Chapter 7

Cash and Receivables

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc.

Slide 7-2

Cash
Coins Coins and and currency currency

Petty Petty cash cash Cashier’s Cashier’s checks checks

Certified Certified checks checks Amounts Amounts on on deposit deposit with with financial financial institutions institutions
© 2004 The McGraw-Hill Companies, Inc.

Money Money orders orders
McGraw-Hill/Irwin

Slide 7-3

Cash Equivalents
Items Items very very near near cash cash but but not not in in negotiable negotiable form form
Money Money market market funds funds Treasury Treasury bills bills Commercial Commercial paper paper
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.

Inc.Slide 7-4 Internal Control of Cash Encourages Encourages adherence adherence to to company company policies policies and and procedures procedures Promotes Promotes operational operational efficiency efficiency Minimizes Minimizes errors errors and and theft theft © 2004 The McGraw-Hill Companies. Enhances Enhances the the reliability reliability and and accuracy accuracy of of accounting accounting data data McGraw-Hill/Irwin .

cash.  recording recording cash cash transactions. balances. . McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc. transactions. received. and and  reconciling reconciling cash cash balances. Close Close supervision supervision of of cash!handling cash!handling and and cash! cash! recording recording activities. Agreed Agreed cash cash amounts amounts deposited deposited ith ith cash cash amounts amounts received.Slide 7-5 Control of Cash Receipts Separate Separate responsibility responsibility for for  handling handling cash. activities.

disbursements. All All disbursements. and and  record record #eeping. signing. e$cept e$cept petty petty cash. made made by by chec#. chec#.  chec# chec# mailing. cash. mailing. .  chec# chec# riting.  chec# chec# signing.Slide 7-6 Control of Cash "isbursements Separate Separate responsibilities responsibilities for for  cash cash disbursement disbursement documents. #eeping. documents. Inc. riting. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

Compensating Compensating %alance %alance  &inimum &inimum balance balance that that must must be be maintained maintained in in a a company's company's account account as as support support for for funds funds borro borro ed ed from from the the ban#. debt. ban#.Slide 7-7 Restricted Cash and Compensating %alances Restricted Restricted Cash Cash  &anagement's &anagement's intent intent to to use use a a certain certain amount amount of of cash cash for for a a specific specific purpose purpose ( ( future future plant plant e$pansion. e$pansion. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. future future payment payment of of debt. Inc. .

Slide 7-8

Accounts Receivable
Amounts Amounts due due from from customers customers for for credit credit sales. sales. Credit Credit sales sales require: require:
 Maintaining  Maintaining a a separate separate

account account receivable receivable for for each each customer. customer.  Accounting  Accounting for for bad bad debts debts that that result result from from credit credit sales. sales.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.

Slide 7-9

Cash "iscounts
Increase Increasesales sales Encourage Encourageearly early payment payment Increase Increaselikelihood likelihoodof of collections collections

Cash Cash discounts discounts

McGraw-Hill/Irwin

© 2004 The McGraw-Hill Companies, Inc.

Slide 7-10

Cash "iscounts

)*+,,n*-,
"iscount "iscount Percent Percent !umber !umber of of "ays "ays "iscount "iscount is is A#ailable A#ailable $therwise% $therwise% !et !et &or &or All' All' is is "ue "ue Credit Credit Period Period
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.

Slide 7-11 Cash "iscounts (ales (ales are are recorded recorded at at the the in#oice in#oice amounts amounts (ales (ales discounts discounts are are recorded recorded if if payment payment is is recei#ed recei#ed within within the the discount discount period period © 2004 The McGraw-Hill Companies. Inc. )ross Method McGraw-Hill/Irwin .

Slide 7-12 Cash "iscounts !et Method (ales (ales discounts discounts forfeited forfeited (ales are are recorded recorded at at the the (ales in#oice in#oice amount amount less less the the are are recorded recorded if if payment payment discount is discount is recei#ed recei#ed after after the the discount discount period period McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. . Inc.

/0. Eddy..... 4b5 4b5 the the net net method. ..n &ay &ay +. Inc. method. inventory. n*-. +*+.. method... McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.Slide 7-13 Cash "iscounts . of of merchandise merchandise to to a a customer customer sub1ect sub1ect to to a a cash cash discount discount of of +*+.. Inc... Eddy Eddy uses uses the the periodic periodic method method to to account account for for inventory. +. 2repare 2repare the the 1ournal 1ournal entry entry to to record record the the sale sale if if Eddy Eddy uses3 uses3 4a5 4a5 the the gross gross method. Eddy. n*-.n . Inc. sold sold /0..

