Cash and Receivables

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Cash and Receivables

• Chapter 7

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Cash
Coins and currency
Petty cash
Cashiers checks
Certified checks
Amounts on deposit with financial institutions
Money orders
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Cash Equivalents
Items very near cash but not in negotiable form
Money marketfunds
Treasury bills
Commercialpaper
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Internal Control of Cash
Encourages adherence to company policies and
procedures
Promotes operational efficiency
Enhances the reliability and accuracy of
accounting data
Minimizes errorsand theft
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Control of Cash Receipts

• Separate responsibility for
• handling cash,
• recording cash transactions, and
• reconciling cash balances.
• Agreed cash amounts deposited with cash amounts
  received.
• Close supervision of cash-handling and
  cash-recording activities.

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Control of Cash Disbursements

• Separate responsibilities for
• cash disbursement documents,
• check writing,
• check signing,
• check mailing, and
• record keeping.
• All disbursements, except petty cash, made by
  check.

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Restricted Cash andCompensating Balances

• Restricted Cash
• Managements intent to use a certain amountof
  cash for a specific purpose future plant
  expansion, future payment of debt.
• Compensating Balance
• Minimum balance that must be maintainedin a
  companys account as support forfunds borrowed
  from the bank.

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Accounts Receivable
Amounts due from customers for credit sales.

• Credit sales require
• Maintaining a separate account receivable for
  each customer.
• Accounting for bad debts that result from credit
  sales.

Credit sales and the resulting accounts
receivable are recorded net of trade discounts,
not at list price.
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Cash Discounts
Cash discounts . . .
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Cash Discounts
2/10,n/30
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Cash Discounts
Gross Method
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Cash Discounts
Net Method
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Sales Returns and Allowances
Sales Returns
Sales Allowances
Merchandise returned by a customer to a supplier.
A reduction in the cost of defective merchandise.
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Sales Returns

• On June 1, a customer of LarCo returns 750 of
  merchandise. The merchandise had been purchased
  on account and the customer had not yet paid.
  LarCo uses the periodic method to account for
  inventory.
• Record the journal entry for the return of
  merchandise.

Sales Returns is a contra account that reduces
Sales Revenue in the current accounting period.
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Uncollectible Accounts Receivable

• Bad debts result from credit customers who are
  unable to pay the amount they owe, regardless of
  continuing collection efforts.

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Uncollectible Accounts Receivable

• In conformity with the matching principle, bad
  debt expense should be recorded in the same
  accounting period in which the sales related to
  the uncollectible account were recorded.

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Uncollectible Accounts Receivable

• Most businesses record an estimate of the bad
  debt expense by an adjusting entry at the end of
  the accounting period.

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Uncollectible Accounts Receivable
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Allowance for Uncollectible Accounts
Accounts Receivable Less Allowance for
Uncollectible Accounts Net Realizable Value

• Net realizable value is the amount of the
  accounts receivable that the business expects to
  collect.

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Estimating Bad Debts

• Income Statement Approach
• Balance Sheet Approach
• Composite Rate
• Aging of Receivables

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Income Statement Approach

• Focuses on past credit sales to make estimate of
  bad debt expense.
• Emphasizes the matching principle by estimating
  the bad debt expense associated with the current
  periods credit sales.

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Income Statement Approach

• Bad debts expense iscomputed as follows

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Income Statement Approach
In 2009, MusicLand has credit sales of 400,000
and estimates that 0.6 of credit sales are
uncollectible. What is Bad Debt Expense for 2009?
MusicLand computes estimated Bad Debt Expense of
2,400.
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Balance Sheet Approach

• Focuses on the collectibility of accounts
  receivable to make the estimate of uncollectible
  accounts.
• Involves the direct computation of the desired
  balance in the allowance for uncollectible
  accounts.

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Balance Sheet ApproachComposite Rate

• Compute the desired balance in the Allowance for
  Uncollectible Accounts.
• Bad Debts Expense is computed as

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Balance Sheet ApproachComposite Rate
On Dec. 31, 2009, MusicLand has 50,000 in
Accounts Receivable and a 200 credit balance in
Allowance for Uncollectible Accounts. Past
experience suggests that 5 of receivables are
uncollectible. What is MusicLands Bad Debt
Expense for 2009?
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Balance Sheet ApproachComposite Rate
Desired balance in Allowancefor Uncollectible
Accounts
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Balance Sheet Approach Aging of Receivables

• Year-end Accounts Receivable is broken down into
  age classifications.

• Each age grouping has a different likelihood of
  being uncollectible.

• Compute desired uncollectible amount.

• Compare desired uncollectible amount with the
  existing balance in theallowance account.

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Balance Sheet Approach Aging of Receivables
At December 31, 2006, the receivables for EastCo,
Inc. were categorized as follows

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Balance Sheet Approach Aging of Receivables
EastCos unadjusted balance in the allowance
account is 500. Per the previous computation,
the desired balance is 1,350.

