Concepts, Rules, and Examples


The only real guidance to the accounting for cash offered by the international standards is that found in IAS 1. Common practice is to define cash as including currency on hand, as well as current and other accounts maintained with banks. However, cash that is not available for immediate use is normally given separate disclosure to prevent misleading implications. IAS 1 requires that restricted cash not be included in current assets, but the standard does not require presentation of a classified balance sheet, nor does it mandate that restricted and unrestricted cash be shown in separate balance sheet captions in the absence of the current/noncurrent distinction. Thus, it remains an open question whether the mere footnote disclosure of restrictions would suffice under some circumstances.

Cash and cash equivalents which are not restricted as to use should always be included in current assets, if indeed a classified balance sheet is presented. When restrictions exist, IAS 1 suggests that assets should be included in the noncurrent category; so presumably cash subject to restrictions, even if set to expire within one year, should be excluded from current assets. It is the authors' belief that to be included as cash in the balance sheet, funds must be represented by actual coins and currency on hand or demand deposits available without restriction.

It must furthermore be management's intention that the cash be available for current purposes. For example, cash in a demand deposit account, being held for the retirement of long-term debts not maturing currently, should be excluded from current assets and shown as a noncurrent investment. This would apply only if management's intention was clear; otherwise it would not be necessary to segregate from the general cash account the funds that presumably will be needed for a scheduled debt retirement, as those funds could presumably be obtained from alternative sources, including new borrowings.

It has become more common to see the caption "cash and cash equivalents" in the balance sheet. This term includes other forms of near-cash as well as demand deposits and liquid, short-term securities. To justify inclusion, however, cash equivalents must be available upon demand.

IAS 7 defines cash equivalents as short-term, highly liquid investments, readily convertible into known amounts of cash that are subject to an insignificant risk of changes in value. The reasonable, albeit arbitrary, limit of three months is placed on the maturity dates of any instruments acquired to be part of cash equivalents. (This is, not coincidentally, the same limit applied by the US standard on cash flow statements, SFAS 95, which preceded the revision of IAS 7 by several years.)

Compensating balances are cash amounts that are not immediately accessible by the owner. Pursuant to borrowing arrangements with lenders, an entity will often be required to maintain a minimum amount of cash on deposit (the "compensating balance"). While stated to provide greater security for the loan, the actual purpose of this balance is to increase the yield on the loan to the lender. Since most organizations will need to maintain a certain working balance in their cash accounts simply to handle routine transactions and to cushion against unforeseen fluctuations in the demand for cash, borrowers often find compensating balance arrangements not objectionable and may well have sufficient liquidity to maintain these with little hardship being incurred. They may even be viewed as comprising "rotating" normal cash balances that are flowing into and out of the bank on a regular basis.

Notwithstanding how these are viewed by the debtor, however, the fact is that compensating balances are not available for unrestricted use, and penalties will result if they are used rather than being left intact, as called for. Therefore, the portion of an entity's cash account that is a compensating balance must be segregated and shown as a noncurrent asset if the related borrowings are noncurrent liabilities. If the borrowings are current liabilities, it is acceptable to show the compensating balance as a separately captioned current asset, but under no circumstances should these be included in the caption "cash."

In some jurisdictions, certain cash deposits held by banks, such as savings accounts or corporate time deposits, are subject to terms and conditions that might prevent immediate withdrawals. While not always exercised, these rights permit a delay in honoring withdrawal requests for a stated period of time, such as seven days or one month. These rules were instituted to discourage panic withdrawals and to give the depository institution adequate time to liquidate investments in an orderly fashion. Cash in savings accounts subject to a statutory notification requirement and cash in certificates of deposit maturing during the current operating cycle or within one year may be included as current assets, but as with compensating balances, should be separately captioned in the balance sheet to avoid the misleading implication that these funds are available immediately upon demand. Typically, such items will be included in the short-term investments caption, but these could be separately labeled as time deposits or restricted cash deposits.

Petty cash and other imprest cash accounts are usually presented in financial statements with other cash accounts. Due to materiality considerations, these need not be set forth in a separate caption unless so desired.


