chapter 7 the revenue/receivable/cash cycle · pdf file7-1 1. the normal operating cycle of a...
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7-1
1. The normal operating cycle of a business
2. Record sales revenue, bad debts and warranties
3. Analyze accounts receivable
4. The composition, management, and control of
cash
5. The disclosures for sales and receivables
6. Receivables used as a source of cash
7. Accounting and valuation of notes receivable
8. The impact of uncollectible accounts on the
statement of cash flows
Chapter 7 The Revenue/Receivable/Cash Cycle
7-27-2
7-3
The Operating Cycle of a Business
• The normal operating cycle of a business
involves purchasing inventory (using either
cash or credit), which is then sold, often on
account.
• Once the receivable is collected, the cycle
begins again.
• The normal operating cycle is the lifeblood of
any business enterprise.
1. Explain the normal operating cycle of a
business
7-4
• The recognition of revenue is generally
related to the recognition of accounts
receivable.
• Revenues are generally recorded when the
earning process is complete and a valid
promise of payment (or payment itself) is
received.
• A receivable arising from the sale of goods is
generally recognized when the title to the
goods passes to a bona fide buyer.
The Operating Cycle of a Business
7-57-5(continued)
7-6
The entry for recognizing revenue and a
receivable from the sale of goods or services
is as follows:
Accounts Receivable xx
Sales xx
The Operating Cycle of a Business
When the amount is collected, Accounts
Receivable is credited and Cash is debited as
follows:
Cash xx
Accounts Receivable xx
7-7
Types of Receivables
• Trade receivables, generally most significant
category of receivables, result from the normal
activities of a business.
• Trade receivables may be evidenced by a
formal written promise to pay and classified as
notes receivables.
In its broadest sense, the term receivable is
applicable to all claims against others for money,
goods, or services.
7-8
Nontrade Receivables
Nontrade receivables include all other types of
receivables. They arise from a variety of
transactions, such as:
1) The sale of securities or property other than
inventory
2) Deposits to guarantee contract performance
or expense payment
3) Claims for rebates and tax refunds
4) Dividends and interest receivable
• Discounts—Discounts are offered at the time of sale or
at the time of payment.
• Sales Returns and Allowances—Returns and
allowances occur subsequent to the sale and can occur
before or after payment has been made.
• Bad Debts—Bad debts must be estimated in the period
when credit sales are made or accounts receivable are
outstanding.
• Warranties for Service or Replacement—Long after a
sale occurs and collection is made, a warranty period
associated with that sale may still be in place. 7-9
Accounting for Sales Revenue
2. Prepare journal entries to record sales revenue,
including the accounting for bad debts and
warranties for service or replacement
7-10
Discounts
• A trade discount reduces the list sales price
to the net sales price charged to the
customer.
• A cash (sales) discount is offered to
customers to encourage prompt payment of
bills. It can only be taken if the customer
makes the payment within a specified time
period. There are two methods to account for
this: (a) gross method and (b) net method.
(continued)
7-11
Cash (Sales) Discount—Gross Method
The gross method for cash (sales) discounts is
illustrated as follows with credit terms of 2/10, n/30
(2% discount if paid within 10 days, net amount due
in 30 days).
7-12
The net method records the sale and the
receivable net of the discount.
Cash (Sales) Discount—Net Method
7-13
Sales Returns and Allowances
Red sweaters costing $600 are sold to a
customer for $1,000. The customer calls and
states that green sweaters were ordered and
should have been shipped. Rather than return
the sweaters, the customer agrees to keep the
sweaters for a reduction in price—an
allowance of $200. The return is recorded as
follows:
Sales Returns and Allowances 200
Accounts Receivable 200
(continued)
7-14
Suppose that instead of an allowance, the
customer elects to return the sweaters. The
return requires two entries.
Sales Returns and Allowances 1,000
Accounts Receivable 1,000
Inventory 600
Cost of Goods Sold 600
The first entry recognizes the return and the
reduction of the customer’s account. The
second entry reports that the sweaters are now
in inventory.
Sales Returns and Allowances
7-15
Accounting for Bad Debts
• Bad debts occur when customers do not pay for
items or services purchased on credit; thus, bad
debts are uncollectible accounts receivable.
