chapter 8--learning objectives 4 1.understand the composition and control of cash
TRANSCRIPT
What is cash ?
For accounting purposes, cash includes: Currency and coins (including petty cash) Demand deposits (checking accounts) Checks, drafts and money orders Readily usable foreign currency Savings accounts (technically investments)
What is NOT cash ?
Postage stamps Post-dated checks Certificates of deposit IOUs and notes receivable
Cash equivalents
Must be readily convertible to cash Must be close to maturity Cash equivalents frequently include:
Treasury bills Commercial paper
Certificates of deposit (within 90 days of maturity)
Internal control
Procedures used to safeguard assets Probably cannot prevent theft altogether But can make the potential crook’s job
more difficult Separate duties Create paper trails
Cash Control
Record and deposit receipts promptly Separation of duties No unauthorized or undocumented disbursements Job rotation Imprest funds Internal and external audits Bank reconciliations
Petty cash fund
Known as imprest (advanced) fund Establish fund with set amount Debit “Petty Cash” when fund set up Subsequent entries debit various expenses
and credit “Cash” Shortages debited to “Cash Over and
Short,” treated as misc. expense
Bank reconciliation
Prepared when statements received Start with “balance per bank” and “balance
per books” Bring both numbers to “corrected cash” or
“true cash” Adjust books for items on “books” side of
reconciliation
Typical items on“bank” side of reconciliation Balance per bank XXX Deposits in transit + XXX Outstanding checks - XXX Errors by bank + or - XXX Corrected cash balance XXX
Typical items on“books” side of reconciliation Balance per books XXX Interest earned on account + XXX Items collected by bank + XXX Bank service charges - XXX NSF checks - XXX Errors on books + or - XXX Corrected cash balance XXX
Typical bank reconciliationadjusting entryAcct. Receivable--Ima Deadbeat XXX
Service Charge Expense XXX
Interest Income XXX
Cash XXX
Note handling of NSF check from Ima Deadbeat, one of our customers.
Trade Receivables Result from sales of goods or services on account Balance Sheet Measurement:
Net Realizable Value
Discounts
Trade Discounts
Cash Discounts
Net Realizable Value
Amount expected to be realized (collected) Gross Accounts Receivable, net of
Expected returns & Allowances
Cash discounts expected to be taken
Expected uncollectible amounts
Cash Discounts Offered to encourage early payment Examples
2, 10, net 30 2, 10, eom
Accounting approaches Gross Method Net Method
Terms and discounts
2 / 10 , n / 30means that a
2 percent discount is available
if paid within 10 days
and that the balance is due in 30 days
Recording sales discountsThe gross methodAssume a $100 sale, terms 2/10, n/30
The sale is recorded:
Accounts Receivable 100
Sales 100
Recording sales discountsThe gross methodIf paid within 10 days:
Cash 98
Sales Discounts 2
Accounts Receivable 100
“Sales Discounts” is a contra-account to “Sales Revenue”
Recording sales discountsThe net method Assume a $100 sale, terms 2/10, n/30
The sale is recorded:
Accounts Receivable 98
Sales 98
Recording sales discountsThe gross methodIf paid after 10 days:
Cash 100
Accounts Receivable 98
Sales Discounts Forfeited 2
“Sales Discounts Forfeited” is a miscellaneous revenue account
BAD DEBTSIf you do business on credit,
the question is not “whether”
but “how much”
Some people cannot or will not pay their bills
You know that they are out there
You just don’t know who they are
Accounts receivable entries
Writing off an uncollectible account
Allowance for Bad Debts XXX Accounts Receivable XXX
Accounts receivable entries
Reinstating an account previously written off
Accounts Receivable XXX
Allowance for Bad Debts XXX
Cash XXX
Accounts Receivable XXX
Accounts receivable entries
The provision for bad debts(an adjusting entry)
Bad Debt Expense XXX
Allowance for Bad Debts XXX
Valuation of accounts receivableor estimating bad debt expense
Two methods will be examined:
1. The percentage of sales method
(also known as the income
statement method)
2. The percentage of receivables
method (also known as the balance
sheet method)
Percentage of sales method
An income statement approach The more you sell--the more you can expect
to lose Consistent with matching principle Select a percentage based on past
experience or industry averages Multiply the percentage by total credit sales
Percentage of sales method
Assume $1,000,000 sales and 3% estimated bad debts
Bad Debt Expense 30,000
Allow. for Bad Debts 30,000
Percentage of receivables
Based on “aging” the individual accounts receivable
The later they are in paying--the less likely they are to pay up
Percentages likely to default are assigned to each age category
The result is the balance needed in the “Allowance for Bad Debts” account
Assume that an aging schedule yields the following information:
Percent Amount
likely to likely to
Status Amount default default
Current $ 70,000 0 $ -0-
30-60 days overdue 40,000 5 2,000
60-90 days overdue 30,000 10 3,000
90-180 days overdue 30,000 25 7,500
Over 180 days 10,000 30 3,000
Totals $180,000 $15,500
The $15,500 is the total amount needed in the “Allowance” account Assume that the “Allowance for Bad Debts”
account has a $3,000 credit balance prior to adjustment
Allowance for Bad Debts
3,000
The $15,500 is the total amount needed in the “Allowance” account To go from a $3,000 credit to a $15,500
credit will require a $12,500 credit
Allowance for Bad Debts
3,000
15,500
12,500
$12,500 is the amount needed to adjust the “Allowance” account The necessary entry is:
Bad Debt Expense 12,500
Allow. for Bad Debts 12,500
Account write-offs do not reduce total assets ! Assume $10,000 of Accts. Receivable and a
$1,000 Allowance for Bad Debts Net collectible receivables are $9,000
