Chapter 7
Cash and Receivables
7–1
Pivotal Issues When Managing
Cash and Receivables
1. Cash needs
2. Credit policies
3. Level of accounts
receivable
4. Financing receivables
5. Ethical estimates of credit
losses
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7–2
Cash Considerations
 Most liquid of all assets
 Central to operating
cycle
Consists of:
 Currency and coins on
hand
 Checks and money
orders from customers
 Deposits in checking
and savings accounts
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Cash may include a
compensating balance—a
minimum amount required
by a bank for a creditgranting agreement.
7–3
Seasonal Cash Needs
Cycles of business activities require different
levels of cash needs
Plan for these cash activities:
Cash inflows
Borrowing
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Cash outflows
Investing
7–4
Cash Requirements
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7–5
Cash Equivalents
example SE3, hwk E5
Investments like time
deposits or certificates of
deposit (CDs) that have a
term of 90 days or less
Nike’s Annual Report
Cash and equivalents represent cash
and short-term, highly liquid
investments with maturities of three
months or less at date of purchase.
The carrying amounts reflected in the
consolidated balance sheet for cash
and equivalents approximate fair
value.
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7–6
Cash Control: Imprest Systems
Petty Cash Fund
 Established at a fixed amount
 Reimbursed periodically,
based on documented
expenditures
 Total cash and receipts must
equal the original amount
 One person should be made
responsible for the accuracy
and security of the fund
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7–7
Cash Control:
Electronic Funds Transfer (EFT)
Method of conducting business transactions
in which funds are transferred electronically
from one bank to another bank
Wal-Mart makes
75% of its
payments to
suppliers using
EFT
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Electronic Banking
ATM transactions
Debit and credit card purchases
Online bill-pay
7–8
Cash Control: Bank Reconciliations
The bank statement is reconciled to the company’s
Cash account to account for any difference between
the two balances
What items might appear
in the company’s records
that do not appear on the
bank statement?
What items might appear
on the bank statement
that do not appear in the
company’s records?
Outstanding checks
Deposits in transit
Errors
Service charges
NSF (nonsufficient funds)
checks
Miscellaneous debits or credits
Interest income
Errors
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7–9
Illustration: Bank Reconciliation
1. A $138.00
deposit was
mailed to the
bank on
August 31 and
has not been
recorded by
the bank.
Terry Services Company
Bank Reconciliation
August 31, 2010
Balance per bank, August 31
Add deposit of August 31 in transit
$1,735.35
138.00
Balance per books, August 31
$1,207.95
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7–10
Bank Reconciliation (cont’d)
Terry Services Company
Bank Reconciliation
August 31, 2010
2. Five checks
issued in
August or
earlier have
not been paid
by the bank.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
Balance per books, August 31
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$1,735.53
138.00
$75.00
20.34
250.00
185.00
65.25
595.59
$1,207.95
7–11
Bank Reconciliation (cont’d)
Terry Services Company
Bank Reconciliation
August 31, 2010
3. A deposit on
August 6 was
incorrectly
recorded in the
company’s
books as
$165.00. The
bank correctly
recorded the
deposit as
$150.00.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
$1,735.53
138.00
$75.00
20.34
250.00
185.00
65.25
Balance per books, August 31
Less:
Overstatement of deposit of October 6
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595.59
$1,207.95
$ 15.00
7–12
Bank Reconciliation (cont’d)
Terry Service Company
Bank Reconciliation
August 31, 2010
4. A credit
memorandum was
enclosed with the
bank statement
showing a note
had been collected
in the amount of
$140.00 along
with interest of
$10.00. A debit
memorandum was
enclosed for the
$2.50 collection
fee.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
$1,735.53
138.00
$75.00
20.34
250.00
185.00
65.25
Balance per books, August 31
Add:
Note receivable collected by bank
Interest income on note
$140.00
10.00
Less:
Overstatement of deposit of August 6
Collection fee
$ 15.00
2.50
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595.59
$1,207.95
7–13
Bank Reconciliation (cont’d)
Terry Services Company
Bank Reconciliation
August 31, 2010
5. An NSF check
was returned
with the
statement for
$64.07. The
NSF check
from Austin
Chase was not
reflected in the
company’s
books.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
$1,735.53
138.00
$75.00
20.34
250.00
185.00
65.25
Balance per books, August 31
Add:
