CHAPTER 5

CASH AND
RECEIVABLES
Nature of Cash and
Cash Control
 Nature of cash
• Cash is the standard medium of exchange and the basis for
measuring and accounting for all other items.
• Negotiable instruments (i.e., money orders, certified checks,
cashier’s checks, personal checks, and bank drafts) are viewed as
cash.
• Some negotiable instruments provide small investors with an
opportunity to earn interest.
• These items, more appropriately classified as temporary
investments than as cash, include:
• money market funds, money market savings certificates, certificates of
deposit (CDs)
 Cash control
• The main purpose of having internal control systems is to assure
that assets are:
• received when tendered (offered);
• protected while in the custody of the enterprise and
• used only for authorized business purposes.
• It consists of administrative control and accounting control:
Administrative controls: Promote operational efficiency ( to
ensure no authorized transactions are entered into by officers or
employees)
• Encourage adherence to prescribed managerial policies and
achieving the objectives of the organization
Accounting Controls: Ensure the protection of assets for it is
susceptible to improper diversion and use
• Ensure the accuracy and reliability of accounting data
• To have access to assets only in accordance with management's
authorization
• To maintain accountability for assets
 Internal control procedures
• It is not designed primarily to detect errors but rather to reduce the
opportunity of errors or dishonesty to occur.
• Effective system of internal control procedures should consider the
following points:
• Segregation of duties; like separating one that works on custody with
record keeper, purchaser or receiver of purchased item.
• Assignment of Responsibilities and Authorities; giving a specific
authority to a specific body can create accountability.
• Using mechanical devices and pre-numbered documents; using
cash registers, pre-numbered business forms.
• Maintaining physical safeguarding tools; for example safe boxes,
drawers with lockers, having daily deposits etc.
• Implementing periodical performance evaluation methods;
evaluating helps to take periodical corrections and to take sure
that regulations are properly implemented.
• Hiring competent employee and having computer help,
creates to have efficient and accurate record keeping and report
preparation function
• Planning (budgeting): forecasting cash necessary for future
operations such as through preparing periodic cash budgets
 Control over cash receipts
• It is required to safeguard all cash receivables is collected
and recorded without loss.
• It includes:
• Immediate counting;
• Daily recording and
• intact deposit.
 Control over cash payments
• The main objective is to ensure no authorized payments are
made.
• It includes;
• Verifying and approving payments
• E.g. using voucher system;
• Making payments by checks and
• Periodic preparation of Bank reconciliation
 Elements of internal control over cash payments

Petty cash fund: refers to a fund of fixed amount used for small
expenditures that are most conveniently paid in cash such as
• payments for taxi fare,
• postage stamps,
• minor amount of supplies etc.
• Establishment: Estimate the required amount of payment to meet
minor expenditures for specified period.
Petty Cash fund XX
Cash XX
• Operation: As each cash payment is made from the petty cash
fund, prepare a voucher or other receipts.
• No Journal entry needed.
 Cont…
• Replenishment: petty cash fund is replenished when it reaches
minimum cash balance and
• at the end of the accounting period to recognize the periodic
expenses paid from the fund and
• to report the yearend cash balance correctly.
• A check will be issued on the total amount of the vouchers to
restore the petty cash fund to its original amount.
• Journal Entries at the time of replenishment will be
Various expenses xx
Cash xx
• The cash shortage and overage ledger account is classified as
revenue when it has credit balance and as expense when it has a
debit balance.
Illustration pp81
 Cont…
Cash Change Fund: A change fund is used to facilitate the
collection of cash from customers
• Establishment: Estimate the required types and amounts
denominations.
Cash change fund xx
Cash xx
• Operation: Make the necessary changes and deduct the amount
of the change fund from the total cash money on hand at the close
of each business day to determine the daily collections.
• No Journal entry will be required.
 Cont…
Bank checking account (Reconciliation of bank balances):
Enterprises usually open checking account in a bank to have a
daily deposits of all cash collections and to make payments
from the bank by issuing checks.
• Bank reconciliation is a schedule that analyzes and explains the
difference between the ending balance of cash in a bank and
bank statement.
 Cont…
• The possible reasons for the difference between two balances
could be
• Delay in recording transactions: For example: Deposit in transit
(deposits made after the bank closes it records for the statement
period), outstanding checks (checks issued but not presented for
payment in the bank), bank service charges, collections made
bank.
• Errors or omissions in recording transactions
• The two commonly used forms of bank reconciliation are:
• Reconcile both bank balance and depositors balance to correct cash
balance (Direct method).
• Reconcile the bank balance to the balance in the depositor's record
(Indirect method) Illustration pp82
 Reconciliation of Cash Receipts and cash
payments (Proof of cash)
• It is made to establish the accuracy of the cash balance and the
effectiveness of internal controls over cash receipts and cash
payment for a selected month or a longer period.
Step 1: Reconcile cash receipts in bank statement and in depositor's
record.
Step 2: Reconcile cash payment in bank statement and in
depositor’s record.
Step 3: Reconciliation of bank and depositor cash balances.

