Ch6-Examples

Example 1: Sales discounts, sales returns and allowances Gross sales, terms: (2/10/n20) $ 15,000 sales returns/allowances $ 200 70% of sales paid within discount period: $ 10,500 discount $ 210 net cash $ 10,290 journal entries: dr. accounts receivable $ 15,000 cr. Revenue $ 15,000 (to record credit sales) dr. sales returns & allowances $ 200 cr. Accounts receivable $ 200 (to record sales returns) dr. cash $ 10,290 dr. Sales discounts $ 210 cr. Accounts receivable $ 10,500 (to record cash receipt and sales discounts) dr. cash $ 4,500 cr. Accounts receivable $ 4,500 (to record cash receipt from remaining receivables) Note: this assumes all accounts are paid Income Statement: Revenue $ 15,000 less sales returns $ (200) less sales discounts $ (210) or: Revenue (net) Example 2: $ 14,590 $ 14,590 Bad Debt Expense total credit sales $ 22,000 accounts receivable, 12/31 $ 9,000 allowance for uncollectible accounts, 12/31 before adjustments: $ 200 percent of revenue expected to be uncollectible 3% bad debt expense: ($22,000*3%) $ 660 Journal entry: dr. bad debt expense $ 660 cr. Allowance for uncollectible accounts Income Statement: Revenue $ 22,000 $ 660 Operating expenses: bad debt expense $ (660) Balance Sheet: Accounts receivable $ 9,000 less allowance for uncollectible accounts $ (860) Accounts receivable (net) $ 8,140 Aging of Accounts Method Aging Schedule Age $ amount percent $ amount uncollectible uncollectible 0 to 20 days $ 5,000 2% $ 100 20 to 40 days $ 3,000 12% $ 360 40 to 60 days $ 600 20% $ 120 60 + days $ 400 50% $ 200 Total $ 9,000 $ 780 Journal entry: dr. bad debt expense $ 580 cr. Allowance for uncollectible accounts $ 580 Income Statement: Revenue $ 22,000 Operating expenses: bad debt expense $ (580) Balance Sheet: Accounts receivable $ 9,000 less allowance for uncollectible accounts $ (780) Accounts receivable (net) $ 8,220 to write off an account: dr. allowance for uncollectible accounts cr. Accounts receivable $ 150 $ 150 Example 3: Pledging, Assigning of Accounts Receivable 1. Pledging: X Company has accounts receivable in the amount of $ 75,000. X Company borrows $40,000 at 8% payable in six month, from First Bank and pledges receivables in he amount of $60,000 as security. Journal entries: dr. cash $ 40,000 cr. note payable $ 40,000 (record loan) No formal entry is made of the pledging of accounts receivable as security for the loan. However, this fact must be disclosed on the balance sheet (footnote) dr. cash $30,000 cr. accounts receivable $30,000 (record partial collection of accounts receivable) dr. note payable $40,000 dr. interest expense $ cr. cash 160 $40,160 (record payment of principal and interest) 2. Assigning of Accounts Receivable X Company assigns accounts receivable in the amount of $40,000 and receives $35,000 cash from First Bank. 8% interest on the outstanding loan balance. dr. cash $35,000 cr. note payable $35,000 dr. accounts receivable $40,000 assigned cr. accounts receivable $40,000 (to record receipt of cash and assigning of accounts) dr. cash $10,000 cr. accounts receivable $10,000 dr. note payable $ 10,000 dr.interest expense $ cr. cash 233 $10,233 (to record collection of 1st month accounts receivable and payment to bank, including 1 month interest (35,000*.08/12) dr. cash $28,000 cr. accounts receivable $28,000 dr. note payable $ 25,000 dr.interest expense $ cr. cash 167 $10,167 (to record collection of 2nd month accounts receivable and payment to bank, including 1 month interest (25,000*.08/12) dr. accounts receivable $ 2,000 cr. accounts receivable - assigned $ 2,000 (to reverse assignment of remaining acounts receivable) Example 4: Factoring of Accounts Receivable X Company has accounts receivable in the amount of $ 75,000. X Company factors (sells) the receivable without recourse to First Bank and receives $ 68,250 in cash The amount of cash received is determined as follows: factoring expense $ 4,500 provision for sales discounts $ 1,500 provision for sales returns $ 750 Note: the provisions for sales discounts and returns are contingent. These amounts are withheld by the factor and X company may receive some of these amounts, if actual returns and discounts are less than estimated. Journal entries: dr. cash $ 68,250 dr. factoring expense $ 4,500 dr. due from factor $ 2,250 cr. accounts receivable $75,000 (to record factoring of accounts receivable without recourse) X Company is notified by First Bank that actual sales returns amounted to $500 and sales discounts were taken in the amount of $ 1,200. X Company receives a check for $550 from First Bank Journal entries: dr. cash $ 550 dr. sales discounts $1,200 dr sales returns. $ 500 cr. due from factor $2,250 (to record sales returns and discounts and receipt of cash) Note that this was a factoring without recourse (risk was transferred) If the accounts had been factored with recourse the initial set of journal entries would have differed: instead of a credit to accounts receivable. it would have required a credit to accounts receivable - factored with