Note receivable collected by bank
Interest income on note
$140.00
10.00
Less:
Overstatement of deposit of August 6
Collection fee
NSF check of Austin Chase
$ 15.00
2.50
64.07
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595.59
$1,207.95
7–14
Bank Reconciliation (cont’d)
Terry Service Company
Bank Reconciliation
August 31, 2010
6. A debit
memorandum
for the monthly
$6.25 service
charge was
enclosed with
the bank
statement.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
$1,735.53
138.00
$75.00
20.34
250.00
185.00
65.25
Balance per books, August 31
Add:
Note receivable collected by bank
Interest income on note
$140.00
10.00
Less:
Overstatement of deposit of August 6
Collection fee
NSF check of Austin Chase
$ 15.00
2.50
64.07
Service charge
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595.59
$1,207.95
6.25
7–15
Bank Reconciliation (cont’d)
Terry Services Company
Bank Reconciliation
August 31, 2010
7. Interest earned
by the company
on its average
balance was
$7.81.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
$1,735.53
138.00
$75.00
20.34
250.00
185.00
65.25
Balance per books
Add:
Note receivable collected by bank
Interest income on note
Interest income
$140.00
10.00
7.81
Less:
Overstatement of deposit of August 6
Collection fee
NSF check of Austin Chase
Service charge
$ 15.00
2.50
64.07
6.25
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595.59
$1,207.95
7–16
Bank Reconciliation (cont’d)
Example SE 4, hwk E6
Terry Services Company
Bank Reconciliation
August 31, 2010
After all items
have been listed
on the
reconciliation,
total the columns.
The adjusted
bank balance
should equal the
adjusted book
balance.
Balance per bank, August 31
Add deposit of August 31 in transit
Less outstanding checks:
No. 551
No. 576
No. 578
No. 579
No. 580
Adjusted bank balance, August 31,2010
$1,735.53
138.00
$1,873.53
$75.00
20.34
250.00
185.00
65.25
Balance per books
Add:
Note receivable collected by bank
Interest income on note
Interest income
$140.00
10.00
7.81
Less:
Overstatement of deposit of August 6
Collection fee
NSF check of Austin Chase
Service charge
$ 15.00
2.50
64.07
6.25
Adjusted bank balance, August 31,2010
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595.59
$1,277.94
$1,207.95
157.81
$1,365.75
$87.82
$1,277.94
7–17
Accounts Receivable (A/R)
 Short-term financial assets
 Result from extending credit to an individual or a
business, also called trade credit
Retailers like Sears,
Lowe’s, and JCPenney
offer credit terms to
customers
Wholesalers and
manufacturers also
provide credit terms to
their customers for
purchases
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7–18
Credit Policies
To increase the likelihood of selling to customers who will
pay on time, companies develop control procedures and
maintain a credit department
The credit department:
 Examines the financial resources and debts of the
credit applicant
 Asks for personal references
 Gets credit rating from credit bureaus
 Determines the extent to which the company can
grant credit, if any
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7–19
Evaluating the Level of
Accounts Receivable
How many times, on
average, does a company
turn its receivables into
cash during an accounting
period?
Receivable Turnover
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How long, on
average, does it take a
company to collect its
accounts receivables?
Days’ Sales
Uncollected
7–20
Receivable Turnover
Reflects the relative size of a company’s accounts
receivable and the success of its credit and
collection policies
Net Sales
Receivable Turnover =
Average Net Accounts Receivable
(Amounts in Millions)
Nike’s Receivable
Turnover for 2007
=
=
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$16,325.9
($2,494.7 + $2,382.9) ÷ 2
6.7 times
7–21
Days’ Sales Uncollected
example SE2, hwk E4
To interpret a company’s ratios, take into
consideration the industry in which it operates
Days’
Sales Uncollected =
Nike’s Days’
Sales Uncollected
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365 days
Receivable Turnover
=
365 days
6.7
=
54.5 days
7–22
Receivable Turnover for
Selected Industries
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7–23
Estimating Uncollectibles
 There will always be
customers who do not
pay their accounts,
called uncollectible
accounts, or bad debts
 Match these expenses
of selling on credit to
the revenues they help
generate
Estimate the uncollectible
expense in the fiscal year
in which the sales are
made
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7–24
Estimating Uncollectibles and Ethics
Because estimations are involved, earnings may
be easily manipulated…
If the amount of losses
from uncollectible accounts earnings are overstated.
are understated,
If the amount of losses
from uncollectible accounts
are overstated,
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earnings are
understated.
