Financial & Managerial
Accounting 2002e
Belverd E. Needles, Jr.
Marian Powers
Susan Crosson
----------Multimedia Slides by:
Harry Hooper
Santa Fe Community College
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1
Chapter 7
Short-Term Liquid
Assets
LEARNING OBJECTIVES
1. Identify and explain the management
issues related to short-term liquid
assets.
2. Explain cash, cash equivalents, and
the importance of electronic funds
transfer.
3. Account for short-term investments.
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3
LEARNING OBJECTIVES
(continued)
4. Define accounts receivable and apply
the allowance method of accounting
for uncollectible accounts, using
both the percentage of net sales
method and the accounts receivable
aging method.
5. Define and describe a promissory
note, and make calculations and
journal entries involving promissory
notes.
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4
Management Issues Related to
Short-Term Liquid Assets
OBJECTIVE 1
Identify and explain the
management issues related
to short-term liquid assets.
Managing Cash Needs
During Seasonal Cycles
 Most
companies experience seasonal cycles
of business activity during the year.
 Weak
sales, strong sales.
 Expenditures are greater, expenditures are
smaller.
 Companies
must carefully plan cash
inflows, outflows, borrowing, and
investing.
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6
Seasonal Cycles and Cash Requirements for a Home Improvement Company
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7
Setting Credit Policies
 Companies
sell on credit to be
competitive and to increase sales.
 When setting terms, management
must consider terms being offered by
competitors and the needs of
customers.
 Most companies develop control
procedures and establish a credit
department, to increase likelihood of
customers paying on time.
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8
The Credit Department
 Examines
each customer who applies for
credit.
 Approves or rejects credit sales.
 Requests information about a potential
credit customer, including resources, debts,
references, and credit bureaus.
 Decides whether to extend credit to the
customer.
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9
Analyzing Credit Policies

Two common measures of the effect of
a company’s credit policies.
1. Receivable turnover.
2. Average days’ sales uncollected.
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10
Receivable Turnover
 Receivable
turnover (R/T) measures the relative
size of accounts receivable (A/R) and the success
of a company’s credit and collection policies.
Net Sales
Receivable Turnover =
Average Net A/R
R/T =
$2,175,236,000
($430,825,000 + $390,740,000) / 2
$2,175,236,000
R/T =
$410,782,500
R/T = 5.3 times
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11
Average Days’ Sales
Uncollected
 Average
days’ sales uncollected (ADSU)
measures, on average, how long it takes to
collect accounts receivable.
365 days
ADSU =
Receivable turnover
365
=
5.3
= 68.9 days
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12
Receivable Turnover for Selected Industries
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13
Financing Receivables
 Companies
that have significant A/R may be
unwilling or unable to wait until the A/R are
collected to get their cash.
 Many companies set up finance companies to
help their customers finance their purchases.
 Some companies borrow the funds they need
and use their A/R as collateral.
 Funds can also be raised by selling or
transferring (factoring) their A/R to another
entity called a factor.
 Factoring can be done with or without recourse.
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14
Factoring Without Recourse
The
factor bears any losses from
uncollectible accounts.
A company’s acceptance of credit
cards is an example of factoring.
The factor charges a higher fee
than with recourse.
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15
Factoring With Recourse
 The
seller of the receivables is liable to the
purchaser if the receivable is not collected.
 The factor charges a lower fee than without
recourse.
 The seller of the receivables has a contingent
liability.
 A contingent liability is a potential liability
that can develop into a real liability if a
possible subsequent event occurs.
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16
Discounting (Selling)
Notes Receivable
 The
bank deducts the interest from the maturity
value of the note to determine the proceeds.
 The holder of the note (usually the payee)
endorses the note and delivers it to the bank.
 The bank expects to collect the maturity value of
the note.
 The bank has recourse against the endorser/seller
of the note (contingent liability).
 The company who sells the note must disclose the
contingent liability.
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17
Discussion
Q. Indicate whether each of the following is
related to (a) managing cash needs during
seasonal cycles, (b) setting credit policies, or
(c) financing receivables.
1.
2.
3.
4.
Selling accounts receivable to a factor.
Borrowing funds for short-term needs
during slow periods.
Conducting thorough checks of new
customers’ ability to pay.
Investing cash that is not currently needed
for operations.
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18
KEY
(a) managing cash needs during seasonal cycles.
(b) setting credit policies.
(c) financing receivables.
A.
1. c
2. a
3. b
4. a
Cash and Cash Equivalents
OBJECTIVE 2
Explain cash, cash equivalents, and
the importance of electronic funds
transfer.
Cash
 Most
liquid of all assets.
 Consists of coins and currency on hand,
checks and money orders from customers,
and deposits in bank checking accounts.
 Compensating balance.
 A minimum
amount that a bank requires a
company to keep in its account as part of a
credit-granting arrangement.
 Restricts liquidity and increases interest rate.
 SEC requires disclosure in a note to the
financial statements.
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21
Cash Equivalents
 Excess
cash should be invested to earn
interest.
 Short-term investments with a maturity
term of 90 days or less when purchased.
 Shown on balance sheet at cost.
 Examples: time deposits, certificates of
deposit, government securities such as U.S.
Treasury notes.
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22
Cash on Hand
Kept
for cash registers and for paying
expenses that are impractical to pay by
check.
Kept in an imprest (petty cash) fund.
 The
fund is established at a fixed amount.
 Receipts are maintained for expenditures.
 The fund is periodically reimbursed to
restore it to its fixed amount.
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23
Banking and Electronic
Funds Transfer

