Chapter 7
CASH AND
RECEIVABLES
© 2009 The McGraw-Hill Companies, Inc.
Slide 2
Cash and Cash Equivalents
Cash
Currency
and coins
Balances in
checking
accounts
Items for deposit such as
checks and money orders
from customers
Cash equivalents are short-term, highly liquid
investments that can be readily converted to cash.
Money market
funds
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Treasury bills
Commercial
paper
Slide 3
Internal Control
Encourages
adherence to
company policies
and procedures
Enhances the
reliability and
accuracy of
accounting data
Promotes
operational
efficiency
Minimizes errors
and theft
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Slide 4
Internal Control Procedures
Cash Receipts
 Separate responsibilities for handling cash, recording cash
transactions, and reconciling cash balances.
 Match the amount of cash received with the amount of cash
deposited.
 Close supervision of cash-handling and cash-recording
activities.
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.
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Slide 5
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 bank
account as support for funds
borrowed from the bank.
McGraw-Hill /Irwin
Slide 6
Accounts Receivable
Amounts due from customers for credit sales.
Credit sales require:
• maintaining a separate account receivable account for
•
each customer.
accounting for bad debts and sales returns that result
from credit sales.
Credit sales and the resulting accounts receivable
are recorded net of trade discounts, not at list price.
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Slide 7
Cash Discounts
increase sales
Cash discounts
encourage early
payment
increase likelihood of
collections
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Slide 8
Cash Discounts
2/10,n/30
Discount
percent
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Number of
days
discount is
available
Otherwise,
net (or all)
is due
Credit
period
Slide 9
Cash Discounts
Gross
Method
Net
Method
Sales are recorded
at the invoice
amounts.
Sales are recorded at
the invoice amount
less the discount.
Sales discounts
are recorded if
payment is
received within the
discount period.
Sales discounts
forfeited are recorded
if payment is received
after the discount
period.
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Slide 10
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.
Prepare the journal entry to record the sale if Eddy uses:
GENERAL
JOURNAL
(a) the
gross method;
(b) the net method. Page 56
Date
Description
Post.
Ref.
Debit
Credit
GROSS METHOD
May 10 Accounts Receivable
5,000
Sales Revenue
5,000
NET METHOD
May 10 Accounts Receivable
Sales Revenue
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4,950
4,950
Slide 11
Cash Discounts
Assume that on May 19, Eddy, Inc. received a check in full
payment of the sale made on May 10.
GENERAL
56
Prepare the journal
entryJOURNAL
to record the cash receiptPage
if Eddy
uses (a) the gross method;Post.
(b) the net method.
Date
Description
Ref.
Debit
Credit
GROSS METHOD
May 19 Cash
4,950
Sales Discount
50
Accounts Receivable
5,000
NET METHOD
May 19 Cash
Accounts Receivable
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4,950
4,950
Slide 12
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
GENERAL
JOURNAL
Page 56
sale made
on May 10.
Post.
Ref.
record
Date
Prepare
Description
Creditif
the journal
entry to
theDebit
cash receipt
GROSS
METHOD
Eddy uses:
(a) the
gross method; (b) the net method.
May 31 Cash
5,000
Accounts Receivable
5,000
NET METHOD
May 31 Cash
Interest Revenue
Accounts Receivable
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5,000
50
4,950
Slide 13
Sales Returns and Allowances
Sales Returns
Sales Allowances
Merchandise
returned by a
customer to a
supplier.
A reduction in
the cost of
defective
merchandise.
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Slide 14
Sales Returns
On June 1, a customer of LarCo returns $750 of
merchandise. The merchandise had been purchased
on account and the customer had not yet paid. LarCo
uses the periodic method to account for inventory.
Record
the journal
the return
merchandise.
Sales Returns
is a entry
contraforaccount
thatofreduces
Sales
Revenue in the current accounting period.
GENERAL JOURNAL
Date
Jun
Description
1 Sales Returns
Accounts Receivable
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Post.
Ref.
Page 56
Debit
Credit
750
750
Slide 15
Uncollectible Accounts Receivable
Bad debts result from credit customers who
are unable to pay the amount they owe,
regardless of continuing collection efforts.
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.
PAST DUE
McGraw-Hill /Irwin
Slide 16
Uncollectible Accounts Receivable
Most businesses record an estimate of the
bad debt expense by an adjusting entry
at the end of the accounting period.
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
Accounts
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Page 78
Post.
Ref.
Debit
Credit
####
####
Slide 17
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.
Income Statement Approach
 Balance Sheet Approach

◦ Composite Rate
◦ Aging of Receivables
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Slide 18
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.
