19th Edition Chapter The Revenue/Receivable/ Cash Cycle Intermediate Accounting James D Stice Earl K Stice PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2014 Cengage Learning 7-1 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 (continued) 7-2 The Operating Cycle of a Business • • • 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 (continued) 7-3 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 (continued) 7-4 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 7-5 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 In its its broadest broadest sense, sense, the the term term receivable receivable is is applicable applicable to to all all claims claims against against others others for for money, money, goods, goods, or or services services 7-6 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 7-7 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 Accounts Receivable 200 (continued) 200 7-8 Sales Returns and Allowances Suppose that instead of an allowance, the customer elects to return the sweaters The return requires two entries Sales Returns and Allowances Accounts Receivable 1,000 Inventory 1,000 600 Cost of Goods Sold 600first entry recognizes the return and the The reduction of the customer’s account The second entry reports that the sweaters are now in inventory 7-9 Accounting for Bad Debts • Bad debts occur when customers 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) 7-10 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 (continued) 7-61 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 (continued) 7-62 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 7-63 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 7-64 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 • (continued) 7-65 Valuation of Notes Receivable • 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 7-66 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 (continued) 7-67 Special Valuation Problems 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 (continued) 7-68 Special Valuation Problems 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 7-69 Determine the Amount to be Received from the Bank 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 (continued) 7-70 Determine the Amount to be Received from the Bank Determine the amount of discount Discount = Maturity value x Discount rate x Discount period Discount period = Date of discount to date of maturity The The amount amount of of time time you you have have to to wait wait to to get get the the money money is is termed termed the the discount discount period period Determine the proceeds: Proceeds = Maturity Value ‒ Discount 7-71 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 7-72 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 7-73 Chapter ₵ The The End End $ 7-74 7-75 ... 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 In its its broadest broadest... reduction of the customer’s account The second entry reports that the sweaters are now in inventory 7-9 Accounting for Bad Debts • Bad debts occur when customers not pay • • for items or services purchased... Uncollectible Accounts Receivable— Direct Write-Off Method • The direct write-off method is often used by • small businesses because of its simplicity The use of the direct write-off method is not allowed