Cash and Receivables. Chapter. Learning Objectives. Nature and Composition of Cash. Additional Cash Issues

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7-1 UCSB, Anderson

Cash and Receivables

Chapter

7

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No substantial departures from the text, Chapter 7.

Learning Objectives

Nature and Composition of Cash

Cash is classified as a ...

To be reported as CASH:

Must be readily available for the payment of current obligations, and ....…

it must be free from any contractual restriction that limits its use in satisfying debts.

Current Asset

Additional Cash Issues

 Bank Overdrafts (means negative cash)

– Happens when outstanding checks exceeds cash at bank plus

deposits in transit (or when the Company has overdraft protection)

– Is this an asset?

NO!!- current liability called “bank

overdraft”

 Restricted Cash- such as cash held as collateral for bank. – Requires disclosure

 Cash Equivalents

• Some companies include investments which are readily converted

to cash within 90 days as a “cash equivalent”- requires disclosure. Hence their financial statement presentation for the cash line reads: “cash and cash equivalents”.

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Slide 7-5 UCSB, Anderson

Account Classification

Cash Temporary investments Temporary investments Accounts receivable Receivable Long-term investments (bond sinking fund) Cash

Investments (ST or LT?) a. Coins and currency

b. U.S. Treasury bonds c. Certificate of deposit d. NSF check (customer) e. Postdated checks f. Cash to be used for

bond retirement g. Deposits in transit h. Shares of AOL stock

Items Account

NOTE: Treasury bills are 1 year Or less, but treasury bonds always

1 year or more Slide 7-6 UCSB, Anderson

Account Classification

Cash Cash Postage expense Prepaid i. Savings account j. Petty cash k. Stamps l. Travel advances Items Account

Cash Controls

Why are cash controls important?  Cash is most susceptible asset to theft.

 Because ultimately everything culminates in cash, consequently other problems frequently manifest themselves as unknown “reconciling items” when the bank reconciliation is performed.

What do you think are the two most important cash controls to have?

 Segregation of duties (forces collusion)

 Check signing authority (have to get the cash out of the bank in order to steal it!

Bank Reconciliation

Reconciling Items:

 unrecorded by bank, but recorded by entity  recorded by bank, but not by entity  errors by the bank or the entity Reconciling Items:

 unrecorded by bank, but recorded by entity  recorded by bank, but not by entity  errors by the bank or the entity CRUTCH TOOL

Reconciling From A to B (A at top of reconciliation):  Recorded by A but NOTB: Opposite direction in

reconciliation

 Recorded by B but NOTA: Same direction in reconciliation.

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BANK RECONCILIATION CRUTCH

RECONCILING

FROM BOTH X & Y X BUT NOT Y Y BUT NOT X X No opposite direction same direction

adjustment Increase= negative Increase= positive Decrease=positive Decrease= negative Y

RECORDED BY

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Bank Reconciliation Example

For example: XYZ Company. The following relevant information exists:

 The bank balance is $250,000 as of December 31, 200X while your general ledger shows cash at $200,000. Careful examination of activity reveals the following:

– There are $20 in bank fees which were not recorded in the general ledger;

– XYZ received checks and posted the entry for $95,000 during the last week of December which did not get deposited to the bank.

– XYZ wrote checks during the last week of December totaling $175,000 which have not yet cleared the bank. – There was a $29,980un-located reconciling item (general

ledger exceeding bank) on every bank statement sense the beginning of the year.

Bank reconciliation to example on previous slide:

Balance per bank 250,000

Bank charges not recorded 20 entry required to Gl Deposit in transit 95,000

Outstanding checks (175,000)

Other misc. 29,980 Possible error! 200,000

Written promises to pay a certain sum of money on a specified

future date. Claims held against customers and others for

money, goods, or services.

Oral promises of the purchaser to pay for

goods and services sold.

Receivables

Accounts

Receivable

“Trade receivables” if from their primary activities.

Notes

Receivable

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Slide

A/R Measurement

Trade Discounts

 Reductions from the list price

 Not recognized in the accounting records  Customers are billed net

of discounts

10 %

Discount

for new

Retail

Store

Customers

A/R Measurement

Cash Discounts

 Inducements for prompt payment – 2/10, n/30 means: 2%

discount if paid within 10 days, all of it if you don’t!

 Can account for it using the

Gross Method or Net Method (Illustration 7-4 pg. 321)

 Gross Method is more practical

and common.

