Chapter Seven
Cash and
Receivables
What Items Qualify as Cash
and Cash Equivalents?
Cash:
Cash Equivalents:
• Bank deposits
• Money market funds
• Currency and coins
• Checks from
customers
• Commercial paper
• Tax-exempt notes
and bonds
• U.S. government
agency securities
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7-2
Types of Restricted Cash
• Cash earmarked by management for
a specific purpose
• Cash restricted as a result of a creditgranting agreement, called a
compensating balance
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Foreign Currencies
• Remeasure foreign currency against the U.S. dollar
at each balance sheet date
• Recognize any exchange gain or loss
• Example: Monitor, Inc. received 100,000 Mexican
pesos on Oct. 15, 2005. (At this date, the exchange
rate was 1 peso = U.S. $.09.) The funds remained
on deposit in pesos at December 31, 2005. (At year
end, the exchange rate was 1 peso = U.S. $.11.)
• Record the gain as follows:
Cash [100,000 x ($.11 - $.09)]
Foreign Exchange Gain
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2,000
2,000
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Cash Controls
Cash must be protected from loss, waste,
and theft:
• Limit the number of persons who handle cash.
• Separate tasks involving cash between different
employees.
• Bond employees who handle cash or cash records.
• Use a cash register and safe.
• Use a checking account for all cash payments to
provide a separate record of all transactions.
• Deposit cash receipts in a timely fashion.
• Reconcile the bank account regularly.
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7-5
Critical Thinking
• Discussion: What tools do you use to
protect your personal cash and liquid
assets?
• Consider how you transact business when
making payments or receiving cash. Do
you utilize debit cards, checks, or
electronic methods? Do you choose these
methods for the paper trail they provide?
PINs and passwords are often used for
cash transaction protection.
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7-6
Why Reconcile the Bank
Account?
Differences between the cash balance
reported by the bank and the cash balance in
the general ledger result from:
• Deposits in transit
• Outstanding checks
• Direct collection of
receivables
• Interest
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• Direct charges and
payments
• Errors
• Insufficient funds
checks
7-7
Reconciling the Bank
Statement
$ Bal. per bank
statement
+ deposits in transit
- outstanding checks
+/- errors made by bank
$
+
+
-
$ Adj. bank balance
$ Adj. ledger balance
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Cash bal. per ledger
interest income
receivables collected
bank fees
returned checks
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Reconciling the Bank
Statement: Illustration
Relevant Data:
•
•
•
•
•
•
•
•
•
Dogwood Co. Cash account = $60,645 at 8/31/05
Bank statement balance = $71,980 at 8/31/05
Bank fees $60
Receivables collected by bank: $6,500 & $10,000
(Collection fee $250)
Returned check $1,900
Dogwood Co. account earned $185 interest
Outstanding checks = $4,560
Outstanding deposit = $5,000
Bank recorded a deposit as $300 instead of $3,000
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7-9
Bank Reconciliation: Dogwood
Corporation
Balance per bank statement
Add:
Deposits in transit
Bank error
Subtract:
Outstanding checks
Cash balance at August 31, 2005
Balance per ledger
Add:
Receivables collected
Interest income
Require
16,685
journal
Subtract:
entries
Bank fees
Returned check
(2,210)
Cash balance at August 31, 2005
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$71,980
$5,000
2,700
7,700
(4,560)
$75,120
$60,645
$16,500
185
(310)
(1,900)
$75,120
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Journal Entries for Bank
Reconciliation
To record receivables collected by the bank:
Cash
16,500
Accounts Receivable
16,500
To record interest earned on the account:
Cash
Interest Income
185
185
To record bank charges:
Miscellaneous Bank Exp. 310
Cash
310
To record returned check:
Accounts Receivable 1,900
Cash
1,900
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Classifying Receivables on the
Balance Sheet
• Accounts Receivable • Result from the sale
of goods or services
on credit
• Other Receivables
• Tax refund claims,
insurance claims,
advances to employees
• Notes Receivable
• Written contract
promising to pay certain
amounts on specific
dates
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Recording Accounts
Receivable
• Home Depot sells a hammer to a
customer in exchange for a promise to
pay $25 within 30 days. How will Home
Depot record this transaction?