Receivables include trade receivables, which are amounts due from customers for goods sold or services performed in the normal course of business, as well as such other categories of receivables as notes receivable, trade acceptances, third-party instruments, and amounts due from officers, stockholders, employees, or affiliated companies.

Notes receivable are formalized obligations evidenced by written promissory notes. The latter categories of receivables generally arise from cash advances but could develop from sales of merchandise or the provision of services. The basic nature of amounts due from trade customers is often different from that of balances receivable from related parties, such as employees or stockholders. Thus, the general practice is to insist that the various classes of receivables be identified separately either on the face of the balance sheet or in the notes. Former standard IAS 5 did require that trade receivables, amounts due from officers, amounts due from related parties, and other distinct categories of receivables be separately presented in the balance sheet, but superseding standard IAS 1 fails to address this. However, the authors believe that distinguishing among categories of receivables is an important financial reporting objective, and that the formerly prescribed guidelines should continue to be observed.

IAS 39 addresses recognition and measurement of receivables. In addition, a number of international standards allude to the accounting for receivables. For example, IAS 18, Revenue Recognition, addresses the timing of revenue recognition, which implicitly addresses the timing of recognition of the resulting receivables.

If the gross amount of receivables includes unearned interest or finance charges, these should be deducted in arriving at the net amount to be presented in the balance sheet. Deductions should be taken for amounts estimated to be uncollectible and also for the estimated returns, allowances, and other discounts to be taken by customers prior to or at the time of payment. In practice, the deductions that would be made for estimated returns, allowances, and trade discounts are usually deemed to be immaterial, and such adjustments are rarely made. However, if it is known that sales are often recorded for merchandise that is shipped on approval and available data suggests that a sizable proportion of such sales are returned by the customers, these estimated future returns must be accrued. Similarly, material amounts of anticipated discounts and allowances should be recorded in the period of sale.

The foregoing comments apply where revenues are recorded at the gross amount of the sale and subsequent sales discounts are recorded as debits (contra revenues). An alternative manner of recording revenue, which does away with any need to estimate future discounts, is to record the initial sale at the net amount; that is, at the amount that will be remitted if customers take advantage of the available discount terms. If customers pay the gross amount later (they fail to take the discounts), this additional revenue is recorded as income when it is remitted. The net method of recording sales, however, is rarely encountered in practice.

Bad Debts Expense

In theory, accruals should be made for anticipated sales returns, sales allowances, and discounts that pertain to sales already consummated as of the date of the financial statements. This is usually not done, however, because of materiality considerations. On the other hand, the recording of anticipated uncollectible amounts is almost always necessary. The direct write-off method, in which a receivable is charged off only when it is clear that it cannot be collected, is unsatisfactory since it results in a significant mismatching of revenues and expenses. Proper matching can be achieved only if bad debts expense is recorded in the same fiscal period as the revenues to which they are related. Since this expense cannot be known with certainty, an estimate must be made.

There are two popular estimation techniques. The percentage-of-sales method is principally oriented toward achieving the best possible matching of revenues and expenses. Aging the accounts is more oriented toward the presentation of the correct net realizable value of the trade receivables in the balance sheet. Both methods are acceptable and widely employed.

Percentage-of-sales method of estimating bad debts.

Historical data are analyzed to ascertain the relationship between credit sales and bad debts. The derived percentage is then applied to the current period's sales revenues to arrive at the appropriate debit to bad debts expense for the year. The offsetting credit is made to allowance for uncollectibles. When specific customer accounts are subsequently identified as uncollectible, they are written off against this allowance.

Example of percentage-of-sales method

start example

Total credit sales for year:


Bad debt ratio from prior years or other data source:

1.75% of sales

Computed year-end adjustment for bad debts expense:


($7,500,000 x .0175)

The entry required is

  • Bad debts expense


    • Allowance for uncollectibles


end example

Note that the foregoing entry assumes that no bad debts expense has yet been recognized with respect to the year's credit sales. If some such expense has already been recognized, as a consequence of interim accruals, for example, the final adjusting entry would be suitably reduced.

Aging method of estimating bad debts.

