Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Cash and Receivables 7...

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Cash and Receivables

7Insert Book Cover

Picture

7-2

Cash

Amounts on deposit with

financial institutions

Amounts on deposit with

financial institutions

Coins and currency

Coins and currency

Petty cashPetty cash

Cashier’s checksCashier’s checks

Certified checksCertified checks

Money ordersMoney orders

7-3

Cash Equivalents

Items very near cash but not in negotiable form

Items very near cash but not in negotiable form

Money marketfunds

Money marketfunds

Treasury billsTreasury bills

Commercialpaper

Commercialpaper

7-4

Learning Objectives

Define what is meant by internal control and describe some key elements of an internal

control system for cash receipts and disbursements.

7-5

Internal Control of Cash

Encourages adherence to company policies

and procedures

Encourages adherence to company policies

and procedures

Promotes operational efficiency

Promotes operational efficiency

Minimizes errorsand theft

Minimizes errorsand theft

Enhances the reliability and accuracy of accounting data

Enhances the reliability and accuracy of accounting data

7-6

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.

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.

7-7

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.

Separate responsibilities for cash disbursement documents, check writing, check signing, check mailing, and record keeping.

All disbursements, except petty cash, made by check.

7-8

Learning Objectives

Explain the possible restrictions on cash and their implications for classification in the

balance sheet.

7-9

Restricted Cash andCompensating Balances Restricted Cash

Management’s 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 maintained

in a company’s account as support forfunds borrowed from the bank.

Restricted Cash Management’s intent to use a certain amount

of cash for a specific purpose – future plant expansion, future payment of debt.

Compensating Balance Minimum balance that must be maintained

in a company’s account as support forfunds borrowed from the bank.

7-10

Learning Objectives

Distinguish between the gross and net methods of accounting for cash discounts

7-11

Credit sales require: Maintaining a separate

account receivable for each customer.

Accounting for bad debts that result from credit sales.

Credit sales require: Maintaining a separate

account receivable for each customer.

Accounting for bad debts that result from credit sales.

Amounts due fromcustomers for credit sales.

Amounts due fromcustomers for credit sales.

Accounts Receivable

7-12

Cash Discounts

Increase sales.Increase sales.

Encourage early payment.

Encourage early payment.

Increase likelihood of collections.

Increase likelihood of collections.

Cash discounts . . .Cash discounts . . .

7-13

2/10,n/302/10,n/30Number of

Days Discount is Available

Number of Days

Discount is Available

Otherwise, Net (or All)

is Due

Otherwise, Net (or All)

is Due

CreditPeriodCreditPeriod

Discount Percent

Discount Percent

Cash Discounts

7-14

Cash Discounts

Sales are recorded at the

invoice amounts.

Sales are recorded at the

invoice amounts.

Sales discounts are recorded if

payment is received within

the discount period.

Sales discounts are recorded if

payment is received within

the discount period.

Gross Method

7-15

Cash Discounts

Sales are recorded at the invoice amount less the

discount.

Sales are recorded at the invoice amount less the

discount.

Sales discounts forfeited are recorded if payment

is received after the discount period.

Sales discounts forfeited are recorded if payment

is received after the discount period.

Net Method

7-16

Cash Discounts

On May 10, Eddy, Inc. sold $5,000 of merchandise to a customer subject to a cash

discount of 1/10, n/30.

Prepare the journal entry to record the sale if Eddy uses:

(a) the gross method.(b) the net method.

On May 10, Eddy, Inc. sold $5,000 of merchandise to a customer subject to a cash

discount of 1/10, n/30.

Prepare the journal entry to record the sale if Eddy uses:

(a) the gross method.(b) the net method.

7-17

Cash Discounts

7-18

Cash Discounts

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.

Assume that on May 19, Eddy, Inc. received a check in full payment of the sale made on

May 10.



(b) the net method.

7-19

Cash Discounts

7-20

Cash Discounts

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.



(b) the net method.

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.



(b) the net method.

7-21

Cash Discounts

7-22

Learning Objectives

Describe the accounting treatment for merchandise returns.

7-23

Sales Returns

Merchandise returned by a customer to a

supplier.

Sales Allowances

A reduction in the cost of defective

merchandise.

Sales Returns and Allowances

7-24


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.

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.

7-25


Sales Returns and Allowances is a contra account that reduces Sales Revenue in the

current accounting period.

