each receivable transaction involves:each receivable transaction involves:

Effective Interest Method Whether we are selling a good or service OR is a short-term accounts receivable becomes a long-term note receivable, the accounting is very similar. Therefore, the annual amortization is $432.95 ($2,164.74 5 years) each year is recorded as: When property, goods, or services are exchanged for a note, and the market rate and the timing and amounts of cash received are all known, the present value of the note can be determined. The following timelines will illustrate how present value using discounted cash flows works. This difference would be deemed as additional compensation and recorded as Compensation expense. Notice that the AFDA ending balance of $8,000 is the same for both examples when applying the percentage of accounts receivable method. C. Receivables occur when a business loans money to another party. Typical receivable-related categories include: The table below shows a portion of the balance sheet for cash and cash equivalents and various receivables on the financial statements: It is important to consider carefully how to manage and control accounts receivable balances. Many ASPE companies have policies that allow for the return of goods under certain circumstances and will refund all or a partial amount of the returned items cost. The given statement "each receivable transaction involves two partiesthe one who takes on the obligation and the one . True False . Referring to the journal entry above, in both cases cash flow increased by $90,000, but for the secured borrowing, there is added debt of $90,000, affecting Cromwells debt ratio and negatively impacting any restrictive covenants Cromwell might have with other creditors. For each method above, management estimates a percentage that will represent the likelihood of collectability. The notes present value is calculated as: In this case, the notes face value and present value (fair value) are the same ($10,000) because the effective (market) and stated interest rates are the same. Each receivable transaction involves two parties: The creditor, who receives a receivable (an asset). The debtor, the party to a credit transaction who takes on an obligation/payable (a liability). 2.5 Challenges and Opportunities in Financial Reporting, 3.0 Financial Reports: Statement of Income, Comprehensive Income and Changes in Equity, 3.2 Factors that Influence Financial Reports, 3.3 Financial Statements and Their Interrelationships, 3.4 Statement of Income and Comprehensive Income, 3.5 Statement of Changes in Equity (IFRS) and Statement of Retained Earnings (ASPE), 3.6 Analysis of Statement of Income and Statement of Changes in Equity, 4.0 Financial Reports Statement of Financial Position and Statement of Cash Flows, 4.2 Statement of Financial Position/Balance Sheet, 6.6 Appendix A: Review of Internal Controls, Petty Cash, and Bank Reconciliations, 7.3 Subsequent Recognition and Measurement, 9.0 Property, Plant and Equipment Overview, 9.4 Measurement After Initial Recognition, 10.0 Depreciation, Impairment, and Derecognition of Property, Plant, and Equipment, 10.5 Presentation and Disclosure Requirements, 10.7 Appendix A: ASPE Standards for Impairment, 11.1 Intangible Assets and Goodwill: Overview, 11.2 Intangible Assets: Initial Recognition and Measurement, 11.4 Disclosures of Intangible Assets and Goodwill. The amortized discount is added to the notes carrying value each year, thereby increasing its carrying amount until it reaches its maturity value of $10,000. The bottom line is that receivables management is about finding the right level of receivables to maintain when implementing the companys credit policies. For sales without recourse, all the risks and rewards (IFRS) as well as the control (ASPE) have been transferred to the factor, and the selling company no longer has any involvement. For example, if credit sales were $325,000 at the end of the period and the uncollectible accounts was estimated to be 3% of credit sales, the entry would be: Often companies will use the percentage of credit sales method to adjust the net accounts receivables for interim (monthly) financial reporting purposes because it is easy to apply. Stated rate 10% and market rate of 12%. Aging schedules are also a good indicator of which accounts may need additional attention by management, due to their higher credit risk group, such as the length of time the account has been outstanding or overdue. Accounts receivable are listed on the balance sheet as. This results in the accounts receivable being valued at its net realizable value and based on Cramers more likely than not estimate of sales discounts expected to be taken, which is consistent with IFRS 15.53. For example, a purchaser who fails to take the 1.5% reduction offered for payment within ten days for an account due in thirty days is equivalent to missing a stated annual interest rate return on their cash for 27.38% (365 days 20 days 1.5%). There are risks associated with factoring receivables. Answer: It is common knowledge that money deposited in a savings account will earn interest, or money borrowed from a bank will accrue interest payable to the bank. If amounts in this contra account become too high, it could indicate to management the possibility of future sales lost due to unsatisfied customers. Securitization is a financing transaction that gives companies an alternative way to raise funds other than by issuing debt, such as a corporate bond or note. Factoring is when individual accounts receivable are sold or transferred to a recipient or factor, usually a financial institution, in exchange for cash minus a fee called a discount. In subsequent accounting periods, accounts receivable are to be measured at their amortized cost which is the same as cost, since there is no present value interest component to recognize. In scenario 1, the principal is not reduced until maturity and interest would accrue over the full five years of the note. The collection period of accounts receivable is usually long, and therefore, it