💰Intermediate Financial Accounting I Unit 6 – Cash and Receivables

Cash Basics and Management

• Cash consists of coins, currency, and available funds on deposit at the bank
  • Includes petty cash, cash in registers, and cash in checking accounts
• Cash equivalents are short-term, highly liquid investments readily convertible to cash (money market funds, treasury bills)
• Restricted cash has limitations on its availability or use
  • Examples include compensating balances, legally restricted deposits, or funds held in escrow
• Cash management focuses on optimizing cash inflows and outflows to meet obligations and maximize returns
• The cash conversion cycle measures the time between cash outflows for inventory and cash inflows from sales
• Effective cash management techniques include:
  • Accelerating cash receipts (lockbox systems, remote deposit capture)
  • Controlling disbursements (controlled disbursement accounts, zero-balance accounts)
  • Investing excess cash (sweep accounts, short-term investments)
• Bank reconciliations ensure the accuracy of cash balances by comparing company records to bank statements

Types of Receivables

• Accounts receivable arise from sales of goods or services on credit to customers
  • Represent amounts owed by customers and are typically due within 30 to 60 days
• Trade receivables are accounts receivable from the primary business activities of selling goods or services
• Nontrade receivables arise from transactions other than the sale of goods or services (loans to employees, insurance claims)
• Notes receivable are written promises to pay a specific amount on a specific date
  • Usually result from sales of goods or services, loans to customers or employees, or settlement of accounts receivable
• Installment accounts receivable involve a series of payments over an extended period
• Receivables can be classified as current (due within one year or the operating cycle) or noncurrent
• Advances to suppliers represent prepayments for goods or services to be received in the future
• Receivables from officers, employees, or affiliates should be presented separately on the balance sheet

Recognition and Valuation of Receivables

• Receivables are recognized when the revenue recognition criteria are met (performance obligation satisfied, amount can be reasonably estimated)
• Accounts receivable are recorded at the invoice amount, which is the exchange price of the transaction
• The allowance method estimates uncollectible accounts and records bad debt expense in the same period as the sale
  • Establishes a contra-asset account (allowance for doubtful accounts) to reduce receivables to their net realizable value
• The direct write-off method records bad debt expense when a specific account is determined to be uncollectible
  • Not acceptable under generally accepted accounting principles (GAAP) for financial reporting
• Receivables are reported on the balance sheet at their net realizable value (gross receivables less allowance for doubtful accounts)
• Factors affecting the valuation of receivables include:
  • Creditworthiness of customers
  • Economic conditions
  • Industry trends
  • Historical collection experience
• Aging of accounts receivable analyzes outstanding balances based on the number of days past due (current, 30 days, 60 days, 90+ days)

Estimating Uncollectible Accounts

• The allowance for doubtful accounts represents the estimated portion of receivables that will not be collected
• The percentage of sales method estimates bad debt expense as a percentage of credit sales
  • $Bad Debt Expense = Credit Sales × Estimated Uncollectible Percentage$
• The percentage of receivables method estimates the allowance based on the outstanding receivables balance
  • $Allowance for Doubtful Accounts = Accounts Receivable × Estimated Uncollectible Percentage$
• The aging of receivables method estimates the allowance based on the age categories of outstanding receivables
  • Assigns different percentages to each age category (current, 30 days, 60 days, 90+ days)
  • $Allowance for Doubtful Accounts = Σ(Receivables in Age Category × Estimated Uncollectible Percentage)$
• Companies should consider factors such as historical collection experience, customer credit ratings, and economic conditions when estimating uncollectible accounts
• Bad debt expense is recorded in the period of the sale, and the allowance is adjusted at the end of each period
• Writing off an uncollectible account reduces accounts receivable and the allowance for doubtful accounts
  • $Allowance for Doubtful Accounts$ (debit) and $Accounts Receivable$ (credit)
• Subsequent collection of a previously written-off account is recorded as a recovery
  • $Accounts Receivable$ (debit), $Allowance for Doubtful Accounts$ (credit), and $Recovery of Bad Debts$ (credit)