Prepare the entry to record bad debts expense at
Dec. 31, 2006.
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Balance Sheet Approach Aging of Receivables
EastCos unadjusted balance in the allowance
account is 500. Per the previous computation,
the desired balance is 1,350.

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Methods to Estimate Bad Debts
Balance Sheet Approach
Income Statement Approach
Emphasis on Realizable Value
Emphasis on Matching
Income Statement Focus
Balance Sheet Focus
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Uncollectible Accounts

• As accounts become uncollectible, the following
  entry is made

So what happens if someone pays after a write-off
of the accounts receivable?
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Collection of PreviouslyWritten-Off Accounts

• When a customer makes a payment after an account
  has been written off, two journal entries are
  required.

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Direct Write-off Method

• If uncollectible accounts are immaterial, bad
  debts are simply recorded as they occur (without
  the use of an allowance account).

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Notes Receivable
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Interest Computation
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Interest-Bearing Notes

• On November 1, 2008, West, Inc. loans 25,000
  to Winn, Co. The note bears interest at 12 and
  is due on November 1, 2009.
• Prepare the journal entry on November 1, 2008,
  December 31, 2008, (year-end) and November 1,
  2009 for West.

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Interest-Bearing Notes
25,000 12 3,000 - 500 2,500
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Noninterest-Bearing Notes

• Actually do bear interest.
• Interest is deducted (discounted) from the
  face value of the note.
• Cash proceeds equal face value of note less
  discount.

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Noninterest-Bearing Notes

• On January 1, 2009, West, Inc. accepted a 25,000
  noninterest-bearing note from Winn, Co as payment
  for a sale. The note is discounted at 12 and is
  due on December 31, 2009.
• Prepare the journal entries on January 1, 2009,
  and December 31, 2009 for West.

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Financing With Receivables

• Secured borrowing
• or
• Sale of receivables

Method depends on thesurrender of control
overthe receivables transferred.
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Secured Borrowing Assigning

• The use of specific receivables for collateral,
  and the promise that any failure to repay debt
  will result in proceeds from specific accounts
  receivable collections being used to repay the
  debt.
• Reclassify Accounts Receivable as Accounts
  Receivable Assigned.

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Secured Borrowing Pledging

• Receivables in general are pledged as collateral
  for loans.
• Pledged receivables are disclosed in notes to the
  financial statements.

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Sale of Accounts Receivable
SUPPLIER (Transferor)
RETAILER
FACTOR (Transferee)
A factor is a financial institution that buys
receivablesfor cash, handles the billing and
collection of thereceivables and charges a fee
for the service.
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Sale of Accounts Receivable

• Treat as a sale if all of these conditions are
  met
• Receivables are isolated from transferor.
• Transferee has right to pledge or exchange
  receivables.
• Transferor does not have control over the
  receivables.
• Transferor cannot repurchase receivable before
  maturity.
• Transferor cannot require returnof specific
  receivables.

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Sale of Accounts Receivable

• Without recourse
• An ordinary sale of receivables to the factor.
• Factor assumes all risk of uncollectibility.
• Control of receivable passes to the factor.
• Receivables are removed from the books,cash is
  received and a financing expense or loss is
  recognized.

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Sale of Accounts Receivable

• With recourse
• Transferor (seller) retains risk of
  uncollectibility,
• Must meet the three conditions of determining
  surrender of control to be recognized as a sale.
• If the transaction fails to meet the three
  conditions necessary to be classified asa sale,
  it will be treated as asecured borrowing.

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Discounting a Note

• On December 31, Apex accepted a nine-month 10
  percent note for 200,000 from a customer. Three
  months later on March 31, Apex discounted the
  note at its local bank. The banks discount rate
  12 percent.
• Prepare the journal entry to record the
  discounting of the note receivable as a sale.

Before the preparing the journal entry to record
the discounting, Apex must record the accrued
interest on the note from December 31 until March
31.
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Discounting a Note
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Receivables Management
This ratio measures how many times a company
converts its receivables into cash each year.
This ratio is an approximation of the number of
days the average accounts receivable balance is
outstanding.
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Receivables Management
Electronic Arts vs. Activision comparison
(All dollar amounts in millions)
Can you compute the receivables turnover ratio
andthe average collection period for these two
companies?
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Appendix 7 - Cash Controls
A bank reconciliation explains the difference
between cash reported on bank statement and cash
balance on a companys books.
Bank Balance
Book Balance
All reconciling items on the book side require an
adjusting entry to the cash account.
Bank Collections
Deposits in Transit
- Service Charges - NSF Checks
- Outstanding Checks
Bank Errors
Book Errors
Corrected Balance
Corrected Balance
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Appendix 7 Petty Cash
Used for minor expenditures.
Petty cash fund
Has one custodian.
Replenished periodically.
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End of Chapter 7