• Bad Debt Expense is reported as a selling or
general and administrative expense.
• Accounts Receivable are reported on the
balance sheet at net realizable value; that is,
the expected cash value and not the present
value.
(continued)
7-16
Uncollectible Accounts Receivable
—Direct Write-Off Method
When a receivable proves to be uncollectible,
the direct write-off method requires the
following entry:
Bad Debt Expense xxx
Accounts Receivable xxx
• The use of the direct write-off method is not
allowed under GAAP because it does not
provide for the matching of expenses with
current revenues and does not report
receivables at their net realizable value.
• The direct write-off method is often used by
small businesses because of its simplicity.
7-17
• Using the allowance method, which is required by
GAAP, the amount of receivables that are not collectible
has to be estimated.
Uncollectible Account Receivables
—Allowance Method
• A typical entry to recognize bad debt expense, normally
made as an end-of-the-period adjustment is as follows:
Bad Debt Expense xx
Allowance for Bad Debts xx
To record estimated uncollectible
accounts receivable for the period.
• Bad Debt Expense is reported as a selling or general
and administrative expense.
Establishing an Allowance for Bad Debts
7-18
• When positive evidence is available concerning
the partial or complete worthlessness of an
account, the account is written off using the
following entry:
Note: Bad Debt Expense
is not debited.
Writing off an Uncollectible Account
Under the Allowance Method
Allowance for Bad Debts xx
Accounts Receivable xx
To record the write-off of an
uncollectible account.
7-19
Occasionally, an account that has been written off is
unexpectedly collected. Assume a $1,500 account
previously written off is collected. Two entries are
required as shown next: the first to reverse the write-off
entry; the second to record receipt of the cash.
Collecting a Written-off Account
Under the Allowance Method
Accounts Receivable 1,500
Allowance for Bad Debts 1,500
To reverse the entry made to
write off the account.
Cash 1,500
Accounts Receivable 1,500
To record collection of the
account.
7-207-20
7-21
Allowance for Bad Debts
• Allowance for Bad Debts is a contra-asset
account that is subtracted from Accounts
Receivable on the balance sheet.
• The actual write-off entry for $1,500 does not
reduce net receivables, as shown below:
Accts. receivable $300,000 Accts. receivable $298,500
Less: Allowance for Less: Allowance for
bad debts 15,000 bad debts 13,500
Net receivables $285,000 Net receivables $285,000
7-22
Estimating Uncollectibles Based on
Percentage of Sales
When basing estimated uncollectibles on sales
for the period, it is preferable to apply the
percentage to credit sales. However, the
percentage is frequently applied to total sales
to avoid having to maintain separate records
for cash and credit sales.
(continued)
7-23
• If 2% of sales is considered doubtful in terms of
collection and sales for the period are
$100,000, the charge for Bad Debt Expense
would be 2% of the current period’s sales, or
$2,000.
• The existing balance in Allowance for Bad
Debts is ignored.
Bad Debt Expense 2,000
Allowance for Bad Debts 2,000
To record estimated bad debt expense
for the period ($100,000 0.02 = $2,000).
Estimating Uncollectibles Based on
Percentage of Sales
(continued)
7-24
Allowance for Bad Debts
Balance 350
Adjusting 2,000
Dec. 31, Bal. 2,350
After the adjusting entry is posted, Allowance
for Bad Debts will have a balance of $2,350.
Estimating Uncollectibles Based on
Percentage of Sales
7-25
If total accounts receivable for Lamberson Company
are $50,000 and it is estimated that 3% of those
accounts will be uncollectible, the allowance account
needs to have a balance of $1,500 ($50,000 0.03). If
the allowance account already has a $600 credit
balance, the current-period adjusting entry is as
follows:
Bad Debt Expense 900
Allowance for Bad Debts 900To record estimated bad debt expense
for the period ($1,500 required balance
$600 current balance = $900
adjustment).
Estimating Uncollectibles Based on
A/R Balance
(continued)
7-26
• The ending balance must be forced to achieve the desired balance.
• For instance, in the previous example if the allowance account had already had a debit balance of $200, the adjustment required would be for $1,700 to bring the allowance account to the desired ending balance of $1,500.