Bad debt expense is computed as follows:
Current Period Sales
× Bad Debt %
= Estimated Bad Debt Expense
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Slide 19
Income Statement Approach
In 2009, MusicLand has credit sales of $400,000 and
estimates that 0.6% of credit sales are uncollectible.
What is Bad Debt Expense for 2009?
MusicLand computes
estimated Bad Debt
Expense of $2,400.
$ 400,000
×
0.60%
= $
2,400
GENERAL JOURNAL
Date
Dec.
Description
31 Bad debt expense
Allowance for
uncollectible accounts
McGraw-Hill /Irwin
Post
Ref.
Page 95
Debit
2,400
Credit
2,400
Slide 20
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.
Compute the desired balance in the Allowance for
Uncollectible Accounts.
Bad Debt Expense is computed as:
Desired Balance in Allowance for
Uncollectible Accounts
Existing Year-End Balance in Allowance for
Uncollectible Accounts
= Estimated Bad Debt Expense
-
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Slide 21
Balance Sheet Approach
Composite Rate
On Dec. 31, 2009, 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 Debt
Expense for 2009?
McGraw-Hill /Irwin
Slide 22
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 Debt Expense
Allowance for
Uncollectible Accounts
McGraw-Hill /Irwin
Post
Ref.
Page 95
Debit
2,300
Credit
2,300
Slide 23
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 desired uncollectible amount.
 Compare desired uncollectible amount
with the existing balance in the
allowance account.
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Slide 24
Balance Sheet Approach
Aging of Receivables
At December 31, 2009, 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, 2009
Accounts
Estimated
Receivable
Percent
Balance
Uncollectible
$

$
McGraw-Hill /Irwin
45,000
15,000
5,000
2,000
67,000

Estimated
Allowance
1% $
3%
5%
10%
$
450
450
250
200
1,350

Slide 25
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.
850
1,350
GENERAL JOURNAL
Date
Dec.
Description
31 Bad Debt Expense
Allowance for
Uncollectible Accounts
McGraw-Hill /Irwin
Post
Ref.
Page 95
Debit
850
Credit
850
Slide 26
Uncollectible Accounts
As accounts become uncollectible, this entry is made:
GENERAL JOURNAL
Date
Description
Page 69
Post.
Ref.
Allowance for Uncollectible Accounts
Debit
Credit
####
Accounts Receivable
####
When a customer makes a payment after an account
has been
writtenJOURNAL
off, two journal entries are
GENERAL
Page 69
required. Post.
Date
Description
Accounts Receivable
Ref.
Debit
####
Allowance for Uncollectible Accounts
Cash
Accounts Receivable
McGraw-Hill /Irwin
Credit
####
####
####
Slide 27
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 Debt Expense
Accounts Receivable
Post
Ref.
Page 18
Debit
#####
Credit
#####
Slide 28
Uncollectible Accounts Receivable Example
Penn Company accrues a monthly charge to bad
debt expense equal to 2 percent of credit sales. At
year end, the allowance for uncollectible accounts is
adjusted by aging accounts receivable. Penn’s
relevant financial information for the year is:
Accounts receivable, beginning balance
Credit sales for the year
Cash collections on account for the year
Allowance for uncollectible accounts, beginning balance
Actual write-offs during the year
$
305,000
1,300,000
1,250,000
(25,500)
25,000
An aging of accounts receivable at the end of the
year indicates a required balance of $30,000.
Determine (1) the balance in accounts receivable at
year end, and (2) amount of the year-end adjustment
to the allowance for uncollectible accounts.
McGraw-Hill /Irwin
Slide 29
Uncollectible Accounts Receivable Example
Accounts Receivable
305,000
1,300,000
1,250,000
25,000
330,000
Allow a nce for
Uncolle ctible
Accounts
25,500
25,000
26,000
3,500
30,000
McGraw-Hill /Irwin
Write-offs for the year
Ending balance
Monthly charge
= 2% of $1,300,000
Amount needed to
bring desired balance
to $30,000
Slide 30
Notes Receivable
A written promise to pay a specific
amount at a specific future date.
Face
amount
of the
note
×
Annual
interest
rate
Even for
maturities
less than 1
year, the rate
is annualized.
McGraw-Hill /Irwin
×
Fraction of
the annual =
period
Interest
Slide 31
Interest-Bearing Notes
On November 1, 2008, West, Inc. loans $25,000 to Winn,
Co. The note bears interest at 12% and is due on
November 1, 2009.
Prepare the journal entry on November 1, 2008, December
31, 2008, GENERAL
(year-end) JOURNAL
and November 1, 2009 for West.
Page 56
Date
Description
Post.
Ref.