7–25
Uncollectible Accounts
Accounts owed by
customers who will
not
or cannot pay
• Losses may be
recognized using
– Direct charge-off
method
– Allowance method
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7–26
Direct Charge-Off Method
Recognize a loss
at the time it is
determined that
an account is
uncollectible
Date
Tax law requires
use of this
method when
computing
taxable income
Uncollectible Accounts Expense
Accounts Receivable
XXX
XXX
Most companies do not use this method for financial reporting
purposes because it does not conform to GAAP.
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7–27
The Allowance Method
Most companies use this method for financial reporting
purposes because it conforms to GAAP.
Losses from bad debts are matched against the
sales they help generate
At the time of sale, management cannot
identify which customers will not pay
To observe the matching rule, losses from
uncollectible accounts must be estimated
The estimate becomes an expense in the
fiscal year in which the sales are made
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7–28
The Allowance Method Illustrated
Dec. 31, 2010: Management estimated that approximately $12,000 of
the $200,000 of accounts receivable was uncollectible.
Dec. 31
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
Uncollectible Accounts
Expense appears on the
income statement as an
operating expense
12,000
12,000
Allowance for Uncollectible Accounts appears
on the balance sheet as a contra-asset account
that is deducted from Accounts Receivable
Accounts receivable may be shown “net,” with
the amount of the Allowance for Uncollectible
Accounts shown in a note to the financial
statements
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7–29
Alternate Account Names
Allowance for
Uncollectible Accounts
Uncollectible
Accounts Expense
 Allowance for Doubtful
Accounts
 Allowance for Bad
Debts
 Reserve for Bad Debts
(not used in modern
practice)
 Bad Debts Expense
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7–30
Estimating Uncollectible Accounts
• Estimated loss should be:
Realistic
Based on objective information
Based on past experience
Based on current economic conditions
Two commonly
used methods for
estimating loss
1. Percentage of net sales method
2. Accounts receivable aging method
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7–31
Percentage of Net Sales Method
How much of this year’s
net sales will not be
collected?
The answer determines the
amount of uncollectible
accounts expense for the year
The amount is actually based on the company’s historic losses
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7–32
Percentage of Net Sales
Method Illustrated
Dec. 31, 2012: Account balances: Sales, $322,500; Sales Returns and
Allowances, $20,000; Sales Discounts, $2,500; Allowance for
Uncollectible Accounts, $1,800. Management estimates that
uncollectible accounts will average about 2 percent of net sales.
Uncollecti ble accounts expense  .02 x ($322,500 – $20,000 – $2,500)  $6,000
Dec. 31
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
6,000
6,000
example SE5, hwk E7
After the above entry is
posted, Allowance for
Uncollectible Accounts will
have a credit balance of
$7,800
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Allowance for Uncollectible Accounts
Dec. 31 adj.
1,800
6,000
Dec. 31 bal.
7,800
Dec. 31
7–33
Accounts Receivable Aging Method
How much of the ending
balance of accounts
receivable will not be
collected?
The ending balance of
Allowance for
Uncollectible Accounts is
determined directly through
an analysis of accounts
receivable
The difference between the amount determined to be
uncollectible and the actual balance of Allowance for
Uncollectible Accounts is the expense for the period.
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7–34
Analysis of Accounts Receivable
by Age
 The total past due for each category is multiplied by the
estimated percentage uncollectible
 The sum of the totals for each category is the estimated
balance of Allowance for Uncollectible Accounts
Notice that the estimated percentage uncollectible increases as
accounts become further past due.
7–35
Accounts Receivable Aging Method
(Case 1)
Dec. 31, 2010: Management has estimated that $4,918 of Accounts
Receivable are uncollectible. Allowance for Uncollectible Accounts
has a credit balance of $1,600.
Allowance for Uncollectible Accounts
Dec. 31 adj.
1,600
3,318
Dec. 31 bal.
4,918
Dec. 31
The target balance for
the account is $4,918
Dec. 31
A credit adjustment of $3,318 will bring the
account to its target balance
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
To bring the allowance for uncollectible
accounts to the level of estimated losses
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3,318
3,318
7–36
Accounts Receivable Aging Method
(Case 2)
Dec. 31, 20x6: Management has estimated that $4,918 of Accounts
Receivable are uncollectible. Allowance for Uncollectible Accounts
has a debit balance of $1,600.
Allowance for Uncollectible Accounts
1,600
Dec. 31
The target balance for
the account is $4,918
Dec. 31
Dec. 31 adj.
6,518
Dec. 31 bal.
4,918
A credit adjustment of $6,518 will bring the
account to its target balance
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
To bring the allowance for uncollectible
accounts to the level of estimated losses
6,518
6,518
example SE6, hwk E8
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7–37
Comparison of Two Methods
hwk E9
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7–38
Estimates Differ from Write-Offs?
