Chapter 7
Cash and Receivables
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-2
Cash
Coins and
currency
Petty cash
Cashier’s checks
Certified checks
Money orders
McGraw-Hill/Irwin
Amounts on
deposit with
financial
institutions
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-3
Cash Equivalents
Items very near cash but
not in negotiable form
Money market
funds
Treasury bills
Commercial
paper
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-4
Internal Control of Cash
Encourages adherence
to company policies
and procedures
Enhances the reliability
and accuracy of
accounting data
McGraw-Hill/Irwin
Promotes operational
efficiency
Minimizes errors
and theft
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-5
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-6
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-7
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-8
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-9
Cash Discounts
Increase sales.
Cash discounts . . .
Encourage early
payment.
Increase likelihood of
collections.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-10
Cash Discounts
2/10,n/30
Discount
Percent
McGraw-Hill/Irwin
Number of
Days
Discount is
Available
Otherwise,
Net (or All)
is Due
Credit
Period
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-11
Cash Discounts
Sales are
recorded at the
invoice
amounts.
Gross
Method
McGraw-Hill/Irwin
Sales discounts
are recorded if
payment is
received within
the discount
period.
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-12
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-13
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. Eddy uses the
periodic method to account for inventory.
Prepare the journal entry to record the sale if
Eddy uses:
(a) the gross method.
(b) the net method.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-14
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
McGraw-Hill/Irwin
4,950
4,950
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-15
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-16
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
McGraw-Hill/Irwin
4,950
4,950
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-17
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-18
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
Sales Discount Forfeited
Accounts Receivable
McGraw-Hill/Irwin
5,000
50
4,950
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-19
Sales Returns and Allowances
Sales Returns
Sales Allowance
Merchandise
returned by a
customer to a
supplier.
A reduction in
the cost of
defective
merchandise.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-20
Sales Returns and Allowances
On June 1, a customer of LarCo returns $750
of merchandise that was damaged. LarCo
uses the periodic method to account for
inventory.
Record the journal entry for the return of
merchandise.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-21
Sales Returns and Allowances
GENERAL JOURNAL
Date
Jun
Description
1 Sales Returns and Allowances
Post.
Ref.
Page 56
Debit
Credit
750
Accounts Receivable
750
Sales Returns and Allowances is a contra
account that reduces Sales Revenue in the
current accounting period.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-22
Uncollectible Accounts
Receivable
Bad debts result from credit customers who
will not pay the amount they owe,
regardless of continuing collection efforts.
McGraw-Hill/Irwin
PAST DUE
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-23
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-24
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
Page 78
Post.
Ref.
Debit
Credit
####
####
Accounts
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-25
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
Page 78
Post.
Ref.
Debit
Credit
####
####
Accounts
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-26
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-27
Estimating Bad Debts

Income Statement Approach

Balance Sheet Approach
 Composite
Rate
 Aging of Receivables
PAST DUE
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-28
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-29
Income Statement Approach
Bad debts expense is computed as
follows:
Current Period Credit Sales
× Bad Debt %
= Estimated Bad Debts Expense
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-30
Income Statement Approach
In 2003, MusicLand has
credit sales of $400,000 and
estimates that 0.6% of credit
sales are uncollectible.
What is Bad Debts Expense
for 2003?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-31
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
McGraw-Hill/Irwin
Page 95
Post
Ref.
Debit
2,400
Credit
2,400
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-32
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-33
Balance Sheet Approach
Composite Rate
Compute the estimate of the Allowance for
Uncollectible Accounts.
Year-end Accounts Receivable
× Bad Debt %
Bad Debts Expense is computed as:
Estimated Adjusted Balance in Allowance for
Uncollectible Accounts
Unadjusted Year-End Balance in Allowance for
Uncollectible Accounts
= Estimated Bad Debts Expense
-
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-34
Balance Sheet Approach
Composite Rate
On Dec. 31, 2003, 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 2003?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-35
Balance Sheet Approach
Composite Rate
Desired balance in Allowance for
Uncollectible Accounts
$
×
= $
50,000
5.00%
2,500
Allowance for
Uncollectible
Accounts
200
2,300
2,500
GENERAL JOURNAL
Date
Dec.
Description
31 Bad Debts Expense
Allowance for
Uncollectible Accounts
McGraw-Hill/Irwin
Post
Ref.
Page 95
Debit
2,300
Credit
2,300
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-36
Now, let’s
look at the
accounts
receivable
aging
approach!
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-37
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 estimated uncollectible
amount.
 Compare estimated uncollectible
amount with the balance in the allowance
account.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-38
Balance Sheet Approach
Aging of Receivables
At December 31, 2003, 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, 2003
Accounts
Estimated
Estimated
Receivable Bad Debts Uncollectible
Balance
Percent
Amount
$

