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Cash and
Receivables
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7
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
7-2
Cash
Coins and
currency
Petty cash
Cashier’s checks
Certified checks
Money orders
Amounts on
deposit with
financial
institutions
7-3
Cash Equivalents
Items very near cash but
not in negotiable form
Money market
funds
Treasury bills
Commercial
paper
7-4
Learning Objectives
Define what is meant by internal control and
describe some key elements of an internal
control system for cash receipts and
disbursements.
7-5
Internal Control of Cash
Encourages adherence
to company policies
and procedures
Enhances the reliability
and accuracy of
accounting data
Promotes operational
efficiency
Minimizes errors
and theft
7-6
Control of Cash Receipts
Separate responsibility for
 handling cash,
 recording cash transactions, and
 reconciling cash balances.
Agreed cash amounts deposited with cash
amounts received.
Close supervision of cash-handling and cashrecording activities.
7-7
Control of 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.
7-8
Learning Objectives
Explain the possible restrictions on cash and
their implications for classification in the
balance sheet.
Restricted Cash and
Compensating Balances
Restricted Cash
Management’s intent to use a certain amount
of cash for a specific purpose – future plant
expansion, future payment of debt.
Compensating Balance
Minimum balance that must be maintained
in a company’s account as support for
funds borrowed from the bank.
7-9
7-10
Learning Objectives
Distinguish between the gross and net
methods of accounting for cash discounts
7-11
Accounts Receivable
Amounts due from
customers for credit sales.
Credit sales require:
 Maintaining a separate
account receivable for each
customer.
 Accounting for bad debts
that result from credit
sales.
7-12
Cash Discounts
Increase sales.
Cash discounts . . .
Encourage early
payment.
Increase likelihood of
collections.
7-13
Cash Discounts
2/10,n/30
Discount
Percent
Number of
Days
Discount is
Available
Otherwise,
Net (or All)
is Due
Credit
Period
7-14
Cash Discounts
Sales are
recorded at the
invoice
amounts.
Gross
Method
Sales discounts
are recorded if
payment is
received within
the discount
period.
7-15
Cash Discounts
Net
Method
Sales are recorded at the Sales discounts forfeited
invoice amount less the
are recorded if payment
discount.
is received after the
discount period.
7-16
Cash Discounts
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.
7-17
Cash Discounts
GENERAL JOURNAL
Date
Description
Post.
Ref.
Page 56
Debit
Credit
GROSS METHOD
May 10 Accounts Receivable
5,000
Sales Revenue
5,000
NET METHOD
May 10 Accounts Receivable
Sales Revenue
4,950
4,950
7-18
Cash Discounts
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.
7-19
Cash Discounts
GENERAL JOURNAL
Date
Description
Post.
Ref.
Page 56
Debit
Credit
GROSS METHOD
May 19 Cash
4,950
Sales Discount
50
Accounts Receivable
5,000
NET METHOD
May 19 Cash
Accounts Receivable
4,950
4,950
7-20
Cash Discounts
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.
7-21
Cash Discounts
GENERAL JOURNAL
Date
Description
Post.
Ref.
Page 56
Debit
Credit
GROSS METHOD
May 31 Cash
5,000
Accounts Receivable
5,000
NET METHOD
May 31 Cash
Interest Revenue
Accounts Receivable
5,000
50
4,950
7-22
Learning Objectives
Describe the accounting treatment for
merchandise returns.
7-23
Sales Returns and Allowances
Sales Returns
Sales Allowances
Merchandise
returned by a
customer to a
supplier.
A reduction in
the cost of
defective
merchandise.
7-24
Sales Returns and Allowances
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.
7-25
Sales Returns and Allowances
GENERAL JOURNAL
Date
Jun
Description
1 Sales Returns and Allowances
Post.
Ref.
Page 56
Debit
Credit
750
Accounts Receivable
Sales Returns and Allowances is a contra
account that reduces Sales Revenue in the
current accounting period.
750
7-26
Learning Objectives
Describe the accounting treatment of
anticipated uncollectible accounts receivable.
7-27
Uncollectible Accounts Receivable
Bad debts result from credit customers who
are unable to pay the amount they owe,
regardless of continuing collection efforts.
PAST DUE
7-28
Uncollectible Accounts Receivable
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.
7-29
Uncollectible Accounts Receivable
Most businesses record an estimate of the
bad debt expense by an adjusting entry
at the end of the accounting period.
GENERAL JOURNAL
Date
Description
Dec. 31 Bad Debt Expense
Allowance for Uncollectible
Accounts
Page 78
Post.
Ref.
Debit
Credit
####
####
7-30
Uncollectible Accounts Receivable
Normally classified as
a selling expense and
closed at year-end.
Contra asset account to
Accounts Receivable.
GENERAL JOURNAL
Date
Description
Dec. 31 Bad Debt Expense
Allowance for Uncollectible
Accounts
Page 78
Post.
Ref.
Debit
Credit
####
####
7-31
Allowance for Uncollectible Accounts
Accounts Receivable
Less: Allowance for Uncollectible Accounts
Net Realizable Value
Net realizable value is the amount of the
accounts receivable that the business
expects to collect.
7-32
Learning Objectives
Describe the two approaches
to estimating bad debts.
7-33
Estimating Bad Debts

