Cash and Receivables
Cash
The amount a company reports as cash in the current assets section on its balance sheet
must be available to pay current obligations.
Cash and Cash Equivalents
Some companies use Cash and Cash Equivalents as a title on their balance sheet.
Cash equivalents are short-term, highly liquid investments that are readily convertible
into known amounts of cash and so near their maturity that there is little risk of changes
in value because of changes in interest rates.
Cash Management
Each company must ensure that adequate cash resources are available to meet its current
obligations.
Cash planning systems consist of those methods and procedures adopted to
ensure that a company has adequate cash available to meet maturing and
obligations that it invests any unused or excess cash.
Cash control systems are the methods and procedures adopted to ensure the
safeguarding of the company’s funds.
Internal Control is the process (policies and procedures) a company uses to
enhance the reliability of its financial reports, promote the effectiveness and
efficiency of its operations ( including safeguarding its assets), and ensure its
compliance with applicable laws and regulations.
Cash control systems have two main functions:
1) control over receipts
2) control over payments
Petty Cash System involves a cash fund placed under the control of an employee to
allow a company to pay for small amounts that might be impractical or impossible to pay
by check.
The design and operation of a petty cash system includes the following steps:
1) An employee is appointed petty cash custodian.
2) Petty cash vouchers are printed, prenumbered, and given of the custodian of the
fund.
3) When the amount of cash in the petty cash fund becomes low and/or at the end of
an accounting period, the vouchers are sorted into expense categories and the
remaining cash is counted.
A Bank Reconciliation is a schedule prepared by a company to analyze the difference
between the ending cash balance in the company’s accounting records and the ending
cash balance reported by its bank in a bank statement in order to determine the correct
ending balance.
Causes of Difference between cash balance and the company’s bank statement:
1) Compare the deposits listed on the company’s records with the deposits shown on
the bank statement.
2) Compare the checks listed on the company’s records with the checks shown on
the bank statement.
3) Identify any deposits or charges made directly by the bank that are not included
on the company’s records.
4) Determine the effect of any errors.
5) Complete the bank reconciliation
After the company completes the bank reconciliation it makes journal entries to bring
its accounts up to date.
Electronic Funds Transfers (EFT) – funds are transferred between parties
electronically without need of a check.
Compensating Balances - a portion of any amount loaned to a company that a bank
requires to remain on deposit in the bank for the loan period.
Receivables
Receivables – consist of various claims against customers and other parties arising
form the operations of the company. Those receivable 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 assets.
Trade Receivables – arise from the sale of the company’s products or services to
customers.
Nontrade Receivables – arise from transactions that are not directly related to the sale
of the company’s goods and services.
Valuation Issues
Most trade receivables are recorded initially at their maturity values.
Accounts Receivable
Trade accounts receivables result from credit sales.
Cash (sales) Discounts
Cash Discount (Sales Discount) – is frequently expressed as 2/10, n/30 or perhaps
2/10, n/EOM (end of month). In both cases the first component refers to the discount
rate and period and the second to the invoice due date.
If a selling company extends cash discounts to its customers, it may use one of two
methods:
1) Accounts Receivable and Sales Recorded at Gross Price.
2) Accounts Receivable and Sales Recorded at Net Price.
Sales Returns and Allowances
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When goods are sold that are found to be defective, the customer may retain
the goods and be allowed a reduction in the purchase price.
When goods are returned to the seller, the exchange is called a sale return.
Record the estimated amount of future returns and allowances in the period of
sale so as to correctly report net sales revenue and value ending accounts
receivable.
Valuation of Accounts Receivable for Uncollectible Accounts
Not all A/R will be collected. The following are two methods used to record
uncollectible accounts:
1) In the year of sale, based upon an estimate of the amount of uncollectible
accounts, or
2) When it determines that a specific customer account is uncollectible.
Estimated Bad Debts Method
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A company studies the historical data about the actual bad debts it has
incurred as a result of a particular credit policy.
These relationships provide the information the company needs to prepare the
adjusting entry to record the estimated bad debt expense for the year.
Offsetting Allowance for Doubtful Accounts against Account Receivable
informs financial statement users of the net realizable value (the amount of
cash expected to be collected) of the company’s receivables.
Percentage of Sales (or Net Credit Sales)
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A percentage of total sales may be used of the estimated when there is a stable
relationship between cash and credit sales.
