Cash and Receivables

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Cash and Receivables

• Chapter 2

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Learning Objectives

1. Identify items considered as cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different
   types of receivables.
4. Explain accounting issues related to recognition
   of accounts receivable.
5. Explain accounting issues related to valuation of
   accounts receivable.
6. Explain accounting issues related to recognition
   of notes receivable.
7. Explain accounting issues related to valuation of
   notes receivable.
8. Explain accounting issues related to disposition
   of accounts and notes receivable.
9. Describe how to report and analyze receivables.

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Cash
Cash is the resource on hand to meet planned
expenditures and emergency situations.
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Cash

• Cash includes
• Balances on deposit with financial institutions
• Coins and currency
• Petty cash
• Certain negotiable instruments
• Cashiers checks
• Certified checks
• Money orders

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Cash Equivalents

• Cash equivalents are short-term, highly liquid
  investments that are readily convertible into
  known amounts of cash and near their maturity (90
  days) when purchased.
• Treasury bills
• Commercial paper
• Money market funds

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Cash

• Items that are not cash
• Postdated checks
• Travel advances to employees
• Postage stamps
• Receivables from company employees
• Cash advances to employees or outside parties

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Cash

• Overdraft
• Negative bank account balance reported as
• a current liability.
• Compensating balance
• Minimum balance that must be maintained in a
• companys account as support for funds borrowed
• from the bank.

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Internal Control

• Policies and procedures designed to
• Protect assets.
• Ensure compliance with laws and company policies.
• Provide accurate accounting records.
• Evaluate performance.

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Internal Control for Cash

• Separate custody of and accounting for cash.
• Maintain only the minimum cash balance needed.
• Provide for periodic test counts of cash
  balances.
• Permit reconciliation of ledger and bank cash
  account balances.
• Result in the physical control of cash.

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Control of Cash Receipts

• Separate responsibility for handling cash,
  recording cash transactions, and reconciling cash
  balances.
• Cash-handling and cash-recording activities
  assigned to different people.
• 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.
• Adequate source documents must support all checks.

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Petty Cash

• Imprest fund providing limited cash for routine
  disbursements
• Intended for payment of
• Minor transportation costs
• Postage
• Office supplies
• Delivery charges

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Petty Cash

• Only entries to Petty Cash
• Establish the fund.
• Increase, decrease or close fund.

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Petty CashExample

• Jackson Company maintains a petty cash fund of
  400. The following summary information was
  taken from petty cash vouchers for July
• Travel Expenses 79.30
• Customer Business Lunches 93.42
• Express Mail Postage 55.00
• Miscellaneous Office Supplies 32.48
• Prepare the journal entry to record replenishing
  fund if the balance on July 31 was 137.80.

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Petty CashExample
What amount of cash will be required to replenish
the petty cash fund? a. 260.20 b. 262.20 c.
139.80 d. 137.80
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Petty CashExample
What amount of cash will be required to replenish
the petty cash fund? a. 260.20 b. 262.20 c.
139.80 d. 137.80
Desired Balance 400.00 Actual
Balance 137.80 Amount Needed
262.20
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Petty CashExample
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Bank Reconciliation

• Bank Reconciliation is prepared periodically to
• Explain the difference between cash reported on
  bank statement and cash balance on companys
  books.
• Arrive at the adjusted (correct) cash balance.
• Provide information for reconciling journal
  entries.

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Bank ReconciliationBalance Per Bank Section

• Start with balance per bank statement.
• Add deposits in transit.
• Deduct outstanding checks.
• Add or deduct bank errors as appropriate.

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Bank ReconciliationBalance Per Book Section

• Start with balance per books.
• Add deposits credited by bank, but not recorded
  in books.
• Deduct bank service charges and Non- Sufficient
  Funds (NSF) checks.
• Add or deduct book errors as appropriate.

