McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. CASH AND RECEIVABLES Chapter 7.

McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.

CASH AND CASH AND RECEIVABLESRECEIVABLES

Chapter 7

7-2

Cash and Cash EquivalentsCash and Cash Equivalents

Balances inchecking accounts

Balances inchecking accounts

Currency and coinsCurrency and coins

Cash equivalents are short-term, highly liquid investments that can be readily converted to cash.

Cash equivalents are short-term, highly liquid investments that can be readily converted to cash.

Money marketfunds

Money marketfunds Treasury billsTreasury bills Commercial

paperCommercial

paper

CashCash

Items for deposit such as checks and money orders

from customers

Items for deposit such as checks and money orders

from customers

7-3

Internal ControlInternal Control

Encourages adherence to

company policiesand procedures

Encourages adherence to

company policiesand 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

7-4

Internal Control ProceduresInternal Control Procedures

Cash ReceiptsSeparate responsibilities for handling cash, recording cash

transactions, and reconciling cash balances.Match the amount of cash received with the amount of cash

deposited.Close supervision of cash-handling and cash-recording

activities.

Cash ReceiptsSeparate responsibilities for handling cash, recording cash

transactions, and reconciling cash balances.Match the amount of cash received with the amount of cash

deposited.Close supervision of cash-handling and cash-recording

activities.

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.

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.

7-5

Restricted Cash andRestricted Cash andCompensating BalancesCompensating Balances

Restricted CashManagement’s intent to use a certain amountof cash for a specific purpose – future plant expansion, future payment of debt.

Compensating BalanceMinimum balance that must bemaintained in a company’s bankaccount as support for fundsborrowed from the bank.

Restricted CashManagement’s intent to use a certain amountof cash for a specific purpose – future plant expansion, future payment of debt.

Compensating BalanceMinimum balance that must bemaintained in a company’s bankaccount as support for fundsborrowed from the bank.

7-6

Credit sales require:• maintaining a separate account receivable account for

each customer.

• accounting for bad debts and sales returns that result from credit sales.

Credit sales require:• maintaining a separate account receivable account for

each customer.

• accounting for bad debts and sales returns that result from credit sales.

Amounts due from customers for credit sales.Amounts due from customers for credit sales.

Accounts ReceivableAccounts Receivable

Credit sales and the resulting accounts receivable are recorded net of trade discounts, not at list price.

7-7

increase salesincrease sales

encourage early payment

encourage early payment

increase likelihood of collections

increase likelihood of collections

Cash discountsCash discounts

Cash DiscountsCash Discounts

7-8

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


7-9


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

Sales are recorded at the invoice amount less the discount.

Sales are recorded at the invoice amount less the discount.

Sales discounts forfeited are recordedif payment is received

after the discount period.

Sales discounts forfeited are recordedif payment is received

after the discount period.

Net Method

7-10

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.


7-11

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.

Prepare the journal entry to record the cash receipt if Eddy uses (a) the gross method; (b) the net method.


7-12

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.

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.


7-13

Sales Returns

Merchandise returned by a customer to a

supplier.

Sales Allowances

A reduction in the cost of defective

merchandise.

Sales Returns and AllowancesSales Returns and Allowances

7-14

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.

Sales ReturnsSales Returns

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

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Uncollectible Accounts ReceivableUncollectible 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

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.

7-16

Uncollectible Accounts ReceivableUncollectible Accounts Receivable

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

Normally classified asa selling expense and

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

7-17

Allowance for Uncollectible AccountsAllowance 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

Income Statement ApproachBalance Sheet Approach

◦ Composite Rate◦ Aging of Receivables

Income Statement ApproachBalance Sheet Approach

◦ Composite Rate◦ Aging of Receivables

7-18

Income Statement ApproachIncome 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 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.

Bad debt expense is computed as follows: Bad debt expense is computed as follows:

7-19

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?

Income Statement ApproachIncome Statement Approach

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

7-20

Balance Sheet ApproachBalance Sheet ApproachFocuses 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.

Compute the desired balance in the Allowance for Uncollectible Accounts.

Bad Debt Expense is computed as:

7-21

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 MusicLand’s Bad Debt Expense for 2009?

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 MusicLand’s Bad Debt Expense for 2009?

Balance Sheet ApproachBalance Sheet ApproachComposite RateComposite Rate

7-22

Desired balance in Allowancefor Uncollectible Accounts

Balance Sheet ApproachBalance Sheet ApproachComposite RateComposite Rate

7-23

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 Balance Sheet Approach Aging of ReceivablesAging 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.