Accounts Receivable
Sales
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25
25
7 - 13
Cash Discounts
• Offered to encourage customers to pay bills
quickly
• Payment terms that discount the cost of the
purchase if paid within a certain time period
Record cash discounts using either method:
Gross Method
Net Method
Record full amount
of sale and
account for
discount
when taken
Sales revenues
recorded at
net amount,
less
discount
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7 - 14
Recording a Cash Discount—
Gross Method
Example: Catalpa Co. sells products to Juniper
Corp. for $200 with payment terms of 2/10, net 30.
Record the sale:
Accounts Receivable
Sales
200
200
If payment received within 30 days, record the receipt
and discount taken:
Cash
196
Cash Discounts
4
Accounts Receivable
200
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Valuation of Accounts
Receivable
Most companies report receivables at their net
realizable value (what the company expects to
receive)
Net Realizable Value =
Gross Receivables – Estimated Uncollectibles
Balance Sheet
Accounts receivable, net
$535,350
Accounts Receivable
$589,050
Allowance for Uncollectibles (53,700)
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Accounts Receivable and
Uncollectibles
Allowance Method: Direct Write-Off Method:
• Adjustment is made • No entries are made until
a customer defaults on an
at the end of a period
account
to reduce accounts
receivable and to
• Used when impossible to
create a bad debt
estimate uncollectibles or
expense for the
when amounts are
estimated amount of
immaterial
uncollectibles
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7 - 17
Estimating Uncollectibles
• Percentage-of-Sales Method: Base
estimate on historically determined percentage
of each period’s credit sales
Historical Percentage x Current Month Credit Sales = Estimate
• Percentage-of-Receivables Method: Base
estimate on historically determined percentage
of gross receivables; adjust allowance account
1. Percentage x A/R balance = New balance of Allowance account
2. Prior bal. of Allowance – New balance of Allowance = Adjustment
amount
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Recording Interest-Bearing
Notes Receivable
Example: Fly Fishing Suppliers accepts a $4,000,
12-month, 10 percent note from Fishing Vacations
on Jan. 1, 2005. Interest is payable at maturity.
To record the note:
Jan. 1 Notes Receivable
Sales
4,000
4,000
To record the payment:
Dec. 31 Cash
Interest Income
Notes Receivable
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4,400
400
4,000
7 - 19
Recording Non-InterestBearing Notes Receivable
Example: On January 1, Linden Corp. sells
equipment for $1,000 in exchange for a 12-month
non-interest-bearing note receivable with a
discount rate of 10 percent.
To record the note and subsequent payment:
Jan. 1 Notes Receivable
1,000
Discount on Notes Receivable
Sales
Dec. 31 Cash
Discount on Notes Receivable
Interest Income
Notes Receivable
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100
900
1,000
100
100
1,000
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Critical Thinking
• Discussion: Why do you think companies
agree to accept notes receivable from
customers and clients?
• Notes receivable transactions afford the
opportunity for earning interest revenue.
They also provide additional financing
options to customers who may otherwise
not be able to make purchases.
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What Techniques Do Companies Use
To Accelerate the Receipt of Cash?
Factoring
receivables
Lockboxes
Securitization of
receivables
Private-label
credit cards
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Factoring Receivables
Transferring, or selling, of receivables
to a third party
With
Recourse
Seller guarantees
payment to the buyer
even if some receivables
are uncollectible
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Without
Recourse
Buyer assumes the risk of
bad debts
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Securitization of Receivables
• Transfer of receivables, either individually
or pooled, to a trust account in which
investors may purchase shares that entitle
them to receive cash as receivables are
paid
• Credit card companies
Often
used by:
• Mortgage lenders
• Leasing companies
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7 - 24
Lockboxes
• Payment lockboxes accelerate cash
collections
• Bank is given access to box where
customer payments are mailed
• Deposits are made daily and deposits
thus earn interest more quickly
• Increases internal control over cash
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7 - 25
Private Label Credit Cards
• Companies often offer private-label credit
cards to their customers for credit
purchases
• Lower transaction fees charged by
companies like VISA or MasterCard
• Provide the company more control over
the customer relationship and payment
terms
• Provide ability to track customer buying
habits
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7 - 26
Liquidity Analysis: The Current
Ratio
Current Assets  Current Liabilities
Indicates how well a firm is able
to meet its current obligations
Home Depot calculations (in millions):
2001 Current Ratio = $7,777  $4,385 = 1.77
2002 Current Ratio = $10,361  $6,501 = 1.59
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Comparisons:
Lowe’s = 1.43
Industry Average = 1.50
7 - 27
Quick Check
• Which is stronger: Lowe’s current ratio of
1.43 or Home Depot’s current ratio of
1.59? Why?
