Stice | Stice | Skousen Intermediate Accounting,17E The Revenue/Receivable/ Cash Cycle PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2010 Cengage Learning The Operating Cycle of a Business Purchase inventory with cash or credit Sell the inventory, usually on account Collect the receivable Reinvest cash in the business 7-2 The Operating Cycle of a Business The entry for recognizing revenue and a receivable from the sale of goods or services is as follows: Accounts Receivable xx Sales xx 7-3 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 7-4 Types of Receivables • Trade receivables—most significant category resulting from everyday credit sales of goods/services to customers • Notes receivables—trade receivables with a formal written promise to pay 7-5 Nontrade Receivables Nontrade receivables include all other types of receivables They arise from a variety of transactions, such as: The sale of securities or property other than inventory Deposits to guarantee contract performance or expense payment Claims for rebates and tax refunds Dividends and interest receivable 7-6 Accounting for Sales Revenue • Discounts—offered at the time of sale or the time of payment • Sales Returns and Allowances—occur subsequent to the sale and can occur before or after payment has been made • 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 is made, the warranty period may still be in place 7-7 Discounts • A trade discount reduces the list sales price to the net sales price charged to the customer • A cash (sales) discount can only be taken if the customer makes the payment within a specified time period There are two methods to account for this: Gross method Net method 7-8 Cash Discount—Gross Method The gross method is illustrated as follows with credit terms of 2/10, n/30 7-9 Cash Discount—Net Method The net method records the sale and the receivable net of the discount 7-10 7-55 Sale of Receivables With Recourse 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 7-56 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 7-57 Derecognition of Receivables: IAS 39 The purpose of the three conditions in SFAS No 140 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 7-58 Derecognition of Receivables: IAS 39 IAS 39 contains a 2-step test for derecognition 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 (continues) 7-59 Derecognition of Receivables: IAS 39 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 7-60 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 7-61 Special Valuation Problems • When a note is exchanged for cash: • It should be recorded at its face amount • Any difference between face and cash proceeds―record as premium or discount on the note • When a note is exchanged for property, goods, or services: • The present value of the note is found in the terms of the note or supporting documents • If there is no current market price for the property, goods, or services or the note, then use an imputed interest rate 7-62 Note Exchanged for Property Illustration On July 1, 2011, 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 (continues) 7-63 Note Exchanged for Property Illustration 2011 July Notes Receivable Discount on Notes Receivable Land 250,000 Gain on Sale of Land 50,000 The unamortized discount balance 310,000 10,000 would be subtracted from Notes Receivable on the December 31, 2011, balance sheet 7-64 Imputing an Interest Rate If there is no current market price for either the property, good, or service or the note, then the present value of the note must be determined by selecting an appropriate interest rate The imputed interest rate is determined at the date of the exchange and not altered thereafter 7-65 Imputing an Interest Rate Horrocks & Associates accepted a $45,000 note as payment for services The note is noninterest-bearing and comes due in three yearly installments of $15,000 each, beginning December 31, 2012 Assume there is no market value for the note and no objective way to determine the value of the service (continues) 7-66 Imputing an Interest Rate 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* The entry to record the receipt of the note would be: Discount on note $ 7,697 7-67 Imputing an Interest Rate A schedule showing the amortization of the discount on the note follows 7-68 Impact of Uncollectible Accounts on Cash Flows • A decrease in receivables can occur when the: Customers pay on account Customers never pay and the account is written off • To find the net cash provided by operations: Adjust for a change in the Accounts Receivable balance Adjust for changes in the Allowance for Bad Debts account 7-69 ... performance or expense payment Claims for rebates and tax refunds Dividends and interest receivable 7-6 Accounting for Sales Revenue • Discounts—offered at the time of sale or the time of payment • Sales... The the customer’s account The second entry reports that the sweaters are now in inventory 7-12 Accounting for Bad Debts • Occurs when customers not pay for items or services purchased on credit... small businesses • The use of the direct write-off method is not allowed under generally accepted accounting principles 7-15 Uncollectible Receivables (Allowance Method) Using the allowance method,