7-1
Chapter
7
Financial Assets
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
How Much Cash Should a Business
Have?
McGraw-Hill/Irwin
$
7-2
Every
business
needs
enough
cash to pay
its bills!
© The McGraw-Hill Companies, Inc., 2008
How Much Cash Should a Business
Have?
7-3
Financial
Assets
Cash
Receivables
Short-term
Investments
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
How Much Cash Should a Business
Have?
Collections
from
customers
Cash (and cash
equivalents)
Accounts
7-4
Cash
payments
receivable
“Excess”
cash is
invested
temporarily
Investments
are sold as
cash is
needed
Marketable
securities
(short-term
investments)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-5
The Valuation of Financial Assets
Basis for Valuation in
Type of Financial Assets
the Balance Sheet
Cash (and cash equivalents) Face amount
Short-term investments
Current market value
(marketable securities)
Receivables
Net realizable value
Estimated collectible amount
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-6
Cash
Coins and
paper
money
Bank credit
card sales
Cash is
defined as
any deposit
banks will
accept.
Checks
Money orders
Travelers’ checks
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Reporting Cash in the Balance
Sheet
7-7
Combined
with cash on
balance sheet
Liquid shortterm
investments
Cash
Equivalents
Matures
within 90 days
of acquisition
Stable
market
values
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Reporting Cash in the Balance
Sheet
7-8
Not available
for paying
current
liabilities
Not a current
asset
McGraw-Hill/Irwin
“Restricted”
Cash
Listed as an
investment
© The McGraw-Hill Companies, Inc., 2008
Reporting Cash in the Balance
Sheet
7-9
Bank agrees in
advance to lend
money.
Lines of
Credit
Liability is
incurred when line
of credit is used.
McGraw-Hill/Irwin
Unused line of
credit is disclosed
in notes.
© The McGraw-Hill Companies, Inc., 2008
7-10
The Statement of Cash Flows
Statement of Cash Flows
Summarizes cash
transactions for an
accounting period.
Includes cash and cash
equivalents.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-11
Cash Management

Accurately account for cash.

Prevent theft and fraud.

Assure the availability of
adequate amounts of cash.

Prevent unnecessarily large
amounts of idle cash.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Using Excess Cash Balances
Efficiently
Cash available for
long-term investment
may be used to finance
growth and expansion
of the business, or to
repay debt.
McGraw-Hill/Irwin
7-12
Cash not needed for
business purposes
may be distributed to
the company’s
stockholders.
© The McGraw-Hill Companies, Inc., 2008
7-13
Internal Control Over Cash
•
Segregate authorization, custody and
recording of cash.
•
•
•
•
•
•
Prepare a cash budget (or forecast).
Prepare a control listing of cash receipts.
Require daily deposits.
Make all payments by check.
Verify every expenditure before payment.
Promptly reconcile bank statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-14
Cash Over and Short
On May 5, XBAR, Inc.’s cash drawer
was counted and found to be $10 over.
GENERAL JOURNAL
Date
Account Titles and Explanation
May 5 Cash
Debit
Credit
10
Cash Over and Short
10
Cash Over and Short is debited for
shortages and credited for overages.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-15
Bank Statements
Shows the beginning bank balance,
deposits made, checks paid, other
debits and credits in the month, and
the ending bank balance.
Bank
Statement
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-16
Reconciling the Bank Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositor’s accounting
records.
Provides information for
reconciling journal entries.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-17
Reconciling the Bank Statement
Balance per Bank
Balance per Depositor
+ Deposits in Transit
+ Deposits by Bank
(credit memos)
- Outstanding Checks
- Service Charge
- NSF Checks
± Bank Adjustments
± Book Adjustments
= Adjusted Balance
= Adjusted Balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-18
Reconciling the Bank Statement
All reconciling
items on the
book side
require an
adjusting
entry to the
cash account.
Balance per Depositor
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
± Book Adjustments
= Adjusted Balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-19
Reconciling the Bank Statement
Prepare a July 31 bank reconciliation
statement and the resulting journal entries
for the Simmons Company. The July 31
bank statement indicated a cash balance of
$9,610, while the cash ledger account on
that date shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next page.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-20