Notes Receivable and Interest

• Notes receivable are written promises to pay a specific amount on a specific date
  • Can arise from sales, loans, or settlement of accounts receivable
• The maturity date is the date on which the note becomes due and payable
• Interest is the charge for the use of money over time
  • Calculated based on the principal amount, interest rate, and time period
• The stated interest rate is the rate specified in the note
• The effective interest rate is the true cost of borrowing, considering compounding and other factors
• Simple interest is calculated using the formula: $Interest = Principal × Rate × Time$
• Compound interest is calculated by applying interest to the principal and accumulated interest from previous periods
• Discounting a note receivable records the present value of the future cash flows
  • $Present Value = Future Amount ÷ (1 + Discount Rate)^n$
• Dishonored notes are notes that are not paid at maturity
  • Recorded by reversing the original entry and reinstating the receivable or other asset

Disposal of Receivables

• Factoring involves selling receivables to a third party (factor) at a discount
  • The factor assumes the credit risk and collection responsibilities
  • The seller receives immediate cash and removes the receivables from its balance sheet
• Pledging receivables as collateral involves using receivables to secure a loan
  • The borrower retains ownership and collection responsibilities for the receivables
  • The lender has a security interest in the receivables and can seize them if the borrower defaults
• Securitization pools receivables and sells them as securities to investors
  • The seller transfers the receivables to a special-purpose entity (SPE) that issues securities backed by the receivables
  • The seller receives cash from the sale of securities and may continue to service the receivables
• Transfers of receivables can be accounted for as sales or secured borrowings
  • Sales require the transfer of control and risks and rewards of ownership to the buyer
  • Secured borrowings involve pledging receivables as collateral for a loan
• Factors to consider in the disposal of receivables include:
  • Cash flow needs
  • Cost of alternative financing
  • Credit risk and collection costs
  • Accounting and tax implications

Financial Statement Presentation

• Receivables are reported on the balance sheet under current assets
  • Presented at net realizable value (gross receivables less allowance for doubtful accounts)
• Notes receivable are reported separately from accounts receivable
  • Classified as current or noncurrent based on maturity date
• Receivables from related parties (officers, employees, affiliates) are disclosed separately
• The allowance for doubtful accounts is a contra-asset account that reduces receivables
  • Presented below gross receivables or in the notes to the financial statements
• Bad debt expense is reported on the income statement as an operating expense
• Factoring or securitization transactions are disclosed in the notes to the financial statements
  • Including the amount of receivables sold, the proceeds received, and any retained interests or obligations
• The statement of cash flows reports the change in receivables as part of operating activities
  • Adjustments are made for non-cash transactions (sales, write-offs) and changes in the allowance
• Aging schedules and credit concentrations may be disclosed in the notes to the financial statements
• Significant accounting policies related to receivables (revenue recognition, allowance method) are disclosed in the notes

Real-World Applications and Case Studies

• Analyzing a company's receivables turnover and days sales outstanding (DSO) to assess collection efficiency
  • $Receivables Turnover = Credit Sales ÷ Average Accounts Receivable$
  • $Days Sales Outstanding (DSO) = 365 ÷ Receivables Turnover$
• Evaluating the impact of different allowance methods (percentage of sales, aging of receivables) on financial statements
• Comparing the costs and benefits of factoring, pledging, and securitization for short-term financing
• Assessing the credit risk and potential for bad debts in industries with long payment cycles (construction, healthcare)
• Examining the effects of economic downturns or industry-specific challenges on receivables and collections
• Analyzing the disclosures and footnotes related to receivables in public company financial statements
• Discussing the ethical considerations and potential manipulations related to revenue recognition and allowance estimates
• Exploring the use of technology (credit scoring, automation) in managing receivables and collections
• Investigating real-world cases of financial statement fraud involving receivables (channel stuffing, bill and hold arrangements)
• Examining the impact of new accounting standards (ASC 326, IFRS 9) on the measurement and reporting of receivables and credit losses