Chapter 7: Cash and Receivables

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Chapter 7 Cash and Receivables
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Part 1Cash and Cash Equivalents
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Cash and Cash Equivalents Issues

• Definition of cash various items that
  comprise cash.
• Management and control of cash the importance
  of internal control of cash
• Reporting of cash in the balance sheet

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Items comprising Cash

• Cash must be readily available and be free of
  restrictions
• Cash consists of coins, currency (cash on hand)
• available funds on deposit
• Deposits (CDs) and short term paper are
  classified as temporary investments
• Post dated checks, travel advances and stamps on
  hand are not classified as cash

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Management and control of cash

• Since cash is the most liquid asset, internal
  control of cash is imperative.
• Controls must prevent unauthorized use of cash
• Management must have necessary information for
  proper use of cash

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Internal Control over Cash

• Receipts
• Segregation of duties (recording and custody)
• Joint custody
• Provide receipts
• Lockbox if possible
• Disbursements
• Segregation of duties (recording, custody and
  authorization)
• Checks whenever possible
• Dont use receipts to make disbursements keep
  receipts and disbursements separate

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Bank reconciliations

• Purpose of a bank reconciliation is to reconcile
  cash balance per books to cash balance per bank
  statement.
• Adjust the balances for items not reflected in
  that balance.
• Two kinds of reconciling items
• Things the bank knows about that the company
  doesnt (i.e. fees)
• Things the company knows about that the bank
  doesnt (i.e.outstanding checks)

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Bank Reconciliations

• Two ways to do them
• Reconcile book balance to bank balance (or vice
  versa).
• Reconcile book and bank balance to a common
  adjusted correct balance.

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Petty Cash

• Imprest system should be used
• Petty cash fund is established for a certain
  amount ( say 500)
• The only time the petty cash account is adjusted
  is if the amount in petty cash is changed (not
  changed by routine transactions)
• As money is spent, a receipt is prepared for each
  disbursement
• When the cash is replenished, the receipts are
  recorded to the various expense accounts.

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Reporting of Cash

• The reporting of cash depends upon whether it is
• restricted cash
• a bank overdraft or
• a cash equivalent

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Restricted Cash

• Compensating balances
• are amounts maintained by a corporation with a
  bank in support of existing borrowing
  arrangements
• give bank use of the restricted balance
• are identified as current assets separate from
  cash, if they relate to short-term loans.
• are identified as non-current assets separate
  from cash, if they relate to long-term loans.

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Bank Overdrafts

• Overdrafts represent checks written in excess of
  cash account.
• Overdrafts may be offset against available cash
  in another account in the same bank.
• Otherwise, such offsetting is not allowed.

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Part 2Accounts Receivable
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Accounts Receivable - Issues

• Types of accounts receivable current and
  non-current trade and non-trade
• Recognition of accounts receivable in the
  financial statements - cash discounts / interest
• Valuation of accounts receivable estimated
  bad debts and net realizable value
• Disposition of receivable - transfers / sale

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Accounts Receivable Recognition

• Trade or quantity discounts are not recorded
  in books of account.
• Sale is recorded at discounted price
• Cash (sales) discounts are inducements to
  customers for prompt payment of amounts
  billed.
• Cash discounts are recorded in books as
  reductions of sales revenue.

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Accounts Receivable Recording Cash Discounts

• There are two methods Gross and Net
• Gross method records discounts when taken by
  customers.
• Sale is originally reported at full price
• Net method records discounts not taken by
  customers.
• Sale is originally reported at the discounted
  price.

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Accounts Receivable Recording Cash Discounts
GROSS method
NET method

• Record revenue at gross amount of sales
• When customer takes the discount, record cash
  discounts
• Cash discounts reduce gross sales revenue

• Record revenue at gross amount of sales less cash
  discount
• When customer forfeits discount, record discounts
  not taken.
• Report discounts forfeited as other revenue

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Valuation of Accounts Receivable

• Short term receivables are reported at their net
  realizable value (NRV)
• The NRV is the net amount expected to be
  collected
• The NRV is gross accounts receivable less
  estimated uncollectible accounts.

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Estimating uncollectible receivables
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Estimating uncollectible accountsthe Allowance
method

• The estimate of uncollectible accounts may be
  based on
• either sales (or net sales) or
• accounts receivable balance end of year
• These approaches are referred to as Income
  statement and Balance sheet approaches

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The Allowance method (Sales method - first year)

• Indcom company reports the following balances for
  the year 2000 (first year)
• Net sales 50,000
• Accounts Rec (Dec 31,2000) 4,600
• The company estimates bad debts at 2 of net
  sales.
• Determine estimated uncollectible accounts
  expense for 2000.