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Bank ReconciliationExample

• Prepare a July 31 bank reconciliation statement
  and the resulting journal entries for the Simmons
  Company. The July 31 bank statement indicated a
  cash balance of 9,610, while the cash ledger
  account on that date shows a balance of 7,430.
• Additional information necessary for the
  reconciliation is shown on the next page.

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Bank ReconciliationExample

• Outstanding checks totaled 2,417.
• A 500 check mailed to the bank for deposit had
  not reached the bank at the statement date.
• The bank returned a customers NSF check for 225
  received as payment of an account receivable.
• The bank statement showed 30 interest earned on
  the bank balance for the month of July.
• Check 781 for supplies cleared the bank for 268
  but was erroneously recorded in our books as
  240.
• A 486 deposit by Acme Company was erroneously
  credited to our account by the bank.

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Bank ReconciliationExample
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Bank ReconciliationExample
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Bank ReconciliationExample
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Receivables
Those receivables expected to be collected or
satisfied within one year or the current
operating cycle, whichever is longer, are
classified as current assets the remainder are
classified as noncurrent.
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Accounts Receivable

• Normal circumstances
• Right of return
• Valuation

• Cash discounts
• Sales returns and allowances
• Uncollectible accounts
• Financing arrangements

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Accounts Receivable

• Cash Discounts are used to . . .
• Increase sales.
• Encourage early payment by customers.
• Increase the likelihood of collections of
  accounts receivable.

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Accounts ReceivableCash Discounts
2/10, n/30
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Accounts ReceivableCash Discounts
2/10, n/30
Percentage Discount
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Accounts ReceivableCash Discounts
2/10, n/30
Percentage Discount
of Days Discount is Available
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Accounts ReceivableCash Discounts
2/10, n/30
Percentage Discount
of Days Discount is Available
Otherwise, Net (or All) is Due
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Accounts ReceivableCash Discounts
2/10, n/30
Percentage Discount
of Days Discount is Available
Otherwise, Net (or All) is Due
Net Amount is Due in this of Days
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Accounts ReceivableCash Discounts

• South Company purchased merchandise with a
  1,000 gross sales price on 2/10, n/30 terms.
  South decides to settle on the 30th day following
  the sale, paying 1,000 without taking advantage
  of the 20 cash discount available. Although this
  decision to delay payment cost South 20, the
  annualized interest rate is 37.2.
• 0.02(1,000) 365
• ------------------- x -------
  37.2
• 980 20

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Accounts ReceivableCash Discounts

• Gross Method
• Record sales discounts only if the customer
  pays within the discount period.
• Net Method
• Record sales discounts only if the customer
  fails to pay within the discount period.

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Accounts ReceivableExample

• On May 10, Eddy, Inc. sold 5,000 of
  merchandise to a customer subject to a cash
  discount of 1/10, n/30. Eddy uses the periodic
  method to account for inventory.
• Prepare the journal entry to record the sale if
  Eddy uses
• the gross method.
• the net method.

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Cash DiscountsExample
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Cash DiscountsExample
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Cash DiscountsExample

• Assume that on May 19, Eddy, Inc. received a
  check in full payment of the sale made on May 10.
  
• Prepare the journal entry to record the cash
  receipt if Eddy uses
• (a) the gross method.
• (b) the net method.

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Cash DiscountsExample
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Cash DiscountsExample
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Cash DiscountsExample

• Instead of the payment on May 19, now assume that
  Eddy, Inc. received a check on May 31, in full
  payment of the sale made on May 10. Prepare the
  journal entry to record the cash receipt if Eddy
  uses
• (a) the gross method.
• (b) the net method.

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Cash DiscountsExample
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Cash DiscountsExample
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Trade Discounts
The catalog price minus the trade discount equals
the invoice price
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Sales Returns and Allowances

• The right of return is frequently given as part
  of a companys overall marketing plan.
• An allowance may be given for damaged
  merchandise.
• Returned and damaged merchandise is tracked
  separately in an account called Sales Returns and
  Allowances.

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Sales ReturnsExample

• On June 1, a customer of LarCo returns 750 of
  merchandise that was damaged. LarCo uses the
  periodic method to account for inventory.
• Record the journal entry for the return of
  merchandise.