is classified as a long-term asset on the balance sheet. The entry for payment of the note ninety days at maturity on June 12 would be: Assuming that returns for this company are insignificant, the entry for a $1,000 sales return on account (with a cost $800) returned to inventory, for a company using a perpetual inventory system, would be: Sales allowances are reductions in the selling price for goods sold to customers, perhaps due to damaged goods that the customer is willing to keep if the sales price is reduced sufficiently. Typically, investors with securities linked to the lowest-risk bundles would have little expectation of portfolio losses. If the company follows ASPE, and the unadjusted balance in the allowance for sales returns and allowances account is $5,000 credit balance, the year-end adjusting entry would be: Note how another contra account, the sales returns and allowances account, is used to record the debit entry for the previous two journal entries above. A) Each receivable transaction involves three parties. Once purchased, the originating company (seller) derecognizes the receivables and the SPE accounts for the portfolio assets in its own accounting records. 2. FV is the payment at the end of six months time (future value) of $5,000. Put into context for receivables, if a company must wait until a future date to receive the payment for its receivable, the receivables face value at maturity will not be an exact measure of its fair value on the date the note is legally executed because of the embedded interest component. Below is the transaction recorded as a sale of receivables compared to a secured note payable arrangement, starting with some opening balances: The journal entry to record the sale of the receivables (factoring): Below is the balance sheet after the transaction: Note that the entry for a sale is straightforward with the receivables of $100,000 derecognized from the accounts and a decrease in retained earnings due to the loss reported in net income. The adjusting entry to achieve the correct AFDA adjusted ending balance of $8,000 would be: The AFDA ending balance after the adjusting entry would correctly be $8,000 ($2,500 unadjusted balance + $5,500 adjusting entry). Plus interest and minus any principal collections/receipts. Even though the interest rate is not stated, the implied interest rate can be derived because the cash values lent and received are both known. In this case, a market rate must be imputed and used to determine the notes present value. If the stated interest rate is 10% and the market rate is 11%, the stated rate is lower than the market rate and the note is trading at a discount. Typically, the older the uncollected account, the more likely it is to be uncollectible. Which is a true statement regarding the accounting equation? Issuance of common stock. Companies that intend to sell their receivables to a factor need to check out the bank and customer references of any factor. Even with only a prospective order in hand from a customer, a business can turn to a factor to see if it will assume or share the risk of the receivable. The market rate of interest is 5%. IFRS 7 and IAS 1 specify the separate reporting categories based on significance such as the following: For each receivables category above, the following disclosures are required: Stakeholders, such as investors and creditors, want to know about the various transactions that hold risks. This is similar to factoring without re- course, but is done on a much larger scale. Receivables represent one of a company's most liquid assets. Without the factoring arrangement, the business must take time to secure and collect the receivable; the factor offers a reduction in additional effort and aggravation that may be worth the price of the fee paid to the factor. It is a discounted cash flow concept, which is explained next. This is the same concept as a mortgage owing for a house, where it is commonly stated by financial advisors that a mortgage payment split and paid every half-month instead of a single payment once per month will result in a significant reduction in interest costs over the term of the mortgage. . The mix of methods is perhaps a more realistic view of how companies estimate bad debt expense over a reporting period. Using the gross method, the entry for the sale is: The entry on collection of $10,000 within the ten-day discount period is: The entry on collection of the remaining $30,000 after the discount period is: Note how the accounts receivable would not be reported at its net realizable value with this method. The entry for the note receivable when issued would be: At Eclipses year-end of December 31, the interest income at the end of the first year using the effective interest method would be: At maturity when the cash interest is received, the entry would be: If Eclipse used ASPE instead of IFRS, the entry using straight-line method for amortizing the discount is calculated as the total discount of $2,164.74, amortized over the five-year term of the note resulting in equal amounts each year. True. The land has a historic cost of $5,000 but neither the market rate nor the fair value of the land can be determined. The transferor does not maintain effective control of the transferred assets through a repurchase agreement. The debtor will pay cash later. If receivables are sold without recourse, the purchasers assumes the risk of collection and is responsible for any credit losses. Remember for zero-interest notes, you can re-arrange the present value formula to calculate the interest rate if needed. Savoys net income will be the finance fee of $16,000 with no reductions in revenue due to uncollectible accounts, since these are being guaranteed and assumed by Ashton. This is due to the timing of the cash flows as discussed earlier. This asset valuation account will subsequently be adjusted up or down at the end of each reporting period. This means that the AFDA adjusted ending balance is estimated to be the amount equal to 4% of $200,000, or $8,000. For example, assume that on August 