Illustration pp85
 Cash Overdraft
• Sometimes banks allow their good customers to issue a check in
excess of the balance on their deposit
• This creates an overdraft in the bank account.
• In the rare situation in which a business enterprise maintains only
one bank account and that account is overdrawn on the balance
sheet date, the overdraft amount is reported as a current liability.
• However, if an enterprise has other accounts in the same bank with
larger positive balances, it is reasonable to present the net balance of
cash as a current asset.
• But an overdraft in an account in one bank should not be offset
against positive balances in other banks because no right of offset
exists.
 Cont…
Disclosure of compensating cash balances.
• A compensating cash balance is portion of a deposit maintained
by a depositor that constitutes support for existing borrowing
arrangements with banks.
• Disclosure of compensating balance arrangements is required
because such cash balances are not available for discretionary use
by management on the balance sheet date.
 Reporting cash
• The reporting of cash is relatively straightforward
• A number of issues merit special attention which relate to the
reporting of:
• Cash Equivalents: A current classification that has become
popular is “Cash and cash equivalents.”
• Highly liquid investments that are both
(a) readily convertible to known amounts of cash, and
(b) so near their maturity that they present insignificant risk.
• Generally, only investments with original maturities of three
months or less qualify under these definitions.
E.g. Treasury bills, commercial paper, and money market funds.
 Cont…
• Restricted Cash: Petty cash, payroll, and dividend funds are
examples of cash set aside for a particular purpose.
• In most situations, companies do not segregate them from cash
in the financial statements.
• When material in amount, companies segregate restricted
cash from “regular” cash for reporting purposes.
• Can be classified as current or long-term assets, depending on
the date of availability or disbursement.
 Cont…
• Bank overdrafts: occur when a company writes a check for
more than the amount in its cash account.
• Companies should report bank overdrafts in the current
liabilities section.
• A major exception is when available cash is present in another
account in the same bank on which the overdraft occurred.
• Offsetting in this case is required.
• If material, companies should disclose these items separately,
either on the face of the balance sheet or in the related notes.
 Recognition and Valuation of accounts
receivables
• Receivables are claims held against customers and others for
money, goods, or services.
• It can be classified as either current or noncurrent.
• Receivables are further classified in the balance sheet as either
trade or nontrade receivables.
• Customers often owe a company amounts for goods bought or
services rendered called trade receivable.
• A company may sub classify these trade receivables into
• accounts receivable and
• notes receivable.
 Cont…
• Nontrade receivables arise from a variety of transactions.
Some examples of nontrade receivables are:
• Advances to officers and employees.
• Advances to subsidiaries.
• Dividends and interest receivable etc
• Because of the peculiar nature, companies generally report
them as separate items in the balance sheet.
 Recognition of accounts receivables

