Chp 7: Cash And Receivables(Additional Concepts)

1. All disbursements that aren't petty cash should be made by check, providing a permanent record of all disbursements.

2. All expenditures should be authorized before a check is prepared.

3. Checks should be signed by authorized individuals only.

Responsibilities for check singing, check writing, check mailing, cash disbursements documentation, and recordkeeping should be separated whenever possible.

those other than trade receivables and include tax refund claims, interest receivable, and loans by the company to other entities including stockholders and employees.

Management's goal is to hold the minimum amount of cash to conduct operations, pay off debts, and take advantage of opportunities.
Company needs cash cushion because cash outflows and cash inflows can't be predicted with absolute certainty.
There is a trade-off between risk and return when deciding how much cash to have on hand.
Liquidity is a measure of a company's cash position and its ability to obtain cash.
Managements makes important decisions related to cash, which impact a company's profitability and risk.

Generally, revenue and related accounts receivable are recognized at the point of delivery of the product or service.

Because the difference between FV and PV of A/R are immaterial, GAAP specifically excludes A/R from the general rule that receivables be recorded at present value; A/R initially valued at exchange price between buyer and seller.

could possibly cause the cash ultimately collected to be less than the initial valuation of the receivable:

1. the customer could return the product

2. The customer could default and not pay the agreed upon sales price.

If a customer has paid cash for a returned item, the company refunds the cash when the return occurs and credits the estimated amount of remaining cash to be refunded at the end of the period.

If a note with an unrealistic interest(even a noninterest bearing note) is received solely in exchange for the cash, the cash paid to the issuer is considered to be the note's present value.

GAAP requires that companies disclose the fair value of N/R in disclosure notes.

Companies can choose to report N/R at fair value on their balance sheets, with changes in fair value recognized as gains and losses in the income statement.

Model to account for bad debts on long-term N/R that may be implemented as early as 2017.

Differs from GAAP in two ways:

1. Removes probable threshold for impairment. Thus even if the likelihood of bad debts is low, the creditor estimates bad debts by comparing the receivables balance to the PV of the cash flows expected to be received, discounted at the interest that was effective when the the receivable was initially recognized.

2. Instead of just focusing on the present as does the current GAAP model, this model requires creditors to consider predictions of future events to estimate bad debts, even if no events have occurred that indicate a problem.

1. IFRS No. 9 replacing IAS No. 39 to account for N/R and A/R on Jan 1, 2018

2. both IFRS standards similar to GAAP in accounting of N/R and A/R.

3. both allow fair value option in accounting for receivables, but IFRS restricts the circumstances in which that option is allowed.

4. ECL model is IFRS version of CECL model, which is used to estimate bad debts. key difference is that ECL reports a 12-month ECL, which bases expected credit losses only on defaults that could occur within the next 12 months as opposed to GAAP, which also considers defaults after twelve months.

The various approaches used to finance with receivables differ with respect to the rights and risks that are retained by the transferor that are passed on to the transferee

Approaches:

1. Secured borrowing

2. A sale of receivables

transferor debits cash regardless of whether it's a secured borrowing or sale of receivables. What differs is whether the transferor credits a liability or the receivable asset.

The company who is the original holder of the receivables

The new holder, the financial institution

The transferor(borrower) simply acts like it borrowed money from the transferee(lender), with the receivables remaining on the transferor's balance sheet and serving as collateral for the loan. The transferee recognizes an N/R.

Includes:

1. Pledge

2. Assign

The transferor(seller) derecognizes(removes) the receivables from its balance sheet, acting like it sold them to the transferee(buyer). Transferee recognizes receivables as assets on its balance sheet and measures them at fair value.

The transferor:

1. Removes from the accounts the receivables(and any AFDA associated with them)

2. Recognizes at fair value any assets acquired or liabilities assumed by the seller in the transaction

3. records the difference as a gain or loss

Popular method of financing used in many different industries

2 most common types:

1. Factoring

2. Securitization

A sale of receivables can be with recourse and without recourse

Transferor usually prefers to use the sales approach rather than the secured borrowing approach because the sale approach makes the transferor seem less leveraged, more liquid, and perhaps more profitable.

Determining whether a company can account for a transfer for receivables as a sale is dependent on the extent to which the transferor surrenders control over the assets transferred.

This surrender of control is clear in some cases, such as in a sale of a receivable without recourse and without any other involvement from the transferor.

In other cases, there may be inappropriate use of the sales approach whereby a transferor may structure transactions in ways that qualify for sale treatment but retain enough involvement to have control.

Thus, FASB has provided guidelines to curb this providing that a company has surrendered control over the receivables if all the conditions are met:

1. The transferred assets have been isolated from the transferor- beyond the reach of the transferor and its creditors

2. Each transferee has the right to pledge or exchange the asset it received.

3. The transferor does not maintain effective control over the transferred assets.

All conditions must be met to account for the transfer as a sale.

If one condition is not met, then it's accounted for as a secured borrowing.

Because the sale approach derecognizes A/R and thus reduces assets, while the secured borrowing approach doesn't, the sales approach produces a higher ROA.

Because the sales approach doesn't recognize a liability, while the secured borrowing approach does, the sales approach produces lower liabilities and less leverage.

Because the cash received can be included in the operating section for the sales approach, whereas the cash received is exclusively a financing activity under the secured borrowing approach, it can produce a higher cash flow from operations at the time of the transfer.

Because the sales approach is more likely to recognize a gain on the transfer, it can produce a higher income at the time of transfer.

U.S. GAAP requires that a partial transfer be treated as secured borrowing unless the amount transferred qualifies as a participating interests as well as meeting the surrender of control requirements.

Participating interests are defined as having a proportionate ownership interest in the receivable and sharing proportionally in the cash flows of the receivable.

Much disclosure is required when transferor has continued involvement in a transferred asset but accounts for the transfer as a sale because this usually is indicative of secured borrowing.

Transferors must provide enough information to financial statement users to help them understand:

1. The transfer

2. any continuing involvement with the transferred assets

3. any ongoing risk to the transferor

Must also provide information on the quality of the transferred assets.

Transferor must disclose:

1. How fair values were estimated when recording the transaction

2. Any cash flows occurring between the transferor and transferee

3. How any continuing involvement in the transferred assets will be accounted for on an ongoing basis.

Where IFRS and GAAP differ is in their conceptual basis for their choice of accounting approaches and in the decision process they require to determine which approach to use.

Under IFRS, the company has to consider whether substantially all of the risks and rewards of ownership have been transferred as well as whether the company transferred control.

Thus:

1. If the company transfers substantially all risks and rewards of ownership, the transfer is treated as a sale.

2. If the company retains substantially all risks and rewards of ownership, the transfer is treated as secured borrowing.

If neither of the conditions are met, the company accounts for the transaction as a sale if it has transferred control, and as a secured borrowing if it has retained control.

1. A company's investment in receivables is influenced by several variables, including the level of sales, the nature of the product or services sold, and credit and collection policies

2. Management's choice of credit and collection policies often involves trade-offs, such as offering cash discounts, which increase sales volume, but may also reduce the amount of cash collected from customers.

3. The ability to use receivables as a method of financing also offers management alternative methods of financing.

1. discretionary accruals called "misc cookie jar reserves" is the most common way companies manipulate income

2. A/R, AFDA, and other accounts can be examined to detect low earnings quality.

3. The use of the sales method to distort fair value estimates when recording securitizations and manipulating cash flows from operations when selling A/R.