• Home Depot’s ratio of 1.77 is stronger. A
higher current ratio indicates that a
company has more than enough current
assets to cover its liabilities.
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7 - 28
Liquidity Analysis: The Quick
Ratio
Cash + Short-Term Investments +
Receivables
Current Liabilities
Measures a firm’s ability to pay its short-term
obligations from its most liquid assets
Home Depot calculations (in millions):
Comparisons:
2001 = ($167 + $10 + $835)  $4,385 = .23
Lowe’s = .4
2002 = ($2,477 + $69 + $920)  $6,501 = .53
Industry average= .6
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Liquidity Analysis: Working
Capital
Current Assets – Current Liabilities
Indicates what amount of current Assets
on hand can be used to continue
business operations
Home Depot calculations (in millions):
2001 = $7,777 - $4,385 = $3,392
2002 = $10,361 - $6,501 = $3,860
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Absolute dollar amounts
are not as informative
as ratios when making
comparisons
7 - 30
Liquidity Analysis: Defensive
Ratio
Cash + Investments+Receivables
Average Daily Operating Cash Outflow
• Measures the number of days a business
could operate without obtaining any
additional cash, investments, or
receivables
• Requires access to internal accounting
data
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Receivables Analysis: Accounts
Receivable Turnover Ratio
Net Sales
Average Net Accounts Receivable
Where
Average Net Accounts Receivable
= (Beg. A/R + End A/R)  2
Receivables are
Oakley, Inc. calculations:
Average Net A/R = ($68,116 + $74,775)  2 = $71,446 collected 6.85
times during the
A/R Turnover Ratio = $489,552  $71,446 = 6.85
fiscal year.
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Receivables Analysis: Days in
Receivables
365
Accounts Receivable Turnover Ratio
Indicates the average number of days it takes
a company to collect its accounts
receivables
Oakley, Inc. calculations:
365  6.85 = 53.3 days
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7 - 33
Check Your Understanding
Q List items that would be classified as cash
and cash equivalents on a balance sheet.
A Bank deposits, currency and coins,
checks from customers, money market
accounts and certificates of deposit,
commercial paper, and U.S. Treasury bills
that have a term of 90 days or less from
their date of purchase.
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Check Your Understanding
Q Name several internal controls over cash.
A
(1) Limit number of employees who handle
cash,
(2) Separate cash tasks between employees,
(3) Bond employees who handle cash,
(4) Use a cash register and a safe,
(5) Use a checking account,
(6) Deposit cash receipts in timely fashion,
(7) Reconcile the bank account regularly.
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Check Your Understanding
Q If a deposit is in transit, how should it be
handled on the bank reconciliation?
A Add any deposits in transit to the bank
statement balance.
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7 - 36
Check Your Understanding
Q Describe the difference between a note
receivable and an account receivable.
A
Notes receivable are backed by written
contracts promising to pay specified amounts to
the company on specified dates. Accounts
receivable are not supported by such formal
contracts but rise from the sale of goods on
credit at the wholesale or the retail level in the
normal course of business.
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7 - 37
Check Your Understanding
Q If your company uses the gross method
for accounting for cash discounts, when is
the discount recorded?
A The discount is recorded when the
payment is received within the discount
period, not when the sale is made (as is
done with the net method).
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7 - 38
Check Your Understanding
Q When estimating uncollectibles, what two
methods are often used?
A Percentage-of-sales method and
percentage-of-receivables method
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7 - 39
Check Your Understanding
Q When recording an interest-bearing note
receivable, how is interest calculated?
A Face amount x Annual interest rate x
Time
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7 - 40
Check Your Understanding
Q Explain what factoring receivables without
recourse means.
A
Factoring is the transferring, or selling, of
receivables to a third party. When a company
factors its receivables with recourse, the buyer
assumes all risks associated with collection of
receivables. The transaction is an outright sale
of the accounts receivable.
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7 - 41
Check Your Understanding
Q If you needed to assess the ability of a
firm to meet its current obligations, which
ratio would you employ? How is this ratio
computed?
A Current ratio = Current Assets  Current
Liabilities
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7 - 42