• In most receivable transactions, the amount to be recognized

is the exchange price between the two parties.
• Two factors may complicate the measurement of the exchange
price:
(1) the availability of discounts (trade and cash discounts), and
(2) the length of time between the sale and the due date of
payments.
 Cont…
Trade Discounts
• Prices may be subject to a trade or quantity discount.
• Trade discounts are commonly quoted in percentages.
• The manufacturer, per normal practice, simply deducts the
trade discount from the list price and bills the customer net.
• For example, say your cell phone has a list price of $90, and
the manufacturer sells it to Best Buy for list less a 30 percent
trade discount. The manufacturer then records the receivable
at $63 per phone.
 Cont…
Cash Discounts (Sales Discounts)
• Companies offer cash discounts (sales discounts) to induce
prompt payment.
• Cash discounts generally presented in terms such as 2/10,
n/30 or 2/10, E.O.M.
• Companies usually take sales discounts unless their cash is
severely limited. Why?
• A company that receives a 1 percent reduction in the sales
price for payment within 20 days, total payment due within
30 days, effectively earns 18.25 percent (.01 / [20/365]), or
at least avoids that rate of interest cost.
 Cont…
• There is two methods for recording cash discount namely gross
and net method.
E.g., Sales of $10,000, terms 2/10, n/30
• Payment on $4,000 of sales received within discount period
• Payment on $6,000 of sales received after discount period
 Valuation of Accounts Receivable

• Companies value and report short-term receivables at net

realizable value—the net amount they expect to receive in cash.
Uncollectible Accounts Receivable
• This losses are a normal and necessary risk of doing business on a
credit basis.
• Two methods are used in accounting for uncollectible accounts:
(1) the direct write-off method and
(2) the allowance method.
 Cont…
1. Direct Write-Off Method for Uncollectible Accounts
• Under the direct write-off method, when a company determines a
particular account to be uncollectible, it charges the loss to Bad
Debt Expense.
• Assume, for example, that on December 10 Cruz Co. writes off as
uncollectible Yusado’s $8,000 balance. The entry is:
Bad Debt Expense 8,000
Accounts Receivable (Yusado) 8,000
(To record write-off of Yusado account)

• Supporters of the direct write-off-method (which is often used for

tax purposes) contend that it records facts, not estimates.
 Cont…
• It is theoretically deficient: It usually fails to record expenses
in the same period as associated revenues.
• As a result, using the direct write-off method is not
considered appropriate, except when the amount
uncollectible is immaterial.
 Cont…
2. Allowance Method for Uncollectible Accounts
• The allowance method of accounting for bad debts involves
estimating uncollectible accounts at the end of each period.
• This ensures that companies state receivables on the balance sheet
at their net realizable value.
• The FASB considers the collectability of receivables a loss
contingency.
• Thus, the allowance method is appropriate in situations where it
is probable that an asset has been impaired and that the amount of
the loss can be reasonably estimated.
 Cont…
• The FASB requires the allowance method when bad debts are
material in amount.
• This method has three essential features:
• Companies estimate uncollectible accounts receivable.
• Companies debit estimated uncollectibles to Bad Debt Expense
and credit them to Allowance for Doubtful Accounts.
• When companies write off a specific account, they debit actual
uncollectibles to Allowance for Doubtful Accounts and credit
that amount to Accounts Receivable.
Example pp 92
 Bases Used for Allowance Method
• Companies must estimate that amount when they use the
allowance method.
• Two bases are used to determine this amount:
(1) percentage of sales (income statement) , and
(2) percentage of receivables.
• Both bases are generally accepted.
• The choice is whether to emphasize income statement or balance
sheet relationships.
 Cont…
Percentage-of-sales approach: management estimates what
percentage of credit sales will be uncollectible.
• This percentage is based on past experience and anticipated credit
policy.
• To illustrate, assume that Gonzalez Company elects to use the
percentage-of-sales basis. It concludes that 1% of net credit sales
will become uncollectible. If net credit sales for 2012 are
$800,000, record the adjusting entry.
Bad Debt Expense 8,000
Allowance for Doubtful Accounts 8,000
 Cont…
Percentage-of-receivables approach: Estimate the percentage of its
outstanding receivables that will become uncollectible.
• This procedure provides a reasonably accurate estimate of the
receivables’ realizable value.
• But, it does not fit the concept of matching cost and revenues.
• Rather, it simply reports receivables in the statement of financial
position at net realizable value.
• Companies may apply this method using one composite rate or set up
an aging schedule of accounts receivable.
• An aging schedule identifies which accounts require special attention
by indicating certain accounts are past due.
Illustration pp95
Recognition and Valuation
of notes receivables
• A note receivable is supported by a formal promissory note, a
written promise.
• Although all notes contain an interest element, companies
classify them as interest-bearing or non-interest-bearing.
• Companies frequently accept notes receivable from customers
who need to extend the payment period of an outstanding
receivable.
• Or they require notes from high-risk or new customers.
 Recognition of notes receivables