Slide 7-14 Cash "iscounts McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. . Inc.

4b5 4b5 the the net net method. +6. method. Eddy. Eddy. Inc. . McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. 2repare 2repare the the 1ournal 1ournal entry entry to to record record the the cash cash receipt receipt if if Eddy Eddy uses3 uses3 4a5 4a5 the the gross gross method. Inc. +. received received a a chec# chec# in in full full payment payment of of the the sale sale made made on on &ay &ay +...Slide 7-15 Cash "iscounts Assume Assume that that on on &ay &ay +6. method. Inc.

Slide 7-16 Cash "iscounts McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc. .

no no assume assume that that Eddy. +. Inc. 2repare 2repare the the 1ournal 1ournal entry entry to to record record the the cash cash receipt receipt if if Eddy Eddy uses3 uses3 4a5 4a5 the the gross gross method. -+. Inc. method.. 4b5 4b5 the the net net method. received received a a chec# chec# on on &ay &ay -+. +6. method.. . Inc. Eddy. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. in in full full payment payment of of the the sale sale made made on on &ay &ay +.Slide 7-17 Cash "iscounts Instead Instead of of the the payment payment on on &ay &ay +6.

. Inc.Slide 7-18 Cash "iscounts McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

.Slide 7-19 Sales Returns and Allo ances (ales *eturns (ales Allowance Merchandise returned by a customer to a supplier A reduction in the cost of defecti#e merchandise McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc.

inventory. damaged. of of merchandise merchandise that that as as damaged. Record Record the the 1ournal 1ournal entry entry for for the the return return of of merchandise. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. a a customer customer of of 8arCo 8arCo returns returns /70. merchandise.n 7une 7une +.n .Slide 7-20 Sales Returns and Allo ances . Inc. . +. 8arCo 8arCo uses uses the the periodic periodic method method to to account account for for inventory. /70.

. Inc.Slide 7-21 Sales Returns and Allo ances (ales *eturns and Allowances is a contra account that reduces (ales *e#enue in the current accounting period McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

efforts. Inc. regardless regardless of of continuing continuing collection collection efforts. McGraw-Hill/Irwin PA(T "+E © 2004 The McGraw-Hill Companies. .Slide 7-22 9ncollectible Accounts Receivable %ad %ad debts debts result result from from credit credit customers customers ho ho ill ill not not pay pay the the amount amount they they o o e. e.

recorded. . Inc.Slide 7-23 9ncollectible Accounts Receivable In In conformity conformity ith ith the the matching matching principle. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. principle. bad bad debt debt e$pense e$pense should should be be recorded recorded in in the the same same accounting accounting period period in in hich hich the the sales sales related related to to the the uncollectible uncollectible account account ere ere recorded.

. Inc./ Credit "ec 01 2ad "ebt E3pense McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. "ate "escription Allowance for +ncollectible Accounts Post *ef "ebit 4444 4444 Page . -$+*!A. )E!E*A. period.Slide 7-24 9ncollectible Accounts Receivable &ost &ost businesses businesses record record an an estimate estimate of of the the bad bad debt debt e$pense e$pense by by an an ad1usting ad1usting entry entry at at the the end end of of the the accounting accounting period.

"ate "escription Allowance for +ncollectible Accounts McGraw-Hill/Irwin Page . -$+*!A. .Slide 7-25 9ncollectible Accounts Receivable !ormally classified as a selling e3pense and closed at year5end Contra asset account to Accounts *ecei#able )E!E*A. Inc./ Post *ef "ebit 4444 4444 Credit "ec 01 2ad "ebt E3pense © 2004 The McGraw-Hill Companies.

ess6 Allowance Allowance for for +ncollectible +ncollectible Accounts Accounts !et !et *ealizable *ealizable 7alue 7alue Net realizable value is the amount of the accounts receivable that the business expects to collect.Slide 7-26 Allo ance for 9ncollectible Accounts Accounts Accounts *ecei#able *ecei#able . .ess6 . McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc.

