Cash, Receivables, & Investments Flashcards
Credit terms - example 2/10 net 30
pay w/in 10 days, get 2% discount; otherwise must pay by 30th day
Annual financing cost (AFC)
credit terms
Formula:
AFC = [discount / 100 - discount] * [365/(credit period - discount period)]
E.g. 2/10, net 30
AFC = [2/98] * [365/20]
[2%/98%] * [total year/(30 days - 10 days)]
aka, if it is 2% for 20 days, how much is it for 365 days?
How to determine if you should take the credit terms?
credit terms
Calculate the AFC, compare to interest rate in the market
annual financing cost > interest rate
if have the money, take the discount
it not have the money, borrow and take discount
annual financing cost < interest rate
if have money, pass on discount (invest money)
if not have the money, pass on discount
Discount types
credit terms
Trade discounts & purchase discounts
- never entered into the books (it is a decrease in profit, not a cost)
- purchaser would record purchased inventory at net of trade discount
Cash discount
- discount is recorded
- can be recorded gross of discount or net of discount
Cash discount - when to record sales gross of discount?
credit terms
Based on historical experience, if customers will NOT be likely to take the discount, record GROSS.
- record sales and A/R at full value
- record discount only if customer takes it
Conservatism principle - don’t record expenses you are not likely to take (i.e. customer will not take the discount so you will not have that expense)
sale made
A/R 100
sales 100
cash rec’d - discount not taken
cash 100
A/R 100
cash rec’d - discount taken
cash 98
discount 2
A/R 100
Cash discount - when to record sales net of discount?
credit terms
Based on historical experience, if customers WILL be likely to take the discount, record NET.
- record sales and A/R at net value of discount
Conservatism (prudence) principle - record the future expense you are likely to incur with the related revenue (i.e. customer will take the discount so don’t record the gross rev)
sale made
A/R 98
sales 98
cash rec’d - discount taken
cash 98
A/R 98
cash rec’d - discount not taken
cash 100
A/R 98
sales 2
Bad debts - direct write off method
bad debt
Not allowed for GAAP. Required for tax.
No bad debt allowance allowed. Only record bad debts when actually occur.
Does not comply with GAAP prudence & matching, but is used for tax to prevent tax rate gaming.
Bad debts - allowance method
bad debt
Used to comply with prudence and matching.
- not overstating revenues
- matching expense to the period in which the sale occurred.
From the sales made, anticipate some will be future bad debts and create an allowance.
Allowance for bad debts - sample journal entries
bad debt
At time of sale:
A/R (B) 100
sale (I) 100
bad debt expense (I) 2
ADA* (B) 2
*allowance for doubtful accounts
Cash collection:
cash 90
A/R 90
ADA 10
A/R 10
Bad debt recovery:
A/R 10
ADA 10
cash 10
A/R 10
Allowance for bad debts - % of A/R
bad debt
A company can estimate a percentage of A/R at period end as the ADA.
The % of A/R at period end is calculated. ADA ending balance is adjusted to match this amount.
What items are included in cash & cash equivalents?
cash
- cash-in-hand
- checkable accounts (savings & current accts)
- negotiable instruments (checks, notes receivable, money order)
- t-bill, mm funds, commercial paper, & CDs where original maturity is less than 3 months (issue date to maturity)
- investments w/ remaining time to maturity of less than 3 months (purchase date to maturity)
What investments are not included in cash & cash equivalents?
cash
- bank overdraft (this is a ST loan); can be netted with a checkable acct at the same bank
- restricted cash (e.g. compensating balances, escrow accts, security deposit
- treasury bills, mm funds, commercial paper, and CDs where maturity date is greater than 3 months (issue date to maturity)
- investments with remaining time to maturity of greater than 3 months (purchase date to maturity)
Pledging, Assigning, Factoring A/R
Pledging: A/R is used as collateral on a loan. Control of the receivable stays with the borrower. A/R only goes to lender in case of default.
Assigning: A/R used as collateral on a loan. Promising that all the proceeds from A/R will be used to pay off ht the loan. Control stays w/ the borrower.
Factoring: A/R is sold to a 3rd party for less than 100% (risk, fees, etc.). Factoring w/ recourse and w/o recourse
Credit losses - reporting ADA
credit losses need to be disclosed on two levels:
- by portfolio segment
- by class of financing receivable
portfolio segment: level used by the entity in developing an documenting systematic method for determining losses
class of financing receivable - disaggregation of portfolio segment.