1, Ashton Industries Ltd. factors $200,000 of accounts receivable with Savoy Trust Co., the factor, on a without-recourse basis. The present value is calculated as follows: The entry upon issuance of the note and sale of the land would be: However, if the market rate is not known, either of following two approaches can be used to determine the fair value of the note: Determine an imputed interest rate. Basic types of risks and related disclosures are: In addition, information about company policies for managing risk, including quantitative and qualitative data, is to be disclosed. Accounts Receivable has a credit of $5,500 (from the Jan. 10 . This treatment and entry makes sense because the estimate for uncollectible accounts adjusting entry (with a debit to bad debt expense) had already been done using one of the allowance methods discussed earlier. A. investments B. accounts receivable C. notes receivable D. interest receivable, Notes receivable ________. The company records the proceeds of the loan received from the finance company as a liability with the loan interest and any other finance charges recorded as expenses. In return, Anchor will receive an annual cash payment of $1,000 for three years plus a lump sum payment of $10,000 at the end of the third year, when the note matures. Using the same example, assume that Cramer Plumbing sells fifty bathtubs for $800 each, with credit terms of 1.5/10, n/30. The present value of a note receivable is therefore the amount that you would need to deposit today, at a given rate of interest, which will result in a specified future amount at maturity. Below is an overview of some of the types of transactions that affect these accounts: Some smaller companies may only have a few credit sales transactions and small ac- counts receivable balances. Step-by-step explanation Each receivable transaction involves two parties : the one who takes on the obligation and the one who will collect the cash. In the example above, if financial statements are prepared during the time that the note receivable is outstanding, interest will be accrued to the reporting date of the balance sheet. The Standard defines fair value on the basis of an exit price notion and uses a fair value hierarchy, which results in a market-based, rather than entity-specific, measurement. You'll get a detailed solution from a subject matter expert that helps you learn core concepts. If this happens, the receivable is considered impaired. IFRS 7 (IFRS, 2015) and IAS 1 (IAS, 2003) include significant disclosure requirements that provide information based on significance and the nature and extent of risks. After the transaction, the debt-to- total assets ratio for Cromwell is 20% if the accounts receivable transaction meets the criteria for a sale. This is because the calculation is intended to be an estimate of the AFDA ending balance, so the adjustment amount is whatever is required to result in that ending balance. The interest calculation will differ slightly had the note been stated in months instead of days. Disclosures include a sensitivity analysis for each type of market risk to which the entity is exposed at the end of the reporting period, showing how profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at that date (IFRS, 2015, 7.40 a). Answer: The correct answer is letter "A": Receivables occur when a business loans money to another party. Want to create or adapt books like this? The sales class and receipts class of transactions are the typical journal entries that debit accounts receivable and credit sales revenue, and debit cash and credit accounts receivable, respectively. The year-end adjusting entry to update the accounts receivable allowance account with the estimated sales discounts would be: Throughout the following year, the allowance account can be directly debited each time customers take the discounts and is adjusted up or down at the end of each reporting period. If $10,000 of the account receivable is collected from the reseller within the ten-day discount period (for a cash amount of $9,850), the entry would be: The entry for collection of the remaining amount owing for $30,000 after the discount period is: As can be seen above, the net method records and values the accounts receivable at its lowest, or net realizable value of $39,400, or gross sales for $40,000 less the 1.5% discount. accounts receivable, and inventory. The present value is calculated as follows: The entry upon issuance of the note would be: Its important to note. True or False. 17,900 BrickmanBrickman Company uses the allowance method to account for uncollectible receivables. Each receivable transaction involves two parties: The creditor, who receives a receivable (an asset). trade receivables. Derecognition is the removal of a previously recognized receivable from the companys balance sheet. Given the high rate of return identified in the preceding paragraph, recording the estimate immediately upon sale is conceptually sound and is consistent with the net method described below. Receivables are frequently classified as: Accounts receivable ASPE disclosure requirements are much the same as IFRS, though perhaps requiring slightly less information about risk exposures and fair values than IFRS (CPA Canada, 2016, Part II, Section 3856.3842). Securitization is inherently complex, yet it has grown exponentially. Eclipses year-end is December 31. Notes can also be used for sales of property, plant, and equipment or for exchanges of long-term assets. For example, management estimates the total sales returns and allowances to be $51,500, which it deems to be significant. Two such ways are secured borrowings and sales of receivables, discussed next. . net realizable value), on the balance sheet until payment is received. Larger companies may rely on another way of selling receivables, called securitization. Each receivable transaction involves two partiesthe one who takes on the obligation and the one who will collect the cash. For example, if the interest rate (I/Y) is not known, it can be derived if all the other variables