$
McGraw-Hill/Irwin
45,000
15,000
5,000
2,000
67,000

1% $
3%
5%
10%
$
450
450
250
200
1,350

© 2004 The McGraw-Hill Companies, Inc.
Slide
7-39
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
Credit
Prepare the entry to record bad debts
expense at Dec. 31, 2003.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-40
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
McGraw-Hill/Irwin
Post
Ref.
Page 95
Debit
850
Credit
850
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-41
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
McGraw-Hill/Irwin
Accts.
Rec.
All. for
Uncoll.
Accts.
Balance Sheet
Focus
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-42
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?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-43
Collection of Previously WrittenOff 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
McGraw-Hill/Irwin
Page 69
Post.
Ref.
Debit
####
Allowance for Uncollectible Accounts
Accounts Receivable
Credit
####
####
####
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-44
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
McGraw-Hill/Irwin
Description
Bad Debts Expense
Accounts Receivable
Page 18
Post
Ref.
Debit
#####
Credit
#####
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-45
Notes Receivable
Let’s move
to a new
challenge.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-46
Notes Receivable
PROMISSORY NOTE
$2,000
Face Value
Date of
Note
Sept. 30, 2003
Payee
Date
I promise to pay to the order of
Sixty days after date
National Bank
Principal
Due
Date
Boston, MA
Two thousand and no/100------------------------------------ Dollars
Maker
plus interest at the annual rate of 12% .
Interest Rate
McGraw-Hill/Irwin
Janet Lee
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-47
Interest Computation
Face
amount
of the
note
×
Annual
interest
rate
×
Fraction of
the annual =
period
Interest
Even for
maturities less
than 1 year,
the rate is
annualized.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-48
Interest-Bearing Notes
On November 1, 2002, Winn, Inc. loans
$25,000 to Westward, Co. The note bears
interest at 12% and is due on November 1,
2003.
Prepare the journal entry on November 1,
2002, December 31, 2002, (year-end) and
November 1, 2003.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-49
Interest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2002
Nov 1 Notes Receivable
25,000
Cash
Dec 31 Interest Receivable
Interest Revenue
25,000
500
500
$25,000 × 12% × (2 ÷ 12) = $500
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-50
Interest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2003
Nov 1 Cash
28,000
Note Receivable
25,000
Interest Receivable
500
Interest Revenue
2,500
$25,000 × 12% = $3,000 - $500 = $2,500
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-51
Noninterest-Bearing Notes
 Actually do
McGraw-Hill/Irwin
bear interest.

Interest is deducted
(discounted) from the face
value of the note.

Cash proceeds equal face
value of note less discount.
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-52
Noninterest-Bearing Notes
On January 1, 2003, Winn, Inc. accepted a
$25,000 noninterest-bearing note from
Westward, Co as payment for a sale. The
note is discounted at 12% and is due on
December 31, 2003.
Prepare the journal entries on January 1,
2003, and December 31, 2003.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-53
Noninterest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2003
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
McGraw-Hill/Irwin
25,000
3,000
Interest Revenue
3,000
Notes Receivable
25,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-54
Financing With Receivables
Secured borrowing
or
Sale of receivables
Method depends on the
surrender of control over
the receivables transferred.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-55
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-56
Secured Borrowing – Pledging

Receivables in general are pledged as
collateral for loans.

Pledged Receivable are disclosed in notes
to the financial statements.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-57
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-58
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-59
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-60
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-61
Discounting a Note
On May 31, Apex discounts a customer’s
$25,000 note receivable at the bank. The note
was dated May 1 and matures in 90 days. The
receivable bears interest at 12% and the bank
charges a discount of 15% on the maturity
value of the note.
Prepare the journal entry to record the
discounting of the note receivable as a secured
borrowing.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-62
Discounting a Note
Face amount of note receivable
$ 25,000.00
Interest to maturity, i = 12%, n = 90 days
750.00
Maturity value of note receivable
25,750.00
Discount fee, i = 15%, n = 60 days
(643.75)
Cash proceeds
$ 25,106.25
GENERAL JOURNAL
Date
Description
May 31 Cash
McGraw-Hill/Irwin
Page 69
Post.
Ref.
Debit
Credit
25,106.25
Notes Receivable
25,000.00
Interest Revenue
106.25
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-63
Discounting a Note
If the three conditions for sale treatment are met,
the transaction would be accounted for as a sale,
recognizing a gain or loss for the difference between
the cash proceeds and the book value of the note.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
7-64
End of Chapter 7
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.