Accounts receivable $10,000
Less: AFBD 1,000
Net receivables $ 9,000
Accts. Rec. AFBD
10,000 1,000
Now assume we write off a $100 account The entry to write off the account is
Allowance for Bad Debts 100 Account Receivable 100
Now assume we write off a $100 account The entry to write off the account is
Allowance for Bad Debts 100 Account Receivable 100 Posting the entry has this result:
Accts. Rec. AFBD
10,000 1,000100100
9,900 900
Note that net collectible receivables are:
Accounts receivable $ 9,900
Less: AFBD 900
Net receivables $ 9,000
BEFORE = $9,000
AFTER = $9,000Accts. Rec. AFBD
10,000 1,000100100
9,900 900
Chapter 8--Learning Objectives
3. Demonstrate how accounts receivable are used as the basis for financing
Receivables can be used as an immediate source of cash
Assigning accounts receivable means using them as collateral for a loan
Factoring accounts receivable means selling them
Factoring can be with recourse or without recourse
Recourse refers to ultimate responsibility for payment
Factoring with recourse
When accounts are factored with recourse, uncollectible accounts are absorbed by the transferor
Transaction is treated as a sale if all of the following conditions are met:
1. Risks, rewards & benefits are transferred
2. Future cash flows are estimable at time of transfer
3. Transferee cannot require transferor to repurchase receivables except under recourse provisions
Factoring with recourseas a borrowing
If all conditions for treatment as a sale are not meant, factoring with recourse is treated as a borrowing
Notes receivable
Formal, written promises to pay Negotiable Provide legal evidence of debt Usually interest bearing, but may be
noninterest bearing Should be valued at present value of future
cash inflows
Short term note example assumptions
$1,000 note received in exchange for an account receivable
Received on March 1 Matures in six months Interest rate 10 percent
Short term note journal entries
On March 1
Note Receivable 1,000
Accounts Receivable 1,000
On September 1
Cash 1,050
Note Receivable 1,000
Interest Revenue 50
Noninterest bearing notes
Amount of note is greater than cash or fair value
Difference is recorded in a contra-account to Notes Receivable called “Discount on Note Receivable”
Interest is recorded with debits to “Discount on Note Receivable” and credits to “Interest Revenue”
Noninterest bearing note entries
At time of issue
Note Receivable XXX
Discount on Note Rec. XXX
Cash (etc.) XXX
Interest accrual
Discount on Note Rec. XXX
Interest Revenue XXX
Notes receivable with interest rates lower than current market rate Effective interest rate is assigned to note Determine whether fair market value (FMV) of
assets surrendered is known or unknown If FMV is known, use as present value of note If FMV not known, use current rate for borrower
or rate on other similar loans
Note with low interest rate assumptions--FMV known Three-year, noninterest bearing note dated 12-31-
95 Face value $10,000 Exchanged for land which originally cost $5,000
with a fair market value of $7,120 Discount rate for note is 12 percent ($7,120 is the
present value of $10,000 to be received in 3 years at 12 percent)
Discount must be amortized over life of note
Note with low interest rate entries--FMV knownOn 12-31-95
Note Receivable 10,000
Discount on Note Rec. 2,880
Land 5,000
Gain on Sale of Land 2,120
On 12-31-96 (rounded to nearest dollar)
Discount on Note Rec. 854
Interest Revenue 854
Note with low interest rate entries--FMV knownOn 12-31-97
Discount on Note Rec. 957
Interest Revenue 957
On 12-31-98 (maturity)
Discount on Note Rec. 1,069
Interest Revenue 1,069
Cash 10,000
Note Receivable 10,000
Note with low interest rate assumptions--FMV unknown Three-year note dated 12-31-95 Face value $5,000 Stated interest rate 12 percent paid annually Exchanged for land which cost $2,000 with
unknown fair market value Incremental interest rate for borrower is 15 percent Present value of note at 15 percent is $4,658 (based
on PV of principal and interest)
Note with low interest rate entries--FMV unknownOn 12-31-95
Note Receivable 5,000
Land 2,000
Discount on Note Rec. 342
Gain on Sale of Land 2,658
“Discount” based on difference between PV of note and $5,000 face amount
“Gain” based on difference between PV of note and cost of Land
Formulas for discounting notes receivable
Interest (I) = P x R x T
P = Principal
R = Interest Rate
T = Time
Maturity Value (MV) = P + I
Discount = MV x DR x DP
DR = Discount Rate
DP = Discount Period
Proceeds = MV - Discount
Discounting note receivable assumptions
$1,000, six month note dated 3-1-95 Face interest rate 10 percent Discounted on 7-1-95 Discount rate 12 percent Time to maturity (discount period) is two
months Discounted without recourse
Discount calculations
Interest = $1,000 x .10 x 6/12 = $50 Maturity Value = $1,000 + $50 = $1,050 Discount = $1,050 x .12 x 2/12 = $21
Proceeds = $1,050 - $21 = $1,029
Note value at discount date Interest = $1,000 x .10 x 4/12 = $33
Value = $1,000 + $33 = $1,033
Entry to record discounting of note
July 1, 1995
Cash 1,029
Loss on Sale of Note Rec. 4
Note Receivable 1,000
Interest Revenue 33
Interest Revenue is interest earned to date
Loss on Sale is difference between Proceeds and value of note at date of sale
Same note discountedwith recourseThe bad news here is that if the original maker of the note defaults when the note is due...
The bank or finance company will hold the party discounting the note responsible for payment
Quick ratio
Current assets - Inventory - Prepaid items
Current liabilities
A more stringent indicator of liquidity
than the current ratio
Accounts receivable turnover
Credit Sales
Average net accounts receivable
Average accounts receivable is frequently approximated by adding beginning and ending net
receivables and dividing by two