7-26

Learning Objectives

Describe the accounting treatment of anticipated uncollectible accounts receivable.

7-27

Uncollectible Accounts Receivable

Bad debts result from credit customers who are unable to pay the amount they owe,

regardless of continuing collection efforts.

Bad debts result from credit customers who are unable to pay the amount they owe,

regardless of continuing collection efforts.

PAST DUE

7-28


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.

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.

7-29


Most businesses record an estimate of the bad debt expense by an adjusting entry

at the end of the accounting period.

Most businesses record an estimate of the bad debt expense by an adjusting entry

at the end of the accounting period.

GENERAL JOURNAL Page 78

Date DescriptionPost. Ref. Debit Credit

Dec. 31 Bad Debt Expense ####

Allowance for Uncollectible ####

Accounts

7-30




Dec. 31 Bad Debt Expense ####

Allowance for Uncollectible ####

Accounts

Normally classified asa selling expense and

closed at year-end.Contra asset account toAccounts Receivable.

7-31

Allowance for Uncollectible Accounts

Net realizable value is the amount of the accounts receivable that the business

expects to collect.

Accounts Receivable

Less: Allowance for Uncollectible Accounts

Net Realizable Value

Accounts Receivable

Less: Allowance for Uncollectible Accounts

Net Realizable Value

7-32

Learning Objectives

Describe the two approaches to estimating bad debts.

7-33

Income Statement Approach

Balance Sheet ApproachComposite Rate

Aging of Receivables



Aging of Receivables

PAST DUE

Estimating Bad Debts

7-34


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 period’s credit sales.

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 period’s credit sales.

7-35

Bad debts expense iscomputed as follows:

Bad debts expense iscomputed as follows:


7-36

In 2006, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit

sales are uncollectible.

What is Bad Debts Expense for 2006?


7-37

MusicLand computes estimated Bad Debts Expense of $2,400.


7-38

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.

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.

7-39

Compute the desired balance in the Allowance for Uncollectible Accounts.

Bad Debts Expense is computed as:


7-40

On Dec. 31, 2006, 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 MusicLand’s Bad Debts Expense for 2006?

On Dec. 31, 2006, 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 MusicLand’s Bad Debts Expense for 2006?


7-41

Desired balance in Allowancefor Uncollectible Accounts


7-42

Now, let’s look at the accounts receivable

aging approach!

7-43

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

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

Each age grouping has a different likelihood of being uncollectible.

Each age grouping has a different likelihood of being uncollectible.

Compute desired uncollectible amount. Compute desired uncollectible amount.

Balance Sheet Approach Aging of Receivables

Compare desired uncollectible amount with the existing balance in the

allowance account.

Compare desired uncollectible amount with the existing balance in the

allowance account.

7-44

At December 31, 2006, the receivables for EastCo, Inc. were categorized as follows:


7-45

EastCo’s unadjusted balance in the allowance account is

$500.

Per the previous computation, the desired balance is $1,350.


$500.


Prepare the entry to record bad debts expense at Dec. 31, 2006.


7-46



$500.



$500.


7-47



Emphasis on Realizable Value

Emphasis on Realizable Value

Accts. Rec. All. for

Uncoll. Accts.

Income Statement

Focus

Income Statement

Focus

Balance Sheet Focus

Balance Sheet Focus



Emphasis on Matching

Emphasis on Matching

SalesBad

Debts Exp.

Methods to Estimate Bad Debts

7-48

Uncollectible Accounts

As accounts become uncollectible, the following entry is made:



Allowance for Uncollectible Accounts ####

Accounts Receivable ####

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

7-49




Allowance for Uncollectible Accounts ####

Cash ####


Collection of PreviouslyWritten-Off Accounts

When a customer makes a payment after an account has been written off, two journal

entries are required.

7-50

If uncollectible accounts are immaterial, bad debts are simply recorded as they occur

(without the use of an allowance account).

If uncollectible accounts are immaterial, bad debts are simply recorded as they occur

(without the use of an allowance account).

Direct Write-off Method

7-51

Learning Objectives

Describe the accounting treatment of short-term notes receivable.

7-52

PROMISSORY NOTE

Face Value Date

after date I I promise to pay to the order of

Westward, Inc.

Dollars

plus interest at the annual rate of .

