6.7 Chapter Summary

LO 1: Describe cash and receivables, and explain their role in accounting and business.

Companies usually have significant amounts of accounts receivable and the time frame and effort required to convert receivables to cash is a cycle that calls for regular monitoring for which financial reporting plays a significant role. Cash and receivables are financial assets defined as cash or a contractual right to receive cash or another financial asset from another entity. Cash and receivables are also monetary assets because they represent a claim to cash where the amount is fixed by contract.

Cash and receivables need to be kept in balance for the company to be financially stable. Too many accounts receivable may mean a substandard credit policy, resulting in significant uncollectible accounts. Too few accounts receivable could be an indication that the company’s credit policy is too restrictive, resulting in missed sales opportunities. Effective cash management is essential to ensure that any surplus cash is invested appropriately to maximize interest income and to minimize any bank loans and other borrowings.

LO 2: Describe cash and cash equivalents, and explain how they are measured and reported.

Cash is the most liquid asset and if unrestricted is usually classified as a current asset. Cash consists of coins, currency, bank accounts and petty cash funds, and negotiable instruments such as money orders, cheques, and bank drafts. Temporary same-bank overdrafts are usually netted with the current cash balance. Foreign currencies are reported in Canadian dollars as at the balance sheet date. Cash balances set aside for long-term purposes, such as a plant expansion project or long-term debt retirement, are classified long-term assets. Legally restricted or compensating balances are reported separately as current or non-current assets depending on the classification of the account it is supporting.

Cash equivalents are short-term, highly liquid assets with maturities no longer than three months (or ninety days) at acquisition that can be converted into known amounts of cash. Cash equivalents are usually combined with cash and reported in a single cash and cash equivalents account on the balance sheet. Examples are treasury bills, money market funds, short-term notes receivable, and guaranteed investment certificates (GICs).

LO 3: Describe receivables, identify the different types of receivables, explain their accounting treatment, and prepare the relevant journal entries.

Receivables are claims held against customers and debtors that are contractual rights with a legal claim to receive cash or other financial assets. They can be classified as current or long-term and are initially reported at their fair value. Subsequently they are measured at amortized cost. Categories include trade (accounts) receivable, notes receivable, and non-trade receivables.

Accounts receivable are usually collected within one year, so the interest component is not significant. Measurement in lieu of fair value is net realizable value. This is equivalent to the transaction value on the date the credit sale initially occurred and adjusted by any trade or sales discounts, sales returns, and allowances. Subsequent measurement is at cost (in lieu of amortized cost, since there is no interest component to amortize). Accounts receivable are affected by credit risk which may result in impairment of the accounts thereby reducing their net realizable value. This requires estimating an amount for uncollectible accounts that can be recorded to a valuation account called an allowance for doubtful accounts (AFDA). The AFDA is a contra account to accounts receivable and the net of the two accounts is intended to reflect the accounts receivable’s net realizable value. The calculations to estimate uncollectible accounts will be completed at each re- porting date using either a percentage of accounts receivable, percentages applied to the accounts receivable aging report, a percentage of credit sales, or a mix of these methods. Whenever an actual account is deemed uncollectible, it is written-off by removing it from the accounts receivables and AFDA accounts.

Notes receivable are a written promise to pay a specific sum of money on demand or on a defined future date. Payments can be a single lump sum at maturity, a series of payments, or a combination of both. Notes may be referred to as interest bearing or non-interest-bearing, even though there is always an interest component that must be recognized. For interest-bearing notes, the interest paid is equal to the stated interest rate on the note. For non-interest-bearing notes, the interest paid is the difference between the amount lent (proceeds) and the (higher) amount paid at maturity. Notes may be classified as short-term (less than twelve months) or long-term. Notes are initially measured at their fair value including transaction fees on the date that the note is legally executed. For short-term notes, since the effects of the discounted cash flows are insignificant, the net realizable value is used to approximate fair value. For long-term notes, fair value is equal to the present value of the expected future cash flows discounted by the market rate at the time of note issuance. After issuance, long-term notes receivable are measured at amortized cost, which allocates the interest income and discount or premium, if any, over the term of the note. For ASPE, either the effective interest rate method or the straight-line method can be used for amortization purposes. For IFRS, the effective interest rate method is to be used.

Non-trade receivables are amounts due for item such as income tax refunds, GST/HST receivable, amounts due from the sale of assets, insurance claims, advances to employees, amounts due from officers of the company, or dividends receivable.

To shorten the cycle of receivables to cash, companies can arrange for a borrowing (loan) from a financial institution (using the receivables as collateral) or as a sale of the receivables to another entity for cash. Sales can be either factoring or securitization. Factoring involves a financial intermediary (factor), such as a finance company that purchases the receivables and collects from the customers. Securitization is more complex; it involves a special purpose entity or vehicle (SPV) set up by a financial institution that purchases the receivables from the transferor using proceeds obtained from selling debt instruments to investors. These debt instruments are secured by the receivables received from the transferor. Companies selling receivables may or may not have continuing involvement regarding the transferred receivables. The issue becomes whether the transfer should be treated as a secured borrowing or a sale. For IFRS, receivables are treated as a sale if the risks and rewards have substantially been transferred. This is evidenced by the contractual rights to cash flows being transferred or the company continues to collect but immediately passes the proceeds on to the entity that purchased the receivables. As well, the company cannot sell or pledge the receivables to any other party. For ASPE, the focus is on control of the receivables. Three conditions must be met for control to occur and for receivables to be treated as a sale.

IFRS disclosures of receivables involve levels of significance and the nature and extent of the risks arising from them and how these risks are managed. Separate reporting is required for:

• trade accounts receivable from non-trade accounts
• current accounts receivable from non-current
• disclosures of any impairments or reversals of impairments
• details regarding any allowance accounts.

Other disclosures require details about the carrying amounts such as fair values, amortized costs or costs where applicable, and methods used for estimating uncollectible accounts. For long-term receivables, the amounts and maturity dates are to be disclosed. Information about any assets pledged or held as collateral is to be disclosed. Extensive disclosures are required for any securitization or transfers of receivables. Various types of risks such as credit, liquidity and market risks are to be disclosed. Companies following ASPE require less disclosure than IFRS companies.

LO 4: Identify the different methods used to analyze cash and receivables.

Cash and receivables are analyzed using various techniques to determine the levels of risk for uncollectible accounts as well as the company’s overall liquidity or solvency. The statement of cash flows provides information about the sources and uses of cash. Receivables can be analyzed using accounts receivable aging reports, trendline analysis, and various ratio analyses such as quick and current ratios, accounts receivable turnover ratios, and days’ sales uncollected.

LO 5: Explain the differences between IFRS and ASPE for recognition, measurement, and reporting for cash and receivables.

For the most part, the IFRS and ASPE standards are similar. The differences between IFRS and ASPE arise regarding: 1) what is recognized as cash equivalents; 2) the method used to amortize interest, premiums, or discounts for long-term receivables; 3) the criteria needed for treatment as either a sale of receivables or as a secured borrowing; and 4) both the nature and extent of disclosing requirements for cash and receivables on the balance sheet.