EFT (Electronic Funds Transfer)
A company has cash transferred from its bank to
another company’s bank instead of writing
checks.
 Wal-Mart Stores, Inc. makes 75% of its payments
to suppliers this way.


Debit cards.
A customer’s retail purchase is deducted directly
from his/her bank account.
 The bank documents transactions for the retailer.
 The retailer must develop new internal controls.

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24
Discussion
Q. What items are included in the cash
account? What is a compensating
balance?
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25
A.
Cash consists of coins and currency on
hand, checks and money orders received
from customers, and deposits in bank
checking accounts. A compensating
balance is the minimum amount a bank
requires in a company’s bank account as
part of a credit-granting arrangement. If
this balance is unavailable to pay current
liabilities during the year, what should be
disclosed in the financial statements?
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26
Short-Term Investments
OBJECTIVE 3
Account for short-term investments.
Short-Term Investments or
Marketable Securities
Investments
with a maturity of
more than 90 days, but are intended
to be held only until cash is needed
for current operations.
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28
Long-Term Investments
Intended
to be held for more than
one year.
Classified in an investments section
of the balance sheet.
Intended to be held for an
indefinite time.
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29
Held-to-Maturity Securities
May
be Short- or Long-Term
Investments
Debt securities that management
intends to hold to their maturity
whose cash value is not needed until
that date.
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30
Example of
Held-to-Maturity Securities
Buy U.S. Treasury bills at $97,000, which mature
in 120 days at $100,000.
12/1 Short-Term Investments
Cash
12/31 Short-Term Investments
Interest Income
3/31 Cash
Short-Term Investments
Interest Income
97,000
97,000
750
750
100,000
97,750
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2,250
31
Trading Securities
 Always
Short-Term Investments.
 Debt and equity securities that are bought and
held principally for the purpose of being sold in
the near term.
 Frequently bought and sold to generate profits
on short-term changes in their prices.
 Classified as current assets on the balance sheet.
 Valued at fair (market) value.
 An increase or decrease in the total trading
portfolio is included in net income in the
accounting period in which the increase or
decrease occurs.
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32
Example of Trading Securities
10/25 Short-Term Investments
Cash
Original purchase
1,200,000
12/31 Unrealized Loss on
Investments
Allowance to Adjust
Short-Term Investments
to Market
Recognition of unrealized
loss on trading portfolio
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1,200,000
80,000
80,000
33
3/2 Cash
350,000
Short-Term Investments
Realized Gain on Investments
Sale of part of a portfolio at a gain
12/31 Allowance to Adjust Short-Term
Investments to Market
118,000
Unrealized gain on Investments
Recognition of unrealized
gain on trading portfolio
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300,000
50,000
118,000
34
Available-for-Sale Securities