Adjusting 1,700
Dec. 31, Bal. 1,500
Allowance for Bad Debts
Balance 200
Estimating Uncollectibles Based on
A/R Balance
7-27
Aging Receivables
• The most commonly used method for
establishing an allowance based on outstanding
receivables involves aging receivables.
• Individual accounts are analyzed to determine
those not yet due and those past due.
(continued)
7-28
(continued)
7-28
Aging Receivables
7-29(continued)
7-29
Aging Receivables
7-30
Aging Receivables
The amount derived from aging, $2,870, is the
desired balance of the allowance account after
the adjusting entry. If Allowance for Bad Debts
already has a credit balance of $620 before
adjustment, the following entry is needed:
Bad Debt Expense 2,250
Allowance for Bad Debts 2,250
To record estimated bad debt expense
for the period ($2,870 required balance
$620 current balance = $2,250
adjustment)
7-31
Corrections to Allowance for Bad Debts
• If the allowance provisions are too large or
small, a correction in the allowance as well
as a change in the rate or in the method
employed will be needed (if the amount is
material).
• The effect of this change in accounting
estimate would be reported in the current
and future periods as an ordinary item on
the income statement, usually as an
addition or subtraction from Bad Debt
Expense.
7-32
Helpful Reminder
• When bad debts are estimated based on a
percentage of sales, bad debt expense is
computed and the balance of the allowance
account is then determined.
• When you are using the percentage-of-
receivables method, the balance in the
allowance account is computed, and then the
amount of bad debt expense for the period is
determined.
7-33
Warranties for Service or Replacement
• Many companies agree to provide free
services on units failing to perform
satisfactorily or to replace defective goods.
These agreements are referred to as
warranties.
• When warranties are priced separately from
the product, the revenue for the sale should
be divided between the product and the
warranty service.
(continued)
7-34
MJW Video & Sound sells DVD players with a 2-
year warranty. Past experience indicates that 10%
of all systems sold will need repairs in the first year,
and 20% will need repairs in the second year. The
average repair cost is $50 per system.
Warranties for Service or Replacement
The number of systems sold in 2012 and 2013 was
5,000 and 6,000, respectively. Actual repair costs
were $12,500 in 2013 and $55,000 in 2014.
7-35
To record estimated warranty expense:
2012
Warranty Expense 75,000
Estimated Liability for Warranties 75,000
To record estimated warranty
expense based on systems sold
(5,000 0.30 $50 = $75,000).
Warranties for Service or Replacement
To record the cost of actual repairs in 2012:
Estimated Liability for Warranties 12,500
Cash 12,500
To record cost of actual repairs
in 2012.
7-36
To record estimated warranty expense:
Warranty Expense 90,000
Estimated Liability for Warranties 90,000
To record estimated warranty
expense based on systems
sold (6,000 0.30 $50).
2013
Warranties for Service or Replacement
To record cost of actual repairs in 2013:Estimated Liability under Warranties 55,000
Cash 55,000
To record cost of actual repairs in
2013.
7-37
Periodically, the warranty liability account
should be analyzed to see whether the actual
repairs approximate the estimate. In this case,
by the end of 2013, the analysis is as follows:
Warranties for Service or Replacement
2012 sales still under warranty for 6 months:
$50 x [5,000 units x (6/12 x 0.20)] $ 25,000
2013 sales still under warranty for 18 months:
$50 x [6,000 units x (6/12 x.10) +
6,000 units x (12/12 x .020)] 75,000
Total $100,000
The $100,000 approximation is
reasonably close to the $97,500
balance in the allowance account.
(continued)
7-38
Assume that warranty costs incurred in 2013 were
only $35,000. Then the ending balance in the
allowance account of $117,500 would be
considered much higher than the $100,000
estimate. The following adjustment would be made
in 2013.
Warranties for Service or Replacement
Estimated Liability under Warranties 17,500
Warranty Expense. 17,500
To record adjustment for
estimate for warranty repair.
7-39
Monitoring Accounts Receivable
• The average collection period is the average
number of days that lapse between the time that
a sale is made and the time that cash is
collected.
• It is calculated by dividing the average
receivables outstanding by the average daily
sales.