Income Statement Approach

Balance Sheet Approach
Composite Rate
Aging of Receivables
PAST DUE
7-34
Income 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.
7-35
Income Statement Approach
Bad debts expense is
computed as follows:
Current Period Credit Sales
× Bad Debt %
= Estimated Bad Debts Expense
7-36
Income Statement Approach
In 2006, MusicLand has
credit sales of $400,000 and
estimates that 0.6% of credit
sales are uncollectible.
What is Bad Debts Expense
for 2006?
7-37
Income Statement Approach
$ 400,000 MusicLand computes
×
0.60% estimated Bad Debts
= $
2,400 Expense of $2,400.
GENERAL JOURNAL
Date
Dec.
Description
31 Bad Debts Expense
Allowance for
Uncollectible Accounts
Post
Ref.
Page 95
Debit
2,400
Credit
2,400
7-38
Balance Sheet Approach
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.

7-39
Balance Sheet Approach
Composite Rate
 Compute the desired balance in the Allowance for
Uncollectible Accounts.
Year-end Accounts Receivable
× Bad Debt %
 Bad Debts Expense is computed as:
Balance Sheet Approach
Composite Rate
On Dec. 31, 2006, 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 Debts
Expense for 2006?
7-40
7-41
Balance Sheet Approach
Composite Rate
Desired balance in Allowance
for Uncollectible Accounts
$
×
= $
50,000
5.00%
2,500
GENERAL JOURNAL
Date
Dec.
Description
31 Bad Debts Expense
Allowance for
Uncollectible Accounts
Post
Ref.
Page 95
Debit
2,300
Credit
2,300
7-42
Now, let’s
look at the
accounts
receivable
aging
approach!
Balance Sheet Approach
Aging of Receivables
 Year-end Accounts Receivable is
broken down into age classifications.
 Each age grouping has a different
likelihood of being uncollectible.
 Compute desired uncollectible amount.
 Compare desired uncollectible amount
with the existing balance in the
allowance account.
7-43
7-44
Balance Sheet Approach
Aging of Receivables
At December 31, 2006, the receivables for
EastCo, Inc. were categorized as follows:
EastCo, Inc.
Schedule of Accounts Receivable by Age
Days Past Due
Current
1 - 30
31 - 60
Over 60
December 31, 2006
Accounts
Estimated
Estimated
Receivable Bad Debts Uncollectible
Balance
Percent
Amount
$

$
45,000
15,000
5,000
2,000
67,000

1% $
3%
5%
10%
$
450
450
250
200
1,350

7-45
Balance Sheet Approach
Aging of Receivables
EastCo’s unadjusted balance
in the allowance account is
$500.

Allowance for
Uncollectible
Accounts
500
Per the previous computation,
the desired balance is $1,350.
1,350
GENERAL JOURNAL
Date
Description
Post
Ref.
Page 95
Debit
Prepare the entry to record bad debts
expense at Dec. 31, 2006.
Credit
7-46
Balance Sheet Approach
Aging of Receivables
EastCo’s unadjusted balance
in the allowance account is
$500.

Allowance for
Uncollectible
Accounts
500
850
1,350
Per the previous computation,
the desired balance is $1,350.
GENERAL JOURNAL
Date
Dec.
Description
31 Bad Debts Expense
Allowance for
Uncollectible Accounts
Post
Ref.
Page 95
Debit
850
Credit
850
7-47
Methods to Estimate Bad Debts
Income
Statement
Approach
Balance Sheet
Approach
Emphasis on
Matching
Emphasis on
Realizable Value
Sales
Bad
Debts
Exp.
Income
Statement
Focus
Accts.
Rec.
All. for
Uncoll.
Accts.
Balance Sheet
Focus
7-48
Uncollectible Accounts
As accounts become uncollectible, the
following entry is made:
GENERAL JOURNAL
Date
Description
Allowance for Uncollectible Accounts
Accounts Receivable
Page 69
Post.
Ref.
Debit
Credit
####
####
So what happens if someone pays after a write-off
of the accounts receivable?
7-49
Collection of Previously
Written-Off Accounts
When a customer makes a payment after an
account has been written off, two journal
entries are required.
GENERAL JOURNAL
Date
Description