Accounts receivable written off during a period will
rarely equal the estimated uncollectible amount
Allowance for Uncollectible Accounts
Shows a debit balance
when the total of
accounts written off is
greater than the
estimated uncollectible
amount
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Shows a credit balance
when the total of
accounts written off is
less than the estimated
uncollectible amount
7–39
Writing Off an Uncollectible Account
 When it becomes clear
an account will not be
collected, the amount
should be written off to
Allowance for
Uncollectible Accounts
 The uncollectible
amount was already
accounted for as an
expense when the
allowance was
established
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7–40
Writing Off an
Uncollectible Account Illustrated
Jan. 15, 2011: TV GO, who owes Gomez Company $500,
is declared bankrupt by federal court.
Jan. 15
Allowance for Uncollectible Accounts
500
Accounts Receivable
To write off receivable from TV GO as uncollectible
because of his bankruptcy
500
example SE7, hwk E12
Accounts Receivable
Allowance for Uncollectible Accounts
Dec. 31
Jan. 15
4,918
Dec. 31
88,800
500
Jan. 15
Bal.
The write-off does not affect
the estimated net realizable
value of accounts receivable
4,418
Bal.
500
88,300
Net realizable value of A/R
Before write-off
$88,800 – $4,918 = $83,882
After write-off
$88,300 – $4,418 = $83,882
7–41
Notes Receivable
Unconditional
promises to pay
a definite sum
of money on
demand or at a
future date.
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7–42
Making and Paying Notes
A promissory note is an unconditional promise to pay
a definite sum of money on demand at a future date
Maker
Person or company that
signs the note and
promises to pay the
amount
All promissory notes that the
maker holds that are due in less
than one year are categorized as
notes payable in the current
liability section of the balance
sheet
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Payee
Entity to whom
payment is to be made
All promissory notes that the
payee holds that are due in less
than one year are categorized as
notes receivable in the current
assets section of the balance sheet
7–43
A Promissory Note
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7–44
Key Components of Promissory Notes
Maturity Date
Date on which the note must be paid
Duration
Length of time in days between the
note’s issue date and its maturity date
Interest and
Interest Rate
Cost of borrowing money or the return
for lending money, usually stated on an
annual basis
Maturity Value
Total proceeds of a note at maturity
date (face value plus interest)
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7–45
Maturity Date
Ways in which maturity date may be stated:
Due “November 14, 2010”
Due “three months after November 14, 2010”
Due “90 days after November 14, 2010”
Exclude the date of the note when computing the maturity date:
A note dated May 20 and due in 90 days would be due on August 18,
determined as follows:
Days remaining in May (31 – 20)
Days in June
Days in July
Days in August
Total days
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11
30
31
18
90
7–46
Duration of a Note
Why is duration of a note important?
Interest is calculated on this basis
If maturity date is stated as
a specific number of days
from date of note…
If maturity date is stated as
a specific date…
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duration is easy to
calculate. Duration is the
same as number of days.
number of days must be
calculated.
7–47
Interest and Interest Rate
hwk E13
• Amount of interest
is based on:
 Principal
 Rate of interest
 Loan’s length of
time
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What is the interest on a 90-day, 8 percent, $1,000 note?
Principal x Rate of Interest x Time = Interest
$1,000 x .08 x 90/365 = $19.73
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7–48
Maturity Value
example SE8, hwk E16
Total proceeds of loan
90-day
8 percent
proceeds
$1,000 loan
= Principal + Interest
= $1,000 + ($1,000 × 8/100 × 90/365)
= $1,000.00 + $19.73
= $1,019.73
The maturity value of a non-interest-bearing note is the
principal amount. In this case, the principal includes an
implied interest cost
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7–49
Accrued Interest
 A promissory note received in one accounting
period may not be due until a later period
 Accrue the interest applicable to the note at the end
of the accounting period
$1,000 note, 90-day,
8 percent note was
received on Aug. 31.
The fiscal year ends
on Sept. 30.
© Royalty-Free/Corbis
30 days interest, or $6.58 ($1,000 × 8/100 × 30/365 =
$6.58), is earned in the fiscal year that ends on Sept. 30
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7–50
Dishonored Notes
 When the maker of a note does not pay at
maturity, the note is said to be a dishonored note.
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 The holder, or
payee, of the note
should make an
entry to transfer
the amount due
to an accounts
receivable from
the debtor.
7–51