3. Analyze accounts receivable to measure
how efficiently a firm is using this operating
asset
7-40
In 2012, WS Corporation had average
receivables of $354,250 and net sales of
$1,650,000. The average collection period can
be calculated as follows:
Average collection period = 78 days
Average receivable $354,250
Average daily sales ($1,650,000/365)=
Monitoring Accounts Receivable
7-41
Accounts receivable turnover = 4.7 times
Accounts receivable turnover is determined
by dividing net sales by the average trade
accounts receivable outstanding during the year.
The calculation for 2012 is as follows:
Net sales $1,650,000
Average net receivables $354,250=
Monitoring Accounts Receivable
7-42
In some cases, it may be more useful to report
the average collection period for the receivables
existing at the end of the period.
(continued)
Monitoring Accounts Receivable
7-437-43
7-44
• Revenues and receivables have value because
they will eventually be converted to cash.
• Cash is important because it provides the basis for
measurement and accounting for all other items.
• The FASB identified the need to report information
on cash and liquidity as one of the key objectives of
financial reporting.
Cash Management and Control
(continued)
4. Discuss the composition, management, and
control of cash, including the use of a bank
reconciliation
7-45
• Because cash is a measure of value, it cannot
expand or grow unless it is converted into
other properties.
• Because cash is the most liquid of all assets,
it is also the one that needs to be safeguarded
the most.
Cash Management and Control
7-46
Composition of Cash
• Coins and currency not yet
deposited
• Demand deposits
• Petty cash funds
• Cashier’s checks
• Personal checks
• Very short-term
interest-earning securities
Funds that can
be withdrawn
on demand
Sometimes
referred to as
cash
equivalents
(continued)
7-47
Composition of Cash
• Deposits that are not immediately available for
withdrawal or have other restrictions are sometimes
referred to as time deposits.
• Time deposits are sometimes separately classified as
temporary investments.
• Deposits in foreign banks that are subject to immediate
and unrestricted withdrawal generally qualify as cash.
• Cash balances specifically designated by
management for special purposes should be reported
separately, e.g. a bond sinking fund.
• A credit balance in the cash account resulting from the
issuance of checks in excess of the amount on deposit
is known as a cash overdraft.
7-487-48
7-49
Compensating Balances
• In connection with financing arrangements, it is
common practice for a company to agree to
maintain a minimum or average balance on deposit
with a bank.
• These compensating balances are defined by the
SEC as “that portion of any demand deposit
maintained by a corporation . . . which constitutes
support for borrowing arrangements . . .”
7-50
Management and Control of Cash
1. Specifically assigned responsibilities for handling
cash receipts
2. Separation of handling and recording cash receipts
3. Daily deposits of all cash received
4. Voucher system to control cash payments
5. Internal audits at irregular intervals
6. Double record of cash—bank and books, with
reconciliations performed by someone outside the
accounting function
Basic characteristics of a cash control system are:
These controls are more likely to be found in large
companies with many employees.
7-51
Bank Reconciliation
A comparison of the bank balance with the
book balance is usually made monthly by
means of a summary known as a bank
reconciliation.
Bank
balance
Book
balance
(continued)
7-52
Four common types of differences between
the bank statement and the depositor’s
records arise in the following situations:
• Deposit in transit
• Outstanding checksA deposit made near
the end of the month
and recorded on the
depositor’s books, but
not reflected in the
bank statement.Checks written near the end of the
month that have reduced the
depositor’s cash balance have not
clear the bank by statement date.
Bank Reconciliation
7-53
Four common types of differences between
the bank statement and the depositor’s
records arise in the following situations:
• Deposit in transit
• Outstanding checks
• Bank debits for items
such as service
charges and NSF
checks
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Bank Reconciliation
7-54
Four common types of differences between
the bank statement and the depositor’s
records arise in the following situations:
• Deposit in transit
• Outstanding checks
• Bank debits for items such as service
charges and NSF checks
The return of a
customer’s check for
which insufficient
funds are available,…
…known as a not-
sufficient-funds
(NSF) check, is
handled in a similar
manner.