Accounts Receivable

Cash
Page 69
Post.
Ref.
Debit
####
Allowance for Uncollectible Accounts
Accounts Receivable
Credit
####
####
####
7-50
Direct Write-off Method
If uncollectible accounts are immaterial, bad
debts are simply recorded as they occur
(without the use of an allowance account).
GENERAL JOURNAL
Date
Description
Bad Debts Expense
Accounts Receivable
Post
Ref.
Page 18
Debit
#####
Credit
#####
7-51
Learning Objectives
Describe the accounting treatment of shortterm notes receivable.
7-52
Notes Receivable
PROMISSORY NOTE
$25,000
Face Value
Term
One year after date
I
Date of
Note
Nov. 1, 2006
Date
promise to pay to the order of
Payee
Principal
Westward, Inc.
Twenty-five thousand and no/100------------------------ Dollars
Maker
plus interest at the annual rate of 12% .
Interest Rate
Janet Lee , Winn,Co.
7-53
Interest Computation
Face
amount
of the
note
×
Annual
interest
rate
Even for
maturities less
than 1 year,
the rate is
annualized.
×
Fraction of
the annual =
period
Interest
7-54
Interest-Bearing Notes
On November 1, 2006, Westward, Inc. loans
$25,000 to Winn, Co. The note bears
interest at 12% and is due on November 1,
2007.
Prepare the journal entry on November 1,
2006, December 31, 2006, (year-end) and
November 1, 2007 for Westward.
7-55
Interest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2006
Nov 1 Notes Receivable
25,000
Cash
Dec 31 Interest Receivable
Interest Revenue
$25,000 × 12% × (2 ÷ 12) = $500
25,000
500
500
7-56
Interest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2007
Nov 1 Cash
28,000
Note Receivable
Interest Receivable
Interest Revenue
$25,000 × 12% = $3,000 - $500 = $2,500
25,000
500
2,500
7-57
Noninterest-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.
7-58
Noninterest-Bearing Notes
On January 1, 2006, Westward, 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, 2006.
Prepare the journal entries on January 1,
2006, and December 31, 2006 for Westward.
7-59
Noninterest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2006
Jan 1 Notes Receivable
25,000
Discount on Notes Receivable
3,000
Sales Revenue
22,000
$25,000 × 12% = $3,000
Dec 31 Cash
Discount on Notes Receivable
25,000
3,000
Interest Revenue
3,000
Notes Receivable
25,000
7-60
Learning Objectives
Differentiate between the use of receivables
in financing arrangements accounted for
as a secured borrowing and those
accounted for as a sale.
7-61
Financing With Receivables
Secured borrowing
or
Sale of receivables
Method depends on the
surrender of control over
the receivables transferred.
7-62
Secured Borrowing – 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.
7-63
Secured Borrowing – Pledging

Receivables in general are pledged as
collateral for loans.

