Cash and Receivables

1. C 6 hapter Cash and Receivables An electronic presentation by Douglas Cloud Pepperdine University

2. Objectives 1. Understand the importance of cash management. 2. Prepare a bank reconciliation. 3. Discuss revenue recognition when the right of return exists. 4. Understand the credit policies relates to accounts receivable. 5. Explain the gross and net methods to account for cash discounts. Continued

3. Objectives 6. Estimate and record bad debts using a percentage of sales. 7. Estimate and record bad debts using an aging analysis. 8. Explain pledging, assignment, and factoring of accounts receivable. 9. Account for short-term notes receivable. 10. Prepare a proof of cash (Appendix)

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

5. Included in Cash Excluded from Cash Cash Cash • Coins and currency • Checking accounts • Savings accounts • Negotiable checks • Bank drafts • Certificates of deposit • Bank overdrafts • Postdated checks • Travel advances • Postage stamps

6. Cash Equivalents Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and near their maturity.

7. Cash Management Control Over Receipts • Immediately count the receipts (by the person opening the mail or the sales person using the cash register). • Record daily all cash receipts in the accounting records. • Deposit daily all receipts in the company’s bank account.

8. Cash Management Control Over Payments • Make all payments by check (except petty cash items) so that a record exists for every company expenditure. • Authorize and sign all checks only after an expenditure is verified and approved. • Periodically reconcile the cash balance in the bank statements with the company’s accounting records.

9. Petty Cash First: An employee is appointed petty cash custodian. A journal entry is made to record the establishment of the fund. Petty Cash 500 Cash 500

10. Petty Cash Second: Petty cash vouchers are printed, prenumbered, and given to the custodian of the fund. At all times the total of the cash in the fund plus the amounts of expenditure vouchers should be equal to $500 (in this case).

11. Petty Cash …the vouchers are sorted into expense categories and the remaining cash is counted. Third: When the amount of cash in the petty cash fund becomes low and/or at the end of accounting period,... Assume that a count at the end of the month shows $67.54 remaining in the petty cash fund.

12. Petty Cash The sorting of vouchers indicated the following costs were incurred during the month: Office supplies $ 34.16 Postage 178.00 Transportation 132.14 Miscellaneous 83.76 Total expenses $428.06 The fund’s expected balance is $71.94 ($500.00 - $428.06). There is a shortage of $4.40 ($71.94 - $67.54).

13. Petty Cash The company records the actual expenses and the amount needed to replenish the fund. Office Supplies Expense 34.16 Postage Expense 178.00 Transportation Expense 132.14 Miscellaneous Expense 83.76 Cash Short and Over 4.40 Cash 432.46

14. Bank Reconciliation Causes of the difference between the cash balance and the company’s bank statement balance. • Outstanding checks • Deposits in transit • Charges made by the bank • Deposits made directly by the bank • Errors

15. Bank Reconciliation Cash balance from company records $6,925 Cash balance from bank statement $7,218

16. Bank Reconciliation Cash balance from bank statement $7,218 Add: Receipts recorded on the company’s records but not reported on the bank statement. 629 $7,847 Cash balance from bank statement $7,218 Deposits in transit and cash received but not yet deposited totaled $629.

17. Bank Reconciliation Cash balance from bank statement $7,218 Add: Receipts recorded on the company’s records but not reported on the bank statement. 629 $7,847 Cash balance from bank statement $7,218 Add: Receipts recorded on the company’s records but not reported on the bank statement. 629 $7,847 Deduct: Outstanding checks (516 ) Outstanding checks totaled $516.

18. Bank Reconciliation Cash balance from bank statement $7,218 Add: Receipts recorded on the company’s records but not reported on the bank statement. 629 $7,847 Deduct: Outstanding checks (516 ) Adjusted Cash Balance $7,331

19. Bank Reconciliation Cash balance from company records $6,925 Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 $7,640 Notes receivable totaling $700 and interest totaling $15 were collected by the bank.

20. Bank Reconciliation Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 $7,640 Bank service charge, $9.

21. Bank Reconciliation Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 $7,640 Deduct: Bank service charge (9 ) Bank service charge, $9.

22. Bank Reconciliation Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 $7,640 Deduct: Bank service charge (9 ) Customers’ checks were returned for lack of funds (NSF check), $300.

23. Bank Reconciliation Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 $7,640 Deduct: Bank service charge (9 ) NSF checks (300 ) Customers’ checks were returned for lack of funds (NSF check), $300.

24. Bank Reconciliation Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by bank 715 $7,640 Deduct: Bank service charge (9 ) NSF checks (300 ) Adjusted Cash Balance $7,331

25. Bank Reconciliation Adjusted cash balance per company records $7,331 Adjusted cash balance per bank statement $7,331

26. Bank Reconciliation Journal Entries Cash 715 Notes Receivable (note collected) 700 Interest Revenue (interest collected) 15 Miscellaneous Expense (bank service charge) 9 Accounts Receivable (NSF check) 300 Cash 309

27. 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.