$25,000 Nov. 1, 2006

One year

12%

Twenty-five thousand and no/100------------------------

Janet Lee , Winn,Co.

Maker

PayeePrincipal

Interest Rate

Date of Note

Term

Notes Receivable

7-53

Even for maturities less

than 1 year, the rate is

annualized.

Even for maturities less

than 1 year, the rate is

annualized.

Interest Computation

7-54

Interest-Bearing Notes

On November 1, 2006, Westward, Inc. loans $25,000 to Winn, Co. The note bears

interest at 12% and is due on November 1, 2007.

Prepare the journal entry on November 1, 2006, December 31, 2006, (year-end) and

November 1, 2007 for Westward.

7-55


7-56


$25,000 × 12% = $3,000 - $500 = $2,500 $25,000 × 12% = $3,000 - $500 = $2,500

7-57

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.

7-58


On January 1, 2006, Westward, Inc. accepteda $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, 2006.

Prepare the journal entries on January 1, 2006, and December 31, 2006 for Westward.

On January 1, 2006, Westward, Inc. accepteda $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, 2006.

Prepare the journal entries on January 1, 2006, and December 31, 2006 for Westward.

7-59




2006

Jan 1 Notes Receivable 25,000

Discount on Notes Receivable 3,000

Sales Revenue 22,000

$25,000 × 12% = $3,000

Dec 31 Cash 25,000

Discount on Notes Receivable 3,000

Interest Revenue 3,000

Notes Receivable 25,000

7-60

Learning Objectives

Differentiate between the use of receivablesin financing arrangements accounted for

as a secured borrowing and thoseaccounted for as a sale.

7-61

Financing With Receivables

Secured borrowing

or

Sale of receivables

Secured borrowing

or

Sale of receivables

Method depends on thesurrender of control over

the receivables transferred.

Method depends on thesurrender of control over

the receivables transferred.

7-62

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.

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.

7-63

Secured Borrowing – Pledging

Receivables in general are pledged as collateral for loans.

Pledged receivables are disclosed in notes to the financial statements.

Receivables in general are pledged as collateral for loans.

Pledged receivables are disclosed in notes to the financial statements.

7-64

Sale of Accounts Receivable

FACTOR (Transferee)

SUPPLIER(Transferor)

RETAILER

1. Merchandise

2. Accounts Receivable

3. Accounts Receivable

4. Cash5.

Cas

h

A factor is a financial institution that buys receivablesfor cash, handles the billing and collection of thereceivables and charges a fee for the service.

A factor is a financial institution that buys receivablesfor cash, handles the billing and collection of thereceivables and charges a fee for the service.

7-65

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 return

of specific receivables.

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 return

of specific receivables.


7-66


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.

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.

7-67

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.

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.


7-68

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 bank’s discount rate 12 percent.

Prepare the journal entry to record the discounting of the note receivable as a sale.

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 bank’s discount rate 12 percent.

Prepare the journal entry to record the discounting of the note receivable as a sale.

7-69

GENERAL JOURNAL


Mar. 31 Interest Receivable 5,000

Interest Revenue 5,000

Discounting a Note

Before the preparing the journal entry torecord the discounting, Apex must record

the accrued interest on the note fromDecember 31 until March 31.

Before the preparing the journal entry torecord the discounting, Apex must record

the accrued interest on the note fromDecember 31 until March 31.

$200,000 × 10% × 3/12

7-70



Mar. 31 Cash 202,100

Loss on Sale of Note Receivable 2,900

Notes Receivable 200,000

Interest Receivable 5,000

Discounting a Note

$205,000 - $202,100

7-71

Discounting a Note

If the three conditions for sale treatment arenot met, the transaction would be recorded

as a secured borrowing.

If the three conditions for sale treatment arenot met, the transaction would be recorded

as a secured borrowing.

7-72

Learning Objectives

Describe the variables that influence a company’s investment in receivables and calculate the key ratios used by analysts

to monitor that investment.

7-73

Receivables Management

Product orservice soldProduct or

service sold

Creditand collection

policies

Creditand collection

policies

Level of salesLevel of sales

Factors influencinga company’s investment

in receivables

Factors influencinga company’s investment

in receivables

7-74

This ratio measures how many times a company converts its

receivables into cash each year.

Net Sales Average Accounts Receivable

ReceivablesTurnover

Ratio=

This ratio is an approximation of the number of days the average accounts

receivable balance is outstanding.