An analysis is prepared of the customer receivables at the balance sheet date. These accounts are categorized by the number of days or months they have remained outstanding. Based on the entity's past experience or on other available statistics, historical bad debts percentages are applied to each of these aggregate amounts, with larger percentages being applicable to the older accounts. The end result of this process is a computed total dollar amount that is the proper balance in the allowance for uncollectibles at the balance sheet date. As a result of the difference between the previous years' adjustments to the allowance for uncollectibles and the actual write-offs made to the account, there will usually be a balance in this account. Thus, the adjustment needed will be an amount other than that computed by the aging.

Example of the aging method

start example

Under 30 days

Age of accounts 30–90 days

Over 90 days


Gross receivables




Bad debt percentage




Provision required





The credit balance required in the allowance account is $70,125. Assuming that a debit balance of $58,250 already exists in the allowance account (from charge-offs during the year), the necessary entry is

  • Bad debts expense


    • Allowance for uncollectibles


end example

Both of the estimation techniques should produce approximately the same result. This will be true especially over the course of a number of years. Nonetheless, it must be recognized that these adjustments are based on estimates and will never be totally accurate. When facts subsequently become available to indicate that the amount provided as an allowance for uncollectible accounts was incorrect, an adjustment classified as a change in estimate is made. According to IAS 8, adjustments of this nature are never considered fundamental errors subject to subsequent correction or restatement. Only if an actual clerical or mechanical error occurred in the recording of allowance for uncollectibles would correction as a fundamental error be warranted.

Pledging, Assigning, and Factoring Receivables

An organization can alter the timing of cash flows resulting from sales to its customers by using its accounts receivable as collateral for borrowings or by selling the receivables outright. A wide variety of arrangements can be structured by the borrower and lender, but the most common are pledging, assignment, and factoring. The 1AS do not offer specific accounting guidance on these assorted types of arrangements, although the derecognition rules of IAS 39 generally apply to these as well as other financial instruments of the reporting entity.

Pledging of receivables.

Pledging is an agreement whereby accounts receivable are used as collateral for loans. Generally, the lender has limited rights to inspect the borrower's records to achieve assurance that the receivables do exist. The customers whose accounts have been pledged are not aware of this event, and their payments are still remitted to the original obligee. The pledged accounts merely serve as security to the lender, giving comfort that sufficient assets exist that will generate cash flows adequate in amount and timing to repay the debt. However, the debt is paid by the borrower whether or not the pledged receivables are collected and whether or not the pattern of such collections matches the payments due on the debt.

The only accounting issue relating to pledging is that of adequate disclosure. The accounts receivable, which remain assets of the borrowing entity, continue to be shown as current assets in its financial statements but must be identified as having been pledged. This identification can be accomplished either parenthetically or by footnote disclosures. Similarly, the related debt should be identified as having been secured by the receivables.

Example of proper disclosure for pledged receivables

start example

Current assets:

  • Accounts receivable, net of allowance for doubtful accounts of $600,000 ($3,500,000 of which has been pledged as collateral for bank loans)


Current liabilities:

  • Bank loans payable (secured by pledged accounts receivable)


end example

A more common practice is to include the disclosure in the notes to the financial statements.

Assignment of receivables.

The assignment of accounts receivable is a more formalized transfer of the asset to the lending institution. The lender will make an investigation of the specific receivables that are being proposed for assignment and will approve those that are deemed to be worthy as collateral. Customers are not usually aware that their accounts have been assigned and they continue to forward their payments to the original obligee. In some cases, the assignment agreement requires that collection proceeds be delivered to the lender immediately. The borrower is, however, the primary obligor and is required to make timely payment on the debt whether or not the receivables are collected as anticipated. The borrowing is with recourse, and the general credit of the borrower is pledged to the payment of the debt.

Since the lender knows that not all the receivables will be collected on a timely basis by the borrower, only a fraction of the face value of the receivables will be advanced as a loan to the borrower. Typically, this amount ranges from 70 to 90%, depending on the credit history and collection experience of the borrower.

Assigned accounts receivable remain the assets of the borrower and continue to be presented in its financial statements, with appropriate disclosure of the assignment similar to that illustrated for pledging. Prepaid finance charges would be debited to a prepaid expense account and amortized to expense over the period to which the charges apply.