Outstanding checks totaled $2,417.
A $500 check mailed to the bank for deposit had
not reached the bank at the statement date.
The bank returned a customer’s NSF check for
$225 received as payment of an account
receivable.
The bank statement showed $30 interest earned
on the bank balance for the month of July.
Check 781 for supplies cleared the bank for $268
but was erroneously recorded in our books as
$240.
A $486 deposit by Acme Company was
erroneously credited to our account by the bank.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-21
Reconciling the Bank Statement
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-22
Reconciling the Bank Statement
GENERAL JOURNAL
Date
Account Titles and Explanation
Jul 31 Cash
Debit
Credit
30
Interest Revenue
31 Supplies Inventory
Accounts Receivable
Cash
McGraw-Hill/Irwin
30
28
225
253
© The McGraw-Hill Companies, Inc., 2008
7-23
Petty Cash Funds
Used for minor
expenditures.
Petty Cash
Funds
Has one
custodian.
McGraw-Hill/Irwin
Replenished
periodically.
© The McGraw-Hill Companies, Inc., 2008
7-24
Short-Term Investments
Capital
Stock
Investments
Bond
Investments
Readily
Marketable
Marketable
Securities
are . . .
Current Assets
Almost As
Liquid As
Cash
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Accounting for Marketable
Securities
7-25
Most short-term investments in marketable securities
are classified as available for sale and appear on the
balance sheet at their current market value.
Treatment of Unrealized
Classification Management's Intent Holding Gains and Losses
Available-forHeld for short-term
Reported in stockholders'
sale securities resale (often 6 to 18 equity section of the
months)
balance sheet
Trading
Held for immediate Reported in "other" revenue
securities
resale (often within (expense) section of the
hours or days)
income statement
Held-to-maturity Debt securities
Not reported. Securities are
securities
intended to be held reported on balance sheet
until they mature
at amortized
cost.
© The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
7-26
Purchase of Marketable Securities
Foster Corporation purchases as a short-term
investment 4,000 shares of The Coca-Cola
Company on December 1. Foster paid $43.98 per
share, plus a brokerage commission of $80.
GENERAL JOURNAL
Date
Account Titles and Explanation
Marketable Securities
Debit
Credit
176,000
Cash
176,000
Total Cost: (4,000 × $43.98) + $80 = $176,000
Cost per Share: $176,000 ÷ 4,000 =©$44.00
The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
7-27
Recognition of Investment Revenue
On December 15, Foster Corporation receives
a $0.30 per share dividend on its 4,000
shares of Coca-Cola.
GENERAL JOURNAL
Date
Account Titles and Explanation
Cash
Debit
Credit
1,200
Dividend Revenue
1,200
4,000 × $0.30 = $1,200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-28
Sales of Investments
On December 18, Foster Corporation sells 500
shares of its Coca-Cola stock for $46.04 per
share, less a $20 brokerage commission.
GENERAL JOURNAL
Date
Account Titles and Explanation
Cash
Debit
Credit
23,000
Marketable Securities
Gain on Sale of Investment
Sales Proceeds: (500 × $46.04) - $20 = $23,000
22,000
1,000
Cost Basis: 500 × $44 = $22,000
McGraw-Hill/Irwin
Gain
© The McGraw-Hill Companies, Inc., 2008
on Sale: $23,000 - $22,000 = $1,000
Adjusting Marketable Securities to
Market Value
7-29
On December 31, Foster Corporation’s remaining
shares of Coca-Cola capital stock have a current
market value of $42,000. Prior to any adjustment,
the company’s Marketable Securities account has a
balance of $44,000 (1,000 × $44 per share).
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Unrealized Holding Loss on Investments
Credit
2,000
Marketable Securities
2,000
Unrealized Loss: $42,000 - $44,000 = ($2,000)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-30
Accounts Receivable
If a company makes credit
sales to customers, some
accounts inevitably will
turn out to be
uncollectible.
PAST DUE
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-31
Reflecting Uncollectible Accounts in
the Financial Statements
At the end of each period, record
an estimate of the uncollectible
accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
Uncollectible Accounts Expense
McGraw-Hill/Irwin
Credit
$$$$
Allowance for Doubtful Accounts
Selling expense
Debit
$$$$
Contra-asset account
© The McGraw-Hill Companies, Inc., 2008
The Allowance for Doubtful
Accounts
7-32
Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable
The net realizable value is the amount of
accounts receivable that the business
expects to collect.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Writing Off an Uncollectible Account
Receivable
7-33
When an account is determined to be
uncollectible, it no longer qualifies as an
asset and should be written off.
GENERAL JOURNAL
Date
Account Titles and Explanation
Allowance for Doubtful Accounts
Accounts Receivable (X Customer)
McGraw-Hill/Irwin
Debit
Credit
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2008
Writing Off an Uncollectible Account
Receivable
7-34
Assume that on January 5, K-Max
determined that Jason Clark would not pay
the $500 he owes.
K-Max would make the following entry.
GENERAL JOURNAL
Date
Jan.
Account Titles and Explanation
5 Allowance for Doubtful Accounts
Accounts Receivable (J. Clark)
McGraw-Hill/Irwin
Debit
Credit
500
500
© The McGraw-Hill Companies, Inc., 2008
Writing Off an Uncollectible Account
Receivable
7-35
Assume that before this entry, the Accounts
Receivable balance was $10,000 and the
Allowance for Doubtful Accounts balance
was $2,500.
Let’s see what effect the write-off had on
these accounts.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Writing Off an Uncollectible Account
Receivable
Before
Write-Off
Accounts receivable
$ 10,000
Less: Allow. for doubtful accts.
2,500
Net realizable value
$ 7,500
7-36
After
Write-Off
$ 9,500
2,000
$ 7,500
Notice that the $500 write-off did not change the net
realizable value nor did it affect any income
statement accounts.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-37
Monthly Estimates of Credit Losses
At the end of each month,
management should
estimate the probable
amount of uncollectible
accounts and adjust the
Allowance for Doubtful
Accounts to this new
estimate.
Two Approaches to Estimating
Credit Losses:
1. Balance Sheet Approach
2. Income Statement Approach
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Balance Sheet Approach
7-38
Year-end Accounts Receivable is
broken down into age
classifications.
 Each age grouping has a
different likelihood of being
uncollectible.
Compute a separate allowance for
each age grouping.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Balance Sheet Approach
7-39
At December 31, 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, 2007
Estimated
Estimated
Accounts
Receivable Bad Debts Uncollectible
Amount
Percent
Balance
$