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

• When credit is extended, some amount of
  uncollectible receivables is generally
  inevitable.
• If uncollectible receivables are probable and can
  be estimated, an estimate should be made of the
  amount uncollectible and recorded in the period
  in which the revenue was produced (allowance
  method).

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Allowance Method

• When we estimate the amount of our uncollectible
  receivables, we make the following adjusting
  entry

The Allowance for Doubtful Accounts is a contra
account to Accounts Receivables.
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Allowance Method

• As accounts become uncollectible, the following
  entry is made

The balance in the Allowance account reduces
Accounts Receivable on the Balance Sheet.
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Allowance Method

• If an account previously written off proves
  to be collectible in a subsequent period, the
  following entries are made

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Estimated Bad Debts Method
Bad debts can be estimated based on sales or on
accounts receivable.
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Estimated Bad Debts Method

• Relationship to sales (income statement
  approach)
• Credit Sales Method
• Relationship to accounts receivable (balance
  sheet approach)
• Accounts Receivable Method
• --Percentage of outstanding accounts receivable
• --Aging of accounts receivable

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Estimating Bad DebtsCredit Sales Method

• This method emphasizes the matching principle and
  is considered an income statement approach.
• An average percentage relationship between actual
  bad debt losses and net credit sales is
  determined based on historical information.
• The percentage is applied to current period net
  credit sales to estimate bad debt expense for the
  year.

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Credit Sales MethodExample

• Based on base data, Renco, Inc. has determined
  that bad debt losses average 1.25 of net credit
  sales. During 19X6, Renco reported 2,000,000 of
  sales, of which 250,000 were cash sales.
• Prepare the adjusting journal entry to record
  the estimate of bad debt expense in 19X6.

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Credit Sales MethodExample
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Credit Sales MethodExample
The Allowance for Doubtful Accounts is a contra
account that will reduce Accounts Receivable on
the Balance Sheet.
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Estimated Bad Debts Method

• Relationship to sales (income statement
  approach)
• Credit Sales Method
• Relationship to accounts receivable (balance
  sheet approach)
• Accounts Receivable Method
• --Percentage of outstanding accounts receivable
• --Aging of accounts receivable

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Accounts Receivable Method

• This method uses the historical relationship
  between accounts receivable and bad debt losses.
• The historical rate, or multiple rates, is
  applied to the net accounts receivable to
  determine the desired balance in the Allowance
  for Doubtful Accounts.
• Bad Debt Expense is the amount of adjustment
  necessary to bring the Allowance account to its
  desired ending balance.

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Accounts Receivable MethodExample

• Single Composite Rate
• Crecore, Inc. determined that the balance in the
  Allowance for Doubtful Accounts should be 2.5 of
  Accounts Receivable. At year-end Accounts
  Receivable had a balance of 191,000, and the
  Allowance account had a credit balance of 1,250.
• Prepare the adjusting entry to record Bad Debt
  Expense.

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Accounts Receivable MethodExample
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Accounts Receivable MethodExample
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Accounts Receivable MethodExample
After posting the adjusting entry, the Allowance
account has the desired balance of 4,775.
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Aging of Accounts Receivable

• Instead of using a single composite rate, we can
  develop different rates depending upon the length
  of time the account is past due.
• The more days past due, the higher the rate of
  uncollectible receivable.

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Aging of ReceivablesExample

• Wells, Inc. reports accounts receivable of
  233,000 at December 31, 19X7. Wells uses aging
  of receivables to estimate bad debts. The
  company has developed historical loss percentages
  for accounts currently due, those 30, 60 and over
  60 days past due. The following slide shows the
  aging schedule. The Allowance account has a
  credit balance of 327 on December 31.

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Aging of ReceivablesExample
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Aging of ReceivablesExample
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Aging of ReceivablesExample
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Accounts Receivable Financing Agreements
There are three basic forms of financing
agreements to obtain cash from accounts
receivable.

