accounts (AFDA) Estimating AFDA and bad debts expense Allowance method: Look at your receivables balance and see how much is uncollectible – Key: What you are calculating is the ENDING balance in AFDA – You need to adjust whatever AFDA balance is to the ending balance; that is the entry! 5 Allowance method Estimate uncollectible amounts in A/R – CR $37,650 is the ENDING balance in AFDA! 6 Allowance method Remember: the aging schedule told us all the uncollectible amounts – CR $37,650 is the ENDING balance in AFDA! Let’s say AFDA is currently CR $18,800 – Adjustment is 37,650 – 18,800 = 18,850 – DR Bad debts expense 18,850; CR AFDA 18,850 Let’s say AFDA is currently DR $200 – Adjustment is 37,650 – (-200) = 37,850 – DR Bad debts expense 37,850; CR AFDA 37,850 7 Percentage of sales method Estimate bad debts expense as a percentage of sales – Fast and simple way Example: Company estimates 2% of monthly net credit sales are uncollectible; Entries for $400K worth of net credit sales in year? – DR Bad debts expense $8,000; CR AFDA $8,000 (2% x 400K) At period-end though, need to use Allowance Method to update final balance to prepare statements! – “Combined method” 8 Accounts receivable Direct write-off method – No AFDA Any time an account is deemed uncollectible: – DR Bad debts expense, CR A/R Violates matching principle! – Might be writing off bad debts related to revenues earned in prior period So basically, don’t use this method 9 Receivables and interest When interest is material, consider interest – For example, longer duration notes Use effective interest method under IFRS – Effective (or implied) interest rate: The rate actually earned – A.k.a. yield rate, market rate (but NOT coupon rate or stated rate!) – ASPE does not specify method (e.g., can use effective interest method or straight line method) *If the note is interest bearing (see next slide), another option Entries: is to split the DR into DR Interest receivable for the cash – At initiation: DR Notes receivable, CR Cash (or other account) interest receivable accrued and DR Notes receivable for – As time passes: DR Notes receivable; CR Interest income; the the rest. But in practice, amount is effective interest rate x Note receivable balance* companies will often just record one combined DR to – If/when interest is collected: DR Cash, CR Notes receivable Notes receivable. 10 Receivables and interest Tips Face value: principal amount received at maturity – A.k.a. par value Discount: lending out less than face value Premium: lending out more than face value Non (or zero) interest bearing: No periodic interest payments – But the note almost always has implicit interest! – A.k.a. zero coupon note Interest payment is NOT the same as interest income! – Need to consider amortization 11 Receivables and interest Tips Whatever type of note it is: – IFRS: carrying amount x effective interest rate = interest income – Interest vs. non-interest bearing, not all that different! – Premium vs. discounts, not all that different! Interest income gets added to carrying amount of note – Do interest income first before payments! Receipts of payments decrease carrying amount of note Opening note receivable + interest income – cash collected = ending note receivable – Assuming no write-offs 12 Receivables and interest *It is also fine to combine the interest accrual and interest receipt entries: Example: Interest-bearing note with discount DR Cash 1,000 Lend out $9,520 today and get back a three-year note with DR Note receivable 142** face value $10,000 with annual interest payments of 10% CR Interest income 1,142 (the implied rate is 12%) **142 = 1,142 – 1,000 Interest income = End carrying amt Interest payment Beginning carrying beginning carrying = begin + interest = interest rate x amount amt x effective income - interest face value Year rate payment 1 9,520 1,142 1,000 9,662 2 9,662 1,159 1,000 9,821 3 9,821 1,179 1,000 10,000 Year 1: DR Note receivable 9,520; CR Cash 9,520 – DR Note receivable 1,142; CR Interest income 1,142* – DR Cash 1,000; CR Note receivable 1,000* 13 Receivables and interest *It is also fine to combine the interest accrual and interest receipt entries: Example: Interest-bearing note with discount DR Cash 1,000 Lend out $9,520 today and get back a three-year note with DR Note receivable 159** face value $10,000 with annual interest payments of 10% CR Interest income 1,159 (the implied rate is 12%) **159 = 1,159 – 1,000 Interest income = End carrying amt Interest payment Beginning carrying beginning carrying = begin + interest = interest rate x amount amt x effective income - interest face value Year rate payment 1 9,520 1,142 1,000 9,662 2 9,662 1,159 1,000 9,821 3 9,821 1,179 1,000 10,000 Year 2: DR Note receivable 1,159; CR Interest income 1,159* – DR Cash 1,000; CR Note receivable 1,000* 14 Receivables and interest *It is also fine to combine the interest accrual and interest receipt entries: Example: Interest-bearing note with discount DR Cash 1,000 Lend out $9,520 today and get back a three-year note with DR Note receivable 179** face value $10,000 with annual interest payments of 10% CR Interest income 1,179 (the implied rate is 12%) **179 = 1,179 – 1,000 Interest income = End carrying amt Interest payment Beginning carrying beginning carrying = begin + interest = interest rate x amount amt x effective income - interest face value Year rate payment 1 9,520 1,142 1,000 9,662 2 9,662 1,159 1,000 9,821 3 9,821 1,179 1,000 10,000 Year 3: DR Note receivable 1,179; CR Interest income 1,179* – DR Cash 1,000; CR Note receivable 1,000* – DR Cash 10,000; CR Note receivable 10,000 15 Receivables and interest Example: Zero-interest-bearing note Lend out $7,721 today and get back a zero-interest- bearing three-year note with face value $10,000 (implied rate 9%) Interest income = End carrying amt Interest payment Beginning carrying beginning carrying = begin + interest = interest rate x amount amt x effective income - interest face value Year rate payment 1 7,721 695 - 8,416 2 8,416 757 - 9,173 3 9,173 827 - 10,000 Year 1: DR Note receivable 7,721; CR Cash 7,721 – DR Note receivable 695; CR Interest income 695 16 Receivables and interest Example: Zero-interest-bearing note Lend out $7,721 today and get back a zero-interest- bearing three-year note with face value $10,000 (implied rate 9%) Interest income = End carrying amt Interest payment Beginning carrying beginning carrying = begin + interest = interest rate x amount amt x effective income - interest face value Year rate payment 1 7,721 695 - 8,416 2 8,416 757 - 9,173 3 9,173 827 - 10,000 Year 2: DR Note receivable 757; CR Interest income 757 17 Receivables and interest Example: Zero-interest-bearing note Lend out $7,721 today and get back a zero-interest- bearing three-year note with face value $10,000 (implied rate 9%) Interest income = End carrying amt Interest payment Beginning carrying beginning carrying = begin + interest = interest rate x amount amt x effective income - interest face value Year rate payment 1 7,721 695 - 8,416 2 8,416 757 - 9,173 3 9,173 827 - 10,000 Year 3: DR Note receivable 827; CR Interest income 827 – DR Cash 10,000; CR Note receivable 10,000 18 Receivables and interest ASPE permits straight line method Lend out $9,520 today and get back a three-year note with face value $10,000 with annual interest payments of 10% (the implied rate is 12%) Interest income = End carrying amt Interest payment Interest payment Beginning carrying = begin + interest + discount(or - = interest rate x amount income - interest premium) / face value payment Year #periods 1 9,520 1,160 1,000 9,680 2 9,680 1,160 1,000 9,840 3 9,840 1,160 1,000 10,000 Discount: $10,000 – $9,520 = $480; $480 / 3 periods = $160 amortization per period 19 Derecognition of receivables Collected cash Wrote them off Sold them Pledged as collateral? 20 Secured borrowing Pledge receivables as collateral to borrow money from creditor – If don’t pay back creditor, creditor has right collect receivables! Assign/pledge: provide receivables as security as loan, but receivables still under own control 21 Sale of receivables Factoring: Sell receivables to bank/finance company for fee, and they collect it for you! Recourse: Buyer can come after seller if they cannot collect the receivables Securitization: Pool receivables and sell interest in them to third parties – Company continues to service the receivables Big question: is the transaction really a sale, or just a secured borrowing? – Key issue is what the CR is – DR is to cash, but CR is either to Receivables (sale), or to Payables (borrowing) 22 IFRS: Sale vs secured borrowing AND No AND ***AND*** consider whether risks and rewards have been transferred before recording as a sale 23 ASPE: Sale vs secured borrowing 24 Secured borrowing Just debit cash and credit payable! DR Cash, CR payable Of course, if there is interest on the payable, then DR interest expense and CR payable If there are finance charges: – DR Cash, DR Finance charge (expense), CR payable Account for collateralized receivables the same was as before 25 Sale of receivables Factoring without recourse (tends to qualify as a sale) Crest Textiles factors $500K receivables to bank without recourse; Bank takes over collection Bank charges finance charge of 3% of receivables and withholds 5% initially for returns and allowances Entries for Crest Textiles – DR Cash 460K (100% - 5% - 3% = 92% of 500K) – DR Due from Factor 25K (5% of 500K) – DR Loss on disposal of receivables 15K (3% of 500K) – CR A/R 500K – Same under IFRS and ASPE 26 Sale of receivables Factoring without recourse (tends to qualify as a sale) Crest Textiles factors $500K receivables to bank without recourse; Bank takes over collection Bank charges finance charge of 3% of receivables and withholds 5% initially for returns and allowances Entries for Bank – DR Receivables 500K – CR Due to Crest Textiles 25K (5% of 500K) – CR Finance revenue (3% of 500K) – CR Cash $460K (100% - 5% - 3% = 92% of 500K) – Same under IFRS/ASPE 27 Sale of receivables Factoring with recourse Crest Textiles factors $500K receivables to bank with recourse; Bank takes over collection – However, Crest Textiles pays if receivables don’t pay! – Crest Textiles thinks they will pay $6K recourse Bank charges finance charge of 3% of receivables and withholds 5% initially for returns and allowances Under IFRS, tend to treat as secured borrowing (apply criteria) – Reason: Risks and rewards not transferred! Entity does have obligation to pay recipient unless cash is collected from receivables 28 Sale of receivables Factoring with recourse Crest Textiles factors $500K receivables to bank with recourse; Bank takes over collection – However, Crest Textiles pays if receivables don’t pay! – Crest Textiles thinks they will pay $6K recourse Bank charges finance charge of 3% of receivables and withholds 5% initially for returns and allowances Under ASPE, tend to use financial components approach (sale) – Reason: Entity has continuing involvement – Include ALL entries in factoring without recourse, PLUS: – DR Loss on sale of receivables $6K; CR Recourse liability $6K 29 Summary and prep for live lecture We covered cash and receivables! Read Chapter 7 Do Problems P7.3 and P7.8 and Exercises E7.15 and E7.17 We will take these up in week 7 live lecture 30