recourse (a contingent liability) In other words, the same treatment as when accounts are assigned, except for slightly different (factored instead of assigned) terminology) Example 5. Interest bearing notes (short or long term) These type of notes do not present any accounting issues. Just remember to accrue interest income at the appropriate time Face value interest rate $100,000 10% issue date 11/01/1998 maturity date 05/01/1999 Journal entries Date issuance: dr. notes receivable $100,000 cr. Sales revenue dr. interest receivable $100,000 $1,667 cr. interest income dr. cash 11/01/1998 12/31/1998 $1,667 $105,000 05/01/1999 cr. Interest receivable $1,667 cr. interest income $3,333 cr. Notes receivable $100,000 Example 6. Non interest bearing note, less than one year to maturity: Needed: appropriate discount rate. Should be the customer's borrowing rate (if known). Otherwise use the seller's required rate of return Face value $100,000 interest rate 0% issue date 11/01/1998 maturity date 05/01/1999 Assume that 10% is the appropriate disocunt rate 1. Determine correct amount of revenue: 100,000 / 1.05 = Revenue: $95,238 Journal entries: dr. note receivable $100,000 cr. Revenue 11/01/1998 $95,238 cr. Discount on note receivable $4,762 dr. discount on note receivable 1587.30159 cr. Interest income 12/31/1998 1587.30159 Note that straight line is used to determine the amount of interest income as of 12/31/98 Balance Sheet as of 12/31/1998 Note receivable $100,000 less discount -$3,175 dr. cash $96,825 $100,000 dr. discount 05/01/1999 $3,175 cr. Note receivable $100,000 cr. Interest income $3,175 Example 7: Non interest bearing note, more than one year to maturity: needed: appropriate discount rate. Should be the customer's borrowing rate (if known). Otherwise use the seller's required rate of return Face value $100,000 interest rate 0% issue date 01/01/1998 maturity date 01/01/2003 1. Determine correct amount of revenue: 100,000 * PV(10%,5) Revenue: $62,092 0.620921 Journal entries: dr. note receivable $100,000 01/01/1998 cr. Revenue $62,092 cr. Discount on note receivable $37,908 dr. discount on note receivable $6,209 12/31/1998 cr. Interest income 6209.21 Note that the "effective method" is used to determine the amount of interest income See the table below on how to determine the correct amount of interest income each period: Balance Sheet: Note receivable $100,000 less discount -$31,699 dr. cash $100,000 dr. discount $68,301 01/01/2003 $9,091 cr. Note receivable $100,000 cr. Interest income $9,091 (to record payment at maturity) Interest amortization table Carrying value interest interest cash increase in rate income receipt carrying value $62,092 10% $6,209 $0 $6,209 $68,301 10% $6,830 $0 $6,830 $75,131 10% $7,513 $0 $7,513 $82,645 10% $8,264 $0 $8,264 $90,909 10% $9,091 $100,000 -$90,909 $0 Example 8. Non-interest bearing note, more than one year, periodic payments (annual payments) Face value of note annual payments $100,000 20000 discounted at 10%: Revenue Pva(5.10%) $75,816 issue date 01/01/1998 maturity date 12/31/2002 payments are due annually on 12/31 Interest amortization table 3.7908 Carrying value interest interest cash decrease in rate income receipt carrying value $75,816 10% $7,582 $20,000 -$12,418 $63,398 10% $6,340 $20,000 -$13,660 $49,737 10% $4,974 $20,000 -$15,026 $34,711 10% $3,471 $20,000 -$16,529 $18,182 10% $1,818 $20,000 -$18,182 $24,184 $100,000 -$75,816 $0 dr. note receivable 100000.4262 01/01/1998 cr. Revenue $75,816 cr. Discount $24,184 dr. discount $7,582 cr. Interest income dr. cash 12/31/1998 $7,582 $20,000 cr. Note receivable $20,000 Balance Sheet as of 12/31/98: Note receivable less discount dr. cash $80,000 -$16,603 20000 cr. Note receivable dr. discount $63,398 20000 $6,340 cr. Interest income 12/31/1999 $6,340 Balance Sheet as of 12/31/99 Note receivable less discount $60,000 -$10,263 $49,737 Example 9: below market interest rate, 1 year (interest to be paid at maturity) Needed: appropriate discount rate. Should be the customer's borrowing rate (if known) Otherwise use the seller's required rate of return. Assume 10% is appropriate discount rate Face value $100,000 interest rate 2% issue date 01/01/1998 maturity date 01/01/1999 1. Maturity value: (100,000*1.02) $ 102,000 1. Determine correct amount of revenue: 102,000 * PV(10%,1) Revenue: dr. note receivable 0.90909 $90,909 $100,000 cr. Revenue 01/01/1998 $90,909 cr. Discount on note receivable $9,091 dr. discount on note receivable $9,091 dr. interest receivable $2,000 cr. Interest income 12/31/1998 9091 dr. cash $ 102,000 cr. Note receivable 01/01/1999 $100,000 cr. Interest receivable $2,000 Example 10: Notes Receivable, below market interest rate, interest paid annually Face value interest rate annual int. paymnt $100,000 PV(10%,5) 0.62092 62092 3.79079 7581.58 2% $2,000 PVa(10%,5) issue date 01/01/1998 maturity date 01/01/2003 Present value of note + interest payments dr. note receivable (net) $100,000 cr. Revenue 01/01/1998 69673.58 cr. Discount on N/R dr. interest receivable 