• Pledging
• Assigning
• Factoring

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Accounts Receivable Financing Agreements
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Financing with Accounts Receivable
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Pledging
When a company pledges its accounts receivable,
it is using these accounts as collateral for a
loan, and the servicing activities remain its
responsibility.
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Assignment of Accounts Receivable
When a company assigns its accounts receivable to
a financial institution, it enters into a lending
agreement with the institution to receive cash on
specific customer accounts.
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Assignment of Accounts Receivable
On December 1, 2007, the Trussel Company
assigned 60,000 of its accounts to a finance
company. The finance company advances 80 of the
accounts receivable assigned less a service
charge of 500. It also charges an annual
interest of 12 on any outstanding loan balance.
Cash 47,500 Assignment Service Charge
Expense 500 Notes Payable 48,000
(60,000 x 0.80) - 500
60,000 x 0.80
Accounts Receivable Assigned 60,000 Accounts
Receivable 60,000
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Assignment of Accounts Receivable
On December 31, 2007, Trussel collects 10,000 on
assigned accounts. This amount along with the
12 interest for one month is paid to the finance
company.
Cash 10,000 Accounts Receivable Assigned 10,000
Notes Payable 10,000 Interest Expense 480 Cash
10,480
48,000 x 0.12 x 1/12
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Steps in Factoring Receivables
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Steps in Factoring Receivables
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Steps in Factoring Receivables
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Factoring
When a company factors its accounts receivable,
it sells individual accounts to a financial
institution (called a factor).
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Factoring
Farber Corporation sells 80,000 of accounts
receivable to a factor, receives 90 of the value
of the factored accounts, and is charged a 15
commission based on the gross amount of factored
accounts receivable.
(80,000 x .90) - 12,000
Cash 60,000 Receivables from Factor 8,000 Factorin
g Expense 12,000 Accounts Receivable 80,000
80,000 x 0.10
80,000 x 0.15
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Factoring
The FASB addressed these issues when it concluded
in FASB Statement No. 140 that a transferor
records the transfer of financial assets to the
transferee as a sale when all of the following
conditions are met

1. The transferred assets have been isolated from
   the transferor.
2. The transferee obtains the right to exchange the
   transferred assets.
3. The transferor does not maintain effective
   control over the transferred assets through an
   agreement that entitles and obligates the
   transferor to repurchase the transferred assets
   before their maturity.

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Credit Card Sales

• Many retail companies accept national credit
  cards, such as VISA, MasterCard, American Express
  and Diners Club.
• The retailer either deposits the slips at the
  bank or receives an electronic transfer of funds
  from the credit card company.
• The retailer is assessed a charge by the credit
  card company.
• This charge is accounted for as an operating
  expense.

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Credit Card Sales

• Assume that Kern Company sold 1,500 of
  merchandise on credit, which was billed to a
  national credit card company. If the collection
  fee is 5, Kern Company makes the following
  journal entry

Cash 1,425 Credit Card Expense 75 Sales 1,500
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Notes Receivable

• An unconditional written promise. . .
• Made signed by the maker (borrower). . .
• To pay the bearer or stated payee. . .
• A definite amount of money. . .

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Notes Receivable
Notes receivable generally have two attributes
that are not found in accounts receivable.
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Notes Receivable

1. They are negotiable instruments, which means that
   they are legally and readily transferable among
   parities and may be used to satisfy debts by the
   holders of these instruments.
2. They usually involve interest, requiring the
   separation of the receivables into its principal
   and interest components.

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Notes Receivable

• Plus a stated interest rate. . .
• The note does not have to include a stated
  interest
• rate. If there is not a stated rate,
  there is an implicit
• or imputed rate.
• On the maturity date. . .
• On demand, a specific date, or at the end
  of a
• stated period.

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Simple Interest NoteExample

• On November 1, 19X5, Winn, Inc. loans 25,000 to
  Westward, Co. The note bears interest at 12 and
  is due on November 1, 19X6.
• Prepare the journal entry on November 1, 19X5,
  December 31, 19X5 (year-end) and November 1, 19X6.