Payment

terms are

2/10, n/30

Sales Discounts: Gross VS Net

Accounts Receivable 10,000 Accounts Receivable 9,800

Sales 10,000 Sales 9,800

Cash 3,920 Cash 3,920

Accounts receivable 4,000 Accounts receivable 3,920

Sales discounts 80

Cash 6,000 A/R 120

Accounts receivable 6,000 Sales discounts forfeited 120

Cash 6,000

Accounts receivable 6,000

Sales of $10,000, terms 2/10, n/30

Payment of $3,920 received WITHIN discount period (10 days)

Payment of $6,000 received AFTER discount period (10 days) Gross Method- MOST COMMON Net Method

Accounts Receivable Valuation

Allowance Method Losses are Estimated:  Percentage-of-sales  Percentage-of-receivables  Other means

 ALWAYS have to assess whether the methodology utilized is reasonable (judment comes into play again!)

Valued at Net Realizable Value

Methods of Accounting for Uncollectible Accounts

Direct Write-Off

Theoretically undesirable:  no matching

 receivable not stated at net realizable value  Allowable if immaterial

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Slide

Accounting for A/R and Bad Debts

How are these accounts presented on the Balance How are these accounts presented on the Balance

Sheet? Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Slide 7-18 UCSB, Anderson Assets Current Assets: Cash $ 346 Accounts receivable 500

Less allowance for doubtful accounts 25 475

Inventory 812

Prepaids _ 40

Total current assets 1,673

Fixed Assets:

Office equipment 5,679

Furniture & fixtures 6,600

Less: Accumulated depreciation (3,735)

Total fixed assets 8,544

Total Assets $10,217

Assets Current Assets:

Cash $ 346

Accounts receivable, net of $25 allowance

for doubtful accounts 475

Prepaids _ 40

Fixed Assets:

Total Assets $10,217

Accounting for A/R and Bad Debts

Journal entry for credit sale of $100?

Accounts receivable 100 Sales 100 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End.

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Accounting for A/R and Bad Debts

Journal entry for credit sale of $100 ?

Accounts receivable 100 Sales 100 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 600 25 End. Sale 100 Slide 7-22 UCSB, Anderson

Accounting for A/R and Bad Debts

Collected of $333 on account ? Cash 333 Accounts receivable 333 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 600 25 End. Sale 100

Accounting for A/R and Bad Debts

Collected of $333 on account ? Cash 333 Accounts receivable 333 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 25 End. Sale 100 333 Coll.

Accounting for A/R and Bad Debts

Adjustment of $15 for estimated Bad-Debts ?

Bad debt expense 15

Allowance for Doubtful Accounts 15 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 25 End. Sale 100 333 Coll.

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Accounting for A/R and Bad Debts

Adjustment of $15 for estimated Bad-Debts ?

Bad debt expense 15

Allowance for Doubtful Accounts 15 Accounts Receivable

Allowance for Doubtful Accounts

Beg. 500 25 Beg.

End. 267 40 End.

Sale 100 333 Coll. 15 Est.

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Accounting for A/R and Bad Debts

Write-off of uncollectible accounts for $10 ?

Allowance for Doubtful accounts 10

Accounts receivable 10 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 40 End.

Sale 100 333 Coll. 15 Est.

Accounting for A/R and Bad Debts

Write-off of uncollectible accounts for $10 ?

Allowance for Doubtful accounts 10

Accounts receivable 10 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 257 30 End.

Sale 100 333 Coll. 15 Est. W/O 10

10 W/O

Assets Current Assets:

Cash $ 346

Accounts receivable, net of $30allowance

for doubtful accounts 227

Prepaids _ 40

Fixed Assets:

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Slide

Estimating Uncollectible Accounts:

The Allowance Methods

Percentage-of-sales method

Percentage-of-receivable method:

 Ending Accounts Receivable

 Aging of Accounts Receivable

Slide 7-30 UCSB, Anderson Income Statement Approach Balance Sheet Approach

Percentage of Sales

Matching

Sales --- Bad Debt Expense

Percentage of Receivables

Net Realizable Value

Receivables - Allowance for Bad Debt

Comparison of Methods

Estimating Bad Debt Expense

Data

Charge sales $500,000

Estimated % of charge sales

not collected 1.25%

Accounts receivable balance $72,500 Estimated % of A/R not collected 8% Allowance for Doubtful Accounts: $150 (credit

balance)

Percentage-of-Sales Approach

Charge sales

$500,000

Estimated percentage

x 1.25%

---Estimated expense

$ 6,250

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What should the ending balance be for the

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Percentage-of-Sales Approach

Actual balance (150)

Adjustment

(6,250)

Ending balance (6,400)

Journal entry

:

Bad debt expense

6,250

Allowance for D.A.

6,250

Slide 7-34 UCSB, Anderson Percentage-of-Receivables Approach

Accounts receivable

$72,500

Estimated percentage

x

8%

---Desired balance

$ 5,800

Percentage-of-Receivables Approach Actual balance 150 Cr. Desired balance 5,800 Cr. Amount of expense 5,650 Journal entry:

Bad debt expense 5,650

Allowance for D.A. 5,650

Notes Receivable

 Represent claims from borrowers evidenced by a document referred to as the “note” or “note agreement”;

 Can be secured or unsecured;

 Must be properly valued- meaning that impairments to their value must be reflected;  All notes should be recorded using a reasonable

market rate:

– There is NO such thing as a zero percent note

(except for from your parents, and actually they expect you to care for them when they are old and feeble)

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Slide

Interest-Bearing Note

Date: January 1, 2001

Marie Co. made a loan to Don. Co. and received in

exchange a 3-year, $5,000 note bearing

interest at 12%.