69673.58 $30,326 $2,000 12/31/1998 dr. discount $4,967 cr. Interest income $6,967 dr. cash $2,000 01/01/1999 cr. Interest receivable $2,000 Note that the "effective method" is used to determine the amount of interest income See the table below on how to determine the correct amount of interest income each period: Interest amortization table Carrying value interest interest cash increase in rate income receipt carrying value $69,674 10% $6,967 $2,000 $4,967 $74,641 10% $7,464 $2,000 $5,464 $80,105 10% $8,011 $2,000 $6,011 $86,116 10% $8,612 $2,000 $6,612 $92,727 10% $9,273 $102,000 -$92,727 $0 Example 11: Notes receivable discounted with and without recourse Step 1 Face value $ 7,872 Step 2 interest rate 9% Step 3 days 180 Step 4 interest to maturity Step 5 maturity value Step 6 discount rate Step 7 days to maturity $ 354 1*2*3/360 $ 8,226 1+5 15% 120 Step 8 discount $ 617 Step 9 proceeds $ 7,609.27 5-8 60 3-7 Step 10 days interest earned Step 11 interest earned to date 5*6*7/360 $ 118 1*2*10/360 Step 12 bookvalue of note $ 7,990 1+11 Step 13 interst expense $ (175) 9-12 Journal entries (a) without recourse dr. note receivable $ 7,872 cr. revenue dr. interest receivable $ 7,872 $ 118 cr. interest income $118 dr. cash $ 7,815 dr. interst expense $ 175 cr. interest receivable $118 cr. note receivable $ 7,872 Journal entries (b) with recourse dr. note receivable $ 7,872 cr. revenue $ 7,872 dr. interest receivable $ 118 cr. interest income $118 dr. cash $ 7,815 dr. interst expense $ 175 cr. interest receivable $118 cr. note receivable discounted $ 7,872 after notification that note has been paid: dr. notes receivable discounted $ 7,872 cr. note receivable $ 7,872 assuming note was not paid, bank demands full payment and charges $50 fee dr. notes receivable discounted $ 7,872 cr. note receivable $ 7,872 dr. notes receivable dishonored $ 8,276 cr. Cash $ 8,276 Note that a. The amount paid to the bank consists of the maturity value plus the fee charged. b. The entire amount will be recorded in an account called "notes receivable dishonored" and the company will attempt to collect this amount. Only if evidence exists that collection will definitelynot occur (I.e., bankruptcy judgement) will the debit be made to a loss account or to the allowance for uncollectibles. Definitions Account receivable A revolving credit arrangement: Once an account is established, customers can purchase "on account" without further formality, as long as invoices are paid promptly Net realizable value: Account receivable Accounts receivable less allowance for uncollectible accounts Sales discounts A euphemism for interest. "Gross" invoice prices include interest. If customers pay bills quickly (acording to the sales terms) this interest does not have to be paid. The customers pays the "net" amount or receives a discount Sales Terms see sales discounts: (interest/days/net/days) e.g., (3/10,n30) Sales Returns merchandise is returned for refund. Sales Allowances adjustment of sales price, no return of merchandise Assigning Specific accounts receivables are used as security for a loan. As the accounts are collected, the cash is transmitted to the financing institution (plus interest on the outstanding balance) Assigned accounts are identified on the balance sheet Pledging Accounts receivable in general are used as security for a loan. No specific accounts. No special identification on the balance sheet, but footnote disclosure is required. Payment on the loan is independent of receivable collection. Factoring Selling of accounts receivable. Receivables are sold without recourse (all risks are transferred to the financing institution) or with recourse (risk remains with the selling company. This is equivalent to borrowing) Note receivable Formal borrowing arrangement with specified payment terms and interest. Interest may be explicitly stated or may be included in the face value (amount to be paid at maturity) . Sometimes the explicit interest rate is less than the normal market rate. In that case additional interest is "buried" in the face value Discounting (Notes A) Notes without (or with below market) interest rates must be "discounted". This refers to calculating the amount of interest that is included in the face value of the note. If the maturity date of the note (date when the note must be paid) is more than one year away, a present value calculation is required. Discounting (Notes B) Term used for selling of notes. The reason sale of a note is called "discounting" is because it involves an interest calculation to determine how much cash will actually be received. This discounted considers (a) the amount of interest that will be paid by the customer and (b) the amount of interest the financing institution wants to earn. Recourse Refers to the fact that sometimes accounts or notes are sold on a contingent basis. This means that the seller is not released from liability until the customer has actually paid the financing institution. In other words, these types of sales are really a form of borrowing.