Debit
Credit
2008
Nov 1 Notes Receivable
25,000
Cash
Dec 31 Interest Receivable
Interest Revenue
$25,000 × 12% × (2 ÷ 12) = $500
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25,000
500
500
Slide 32
Interest-Bearing Notes
GENERAL JOURNAL
Date
Description
Page 56
Post.
Ref.
Debit
Credit
2009
Nov 1 Cash
28,000
Note Receivable
Interest Receivable
Interest Revenue
$25,000 × 12% = $3,000 - $500 = $2,500
McGraw-Hill /Irwin
25,000
500
2,500
Slide 33
Noninterest-Bearing Notes
 Actually do bear interest.
 Interest is deducted
(discounted) from the face
value of the note.
 Cash proceeds equal face
value of note less discount.
McGraw-Hill /Irwin
Slide 34
Noninterest-Bearing Notes
On January 1, 2009, West, Inc. accepted a $25,000
noninterest-bearing note from Winn, Co as payment for a
JOURNAL at 12% and is duePage
sale. The GENERAL
note is discounted
on 56
Post.
December 31, 2009.
Date
Description
Ref.
Debit
Credit
2009Prepare the journal entries on January 1, 2009, and
Jan 1 Notes Receivable
December 31, 2009 for West. 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
Slide 35
Financing With Receivables
Secured borrowing or sale of receivables
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.
Pledging
• Receivables in general are pledged as collateral for loans.
• Pledged receivables are disclosed in notes to the financial
statements.
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Slide 36
Sale of Receivables
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
Slide 37
Sale of Receivables
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
Slide 38
Sale of Receivables
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.
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
Slide 39
Discounting a Note
On December 31, Apex accepted a nine-month 10 percent
note for $200,000 from a customer. Three months later
on March 31, Apex discounted the note at its local bank.
The bank’s discount rate is 12 percent.
Before
preparing
the journal
to the
record
the discounting,
Prepare
the journal
entry toentry
record
discounting
of the
Apex must record
thereceivable
accrued interest
on the note from
note
as a sale.
December 31 until March 31.
GENERAL JOURNAL
Date
Description
Page 69
Post.
Ref.
Mar. 31 Interest Receivable
Interest Revenue
$200,000 × 10% × 3/12
McGraw-Hill /Irwin
Debit
Credit
5,000
5,000
Slide 40
Discounting a Note
Face amount of note receivable
Interest to maturity ($200,000 × 10% × 9/12)
Maturity value of note receivable
Discount fee ($215,000 × 12% × 6/12)
Cash proceeds
$
$
GENERAL JOURNAL
Date
Page 69
Post.
Ref.
Description
Mar. 31 Cash
Debit
Credit
202,100
Loss on Sale of Note Receivable
2,900
Notes Receivable
200,000
Interest Receivable
5,000
$205,000 - $202,100
McGraw-Hill /Irwin
200,000
15,000
215,000
(12,900)
202,100
Slide 41
Receivables Management
Receivables
Turnover =
Ratio
Net Sales
Average Accounts Receivable
This ratio measures how many
times a company converts its
receivables into cash each year.
Average
Collection
Period
365
=
Receivables Turnover Ratio
This ratio is an approximation of the
number of days the average accounts
receivable balance is outstanding.
McGraw-Hill /Irwin
Slide 42
Receivables Management
Electronic Arts vs. Activision comparison
(All dollar amounts in millions)
Accounts receivable (net)
Net sales
Electronic Arts
Activision
2007
2006
2007
2006
$
256 $
199 $
149 $
29
3,091
1,513
Can you compute the receivables turnover ratio and
the average collection period for these two companies?
Receivables Turnover
Average collection period
McGraw-Hill /Irwin
Electronic Arts
13.6
27 days
Activision
17.0
21 days
Industry Average
6.3
58 days
Slide 43
Appendix 7 ─ Cash Controls
A bank reconciliation explains the difference between cash reported
on bank statement and cash balance on a company’s books.
Provides information for reconciling journal entries.
Bank Balance
All reconciling
items
on
the
+ Deposits in Transit
book side
- Outstanding
requireChecks
an
adjusting entry
± Bank Errors
to the cash
account.
= Corrected
Balance
McGraw-Hill /Irwin
Book Balance
+ Bank Collections
- Service Charges
- NSF Checks
± Book Errors
= Corrected Balance
Slide 44
Appendix 7 ─ Cash Controls
Petty cash is
used for
minor
expenditures.
Petty cash
fund
Has one
custodian.
McGraw-Hill /Irwin
Replenished
periodically.
End of Chapter 7
McGraw-Hill /Irwin
© 2008 The McGraw-Hill Companies, Inc.