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The Allowance method (Sales method - first year)
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The Allowance method (Sales approach - second
year)

• Indcom company reports the following balances for
  the year 2001 (second year)
• Net sales 70,000
• Accounts Rec (Dec 31,2001) 5,700
• The company estimates bad debts at 2 of net
  sales.
• Determine estimated uncollectible accounts
  expense for 2001.

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The Allowance method (Sales approach - second
year)
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The Allowance method (Acct Rec approach - first
year)

• Indcom company reports the following balances for
  the year 2000 (first year)
• Net sales 50,000
• Accounts Rec (Dec 31,2000) 4,600
• The company estimates bad debts at 10 of
  accounts receivable.
• Determine estimated uncollectible accounts
  expense for 2000.

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The Allowance method (Acct Rec approach - first
year)
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The Allowance method (Acct Rec approach - second
year)

• Indcom company reports the following balances for
  the year 2001 (second year)
• Net sales 70,000
• Accounts Rec (Dec 31,2001) 5,700
• The company estimates bad debts at 10 of
  accounts receivable.
• Determine estimated uncollectible accounts
  expense for 2001.

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The Allowance method (Acct Rec approach - second
year)
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The Allowance method (Acct Rec approach - second
year)
Adjusting entry Bad Debts expense Dr 110
Allowance account 110
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Writing off Accounts

• With either allowance method, writing off the
  account works the same way
• Allowance for doubtful account XXX
• Accounts Receivable XXX
• With the direct write-off method
• Bad Debt Expense XXX
• Accounts Receivable XXX

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Balance Sheet Representation

• Short term accounts receivable are shown at their
  net realizable value as follows
• Accounts Receivable (gross) XXX less
  Allowance ( XX) Net Realizable Value
  XX

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Analysis of Receivables

• A/R turnover ratios are an excellent way to
  evaluate the health of a companys receivables.
• Days sales in A/R
• (365)/(Net Sales/Avg. net A/R balance))
• Compare to sales terms.
• Compare trend over time and to industry.
• Aging A/R is used to do the balance sheet
  approach and highlights developing problems

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Part 3 Notes Receivable
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Notes Receivable Issues

• Recognition of Notes Receivable
• issues at face value and issues not at face
  value
• issues for cash / non-cash considerations
• Valuation issues
• Disposition of notes receivable

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Recognition of Notes Receivable
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Recognition of Notes Receivable

• Notes receivable are issued at face value when
  the stated rate of interest is the same as the
  effective (market) rate.
• When the rates are unequal, a discount on the
  note results.
• The discount is amortized to interest revenue by
  the effective interest method.

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Recognition of Notes Receivable
1. Determine discount on notes receivable at
implicit rate of interest 2. The discount is
amortized to interest revenue by the
effective interest method
1. Determine discount on notes receivable at
the effective rate of interest. 2. The
discount is amortized to interest
revenue by the effective interest method
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Discount on notes receivable Example

• Assume Debrief company issues a notes receivable
  (FV 10,000) on 1.1.2000.
• Stated Rate, 10 Effective Rate, 12
• The discount is 480.
• Assume that the discount to be amortized for 2000
  is 142.
• Show necessary journal entries.

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Discount on notes receivable Example

• 1.1.2000 Notes Receivable Dr. 10,000
  Discount (N/R) 480 Cash
  9,520
• December 31, 2000 Discount (N/R) Dr.
  142 Cash Dr. 1,000
  Interest Revenue 1,142

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Part 4 Disposition of Accounts and Notes
Receivable
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Disposition of Accounts andNotes Receivable

• The holder of accounts or notes receivable may
  transfer them for cash.
• The transfer may be
• secured borrowing or
• a sale of receivables
• Holder retains ownership of receivables in a
  secured borrowing transaction (collateral).
• Holder transfers ownership of receivables in a
  sale (retaining risks of collection)

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Transfer of Receivablesborrowing vs. sale
treatment
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Accounting for Transfers of Receivables
Transfers
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Secured Borrowing (highlights)

• Transferor records a finance charge.
• Transferor collects accounts receivable.
• Transferor records sales returns and sales
  discounts.
• Transferor absorbs bad debts expense.
• Transferor records interest expense on notes
  payable.
• Transferor pays on the note periodically from
  collections.
• Transferor discloses arrangement in the footnotes.

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Sale of Receivables

• Transferor transfers ownership of receivables
  to factor.
• Factor records the (transferred) accounts as
  assets in its books.
• Transferor records any amount retained by
  transferee as due from factor
• Transferor records loss on sale of receivables
• Transferor records any component liability (when
  appropriate)