Cash and Receivables
Cash and receivables are heavily tested because they combine classification, measurement, and journal entry issues. FAR questions often ask whether an item is cash, a cash equivalent, a receivable, a contra account, or a liability.
Cash and Cash Equivalents
Cash includes amounts that are available for immediate use and free from material restriction. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and close enough to maturity that interest-rate risk is insignificant.
:::tip Exam rule
A cash equivalent must have an original maturity of three months or less from the date of purchase.
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| Item | Typical treatment |
|---|---|
| Currency and coins | Cash |
| Demand deposits | Cash |
| Treasury bills purchased with 90 days or less to maturity | Cash equivalent |
| Money market funds | Usually cash equivalent |
| Post-dated checks | Receivable, not cash |
| NSF checks | Receivable, not cash |
| Restricted cash | Separate current or noncurrent line item |
Classification examples
- Bear Co.
- Gies Co.
Bear Co. buys a Treasury bill on December 1 that matures on February 1. Because the investment has only two months to maturity when purchased, it is a cash equivalent.
Gies Co. buys a note on March 1 that matures on August 1. Because five months remain at purchase, it is not a cash equivalent even though it matures within the same year.
Restricted Cash and Overdrafts
Restricted cash is segregated for a stated purpose, such as debt service, collateral, or plant expansion. It is not included with unrestricted cash if the restriction is material.
Bank overdrafts are generally reported as current liabilities. If multiple accounts exist at the same bank, a negative balance may be offset against a positive balance at that same bank.
Do not automatically net an overdraft against another bank account at a different bank.
Trade Receivables Overview
Receivables are claims to cash arising from sales, loans, or other transactions. The main categories are:
| Type | Example |
|---|---|
| Accounts receivable | Open-account customer balances |
| Notes receivable | Written promises to pay |
| Other receivables | Interest receivable, employee receivables, tax refunds |
Receivables are usually reported at net realizable value, which is the amount expected to be collected.
Notes Receivable
Non-interest-bearing notes
A non-interest-bearing promissory note is recorded at the present value of future cash receipts, discounted using the market rate of interest. The difference between face value and present value is a discount that is amortized to interest income over the life of the note.
Example: Illini Security accepts a $50,000 note due in one year. The market rate is 8%, but the note states no interest.
Discounting a note
When a note is discounted before maturity, use this sequence:
- compute the maturity value
- compute the bank discount using the maturity value and discount period
- compute proceeds as maturity value less discount
- compare proceeds with the carrying amount to determine gain, loss, or interest income
With recourse vs. without recourse
| Transfer type | Meaning |
|---|---|
| With recourse | Transferor remains contingently liable if the debtor does not pay |
| Without recourse | Transferor has no further liability after transfer |
Expected Credit Losses (CECL)
U.S. GAAP requires an allowance approach for trade receivables and many other financial assets measured at amortized cost. The goal is to recognize expected losses on a timely basis.
Estimating the allowance
Common estimation methods include:
- percentage of ending accounts receivable
- aging of accounts receivable
- Aging method
- Percent of receivables
Older balances receive higher expected loss percentages because they are less likely to be collected.
The entity applies a single expected loss rate to the ending receivable balance.
Core CECL entries
1. Record the estimate
2. Write off a specific account
The write-off entry does not create additional bad debt expense at the time of write-off. Expense was recognized when the allowance was established or adjusted.
Why direct write-off fails under GAAP
The direct write-off method records expense only when a specific account proves uncollectible. That method is not acceptable under U.S. GAAP for material receivables because it:
- fails to match credit loss expense with the related sales period
- overstates receivables before write-off
Factoring Accounts Receivable
Factoring means selling receivables to a third party (the factor) for cash.
Economic distinction
- With recourse: Bear Co. keeps some risk of loss.
- Without recourse: the factor assumes the credit risk.
Example: Bear Co. factors $120,000 of receivables without recourse and receives cash of $116,000.
If the transfer is with recourse, additional liability recognition may be required for the recourse obligation.
Quick Comparison: Accounts vs. Notes
| Feature | Accounts receivable | Notes receivable |
|---|---|---|
| Formal written promise | Usually no | Yes |
| Interest element | Usually implicit or none | Often explicit or imputed |
| Maturity date | Short-term, open account | Specific maturity date |
| Valuation issue | CECL allowance | Present value plus CECL, if applicable |
Integrated Example
Gies Co. records $200,000 of credit sales during December. Based on an aging analysis, it estimates expected credit losses of $6,000. In January, a $1,400 customer balance is written off.
Year-end adjustment
January write-off
At December 31, Gies Co. reports accounts receivable net of the allowance, not at gross face amount.
What to memorize for FAR
:::note Checklist
- Know the 90-day rule for cash equivalents.
- Know that non-interest-bearing notes are recorded at present value.
- Know the four discounting steps for notes.
- Know the difference between with recourse and without recourse.
- Know that CECL uses an allowance account and that write-offs reduce the allowance, not expense.
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