. Inc.Slide 7-27 Estimating %ad "ebts  Income Income Statement Statement Approach Approach  %alance %alance Sheet Sheet Approach Approach  Composite Composite Rate Rate  Aging Aging of of Receivables Receivables PA(T "+E McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

sales. Inc.Slide 7-28 Income Statement Approach  Focuses Focuses on on past past credit credit sales sales to to ma ma estimate estimate of of bad bad debt debt expense. . McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. expense. e e  !mphasizes !mphasizes the the matching matching principle principle b" b" estimating estimating the the bad bad debt debt expense expense associated associated #ith #ith the the current current period$s period$s credit credit sales.

Inc. .Slide 7-29 Income Statement Approach %ad debts expense is computed as follo#s: McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

99%999 and estimates that 9 <= of credit sales are uncollectible >hat is 2ad "ebts E3pense for 8990? McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc.and has credit sales of :. .Slide 7-30 Income Statement Approach In 8990% Music.

. Inc.and computes estimated 2ad "ebts E3pense of :8%.99 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.Slide 7-31 Income Statement Approach Music.

Inc. &nvolves the direct computation of the desired balance in the allo#ance for uncollectible accounts. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.Slide 7-32 %alance Sheet Approach Focuses on the collectibilit" of accounts receivable to ma e the estimate of uncollectible accounts. .

Inc. .Slide 7-33 %alance Sheet Approach Composite Rate  Compute the estimate of the Allo#ance for 'ncollectible Accounts. %ad (ebts !xpense is computed as:  McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

Slide 7-34 %alance Sheet Approach Composite Rate $n $n "ec "ec 01% 01% 8990% 8990% Music.and has has :@9%999 :@9%999 in in Accounts Accounts *ecei#able *ecei#able and and a a :899 :899 credit credit balance balance in in Allowance Allowance for for +ncollectible +ncollectible Accounts Accounts Past Past e3perience e3perience suggests suggests that that @= @= of of recei#ables recei#ables are are uncollectible uncollectible >hat >hat is is Music.and’s Music.and’s 2ad 2ad "ebts "ebts E3pense E3pense for for 8990? 8990? McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.and Music. . Inc.

Slide 7-35 %alance Sheet Approach Composite Rate "esired balance in Allowance for +ncollectible Accounts McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc. .

Slide 7-36 !ow% let’s look at the accounts recei#able aging approachA McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc. .

Inc. .Slide 7-37 %alance Sheet Approach Aging of Receivables broken brokendown downinto intoage ageclassifications classifications  Bear5end Bear5endAccounts Accounts*ecei#able *ecei#ableis is  Each Eachage agegrouping grouping has hasa adifferent different likelihood likelihoodof of being being uncollectible uncollectible amount amount  Compute Computeestimated estimateduncollectible uncollectible  Compare Compareestimated estimated uncollectible uncollectible amount amountwith withthe thebalance balancein inthe theallowance allowance account account McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

Inc. .Slide 7-38 %alance Sheet Approach Aging of Receivables At "ecember 01% 8990% the recei#ables for EastCo% Inc were categorized as follows6  McGraw-Hill/Irwin   © 2004 The McGraw-Hill Companies.

Slide 7-39 %alance Sheet Approach Aging of Receivables EastCo’s EastCo’sunadCusted unadCustedbalance balance in inthe theallowance allowanceaccount accountis is :@99  :@99 Per Perthe thepre#ious pre#iouscomputation% computation% the thedesired desiredbalance balanceis is:1%0@9 :1%0@9 Prepare the entry to record bad debts e3pense at "ec 01% 8990 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. . Inc.

Inc.Slide 7-40 %alance Sheet Approach Aging of Receivables EastCo’s EastCo’sunadCusted unadCustedbalance balance in inthe theallowance allowanceaccount accountis is :@99  :@99 Per Perthe thepre#ious pre#iouscomputation% computation% the thedesired desiredbalance balanceis is:1%0@9 :1%0@9 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. .

Inc.Slide 7-41 &ethods to Estimate %ad "ebts Income Income (tatement (tatement Approach Approach Emphasis Emphasison on Matching Matching (ales 2ad "ebts E3p 2alance 2alance(heet (heet Approach Approach Emphasis Emphasis on on *ealizable *ealizable 7alue 7alue Accts *ec All for +ncoll Accts Income Income (tatement (tatement Docus Docus McGraw-Hill/Irwin 2alance 2alance(heet (heet Docus Docus © 2004 The McGraw-Hill Companies. .