7-24

At December 31, 2009, the receivables for EastCo, Inc. were categorized as follows:


7-25

EastCo’s unadjusted balance in the allowance account is

$500.

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

EastCo’s unadjusted balance in the allowance account is

$500.

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


7-26

Uncollectible AccountsUncollectible Accounts As accounts become uncollectible, this entry is made:



Allowance for Uncollectible Accounts ####

Accounts Receivable ####




Allowance for Uncollectible Accounts ####

Cash ####


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

required.

7-27

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 MethodDirect Write-off Method

7-28

Uncollectible Accounts Receivable ExampleUncollectible Accounts Receivable ExamplePenn Company accrues a monthly charge to bad debt

expense equal to 2 percent of credit sales. At year end, the allowance for uncollectible accounts is adjusted by aging accounts receivable. Penn’s

relevant financial information for the year is:

An aging of accounts receivable at the end of the year indicates a required balance of $30,000.

Determine (1) the balance in accounts receivable at year end, and (2) amount of the year-end adjustment

to the allowance for uncollectible accounts.

7-29

Uncollectible Accounts Receivable ExampleUncollectible Accounts Receivable Example

Write-offs for the yearEnding balance

Monthly charge= 2% of $1,300,000

Amount needed tobring desired balance

to $30,000

7-30

Notes ReceivableNotes Receivable

A written promise to pay a specificamount at a specific future date.

Even for maturities less than 1

year, the rate is annualized.

Even for maturities less than 1

year, the rate is annualized.

7-31

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.

Interest-Bearing NotesInterest-Bearing Notes

7-32

Interest-Bearing NotesInterest-Bearing Notes

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

7-33

Noninterest-Bearing NotesNoninterest-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.

7-34

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.

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.

Noninterest-Bearing NotesNoninterest-Bearing Notes



2009

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

7-35

Financing With ReceivablesFinancing With Receivables

Secured borrowing or sale of receivablesSecured borrowing or sale of receivables

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.

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.

Pledging• Receivables in general are pledged as collateral for

loans. • Pledged receivables are disclosed in notes to the

financial statements.

Pledging• Receivables in general are pledged as collateral for

loans. • Pledged receivables are disclosed in notes to the

financial statements.

7-36

Sale of ReceivablesSale of Receivables

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.

7-37

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.

Sale of ReceivablesSale of Receivables

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Sale of ReceivablesSale of ReceivablesWithout 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.

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 as a sale, it will be treated as a secured 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 as a sale, it will be treated as a secured borrowing.

7-39

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.

Discounting a NoteDiscounting a Note



Mar. 31 Interest Receivable 5,000

Interest Revenue 5,000

$200,000 × 10% × 3/12

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.

7-40



Mar. 31 Cash 202,100

Loss on Sale of Note Receivable 2,900

Notes Receivable 200,000

Interest Receivable 5,000

Discounting a NoteDiscounting a Note

$205,000 - $202,100

7-41

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=

Receivables ManagementReceivables Management

7-42

Electronic Arts vs. Activision comparisonElectronic Arts vs. Activision comparison

2007 2006 2007 2006Accounts receivable (net) 256$ 199$ 149$ 29$ Net sales 3,091 1,513

Electronic Arts Activision2007 2006 2007 2006

Accounts receivable (net) 256$ 199$ 149$ 29$ Net sales 3,091 1,513

Electronic Arts Activision

Receivables ManagementReceivables Management

(All dollar amounts in millions)

Electronic Arts Activision Industry AverageReceivables Turnover 13.6 17.0 6.3 Average collection period 27 days 21 days 58 days

Electronic Arts Activision Industry AverageReceivables Turnover 13.6 17.0 6.3 Average collection period 27 days 21 days 58 days

Can you compute the receivables turnover ratio andthe average collection period for these two companies?

7-43

Appendix 7 ─ Cash ControlsAppendix 7 ─ Cash Controls

Bank Balance

+ Deposits in Transit

- Outstanding Checks

± Bank Errors

= Corrected Balance

Book Balance

+ Bank Collections

- Service Charges - NSF Checks

± Book Errors

= Corrected Balance

Provides information for reconciling journal entries.Provides information for reconciling journal entries.

A bank reconciliation explains the difference between cash reported on bank statement and cash balance on a company’s books.

All reconciling items on the

book side require an

adjusting entry to the cash

account.

7-44

Petty cash is used for

minor expenditures.

Has one custodian.

Replenished periodically.

Petty cash fund

Appendix 7 ─ Cash ControlsAppendix 7 ─ Cash Controls

McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. CASH AND RECEIVABLES Chapter 7.

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Transcript of McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. CASH AND RECEIVABLES Chapter 7.