365 Receivables Turnover Ratio

Average Collection

Period=


7-75

Dell vs. Apple comparisonDell vs. Apple comparison

2004 2003 2004 2003Accounts receivable (net) 3,635$ 2,586$ 774$ 766$ Net sales 41,444 8,279

Dell Apple2004 2003 2004 2003

Accounts receivable (net) 3,635$ 2,586$ 774$ 766$ Net sales 41,444 8,279

Dell Apple

Compute the receivables turnover ratioand the average collection period

for both companies.


(All dollar amounts in millions)

7-76


Dell Apple2004 2003 2004 2003


Dell Apple


Net Sales Average Accounts Receivable

ReceivablesTurnover

Ratio=

Dell

$41,444($3,635 + $2,586)/2

= 13.32

Apple

$8,279($774 + $766)/2

= 10.75

7-77


Dell Apple2004 2003 2004 2003


Dell Apple


Dell

36513.32

= 27.4 days

Apple

36510.75

= 34 days

365 Receivables Turnover Ratio

Average Collection

Period=

7-78

Appendix 7

Cash Controls

7-79

Bank Reconciliation

Provides information for reconciling journal entries.Provides information for

reconciling journal entries.

Explains the difference between cash reported on bank statement and cash

balance on company’s books.

7-80

Bank Reconciliation

Bank Balance

+ Deposits in Transit

- Outstanding Checks

± Bank Errors

= Corrected Balance

Book Balance

+ Bank Collections

- Service Charges - NSF Checks

± Book Errors

= Corrected Balance

7-81

Bank Reconciliation

Balance per Bank

+ Deposits in Transit

- Outstanding Checks

± Bank Errors

= Adjusted Balance

All reconciling items on the

book side require an adjusting

entry to the cash account.

Book Balance

+ Bank Collections

- Service Charges - NSF Checks

± Book Errors

= Corrected Balance

7-82

Let’s prepare a May 31 bank reconciliationfor the Hawthorne Company.

The May 31 bank statement indicated a

balance of $34,680. The cash general ledger account on that date

shows a balance of $35,276.

Additional information necessary for the reconciliation is shown on the next screen.

Let’s prepare a May 31 bank reconciliationfor the Hawthorne Company.

The May 31 bank statement indicated a

balance of $34,680. The cash general ledger account on that date

shows a balance of $35,276.

Additional information necessary for the reconciliation is shown on the next screen.

Bank Reconciliation

7-83

Cash receipts not yet deposited on May 31 totaled $2,965.

A $1,020 check mailed to the bank for deposit had not reached the bank at the statement date.

Outstanding checks totaled $5,536.

A check written to pay for raw materials purchased on account cleared the bank for $1,790 but was erroneously recorded at $790.

The bank statement showed $80 in service charges in May.

The bank returned NSF checks in the amount of $2,187 received as payment on accounts receivable.

The bank collected a note receivable for $1,120 that included $120 of interest.

Bank Reconciliation

7-84

Bank Reconciliation

7-85

Bank Reconciliation

7-86

Prepare the entries to adjust the cash account to the corrected balance.

Prepare the entries to adjust the cash account to the corrected balance.

Bank Reconciliation

7-87

Used for minor

expenditures.

Petty Cash

Has one custodian.

Replenished periodically.

Petty cash fund

7-88

Petty Cash

Hawthorne Co. established a petty cashfund on May 1 by writing a check for $200

to the petty cash custodian.

Prepare the May1st journal entry to record the establishment of the fund.

Hawthorne Co. established a petty cashfund on May 1 by writing a check for $200

to the petty cash custodian.

Prepare the May1st journal entry to record the establishment of the fund.



May 1 Petty Cash 200

Cash 200

7-89

Petty Cash

During May, the petty cash custodian paid bills using cash from the fund totaling $160 as follows:

During May, the petty cash custodian paid bills using cash from the fund totaling $160 as follows:

Postage $40Office supplies 35Delivery charges 55Entertainment 30

Prepare the May 31 journal entry to record replenishing the fund.



May 31 Postage expense 40

Office supplies expense 35

Delivery expense 55

Entertainment expense 30

Cash 160

7-90

End of Chapter 7

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Cash and Receivables 7...

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Transcript of Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Cash and Receivables 7...