28. Revenue Recognition and Valuation Recording and Reporting Accounts Receivable Recording and Reporting Notes Receivable Receivables Trade Receivables • Normal circumstances • Right of return • Valuation • Cash discounts • Sales returns and allowances • Uncollectible accounts • Financing arrangements • Interest-bearing • Non-interest-bearing • Discounted

29. Receivables Right of Return 1. The sales price is fixed or determinable at the date of sale. 2. The buyer has paid or will pay the seller, and the obligation is not contingent upon the resale of the product. 3. The buyer’s obligation to the seller would not be changed by theft or damage to the product. Each of the following criteria must be satisfied when the right of return exists in order to recognize revenue at the time of sale. Continued

30. Receivables Right of Return 4. The buyer has an economic substance apart from the seller. 5. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. 6. The seller can reasonably estimate the amount of future returns.

31. Accounts Receivable Internal Control Procedures for Accounts Receivable • Prenumbered sales invoices. • Separation of the sales function from the cash collection responsibilities.

32. $8,000 - ($8,000 x 0.02) Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method Sold $8,000 of merchandise to various customers on December 4, 2004 with terms of 2/10, n/EOM Accounts Receivable 8,000 Sales 8,000 Accounts Receivable 7,840 Sales 7,840

33. $5,500 - ($5,500 x 0.02) Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method On December 13 received payment on goods originally billed at $5,500. Cash 5,390 Sales Disc. Taken 110 Accts. Receivable 5,500 Cash 5,390 Accts. Receivable 5,390

34. Classified as” Other Items” on the income statement $1,500 - ($1,500 x 0.02) Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method Received payment on goods billed at $1,500 on December 30 (after the discount period). Cash 1,500 Accts. Receivable 1,500 Cash 1,500 Accts. Receivable 1,470 Sales Discounts Not Taken 30

35. Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method Year-end adjustment at the end of the period. No entry required Accounts Receivable 20 Sales Discounts Not Taken 20

36. Loss Contingencies FASB Statement No. 5 requires that estimated losses from loss contingencies be accrued against income and... … recorded as reductions in assets or as liabilities when both of these conditions are met. 1. Information available prior to the issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements. 2. The amount of the loss can be reasonably estimated.

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

38. Estimated Bad Debts Method 1. Relationship to sales (income statement approach): a. Percentage of sales b. Percentage of net credit sales 2. Relationship to accounts receivable (balance sheet approach): a. Percentage of outstanding accounts receivable b. Aging of accounts receivable

39. $525,000 x 0.02 Estimated Bad Debts Method Percentage of Sales If a company’s net credit sales during the year were $525,000 and bad debts historically amount to 2% of net credit sales, what is the required adjusting entry? Bad Debt Expense 10,500 Allowance for Doubtful Accounts 10,500

40. Allowance for Doubtful Accounts 4,500 (current balance) Estimated Bad Debts Method Percentage of Outstanding Accounts Receivable If a company has determined that there has been a 4% relationship between actual bad debts and the year-end account receivable balance ($475,000), what would be the required adjusting entry? $475,000 x 0.04 = $19,000

41. Allowance for Doubtful Accounts 4,500 (current balance) 19,000 (required balance) Estimated Bad Debts Method Percentage of Outstanding Accounts Receivable If a company has determined that there has been a 4% relationship between actual bad debts and the year-end account receivable balance ($475,000), what would be the required adjusting entry? 14,500 (required adjustment)

42. Estimated Bad Debts Method Percentage of Outstanding Accounts Receivable If a company has determined that there has been a 4% relationship between actual bad debts and the year-end account receivable balance ($475,000), what would be the required adjusting entry? Bad Debt Expense 14,500 Allowance for Doubtful Accounts 14,500

43. Aging of Accounts Receivable 1. Gather the unpaid invoices in each customer’s account. 2. Classify the invoice amounts according to the length of time the invoice has been outstanding. 3. Multiply the total amount in each age group by the applicable estimated uncollectible percentage. 4. Make a journal entry to bring the balance in Allowance for Doubtful Accounts to the amount calculated in Step 3. Examine Exhibit 6-3 carefully.

44. Estimated Percentage Uncollectible Estimated Amounts Uncollectible Aging of Accounts Receivable Age x 2% x 8% x 15% x 30% x 50% = $ 1,070 = 2,760 = 540 = 4,710 = 7,250 $16,330 Under 60 days $ 53,500 60-120 days 34,500 121-240 days 3,600 241-360 days 15,700 Over 1 year 14,500 $121,800

45. $16,330 + $1,350 Aging of Accounts Receivable If the firm has a current $1,350 debit balance, the required adjusting entry would be-- Bad Debt Expense 17,680 Allowance for Doubtful Accounts 17,680

46. 850 Allowance for Doubtful Accounts 850 8,750 Writing Off Uncollectibles Accounts Receivable 175,000 Net realizable value = $166,250 Net realizable value = $166,250 Allowance for Doubtful Accounts 850 Accounts Receivable 850 A customer’s account totaling $850 is determined to be uncollectible.

47. Collection of an Account Previously Written Off Later, a payment for $850 is received from the account that was written off in the previous slide. Accounts Receivable 850 Allowance for Doubtful Accounts 850 Cash 850 Accounts Receivable 850

48. Accounts Receivable Financing Agreements There are three basic forms of financing agreements to obtain cash from accounts receivable. • Pledging • Assigning • Factoring

49. Transfer Some Risks and Benefits of Ownership Transfer Risks and Benefits of Ownership Retain Risks and Benefits of Ownership Pledge Assign Factor (Collateral for Loans) (Specific Receivables with Recourse) (Sale without Recourse) Accounts Receivable Financing Agreements

50. 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.