May be Short- or Long-Term Investments.
Debt and equity securities that do not meet the
criteria for either held-to-maturity or trading
securities.
Accounted for in the same way as trading securities
except that the unrealized gain or loss is not reported
on the income statement.
It is reported as a special item in the stockholders’
equity section of the balance sheet.
Dividend and interest income for all three categories is
shown in the Other Income and Expenses section of
the income statement.
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35
Discussion
Q. What are unrealized gains and losses on
trading securities? On what statement are
they reported?
A. Unrealized gains and losses on trading
securities are changes in the fair market
value of securities that have not been sold.
Because the securities have not been sold,
the gains or losses have not been realized.
Unrealized gains and losses are reported on
the
income statement.
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36
Accounts Receivable
OBJECTIVE 4
Define accounts receivable and apply
the allowance method of accounting
for uncollectible accounts, using both
the percentage of net sales method
and the accounts receivable aging
method.
Accounts Receivable
 Accounts
Receivable (A/R) are short-term liquid
assets that arise from sales on credit to customers.
 Trade credit terms vary by industry.
 Installment A/R arise from the sale of goods on
terms that allow the buyer to make a series of time
payments.
Used frequently by department stores, appliance stores,
used car dealers, furniture stores, etc.
 Although the payment period may be 24 months or
more, are still classified as current assets if customary
in the industry.

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38
Accounts Receivable (continued)
 Receivables
from other than regular
customers (employees, owners, officers)
are shown separately with a title such as
Receivables from Employees.
 Normally, individual customer accounts
receivable have debit balances.
 If a customer has a credit balance, this is
shown as a current liability on the
balance sheet.
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39
Accounts Receivable as a Percentage of
Total Assets for Selected Industries
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40
Uncollectible Accounts
Accounts
owed by customers who
will not or cannot pay are called
uncollectible accounts or bad debts.
 A loss
or an expense of selling on
credit.
 Companies sell on credit to increase
their volume of sales.
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41
The Direct Charge-Off Method
 The
direct charge-off method recognizes
the loss at the time the A/R is determined
to be uncollectible.
 Reduces A/R
and increases Uncollectible
Accounts Expense.
 Used for federal tax purposes but not GAAP,
because it violates the matching principle.
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42
Uncollectible Accounts and
the Allowance Method
Bad debt losses are matched against the sales
they help produce.
 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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43
 Uncollectible Accounts
Expense appears
on the income statement as an operating
expense.
 Allowance for Uncollectible Accounts
appears on the balance sheet as a contraasset account that is deducted from
Accounts Receivable.


Reduces the accounts receivable to the
amount expected to be realized in cash.
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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44
Example of the Allowance Method


Assume that of $100,000 in sales, $6,000 are estimated to be
uncollectible.
Uncollectible Accounts Expense would be recorded as
follows:
12/31 Uncollectible Accounts Expense
6,000
Allowance for Uncollectible
Accounts
6,000
To record the estimated
uncollectible accounts
expense for the year
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45
Estimating Uncollectible
Accounts Expense
 It
is necessary to estimate the expense to cover
expected losses for the year.
 Management makes the final decision.
 Can be optimistic or pessimistic about expected
losses.
If optimistic, expense smaller and net income higher.
 If pessimistic, expense larger and net income smaller.

 In
either case, the estimated loss should be
realistic, based on experience, the economy, etc.
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46
Percentage of Net Sales Method




“How much of this year’s net sales will not be collected?”
The answer is the amount of uncollectible expense for the
year.
Usually based on the company’s historical losses.
12/31 Uncollectible Accounts Expense
12,000
Allowance for Uncollectible
Accounts
12,000
To record uncollectible accounts
expense at 2% of $600,000 net sales
Allowance for Uncollectible Accounts contains the
accumulated amounts from previous years.
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47
Accounts Receivable Aging Method





