Chapter 7 The Revenue/Receivable/Cash Cycle · PDF file7-1 1. The normal operating cycle of a business 2. Record sales revenue, bad debts and warranties 3. Analyze accounts receivable

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.


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


When the amount is collected, Accounts

Receivable is credited and Cash is debited as

follows:

Cash 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


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


Allowance for Bad Debts 1,500

To reverse the entry made to

write off the account.

Cash 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


To record estimated bad debt expense

for the period ($100,000 0.02 = $2,000).


Percentage of Sales

(continued)

7-24


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.


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).


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


Balance 200


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


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.


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).


To record the cost of actual repairs in 2012:


Cash 12,500

To record cost of actual repairs

in 2012.

7-36

To record estimated warranty expense:

Warranty Expense 90,000


To record estimated warranty

expense based on systems

sold (6,000 0.30 $50).

2013


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:


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.


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)=


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=


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)


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





• Outstanding checks

• Bank debits for items

such as service

charges and NSF

checks

A m

onth

ly fe

e

charg

ed b

y th

e

ban

k is

a s

erv

ice

ch

arg

e.

The d

epositor

mu

st

deduct th

is a

mount

fro

m the r

ecord

ed

ca

sh

ba

lan

ce

.

Bank Reconciliation

7-54






• 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






• 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)


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)


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


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


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.


7-827-82


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


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


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


Notes Receivable 310,000

Interest Receivable 12,400


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)


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)


7-94

The entry to record the receipt of the note would be:

Dec. 31 Notes Receivable 45,000


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)


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.


7-96

At the end of each year, an entry similar to the

following would be made:

Dec. 31 Cash 15,000



Notes Receivable 15,000

To record the first year’s

installment on notes

receivable and recognize

interest earned during the

year.

2014


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



7-100



7-101



Documents

Chapter 7 The Revenue/Receivable/Cash Cycle · PDF file7-1 1. The normal operating cycle of a business 2. Record sales revenue, bad debts and warranties 3. Analyze accounts receivable