Bank Reconciliation
7-55
Four common types of differences between
the bank statement and the depositor’s
records arise in the following situations:
• Deposit in transit
• Outstanding checks
• Bank debits for items such as service
charges and NSF checks
• Bank credits for items such as the
bank collecting a note for the depositor
An amount owed to
the depositor is
paid directly to the
bank by the…
Bank Reconciliation
7-56
If, after considering these items, the bank
statement and the book balances cannot be
reconciled, a detailed analysis of both the
bank’s records and the depositor’s books may
be necessary to determine whether errors or
irregularities exist on the records of either
party.
(continued)
Bank Reconciliation
7-57
replace
7-58
The following entries would be required on the books
of Svendsen, Inc., as a result of the November 30
reconciliation:
Cash 98.50
Interest Revenue 98.50To record interest earned during
November.
Cash 18.00
Advertising Expense 18.00
To record correction for check
payment of advertising recorded as
$64 instead of the actual amount,
$46.(continued)
Preparing a Bank Reconciliation
7-59
Accounts Receivable 118.94
Miscellaneous General Expense 3.16
Cash 122.10
To record customer’s
uncollectible check and bank
charges for November.
Preparing a Bank Reconciliation
7-60
5. Recognize appropriate disclosures for presenting
sales and receivables in the financial statements
7-61
Presentation of Receivables
in the Financial Statements
• Current receivables may be grouped in the
balance sheet in the following classes:
Notes receivable—trade debtors
Accounts receivable—trade debtors
Other receivables
• It is possible to combine trade notes and
accounts receivable into a single amount.
• Restrictions on any receivables should be
disclosed.
(continued)
7-62(continued)
7-62
7-637-63
7-64
Receivables as a Source of Cash
Receivables may be converted to cash
quickly in one of two ways:
• As a sale (either with or without recourse)
• As a secured borrowing
6. Explain how receivables may be used as
a source of cash through secured
borrowing or sale
7-65
FASB specified in Topic 860 the conditions for
receivables to be accounted for as a sale:
1. The transferred assets have been isolated
from the transferor. That is, the transferor and
its creditors cannot access the assets.
2. The transferee has the right to pledge or
exchange the transferred assets.
3. The transferor does not maintain effective
control over the assets through either (a) an
agreement to repurchase them before their
maturity or (b) the ability to cause the
transferee to return specific assets.
Receivables as a Source of Cash
7-667-66
7-67
Sale of Receivables Without Recourse
• When banks, dealers, and finance companies
purchase receivables from companies, in
many cases, these purchases are done
without recourse.
• Without recourse means the purchaser
assumes the risks associated with the
collectibility of the receivables.
• A sale of receivables without recourse is
commonly referred to as accounts
receivable factoring, and the buyer is the
factor.
7-68
a) failure of the debtors to pay when due,
b) the effects of prepayments, or
c) adjustments resulting from defects in the
eligibility of the transferred receivables.”
Recourse is defined by the FASB as “the right of a
transferee of receivables to receive payment from
the transferor of those receivable for any of the
following reasons:
(continued)
Sale of Receivables Without Recourse
7-69
• Assume that $10,000 of receivables are
factored, that is, sold without recourse, to a
finance company for $8,500.
• An allowance for bad debts equal to $300
was previously established for these
accounts.
• The finance company withheld 5% of the
purchase price as protection against sales
returns and allowances.
(continued)
Sale of Receivables Without Recourse
7-70
Cash 8,075Receivable from Factor 425Allowance for Bad Debts 300Loss from Factoring Receivables 1,200
Accounts Receivable 10,000To record the factoring of receivables.
Computations:
Cash: $8,500 – $425 = $8,075
Factor receivable: $8,500 5% = $425
Factoring loss: ($10,000 – $300) – $8,500 = $1,200
Sale of Receivables Without Recourse
Cash 425Receivable from Factor 425
To record the final settlement associated with previously factored receivables.
Assuming there were no returns or allowances, the final
settlement would be recorded as follows:
7-71
Selling receivables with recourse means that a
purchaser (bank or finance company) advances
cash in return for receivables but retains the right
to collect from the seller if debtors (seller’s
customers) fail to make payments when due.
Sale of Receivables With Recourse
Example: A firm raises funds by selling $9,700 of
its receivables for $8,500. The receivables are sold
with recourse and the seller estimates that the
recourse obligation has a fair value of $500.