$
McGraw-Hill/Irwin
45,000
15,000
5,000
2,000
67,000
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Balance Sheet Approach
7-40
At December 31, 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, 2007
Estimated
Estimated
Accounts
Receivable Bad Debts Uncollectible
Amount
Percent
Balance
$

$
McGraw-Hill/Irwin
45,000
15,000
5,000
2,000
67,000

1%
3%
5%
10%
© The McGraw-Hill Companies, Inc., 2008
7-41
Estimating Credit Losses — The
Balance Sheet Approach
At December 31, 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, 2007
Estimated
Estimated
Accounts
Receivable Bad Debts Uncollectible
Amount
Percent
Balance
$

$
McGraw-Hill/Irwin
45,000
15,000
5,000
2,000
67,000

1% $
3%
5%
10%
$
450
450
250
200
1,350

© The McGraw-Hill Companies, Inc., 2008
7-42
Estimating Credit Losses — The
Balance Sheet Approach
EastCo’s unadjusted balance
in the allowance account is
$500.
Allowance for
Doubtful Accounts
500
Per the previous computation,
the desired balance is $1,350.
850
1,350
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Uncollectible Accounts Expense
Allowance for Doubtful Accounts
McGraw-Hill/Irwin
Debit
Credit
850
850
© The McGraw-Hill Companies, Inc., 2008
7-43
Let’s look at
another way
to estimate
credit losses!
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Income Statement Approach
7-44
Uncollectible accounts’
percentage is based on actual
uncollectible accounts from
prior years’ credit sales.
Focus is on determining the amount to
record on the income statement as
Uncollectible Accounts Expense.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Income Statement Approach
7-45
Net Credit Sales
 % Estimated Uncollectible
Amount of Journal Entry
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Income Statement Approach
7-46
In 2007, EastCo had credit sales of $60,000.
Historically, 1% of EastCo’s credit sales has
been uncollectible.
For 2007, the estimate of uncollectible accounts
expense is $600.
($60,000 × .01 = $600)
Now, prepare the adjusting entry for December
31, 2007.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Estimating Credit Losses — The
Income Statement Approach
7-47
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Uncollectible Accounts Expense
Allowance for Doubtful Accounts
McGraw-Hill/Irwin
Debit
Credit
600
600
© The McGraw-Hill Companies, Inc., 2008
Uncollectible Accounts
Summary
Aging of
Receivables
% of Credit Sales
Emphasis on
Realizable Value
Emphasis on
Matching
Accts.
Rec.
All. for
Doubtful
Accts.
Balance Sheet
Focus
McGraw-Hill/Irwin
Sales
7-48
Uncoll.
Accts.
Exp.
Income
Statement
Focus
© The McGraw-Hill Companies, Inc., 2008
7-49
Concentrations of Credit Risk
Concentrations of credit risk occur if a significant portion
of a company’s receivables are due from a few major
customers or from customers operating in the same
industry or geographic region.
The FASB requires
disclosure of all
significant
concentrations of
credit risk in the
notes to the financial
statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Recovery of an Account Receivable
Previously Written Off
7-50
Subsequent collections require that the original write-off
entry be reversed before the cash collection is recorded.
GENERAL JOURNAL
Date
Account Titles and Explanation
Accounts Receivable (X Customer)
Debit
$$$$
Allowance for Doubtful Accounts
Cash
Accounts Receivable (X Customer)
McGraw-Hill/Irwin
Credit
$$$$
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2008
7-51
Direct Write-Off Method
This method makes no attempt to
match revenues with the expense of
uncollectible accounts.
GENERAL JOURNAL
Date
Account Titles and Explanation
June 15 Uncollectible Accounts Expense
Accounts Receivable (X Customer)
McGraw-Hill/Irwin
Debit
Credit
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2008
Income Tax Regulations and
Financial Reporting
7-52
Direct write-off method
required to calculate
taxable income.
Taxable Income
Allowance methods
better match expenses
with revenues.
Financial
Statement Income
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-53
Internal Controls for Receivables
Separate the following duties:
Maintenance of the accounts receivable