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Simple Interest NoteExample
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Simple Interest NoteExample
25,000 12 3,000 - 500 2,500
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Notes Receivable

• Different Market and Stated Rates
• Requires present value computations.
• Use the stated rate of interest to determine the
  annuity cash flow.
• Use the market rate of interest to determine the
  present value of the face amount and interest
  annuity of the note.

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Different RatesExample

• On December 1, WayCo, Inc. sold a specialized
  piece of equipment receiving 5,000 cash and a
  50,000 note receivable due in three years. The
  note has a stated interest rate of 4 and the
  market rate of interest for a similar note is
  10. Interest payments are made annually.
• Prepare the entries to record the sale on
  December 1, and the adjusting entry required on
  December 31.

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Different RatesExample
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Different RatesExample
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Different RatesExample
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Different RatesExample
2,000 12 167 2,254 12 188 4,254 12
355
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Long-Term Notes Receivable
A note receivable is recorded at the fair value
of the property, goods, or services or the fair
value of the note, whichever is more reliable.
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Long-Term Notes Receivable
On January 1, 2007, Joyce Company accepted a
10,000 non-interest-bearing, 5-year note in
exchange for used equipment it sold to Marsden
Company (12).
Notes Receivable 10,000.00 Accumulated
Depreciation 3,000.00 Discount on Notes
Receivable 4,325.73 Equipment 8,000.00
Gain on Sale of Equipment 674.27
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Long-Term Notes Receivable
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Impairment of a Loan
A loan is impaired if it is probable that the
creditor will not be able to collect all amounts
due according to the contract terms.
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Impairment of a Loan
Snook Company has a 100,000 note receivable from
the Ullman Company that it is carrying at face
value. The loan agreement called for Ullman to
pay 8 interest each December 31 and the
principal on December 31, 2012. Ullman paid the
December 31, 2007, interest, but informed Snook
that it probably would miss the next two years
interest payments because of financial
difficulties. In addition, the principal payment
would be one year late.
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Impairment of a Loan
Value of the impaired loan is 85,733.93
(63,017.00 22,716.93)
Snook Company computes the present value of the
impaired loan.
Present value of the principal 100,000 x
present value of a single sum for 6 years at
8 100,000 x 0.630170 63,017.00
Present value of the interest 8,000 x
present value of an annuity for 4 years at 8
deferred 2 years 8,000 x 3.312127 x
0.857339 22,716.93
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Impairment of a Loan
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Discounting Notes Receivable

• Note is sold to a financial institution.
• Discount fee is the discount rate times the
  maturity value of the note for the time remaining
  to maturity.
• Maker of the note pays the financial institution
  at maturity.

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Discounting Notes Example

• On May 30, Apex discounts a customer 25,000
  note at the bank. The note was dated May 1 and
  matures in 90 days. The note bears interest at
  12 and the bank charges a discount of 15 on the
  maturity value of the note. (no recourse)
• Prepare the journal entry to record the
  discounting of the note.

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Discounting Notes Example
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Discounting Notes Example

• On April 1, 1998, Wyoming Company received a
  3,000, 10 percent, one-year note from a sale of
  equipment to Nell Company. Interest on the note
  is due at maturity. Wyoming Discounted the note
  on August 1, 1998, with recourse.Assume the bank
  charge 15 percent.
• Prepare the journal entry to record the
  discounting of the note.

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Discounting Notes Example
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Discounting Notes Example
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Discounting Notes Example
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Discounting Notes Example
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Discounting Notes Example
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Dishonored Notes

• A note that is not renewed or collected at
  maturity is dishonored.
• Interest continues to accrue on the maturity
  value of the note.
• If the note cannot be collected, the amount of
  the loss depends upon whether it has already been
  considered in the bad debt estimation.

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Dishonored Notes Example
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Dishonored Notes Example
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Dishonored Notes Example
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Lets move on to something else!
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hapter
The End
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