7-72
Cash received $8,500
Estimated value of recourse obligation (500)
Net proceeds $8,000
Book value of receivables $9,700
Net proceeds to be received (8,000)
Loss on sale of receivables $1,700
Example: Sale with Recourse
The loss to be recognized on the transaction is
$1,700 and is computed as follows:
(continued)
7-73
The entry to record the sale of receivable with
recourse would be as follows:
Example: Sale with Recourse
Cash 8,075
Receivable from Factor 425
Allowance for Bad Debts 300
Loss on Sale of Receivables 1,700
Accounts Receivable 10,000
Recourse Obligation 500
7-74
Secured Borrowing
• With an assignment of receivables:
There are no special accounting problems
involved.
Simply record the loan.
• With specific assignment:
Specified accounts receivable pledged
Accounts Receivable reclassified on balance
sheet
Footnote disclosure of loan provisions
required
7-75
• On July 1, 2013, Provo Mercantile Co.
assigns receivables total $300,000 to Salem
Bank as collateral on a $200,000, 12% note.
Provo Mercantile does not notify its account
debtors and will continue to collect the
assigned receivables.
• Salem assesses a 1% finance charge on
assigned receivables in addition to the interest
on the note.
(continued)
Example: Secured Borrowing
7-767-76
7-77
Derecognition of Receivables: IAS 39
The purpose of the three conditions in FASB ASC
Section 860-10-40 is to identify receivable
transfers in which economic ownership of the
receivables has been transferred. IAS 39 contains
the same concept but applied slightly differently.
7-78
IAS 39 contains a 2-step test for derecognition.
1. Determine whether the receivable transfer
involves a transfer of “substantially all of the
risks and rewards of ownership of the
[receivable].” If so, the transfer is accounted for
as a sale of the receivable.
2. If the receivable transfer does not involve the
transfer of substantially all the risks and rewards
of ownership, determine whether control of the
receivable has been transferred. If so, account
for the receivable transfer as a sale. If not, the
transfer is treated as a secured loan.
Derecognition of Receivables: IAS 39
7-79
Notes Receivable
A promissory note is an unconditional written
promise to pay a certain sum of money at a
specified time.
• The note is signed by the maker and is
payable to the order of a specified payee or
bearer.
• Notes usually involve interest stated at an
annual rate.
• Most notes are negotiable notes.
7. Describe proper accounting and
valuation of notes receivable
7-80
Valuation of Notes Receivable
• Notes receivable are initially recorded at their present
value.
• When a note is exchanged for property, goods, or
services, the present value equals the current cash
selling price of the items exchanged.
• An interest-bearing note is written as a promise to pay
principal (or face amount) plus interest at a specified
rate.
• A non-interest-bearing note does not specify an
interest rate, but the face amount includes the interest
charge.
• The present value is the difference between the face
amount and the interest included in that amount,
sometimes called the implicit (or effective) interest.
7-81
• High Value Corporation sells goods on
January 1, 2013, with a price of $1,000. The
buyer gives High Value a promissory note
due December 31, 2014. The maturity value
of the note includes interest at 10%.
• High Value will receive $1,210 ($1,000 1.21
future value factor) when the note is paid.
Valuation of Notes Receivable
7-827-82
Valuation of Notes Receivable
7-83
Special Valuation Problems
When a note is exchanged for cash:
• It should be recorded at its face amount
and
• any difference between face and cash proceeds
should be recorded as premium or discount on
the note.
7-84
When a note is exchanged for property, goods, or
services in an arm’s-length transaction:
• the present value of the note is usually
evidenced by the terms of the note or
supporting documents
• there is a general presumption that the interest
specified by the parties to a transaction
represents fair and adequate compensation for
the use of funds
Special Valuation Problems
7-85
Valuation problems arise when one of the
following conditions exists:
• No interest rate is stated
• The stated rate does not seem reasonable,
given the nature of the transaction and
surrounding circumstances
• The stated face amount of the note is
significantly different from the current cash
equivalent sales price of similar property,
goods, or service
Special Valuation Problems
7-86
Note Exchanged for Property Illustration
On July 1, 2013, Timberline Corporation sells a
tract of land purchased three years ago at a cost
of $250,000. The buyer gives Timberline a 1-year
note with a face amount of $310,000, bearing
interest at a stated rate of 8%. The market value
of the land is $300,000.
