Financial Accounting Chapter 7

Initial recognition and measurement
Cost:
historical cost less adjustments for cash/sales discounts

Gross- show sales discounts for those that took advantage of it

Net- showing sales discounts for those customers who did not take advantage of paying within the discount period

Main objective: receivables = the cash expected to be collected
Cash discounts gross method
Sales entry:
dr accounts receivable
Cr sales revenue

collection entry:
dr cash
dr sales discounts
Cr accounts receivable
Cash discounts net method
Sales entry:
dr accounts receivable
Cr sales revenue

collection entry:
if discount not taken
dr cash
Cr sales discounts forfeited
Cr accounts receivable
Cash discounts gross method
If material cash discounts are expected at year end, adjusting entry:
dr sales discounts
Cr allowance for sales discounts

common practice: record sales discounts when taken during the year and the. Adjust the allowance at year end- just like ADA
Subsequent measurement - ADA
Purpose of ADA:
match bad debt expense with the revenue that generated the sale
show accounts receivable at its NRV- amount expected to be collected

2 methods for ADA:
percentage of credit sales- SCI
aging of accounts receivable method- SFP
Derecognition - write off
ADA- write off JE
dr allowance for doubtful accounts
Cr accounts receivable

ADA - write off and recovery
dr accounts receivable
Cr allow for doubt accts
dr cash
Cr accounts receivable
derecognition - transfer of receivables
Transfer AR to another party (factor) to speed up cash flows

transfer done with either;

a. Recourse- risk of collection stays with the company. Purchaser/transferee can come back to transferor company to collect payment if sold receivable is not collectible

b. Without recourse- purchaser/transferee assumes the risk of collection and absorbs any credit losses
Accounting treatment for the transfer
Either as:
1) a sale (derecognition)
criteria to record as a sale:
IFRS: if risk and reward of ownership is transferred
ASPE: if control is surrendered

if criteria not met then
2) a borrowing arrangement
Transfer of receivables sale
The accounts receivable come off the books of the selling company and a financing fee is recognized

dr cash
dr financing fee
Cr accounts receivable
Transfer of receivables borrowing
The accounts receivable are left on the books of the selling company and the amount received from the finance company is recorded as a loan payable until the customer actually pays.
dr cash
dr discount on note payable
Cr note payable
when customer pays:
dr cash
Cr accounts rec
then pay off note;
dr note payable
Cr cash
Note Receivable- Initial recognition
PV using effective interest
initially recognized at fair value calculated using PV methods
Subsequent measurement
(valuation/impairment)
Amortized cost
Derecognition
Collection
Face value
aka maturity value

the stated dollar amount of note
Stated (nominal) interest rate
The rate on the note and used to determine the cash interest to be received/paid
Market (effective) interest rate
The market rate for similar loans of identical amounts, risk, terms and conditions
Present value
The discounted amount of the future cash flows (both interest and maturity amounts) using the effective interest rate
Effective interest rate method
requires that the market rate is used to value the note and the transaction
the market rate is also used to measure interest revenue or expense
the stated rate is used to determine the cash interest payments
Interest bearing
Specify the interest rate to be applied to the face amount in computing interest payments
Non bearing interest
Do not state an interest rate but command interest though the difference between cash lent and (higher) cash repaid.
Note receivable- initial recognition
Note valuation:
Fair value= PV of all future cash flows using effective interest rate (market yield rate)
1. the PV of the face value of the note
2. PLUS the OV of the interest payments to be received
Equals the PV of the entire note
Initial recognition step 1
Calculate the PV of the note and determine the premium or discount
2 parts:
PV of face value of note- using market (effective) interest rate
PLUS PV of interest received using market interest rate where: interest received= face value x stated interest rate
Premium or discount
Premium- when interest rate charged > market rate

discount- when interest rate charged < market rate
(results in PV of note < Face value of note)
Measurement of interest income
2 methods to amortize the discount or premium over life of the note:
effective interest rate method- measures interest income at the market rate of the notes carrying amount (face value less the discount)- IFRS requires
straight line method- allocates the total premium/discount over the life of the note equally. Not allowed under IFRS

effective interest rate method results in a constant rate of interest throughout life of note

straight line method- results in a constant interest income amount throughout life of note
Step 2
Calculate interest income and premium/discount amortization
A. Effective interest rate method:
interest income= net note rec. x effective (market) interest rate
premium/discount amort.= interest income - interest received

B. Straight line method:
interest income= interest received less (total premium/disc divided by # of periods)
Create and amortization table
Date
Interest income- mkt rate x note rec
Interest received- stated rate x face value
Prem/disc amort- column 1 less column 2
Unamortized prem/disc- prev bal - col 3
Net Note Receivable - prev col 5 +/- col 3
note receivable - interest date =/= year end date
When interest payment dates are diff from year end dates
accrue interest from last interest payment date and
bring discount/premium amortization up to date
then
prorate interest for the period
prorate bond premium/discount for the period