Factoring of receivables.

This category of financing is the most significant in terms of accounting implications. Factoring traditionally has involved the outright sale of receivables to a financing institution known as a factor. These arrangements involved (1) notification to the customer to forward future payments to the factor, and (2) the transfer of receivables without recourse. The factor assumes the risk of an inability to collect. Thus, once a factoring arrangement was completed, the entity had no further involvement with the accounts except for a return of merchandise.

The classical variety of factoring provides two financial services to the business: (1) it permits the entity to obtain cash earlier, and (2) the risk of bad debts is transferred to the factor. The factor is compensated for each of the services. Interest is charged based on the anticipated length of time between the date the factoring is consummated and the expected collection date of the receivables sold, and a fee is charged based on the factor's anticipated bad debt losses.

Some companies continue to factor receivables as a means of transferring the risk of bad debts but leave the cash on deposit with the factor until the weighted-average due date of the receivables, thereby avoiding interest payments. This arrangement is still referred to as factoring, since the customer receivables have been sold. However, the borrowing entity does not receive cash but instead has created a new receivable, usually captioned "due from factor." In contrast to the original customer receivables, this receivable is essentially riskless and will be presented in the balance sheet without a deduction for estimated uncollectibles.

Merchandise returns will normally be the responsibility of the original vendor, who must then make the appropriate settlement with the factor. To protect against the possibility of merchandise returns that diminish the total of receivables to be collected, very often a factoring arrangement will not advance the full amount of the factored receivables (less any interest and factoring fee deductions). Rather, the factor will retain a certain fraction of the total proceeds relating to the portion of sales that are anticipated to be returned by customers. This sum is known as the factor's holdback. When merchandise is returned to the borrower, an entry is made offsetting the receivable from the factor. At the end of the return privilege period, any remaining holdback will become due and payable to the borrower.

Examples of journal entries to be made by the borrower in a factoring situation

start example
  1. Thirsty Corp. on July 1, 2002, enters into an agreement with Rich Company to sell a group of its receivables without recourse. A total face value of $200,000 accounts receivable (against which a 5% allowance had been recorded) is involved. The factor will charge 20% interest computed on the (weighted) average time to maturity of the receivables of 36 days plus a 3% fee. A 5% holdback will also be retained.

  2. Thirsty's customers return for credit $4,800 of merchandise.

  3. The customer return privilege period expires and the remaining holdback is paid to the transferor.

The entries required are as follows:

  1. Cash


  • Allowance for had debts (200,000 x .05)


  • Interest expense (or prepaid) (200,000 x .20 x 36/365)


  • Factoring fee (200,000 x .03)


  • Factor's holdback receivable (200.000 x .05)


    • Bad debts expense


    • Accounts receivable


(Alternatively, the interest and factor's fee can be combined into a $9,945 charge to loss on sale of receivables.)

  1. Sales returns and allowances


    • Factor's holdback receivable


  1. Cash


    • Factor's holdback receivable


end example

Transfers of Receivables with Recourse

In recent years, a newer variant on factoring has become popular. This variation has been called factoring with recourse, the terms of which suggest somewhat of a compromise between true factoring and the assignment of receivables. Accounting practice has varied considerably because of the hybrid nature of these transactions, and a strong argument can be made, in fact, that the factoring with recourse is nothing more than the assignment of receivables, and that the proper accounting (as discussed above) is to present this as a secured borrowing, not as a sale of the receivables. Under IAS 39, a financial asset (such as receivables) can be derecognized (i.e., treated as having been sold or transferred to another entity) only when the enterprise loses control of the contractual rights that comprise the asset. While "factoring with recourse" has previously been held to qualify for derecognition by the transferor under the terms of IAS 39, pending guidance from the IGC will state that this will no longer be permissible when there is no substantive risk assumed by the putative buyer of the receivables.

Wiley Ias 2003(c) Interpretation and Application of International Accounting Standards
WILEY IAS 2003: Interpretation and Application of International Accounting Standards
ISBN: 0471227366
EAN: 2147483647
Year: 2005
Pages: 147 © 2008-2017.
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