July 1 Notes Receivable 310,000
Discount on Notes
Receivable 10,000
Land 250,000
Gain on Sale of Land 50,000
2013
7-87
Dec. 31 Interest Receivable 12,400
Discount on Notes Receivable 5,000
Interest Revenue 17,400
$310,000 x .08 x 6/12
= $12,400
2013
June 30 Cash 334,800
Discount on Notes Receivable 5,000
Notes Receivable 310,000
Interest Receivable 12,400
Interest Revenue 17,400
2014
Timberline Corporation Example
7-88
1. Determine the maturity value of the note.
Maturity value = Face amount + Interest
Interest = Face amount x Interest rate x
Interest period
Interest period = Date of note to date of
maturity
The maturity value is the amount you will
receive when the note matures.
Determine the Amount to be Received
from the Bank
7-89
Determine the Amount to be Received
from the Bank
2. Determine the amount of discount.
Discount = Maturity value x Discount rate x
Discount period
Discount period = Date of discount to date of
maturity
The amount of time you have to wait to get the
money is termed the discount period.
3. Determine the proceeds:
Proceeds = Maturity Value ‒ Discount
(continued)
7-90
• Meeker Corporation received a 3-month,
$5,000, 10% note from a customer on
September 1 to settle a past due accounts
receivable. One month later, the note is
discounted at a bank at a discount rate of
15%.
• Maturity value of the note = $5,000 + ($5,000
x .02 x 3/12) = $5,125
• Amount of the discount = $5,125 x .015 x 2/12
= $128.13
• Proceeds = $5,125 ‒ $128.13 = $4,996.87
Meeker Corporation Example
7-91
Imputing an Interest Rate
• If there is no current market price for either the
property, goods, or services or the note, then
the present value of the note must be
determined by selecting an appropriate
interest rate and using that rate to discount
future receipts to the present.
• The imputed interest rate is determined at
the date of exchange and is not altered
thereafter.
7-92
On December 31, 2013, Horrocks & Associates
accepted a $45,000 note as payment for
services. The note is non-interest-bearing and
comes due in three yearly installments of
$15,000 each, beginning December 31, 2014.
Assume there is no market value for the note and
no objective way to determine the value of the
service. A 10% rate of interest is deemed to be
reasonable.
(continued)
Imputing an Interest Rate
7-93
The computation is based on the present value calculations as follows:
Face amount of note $45,000
Less present value of note
PV: PMT = $15,000; N = 3; I = 10% 37,303*
Discount on note $ 7,697
*Rounded to nearest dollar
(continued)
Imputing an Interest Rate
7-94
The entry to record the receipt of the note would be:
Dec. 31 Notes Receivable 45,000
Discount on Notes Receivable 7,697
Service Revenue 37,303
To record a non-interest-
bearing note receivable at
its present value based on
an imputed interest rate of
10% per year.
2013
(continued)
Imputing an Interest Rate
7-95
A schedule showing the amortization of the discount
on the note follows. This type of computation is
commonly referred to as the effective interest
amortization method.
Imputing an Interest Rate
7-96
At the end of each year, an entry similar to the
following would be made:
Dec. 31 Cash 15,000
Discount on Notes Receivable 3,730
Interest Revenue 3,730
Notes Receivable 15,000
To record the first year’s
installment on notes
receivable and recognize
interest earned during the
year.
2014
Imputing an Interest Rate
7-97
Impact of Uncollectible Accounts
on Cash Flows
A decrease in receivables can occur when the:
• customers pay on account
and
• customers never pay and the account is
written off
8. Understand the impact of uncollectible
accounts on the statement of cash flows
7-98
Illustration of Impact of Uncollectibles on
Statement of Cash Flows
7-997-99
Illustration of Impact of Uncollectibles on
Statement of Cash Flows
7-100
Illustration of Impact of Uncollectibles on
Statement of Cash Flows
7-101
Illustration of Impact of Uncollectibles on
Statement of Cash Flows