subsidiary ledger.
Custody of cash receipts.
Authorization of accounts receivable write-offs.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Management of Accounts
Receivable
Credit Terms
Extending credit encourages
customers to buy from us . . .
. . . but it ties up resources
in accounts receivable.
McGraw-Hill/Irwin
7-54
Minimize
Accounts
Receivable
© The McGraw-Hill Companies, Inc., 2008
Management of Accounts
Receivable
Factoring
Accounts
Receivable
McGraw-Hill/Irwin
7-55
Credit
Card
Sales
© The McGraw-Hill Companies, Inc., 2008
Notes Receivable and Interest
Revenue
7-56
A promissory note is an unconditional
promise in writing to pay on demand or at
a future date a definite sum of money.
Maker—the person who
signs the note and thereby
promises to pay.
Payee—the person to whom
payment is to be made.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Notes Receivable and Interest
Revenue
7-57
PROMISSORY NOTE
Miami, Fl
Location
Nov. 1, 2007
Date
Ninety days after this date
promises to pay to the order of
the sum of
of
12.0%
$10,000.00
per annum.
Porter Company
Hall Company
with interest at the rate
John Caldwell
signed
CFO, Porter Company
title
Porter Company is replacing an existing Accounts Receivable with this
© The McGraw-Hill Companies, Inc., 2008
Note Receivable with Hall Company.
McGraw-Hill/Irwin
7-58
Notes Receivable and Interest
Revenue
On November 1, 2007, Hall Company
would make the following entry.
Date
Description
Debit
Nov. 1 Notes Receivable
Accounts Receivable (Porter Company)
McGraw-Hill/Irwin
Credit
10,000
10,000
© The McGraw-Hill Companies, Inc., 2008
Notes Receivable and Interest
Revenue
7-59
• Interest is a charge made for
the use of money.
• The borrower incurs interest
expense.
• The lender earns interest
revenue.
Interest
rates
down!
Lender
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Notes Receivable and Interest
Revenue
7-60
The interest formula includes three
variables:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time”
equals 1. When the computation period is less
than one year, then “Time” is a fraction.
For example, if we needed to compute interest for
3 months, “Time” would be 3/12.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-61
Notes Receivable and Interest
Revenue
What entry would Hall Company make on
December 31, the fiscal year-end?
Date
Description
Dec. 31 Interest Receivable
Interest Revenue
Debit
Credit
200
200
$10,00012% 60/360 = $200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
7-62
Notes Receivable and Interest
Revenue
What entry would Hall Company
make on the maturity date?
$10,00012% 90/360 = $300
Date
Description
Jan. 30 Cash
Interest Receivable
Interest Revenue
Notes Receivable
McGraw-Hill/Irwin
Debit
Credit
10,300
200
100
10,000
© The McGraw-Hill Companies, Inc., 2008
7-63
Notes Receivable and Interest
Revenue
If Porter Company defaulted on the note,
Hall Company would make the following
entry on the maturity date.
Date
Description
Jan. 30 Accounts Receivable
Interest Receivable
Interest Revenue
Notes Receivable
McGraw-Hill/Irwin
Debit
Credit
10,300
200
100
10,000
© The McGraw-Hill Companies, Inc., 2008
Financial Analysis and Decision
Making
7-64
Accounts Receivable Turnover Rate
This ratio provides useful information for
evaluating how efficient management has
been in granting credit to produce revenue.
Net Sales
Average Accounts Receivable
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Financial Analysis and Decision
Making
7-65
Avg. Number of Days to Collect A/R
This ratio helps judge the liquidity of a
company’s accounts receivable.
Days in Year
Accounts Receivable Turnover Ratio
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Ethics, Fraud, and
Corporate Governance
7-66
Accounts receivable is a significant account for
many companies. Accounts receivable is
particularly prone to misrepresentation because
revenue often increases when accounts receivable
increase. Manipulating accounts receivable can
result in the overstatement of both revenue and
income, which is the objective of many fraudulent
financial reporting schemes.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008