Since this method focuses on an expense account, any existing balance in the
allowance account is ignored when determining the amount of adjusting entry.
Bad Debt Expense
Allowance for Doubtful Accounts
XXXX
XXXX
Percentage of Accounts Receivable
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In using this method, the goal is to determine the ending balance in Allowance
for Doubtful Accounts.
To determine the amount of its adjusting entry, a company must consider the
existing balance (prior to adjustment) in the allowance account.
Same journal entry.
Aging of Accounts Receivable
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A company that “ages” its accounts receivable first classifies the individual
accounts based upon the length of time they have been outstanding, and then
applies a historically developed bad debts percentage to each category.
Since the objective in an aging analysis is to determine the ending allowance
account balance, a company also considers the previous balance of the
allowance account in recording the amount of bad debt expense at the end of
the period.
Writing Off Uncollectible Accounts
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If a company records bad debt expense based on an estimate, it writes off an
individual account when it determines that the account is uncollectible.
The journal entry for the write off is:
Allowance for Doubtful Accounts
Accounts Receivables
XXXX
XXXX
Collection of an Account Previously Written Off
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Occasionally a company will receive payment from a customer whose account
it has already written off.
The first journal entry “reverses” the initial write-off and the second entry
records the cash collection in the usual manner:
Account Receivable
Allowance for Doubtful Accounts
XXXX
Cash
Accounts Receivable
XXXX
XXXX
XXXX
Direct Write-Off Method
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When the company uses the direct write-off method, it records bad debt
expense when it determines that a specific customer account is uncollectible
At that time, it writes off the account by debiting Bad Debt Expense and
crediting Accounts Receivable.
Generating Immediate Cash from Accounts Receivable
There are three basic forms of financing agreements to obtain cash from accounts
receivable:
1) Pledging
2) Assigning
3) Factoring (sale)
Pledging – when a company pledges accounts receivable to a financial institution, it
enters into a lending agreement with the institution to receive cash on specific
customer accounts.
Assigning – when a company assigns its accounts receivable to a financial institution,
it enters into a lending agreement with the institution to receive cash on specific
customer accounts.
Journal entry to record assignment:
Cash
Assignment Service Charge Expense Note Payable
Note Payable
XXXX
XXXX
Accounts Receivable Assigned
Accounts Receivable
XXXX
XXXX
XXXX
This journal entry reclassifies the receivables as assigned A/R:
Cash
Account Receivable Assigned
XXXX
Note Payable
Interest Expense
Cash
XXXX
XXXX
XXXX
XXXX
Factoring (Sale) of Accounts Receivable
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When a company factors its accounts receivable, it sells individual accounts to
a financial institution (called a factor).
Factoring Agreements focus on:
o Notification of the credit customers to remit the amounts owed directly
to the factor.
o Assumption by the factor of all collection activities, setting of credit
policies, and losses from uncollectible accounts.
The journal entry for factoring A/R:
Cash
Receivable from Factor
Factoring Expense
Accounts Receivable
XXXX
XXXX
XXXX
XXXX
Notes Receivable
Note Receivable – is an unconditional written agreement to collect a certain sum of
money on a specific date. Notes receivable generally have two attributes that are not
found in accounts receivable:
1) They are negotiable instruments, which means that they are legally and readily
transferable among parties and may be used to satisfy debts by the holders of
these instruments.
2) They usually involve interest, requiring the separation of the receivable into its
principal and interest components.
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Notes can be long-term or short-term.
They can also bear interest or be non-interest bearing
Notes Receivable Discounted
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When a company discounts a customer’s note receivable at the bank, it is
transferring the note to the bank with recourse.
When a customer’s note receivable is discounted the proceeds (cash received)
are determined to by multiplying the discount rate times the maturity value of
the note (face value of the not plus interest) for the discount period, and
deducting the resulting discount from the maturity value.
The following journal entry records the discounting of a note:
Discount Date
Interest Receivable
Interest Revenue
XXXX
Cash
Loss from Discounting of Note
Notes Receivable Discounted
Interest Receivable
XXXX
XXXX
XXXX
XXXX
XXXX
Payment by Customer Date
Notes Receivable Discounted
Notes Receivable
XXXX
XXXX
In the scenario where the note is dishonored the party that discounted the note
would record the following entry when notified by the bank:
Notes Receivable Dishonored
Notes Receivable Discounted
Notes Receivable
Cash
XXXX
XXXX
XXXX
XXXX