NOTE: Unless stated otherwise in the slides or in the text, the assumption is that any premium or discount on a note is granted as an addition/ deduction from the cash given on the note.

Slide

Present Value at 12% Market Rate:

$5,000 x 0.71178 = $3,558.90

$600 x 2.40183 = 1,441.10

$5,000.00

Journal Entry at Issuance:

Notes receivable 5,000.00

Cash 5,000.00

Interest-Bearing Note

$5,000 x 0.75132 = $3,756.60

$600 x 2.48685 = 1,492.11

$5,248.71

Interest-Bearing Note

Premium on N/R 248.71

Cash 5,248.71

$5,000 x 0.65752 = $3,287.60

$600 x 2.28323 = 1,369.94

$4,657.54

Interest-Bearing Note

Discount on N/R 342.46

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12% Note Discounted at 15%

Cash Effective

Un-Interest Interest Discount Amort. PV of Date 12% 15% Amort. Balance Note 1/1/2001 342 4,658 12/31/2001 600 699 99 243 4,757 12/31/2002 600 714 114 129 4,871 12/31/2003 600 729 129 0 5,000 Slide 7-42 UCSB, Anderson

JOURNAL ENTRY ACTIVITY OF 15% NOTE Note rec. Discount Interest OPENING ENTRY Balance Balance Income Cash

Notes receivable 5,000 5,000 Note discount 342 (342)

Cash 4,658 (4,658)

5,000 (342) - (4,658)

END OF YEAR ONE PAYMENT ENTRY

Cash 600 600

Interest income 699 (699)

Note discount 99 99

5,000 (243) (699) (4,058)

END OF YEAR TWO PAYMENT ENTRY

Cash 600 600

Interest income 714 (714)

Note discount 114 114

5,000 (130) (1,412) (3,458)

END OF YEAR THREE PAYMENT ENTRY

Cash 600 600 Interest income 729 (731) Note discount 129 131 Cash 5,000 5,000 Note receivable 5,000 (5,000) - 1 (2,143) 2,142

Non-Interest-Bearing Note

Marie Co. sold real estate to to Don. Co. for a purchase price of $1,000,000 payable as follows: $800,000 cash due at close of escrow and a $200,000 non-interest bearing note payable in one lump-sum at the end of 5 years. The cost basis of the real estate sold is $750,000.

Is the purchase price of the real estate equal to, more than or less than $1,000,000?

Less than $1,000,000.

Assuming a lender would charge 8% for this note, the present value of the $200,000 note is about $136,117, so what was the purchase price?

$936,117

Computations for JE’s:

Cash 800,000 Future 200,000 Periods 5 Payment ‐ Rate 8% PV of Cash 800,000 PV of note 136,117 936,117

Period Payment Interest Principle Balance

‐ 136,117 1 ‐ 10,889 10,889 147,006 2 ‐ 11,760 11,760 158,766 3 ‐ 12,701 12,701 171,468 4 ‐ 13,717 13,717 185,185 5 ‐ 14,815 14,815 200,000 FACTS PRESENT VALUE RECEIVED AMORTIZATION TABLE

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Non-interest bearing note continued

What is the entry to record the sale?

Cash $800,000

Note receivable $ 136,117

Real estate $750,000

Gain on sale of real estate $ 186,117 .

What will be recorded at the end of the first year (assuming annual compounding)?

Interest receivable $10,889

Interest income $10,889

At the end of the second year? (don’t forget that the $10,889 interest receivable now accrues interest!)

Interest receivable $11,760

Interest income $11,760

Same Journal entry in years 3,4 & 5 for $12,701, $3,717 and $14,815, respectively.

WHEN IT IS ALL FINISHED, THERE WILL BE $63,883 OF ACCRUED INTEREST AND WHEN THE PAYMENT IS RECEIVED, THE FOLLOWING ENTRY WILL BE RECORDED:

Cash $200,000

Note Receivable $ 136,117

Accrued interet rec. $ 63,883

Slide 7-46 UCSB, Anderson 11/12/96 49 Noninterest-Bearing Note Noninterest-Bearing Note Discounted at 15% Discounted at 15%

CashEffective Un-InterestInterestDiscountAmort. PV of Date 0% 15% Amort. Balance Note 1/1/92 1,712 3,288 12/31/92 0 493 493 1,219 3,781 12/31/93 0 567 567 652 4,348 12/31/94 0 652 652 - 5,000