Pledged receivables are disclosed in notes
to the financial statements.
7-64
Sale of Accounts Receivable
2. Accounts Receivable
SUPPLIER
(Transferor)
RETAILER
1. Merchandise
FACTOR
(Transferee)
A factor is a financial institution that buys receivables
for cash, handles the billing and collection of the
receivables and charges a fee for the service.
7-65
Sale of Accounts Receivable
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.
7-66
Sale of Accounts Receivable
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.
7-67
Sale of Accounts Receivable
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.
7-68
Discounting a Note
On December 31, Apex accepted a ninemonth 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.
7-69
Discounting a Note
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.
GENERAL JOURNAL
Date
Description
Page 69
Post.
Ref.
Mar. 31 Interest Receivable
Interest Revenue
$200,000 × 10% × 3/12
Debit
Credit
5,000
5,000
7-70
Discounting a Note
GENERAL JOURNAL
Date
Page 69
Post.
Ref.
Description
Mar. 31 Cash
Debit
Credit
202,100
Loss on Sale of Note Receivable
2,900
Notes Receivable
200,000
Interest Receivable
5,000
$205,000 - $202,100
7-71
Discounting a Note
If the three conditions for sale treatment are
not met, the transaction would be recorded
as a secured borrowing.
7-72
Learning Objectives
Describe the variables that influence a
company’s investment in receivables and
calculate the key ratios used by analysts
to monitor that investment.
7-73
Receivables Management
Factors influencing
a company’s investment
in receivables
Credit
and collection
policies
Product or
service sold
Level of sales
7-74
Receivables Management
Receivables
Turnover =
Ratio
Net Sales
Average Accounts Receivable
This ratio measures how many
times a company converts its
receivables into cash each year.
Average
Collection
Period
365
=
Receivables Turnover Ratio
This ratio is an approximation of the
number of days the average accounts
receivable balance is outstanding.
7-75
Receivables Management
Dell vs. Apple comparison
Dell
Accounts receivable (net)
Net sales
Apple
2004
2003
2004
2003
$
3,635 $
2,586 $
774 $
766
41,444
8,279
(All dollar amounts in millions)
Compute the receivables turnover ratio
and the average collection period
for both companies.
7-76
Receivables Management
Dell
Accounts receivable (net)
Net sales
Receivables
Turnover =
Ratio
Apple
2004
2003
2004
2003
$
3,635 $
2,586 $
774 $
766
41,444
8,279
Net Sales
Average Accounts Receivable
Dell
$41,444
= 13.32
($3,635 + $2,586)/2
Apple
$8,279
= 10.75
($774 + $766)/2
7-77
Receivables Management
Dell
Accounts receivable (net)
Net sales
Average
Collection
Period
Dell
365
= 27.4 days
13.32
=
Apple
2004
2003
2004
2003
$
3,635 $
2,586 $
774 $
766
41,444
8,279
365
Receivables Turnover Ratio
Apple
365
= 34 days
10.75
7-78
Cash Controls
Appendix 7
7-79
Bank Reconciliation
Explains the difference between cash
reported on bank statement and cash
balance on company’s books.
Provides information for
reconciling journal entries.
7-80
Bank Reconciliation
Bank Balance
Book Balance
+ Deposits in Transit
+ Bank Collections
- Outstanding Checks
- Service Charges
- NSF Checks
± Bank Errors
± Book Errors
= Corrected Balance
= Corrected Balance
7-81
Bank Reconciliation
All
reconciling
+items
Deposits in
Transit
on
the
book side
- Outstanding
requireChecks
an
adjusting
± entry
Bank Errors
to the
cash account.
Balance per Bank
= Adjusted Balance
Book Balance
+ Bank Collections
- Service Charges
- NSF Checks
± Book Errors
= Corrected Balance
7-82
Bank Reconciliation
Let’s prepare a May 31 bank reconciliation
for the Hawthorne Company.
The May 31 bank statement indicated a
balance of $34,680.
 The cash general ledger account on that date
shows a balance of $35,276.

Additional information necessary for the
reconciliation is shown on the next screen.
7-83
Bank Reconciliation
 Cash receipts not yet deposited on May 31 totaled $2,965.
 A $1,020 check mailed to the bank for deposit had not
reached the bank at the statement date.
 Outstanding checks totaled $5,536.
 A check written to pay for raw materials purchased on
account cleared the bank for $1,790 but was erroneously
recorded at $790.
 The bank statement showed $80 in service charges in May.
 The bank returned NSF checks in the amount of $2,187
received as payment on accounts receivable.
 The bank collected a note receivable for $1,120 that
included $120 of interest.
7-84
Bank Reconciliation
Bank balance, May 31
Add: Deposit in transit*
Deduct: Outstanding checks
Corrected cash balance
*$2,965 + $1,020 = $3,985
$
$
34,680
3,985
(5,536)
33,129
7-85
Bank Reconciliation
Bank balance, May 31
Add: Deposit in transit*
Deduct: Outstanding checks
Corrected cash balance
$
Book balance, May 31
Add: Note collected by bank
Deduct:
Services charges
NSF checks
Error
Corrected cash balance
$
*$2,965 + $1,020 = $3,985
$
$
34,680
3,985
(5,536)
33,129
35,276
1,120
(80)
(2,187)
(1,000)
33,129
7-86
Bank Reconciliation
Prepare the entries to adjust the cash account to the
corrected balance.
GENERAL JOURNAL
Date
Description
May 31 Cash
Interest Revenue
Notes Receivable
May 31 Miscellaneous Expense
Accounts Receivable
Accounts Payable
Cash
Post.
Ref.
Page 66
Debit
1,120
Credit
120
1,000
80
2,187
1,000
3,267
7-87
Petty Cash
Used for
minor
expenditures.
Petty cash
fund
Has one
custodian.
Replenished
periodically.
7-88
Petty Cash
Hawthorne Co. established a petty cash
fund on May 1 by writing a check for $200
to the petty cash custodian.
Prepare the May1st journal entry to record the
establishment of the fund.
GENERAL JOURNAL
Date
May
Description
1 Petty Cash
Cash
Page 64
Post.
Ref.
Debit
Credit
200
200
7-89
Petty Cash
During May, the petty cash custodian paid bills using
cash from the fund totaling $160 as follows:
Postage
$40
Office supplies
35
Delivery charges
55
Entertainment
30
Prepare the May 31 journal entry to record replenishing the fund.
GENERAL JOURNAL
Date
Description
May 31 Postage expense
Page 65
Post.
Ref.
Debit
Credit
40
Office supplies expense
35
Delivery expense
55
Entertainment expense
30
Cash
160
7-90
End of Chapter 7
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