“How much of the year-end balance of A/R will not be
collected?”
The difference between the amount determined to be
uncollectible and the actual balance of Allowance for
Uncollectible Accounts is the expense for the year.
The target balance less the actual balance equals
expense.
The aging of A/R is the process of listing each
customer’s account according to the due date of the
account.
The older the account, the less likely that it will be
paid.
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48
Example of Accounts Receivable
Aging Method
Targeted Balance for Allowance for
Uncollectible Accounts
Less Current Credit Balance of
Allowance for Uncollectible Accounts
Uncollectible Accounts Expense
12/31 Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
$2,459
800
$1,659
1,659
1,659
Allowance for Uncollectible Accounts
12/31
800
12/31 Adjustment
1,659
12/31 Balance
2,459
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49
Example of Accounts Receivable
Aging Method
Target Balance for Allowance for
Uncollectible Accounts
Plus Current Debit Balance of
Allowance for Uncollectible Accounts
Uncollectible Accounts Expense
12/31 Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
Allowance for Uncollectible Accounts
12/31
800 12/31 Adjustment
12/31 Balance
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$2,459
800
$3,259
3,259
3,259
3,259
2,459
50
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51
Why Accounts Written Off Will
Differ from Estimates
Accounts
written off less than
estimated uncollectible accounts 
credit balance in allowance account at
year end.
Accounts written off greater than
estimated uncollectible accounts 
debit balance in allowance account at
year end.
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52
Writing Off
an Uncollectible Account



When it is clear that a specific A/R will not be collected,
the amount should be written off.
1/15 Allowance for Uncollectible Accounts
250
Accounts Receivable
250
Does not impact the net realizable value of A/R.
Recovery of Accounts Receivable written off.
9/1 Accounts Receivable
100
Allowance for Uncollectible Accounts
100
9/1 Cash
50
Accounts Receivable
50
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53
Discussion
Q. According to generally accepted accounting
principles, at what point in the cycle of
selling and collecting does a loss on an
uncollectible account occur?
A. According to GAAP, a loss from an
uncollectible account occurs at the time the
sale on credit is made.
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54
Notes Receivable
OBJECTIVE 5
Define and describe a
promissory note, and make
calculations and journal
entries involving promissory
notes.
Notes Receivable
 A promissory
note is an unconditional promise to
pay a definite sum of money on demand or at a
future date.
 The signer of the note is called the maker.
 The entity to whom payment is to be made is
called the payee.
 The payee regards all promissory notes it holds
that are due in less than one year as notes
receivable in the current assets section of the
balance sheet.
 The maker regards them as notes payable in the
current liability section of the balance sheet.
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56
Notes Receivable (continued)
Many
companies accept notes
receivable in settlement of past-due
accounts.
Notes produce interest income.
Notes represent a stronger claim than
do accounts receivable.
Selling or discounting notes is a
common financing method.
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57
A Promissory Note
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58
Computations for Promissory Notes
 Several
terms are important in accounting for
promissory notes.
1. Maturity date.

The date on which the note must be paid.
2. Duration of note.

The length of time in days between a promissory note’s issue
date and its maturity date.
3. Interest and interest rate.


The cost of borrowing money or the return for lending money.
Usually stated on an annual basis.
4. Maturity value.

The total proceeds of a at the maturity date.
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59
Illustrative Accounting Entries
6/1 Notes Receivable
Accounts Receivable
Received 12%, 30 day note
in payment of A/R
7/1 Cash
Notes Receivable
Interest Income
4,000
4,000
4,040
4,000
40
Collected 12%, 30 day note
$4,000 x 12/100 x 30/360 = $40
7/1 Accounts Receivable
Notes Receivable
Interest Income
Record dishonored note
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4,040
4,000
40
60
Recording Adjusting Entries
9/1 Interest Receivable
Interest Income
To accrue 30 days’
interest earned on a
note receivable
10/30 Cash
Notes Receivable
Interest Receivable
Interest Income
Receipt of note receivable
plus interest
13.33
13.33
2,026.67
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2,000.00
13.33
13.34
61
Discussion
Q. What is a promissory note? Who is the
maker? Who is the payee?
A. A promissory note is an unconditional
promise to pay a definite sum of money on
demand or at a future date. The person who
signs the note and therefore promises to pay
is called the maker. The person to whom
payment should be made is called the payee.
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62
OK, LET’S REVIEW . . .
1. Identify and explain the management
issues related to short-term liquid
assets.
2. Explain cash, cash equivalents, and
the importance of electronic funds
transfer.
3. Account for short-term investments.
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63
CONTINUING OUR REVIEW...
4. Define accounts receivable and apply
the allowance method of accounting
for uncollectible accounts, using both
the percentage of net sales method
and the accounts receivable aging
method.
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64
AND FINALLY...
5. Define and describe a
promissory note, and make
calculations and journal
entries involving promissory
notes.
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65