Slide 7-42 9ncollectible Accounts As accounts become uncollectible) the follo#ing entr" is made: )E!E*A. . Inc. "ate "escription Allowance for +ncollectible Accounts Accounts *ecei#able Post *ef "ebit 4444 4444 Page <E Credit (o what happens if someone pays after a write5off of the accounts recei#able? McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. -$+*!A.

)E!E*A.Slide 7-43 Collection of 2reviously :ritten! . Page <E Post *ef "ebit 4444 4444 Credit   McGraw-Hill/Irwin . -$+*!A.ff Accounts *hen a customer ma es a pa"ment after an account has been #ritten off) t#o +ournal entries are required. "ate "escription Accounts *ecei#able Allowance for +ncollectible Accounts Cash Accounts *ecei#able 4444 4444 © 2004 The McGraw-Hill Companies. Inc.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.#ithout .Slide 7-44 "irect :rite!off &ethod &f &f uncollectible uncollectible accounts accounts are are immaterial) immaterial) bad bad debts debts are are simpl" simpl" recorded recorded as as the" the" occur occur .#ithout the the use use of of an an allo#ance allo#ance account-. Inc. . account-.

Slide 7-45 . Inc.otes Receivable .et’s mo#e to a new challenge McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. .

Inc.otes Receivable P*$MI(($*B !$TE :8%999 Dace 7alue "ue "ate Payee "ate of !ote (ept 09% 8990 "ate (i3ty days after date Principal I promise to pay to the order of National Ban Boston.Slide 7-46 . . M! Two thousand and noF199555555555555555555555555555555555555 "ollars plus interest at the annual rate of Interest *ate McGraw-Hill/Irwin 18= Maker "anet #ee © 2004 The McGraw-Hill Companies.

Inc.Slide 7-47 Interest Computation E#en E#enfor for maturities maturitiesless less than than1 1year% year% the therate rateis is annualized annualized McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. .

n November /) 0110) *inn) &nc. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. Inc.Slide 7-48 Interest!%earing .and November /) 0116."ear8end. . 7repare the +ournal entr" on November /) 0110) (ecember 6/) 0110) . 4he note bears interest at /05 and is due on November /) 0116.otes . loans 203)111 to *est#ard) Co.

Inc. .Slide 7-49 Interest!%earing .otes McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.

Inc.otes :8@%999 :8@%999 G G 18= 18=H H :0%999 :0%999 55 :@99 :@99 H H :8%@99 :8%@99 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.Slide 7-50 Interest!%earing . .

 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.oninterest!%earing . Cash proceeds equal face value of note less discount. Interest is deducted 4discounted5 from the face value of the note.otes   Actually do bear interest. Inc. .Slide 7-51 .

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.n . sale.oninterest!%earing . 0116.n 9anuar" 9anuar" /) /) 0116) 0116) *inn) *inn) &nc. . 4he 4he note note is is discounted discounted at at /05 /05 and and is is due due on on (ecember (ecember 6/) 6/) 0116. Inc.Slide 7-52 . accepted accepted a a 203)111 203)111 noninterest8bearing noninterest8bearing note note from from *est#ard) *est#ard) Co Co as as pa"ment pa"ment for for a a sale. &nc. 7repare 7repare the the +ournal +ournal entries entries on on 9anuar" 9anuar" /) /) 0116) 0116) and and (ecember (ecember 6/) 6/) 0116.otes . 0116.

Slide 7-53 . Inc. . "ate 8990 -an 1 !otes *ecei#able "iscount on !otes *ecei#able (ales *e#enue :8@%999 G 18= H :0%999 "ec 01 Cash "iscount on !otes *ecei#able Interest *e#enue !otes *ecei#able McGraw-Hill/Irwin Page @< Post *ef "ebit 8@%999 0%999 88%999 Credit "escription 8@%999 0%999 0%999 8@%999 © 2004 The McGraw-Hill Companies.otes )E!E*A.oninterest!%earing . -$+*!A.

transferred. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.Slide 7-54 <inancing :ith Receivables :ecured :ecured borro#ing borro#ing or or :ale :ale of of receivables receivables Method Method depends depends on on the the surrender surrender of of control control over over the the receivables receivables transferred. Inc. .