in the equation are known. Assuming the data above for Taylor and Company and an unadjusted AFDA credit balance as at December 31 of $2,500, the adjusting entry for uncollectible accounts would be: As was illustrated for the percentage of accounts receivable method above, the calculation of the adjusting entry amount must consider whether the unadjusted AFDA balance is a debit or credit amount. The process is extremely complex and the description below is a simplified version. what is account receivable? If stated rate higher than market Present value higher Difference is a premium. If credit policies are too restrictive, potential sales could be lost to competitors. C) Each receivable transaction involves three parties. Types of Receivables For scenario 3, there is an immediate reduction of principal due to the first payment of $1,000 upon issuance of the note. Below are some different examples of sales of receivables; such as factoring and securitization. If the customer pays within the discount period, the applicable discount taken is recorded to a sales discounts account. the debt-to- total assets ratio for Cromwell is 20% if the accounts receivable transaction meets the criteria for a sale. Carpe Diems entry on the date of issuance is: If Carpe Diems year-end was December 31, the interest income recognized each year would be: Assume that Anchor Ltd. makes a loan to Sizzle Corp. in exchange for a $10,000, three- year note bearing interest at 10% payable annually. As well, the company cannot sell or pledge any of these receivables to any third parties other than to the factor. Purchase of inventory 7. Each receivable transaction involves three parties., Which of the following is included in the category of other receivables? The cash flow is discounted to a lesser sum that eliminates the interest componenthence the term discounted cash flow. The interest amounts differ slightly between the two calculations because the ninety-day note uses a 90365 ratio (or 24.6575% for a total amount of $98.63) while the three-month note uses a 312 ratio (or 25% for a total of $100.00). This type of a transfer is considered to be an outright sale of the receivables. If discounts are significant, this would overstate accounts receivable and sales in the financial statements. Issuance of a note payable 6. A note receivable is an unconditional written promise to pay a specific sum of money on demand or on a defined future date and is supported by a formal written promissory note. The remaining four payments are made at the beginning instead of at the end of each year. The gross method is much easier and ASPE can choose either method. Each receivable transaction involves two parties - the one who takes on the obligation . The factor has obtained the right to pledge or to sell the transferred assets. The resulting highly competitive securitization markets with multiple securitizers (financial institutions and SPEs), increase the risk that underwriting standards for the asset-backed securities could decline and cause sharp drops in the bundled or tranched securities market values. For example, assume that on May 1, Hudson Inc. receives a $200,000, five-year note in exchange for land originally costing $120,000. Test bank for Horngren's Financial & Managerial Accounting 6th Edition AC 72751 Sale of equipment for a notereceivable. B) Receivables occur when a business loans money to another party. Subsequent valuation is measured at amortized cost. Please only accept this question if you can answer it within 1hour. The rate will be estimated based on interest rates currently in effect for companies with similar characteristics and credit risk as the company issuing the note. Determining present values requires an analysis of cash flows using interest rates and time lines, as illustrated next. The implied interest rate is calculated to be 5% and the notes interest component (rounded) is $2,165 ($10,000 $7,835), which is the difference between the cash lent and the higher amount of cash repaid at maturity. This is because both the investment return (principal and interest repayment) and losses are allocated among the various bundles according to their level of risk. Market riskthe risk that the fair value or cash flows of a receivable will fluctuate due to changes in market prices which are affected by interest rate risk, currency risk, and other price risks. . The entry for Ashton is: The accounting treatment will be the same for IFRS and ASPE since both sets of con- ditions (risks and rewards and control) have been met. Differences between the stated interest rate (or face rate) and the effective (or market) rate at the time a note is issued can have accounting consequences as follows: If the stated interest rate of the note (which is the interest rate that the note pays) is 10% at a time when the effective interest rate (also called the market rate, or yield) is 10% for notes with similar characteristics and risk, the note is initially recognized as: face value = fair value = present value of the note. and the one who will collect the cash. The notes present value is calculated as: As shown above, the notes market rate (12%) is higher than the stated rate (10%), so the note is issued at a discount. The debt ratio worsens to 36% if the transaction does not meet the criteria for a sale and is treated as a secured borrowing. Where I/Y is interest of .75% each month (9% 12 months) for six months. In this case, the imputed rate is determined to be 7%. This is because the credit sales method is intended to calculate the bad debt expense that will be reported on the income statement. each receivable transaction involves 2 parties : the creditor , who gets a receivable [ an asset ] and the debtor who takes on an obligation / payable [ a liability ] there are 2 major types of receivables: accounts receivable and notes receivable. If Anchor used ASPE, there would be a choice between the effective interest method and the straight-line method. A debtor is a party to a credit transaction who will receive the cash for the transaction at a later date.