Cash and Receivables

1. C 6 hapter Cash and Receivables

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.

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.

4. 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

5. Cash Management Control Over Receipts • The person opening the mail or the sales person using the cash register should count the receipts immediately. • All cash receipts are recorded daily in the accounting records. • All receipts are deposited daily in the company’s bank account.

6. 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.

7. Petty Cash First: An employee is appointed petty cash custodian. Petty Cash 500 Cash 500

8. 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).

9. 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.

10. 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 Petty Cash The fund is short $4.40 ($71.94 - $67.54).

11. 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

12. 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

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

14. 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.

15. 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.

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 Deduct: Outstanding checks (516) Adjusted Cash Balance $7,331

17. Bank Reconciliation Cash balance from company records $6,925 Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Interest earned on the funds on deposit.

18. Bank Reconciliation Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct: Bank service charge (9) Bank service charge, $9.

19. Bank Reconciliation Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct: Bank service charge (9) Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct: Bank service charge (9) NSF checks (300) Customers’ checks were returned for lack of funds (NSF check), $300.

20. Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct: Bank service charge (9) Cash balance from company records $6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct: Bank service charge (9) NSF checks (300) Adjusted Cash Balance $7,331 Bank Reconciliation

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

22. 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

23. Receivables Right of Return • The sales price is fixed or determinable at the date of sale. • The buyer has paid or will pay the seller, and the obligation is not contingent upon the resale of the product. • 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

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

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

26. $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, 2000 with terms of 2/10, n/EOM Accounts Receivable 8,000 Sales 8,000 Accounts Receivable 7,840 Sales 7,840

27. $5,500 - ($5,500 x 0.02) Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method On December 12 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

28. 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

29. 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

30. 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. • 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. • The amount of the loss can be reasonably estimated.

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

32. Estimated Bad Debts Method • Relationship to sales (income statement approach): • Percentage of sales • Percentage of net credit sales • Relationship to accounts receivable (balance sheet approach): • Percentage of outstanding accounts receivable • Aging of accounts receivable

33. $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

34. 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

35. 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)

36. 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

37. Aging of Accounts Receivable • Gather the unpaid invoices in each customer’s account. • Classify the invoice amounts according to the length of time the invoice has been outstanding. • Multiply the total amount in each age group by the applicable estimated uncollectible percentage. • 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.

38. % x 2 x 8 x 15 x 30 x 50 = $ 1,070 = 2,760 = 540 = 4,710 = 7,250 $16,330 Estimated Percentage Uncollectible Estimated Amounts Uncollectible Aging of Accounts Receivable Age 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

39. $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

40. 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.

41. 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

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

43. 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

44. Factoring FASB Statement No. 125 states that a company records transfer of financial assets (e.g., accounts receivable) in which it surrenders control over the financial assets to another company as a sale when all the following conditions are met: • The transferred assets have been isolated from the transferor. • The transferee obtains the right to exchange. • 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.

45. Assignment of Accounts Receivable On December 1, 2000 the Trussel Company assigned $60,000 of its accounts to a finance company. The finance company advances 80% of the accounts receivable assigned less a service charge of $500. It also charges an annual interest of 12% on any outstanding loan balance. ($60,000 x 0.80) - $500 Cash 47,500 Assignment Service Charge Expense 500 Notes Payable 48,000 $60,000 x 0.80 Accounts Receivable Assigned 60,000 Accounts Receivable 60,000

46. Assignment of Accounts Receivable On December 31, 2000 Trussel collects $10,000 on assigned accounts. This amount along with the 12% interest for one month is paid to the finance company. Cash 10,000 Accounts Receivable Assigned 10,000 Notes Payable 10,000 Interest Expense 480 Cash 10,480 $48,000 x 0.12 x 1/12

47. Factoring Factor Corporation sells $80,000 of accounts receivable to a factor, receives 90% of the value of the factored accounts, and is charged a 15% commission based on the gross amount of factored accounts receivable. ($80,000 x .90) - $12,000 Cash 60,000 Receivables from Factor 8,000 Factoring Expense 12,000 Accounts Receivable 80,000 $80,000 x 0.10 $80,000 x 0.15

48. Notes Receivable A note receivable is an unconditional written agreement to collect a certain sum of money on a specific date.

49. Notes Receivable Notes receivable generally have two attributes that are not found in accounts receivable.

50. Notes Receivable • They are negotiable instruments, which means that they are legally and readily transferable among parities and may be used to satisfy debts by the holders of these instruments. • They usually involve interest, requiring the separation of the receivables into its principal and interest components.