Accounts Accounts Receivable Receivable Assigned. Inc. Assigned. .  Reclassif" Reclassif" Accounts Accounts Receivable Receivable as as McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. debt.Slide 7-55 Secured %orro ing ( Assigning  4he 4he use use of of specific specific receivables receivables for for collateral) collateral) and and the the promise promise that that an" an" failure failure to to repa" repa" debt debt #ill #ill result result in in proceeds proceeds from from specific specific accounts accounts receivable receivable collections collections being being used used to to repa" repa" the the debt.

Inc. statements. .Slide 7-56 Secured %orro ing ( 2ledging  Receivables Receivables in in general general are are pledged pledged as as collateral collateral for for loans.  7ledged 7ledged Receivable Receivable are are disclosed disclosed in in notes notes to to the the financial financial statements. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. loans.

nt s * ec . Inc.Slide 7-57 Sale of Accounts Receivable (+PP. @ C as ei #a bl e C .E* 1 Merchandise ou as h h DACT$* &Transferee' A A factor factor is is a a financial financial institution institution that that bu"s bu"s receivables receivables for for cash) cash) handles handles the the billing billing and and collection collection of of the the receivables receivables and and charges charges a a fee fee for for the the service.IE* &Transferor' 0 A cc 8 Accounts *ecei#able *ETAI. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. service.

. receivables. maturity. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.Slide 7-58 Sale of Accounts Receivable =reat =reat as as a a sale sale if if all all of of these these conditions conditions are are met3 met3  Receivables Receivables are are isolated isolated from from transferor. Inc. receivables. > =ransferor =ransferor cannot cannot repurchase repurchase receivable receivable before before maturity.  =ransferor =ransferor does does not not have have control control over over the the receivables. > =ransferor =ransferor cannot cannot require require return return of of specific specific receivables. receivables.  =ransferee =ransferee has has right right to to pledge pledge or or e$change e$change receivables. transferor.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. factor.Slide 7-59 Sale of Accounts Receivable :ithout :ithout recourse recourse  An An ordinary ordinary sale sale of of receivables receivables to to the the factor. boo#s.  Receivables Receivables are are removed removed from from the the boo#s.  Control Control of of receivable receivable passes passes to to the the factor. Inc. recogni?ed. uncollectibility. cash cash is is received received and and a a financing financing e$pense e$pense or or loss loss is is recogni?ed.  <actor <actor assumes assumes all all ris# ris# of of uncollectibility. factor. .

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies. sale. sale. it it ill ill be be treated treated as as a a secured secured borro borro ing. ing. .  &ust &ust meet meet the the three three conditions conditions of of determining determining surrender surrender of of control control to to be be recogni?ed recogni?ed as as a a sale. Inc.Slide 7-60 Sale of Accounts Receivable :ith :ith recourse recourse  =ransferor =ransferor 4seller5 4seller5 retains retains ris# ris# of of uncollectibility. uncollectibility.  If If the the transaction transaction fails fails to to meet meet the the three three conditions conditions necessary necessary to to be be classified classified as as a a sale.

1 da"s.. . borro#ing. 7repare 7repare the the +ournal +ournal entr" entr" to to record record the the discounting discounting of of the the note note receivable receivable as as a a secured secured borro#ing. da"s. 4he 4he note note #as #as dated dated Ma" Ma" / / and and matures matures in in .1 . McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies.n .Slide 7-61 "iscounting a . Inc. note. 4he 4he receivable receivable bears bears interest interest at at /05 /05 and and the the ban ban charges charges a a discount discount of of /35 /35 on on the the maturit" maturit" value value of of the the note.n Ma" Ma" 6/) 6/) Apex Apex discounts discounts a a customer$s customer$s 203)111 203)111 note note receivable receivable at at the the ban ban .ote .

ote )E!E*A.Slide 7-62 "iscounting a . -$+*!A. "escription Credit . Inc. "ate May 01 Cash !otes *ecei#able Interest *e#enue McGraw-Hill/Irwin Page <E Post *ef "ebit 8@%19< 8@ 8@%999 99 19< 8@ © 2004 The McGraw-Hill Companies.

. Inc.Slide 7-63 "iscounting a .ote &f &f the the three three conditions conditions for for sale sale treatment treatment are are met) met) the the transaction transaction #ould #ould be be accounted accounted for for as as a a sale) sale) recognizing recognizing a a gain gain or or loss loss for for the the difference difference bet#een bet#een the the cash cash proceeds proceeds and and the the boo boo value value of of the the note. 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.