• Companies generally record short-term notes at face value

because the interest implicit in the maturity value is
immaterial.
• A general rule is that notes treated as cash equivalents are not
subject to premium or discount amortization.
• However, companies should record and report long-term notes
receivable at the present value of the cash they expect to
collect.
 Valuation of notes receivables
• Companies record and report short-term notes receivable at their
net realizable value.
• Companies estimate the amount of uncollectibles by using either
a percentage-of-sales revenue or an analysis of the receivables.
• The FASB requires that for financial instruments such as
receivables, companies disclose not only their cost but also their
fair value in the notes to the financial statements.
Impairments A note receivable is considered impaired when it is
probable that the creditor will be unable to collect all amounts
due (both principal and interest).
• A loss is recorded for the amount of the impairment.
 Special Issues Related to receivables

Fair Value Option

• Recently, the FASB has given companies the option to use fair
value for most financial instruments, including receivables.
• If companies choose the fair value option, the receivables are
recorded at fair value, with unrealized holding gains or losses
reported as part of net income.
Illustration pp97
 Disposition of Accounts and
Notes Receivable
• In order to accelerate the receipt of cash from receivables, the owner
may transfer accounts/notes receivables to another company for cash.
There are various reasons for this early transfer.
• First, for competitive reasons, providing sales financing for customers
is virtually mandatory when most sales are on an installment contract
basis.
• Many major companies in these industries have created wholly-owned
subsidiaries specializing in receivables financing.
• Second, the holder may sell receivables because money is tight
and access to normal credit is unavailable or too expensive.
• Finally, billing and collection of receivables are often time-
consuming and costly.
 Cont…
• The transfer of receivables to a third party for cash happens in one of
two ways: Secured borrowing and Sales of receivables.
Secured Borrowing
• A company often uses receivables as collateral in a borrowing
transaction.
• If the loan is not paid when due, the creditor can collect the
receivables.
Illustration pp 98
Sales of Receivables
• A common type is a sale to a factor.
• Factors are finance companies or banks that buy receivables from
businesses for a fee and then collect the remittances directly from the
customers.
Cont…
 Cont…
• A company sells receivables on either a without recourse or a
with recourse basis.
• Sale without Recourse. When buying receivables without
recourse, the purchaser assumes the risk of collectibility and
absorbs any credit losses.
• The transfer of accounts receivable in a nonrecourse transaction is
an outright sale of the receivables both in form (transfer of title)
and substance (transfer of control).
Illustration pp99
 Cont…
• Sale with Recourse. the seller guarantees payment to the
purchaser in the event the debtor fails to pay.
• To record this type of transaction, the seller uses a financial
components approach, because the seller has a continuing
involvement with the receivable.

Illustration pp100
Secured borrowing versus sale
 Presentation of Receivables
The general rules in classifying receivables are:
• Segregate the different types of receivables that a company possesses,
if material.
• Appropriately offset the valuation accounts against the proper
receivable accounts.
• Determine that receivables classified in the current assets section will
be converted into cash within the year or the operating cycle,
whichever is longer.
• Disclose any loss contingencies that exist on the receivables.
• Disclose any receivables designated or pledged as collateral.
• Disclose the nature of credit risk inherent in the receivables.
The end