Cash and Receivables C hapter 7

Number and Value of Noncash Payments

3  Accounts receivable conversion (ARC) –Paper checks received at the bank lockbox are converted into automated clearing house debits and then the check is destroyed. –ARC payments are about one-third cheaper than paper checks. –Float time is cut in half.  Check Clearing for the 21 st Century Act (Check 21) –Gives legal status to substitute checks –Allows merchants to scan and transmit checks to the bank Electronic Banking

4 Cash is the resource on hand to meet planned payments and emergency situations. Cash

Excluded from Cash 5 Cash Coins and currency Checking accounts Savings accounts Negotiable checks Bank drafts Included in Cash Certificates of deposit Bank overdrafts Postdated checks Travel advances Postage stamps

6 Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and so near their maturity that there is little risk of changes in value because of changes in interest rates. Cash Equivalents

7 Those receivables expected to be collected or satisfied within one year or the current operating cycle, whichever is longer, are classified as current assets; the remainder are classified as noncurrent. Receivables

8

9 1.The sales price is known at the date of sale. 2.The buyer has paid or will pay the seller, and the obligation is not contingent upon the resale of the product. 3.The buyer’s obligation to the seller would not be changed by theft or damage to the product. Each of the following criteria must be satisfied when the right of return exists in order to recognize revenue at the time of sale. Receivables

10 4.The buyer has an economic substance apart from the seller. 5.The seller does not have significant obligations to help the buyer sell the product. 6.The seller can reasonably estimate the amount of future returns. Receivables Each of the following criteria must be satisfied when the right of return exists in order to recognize revenue at the time of sale.

11 Sales Discounts  Increase sales  Encourage prompt payment  Increase likelihood of collection

12 A 2% discount may be subtracted from the invoice price if payment is made within 10 days, otherwise the total amount is due within 30 days (net of returns and allowances). 2/10, n/30 Calculation of Sales Discounts

13 Sales Returns and Allowances  When goods are sold that are found to be defective, the customer may retain the goods and be allowed a reduction in the purchase price. This reduction is called a sales allowance.  When the customer returns good to the seller, the exchange is called a sales return.

14 Loss Contingencies 1.Information available prior to the issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements. 2.The amount of the loss can be reasonably estimated. 1.Information available prior to the issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements. 2.The amount of the loss can be reasonably estimated.

15 1.Relationship to sales (income statement approach): Percentage of sales Percentage of net credit sales 2.Relationship to accounts receivable (balance sheet approach): Percentage of outstanding accounts receivable Aging of accounts receivable Estimated Bad Debts Method

16 Percentage of Sales If a company’s net credit sales during the year were $525,000 and bad debts have historically amounted to 2% of net credit sales, what is the required year-end adjusting entry? Bad Debt Expense10,500 Allowance for Doubtful Accounts10,500 Estimated Bad Debts Method $525,000 × 0.02

17 Percentage of Outstanding Accounts Receivable If a company has determined that historically there has been a 4% relationship between actual bad debts and the year-end accounts receivable balance ($475,000), what would be the required year-end adjusting entry? Allowance for Doubtful Accounts 4,500 (current balance) $475,000 x 0.04 = $19,000 Estimated Bad Debts Method

18 Percentage of Outstanding Accounts Receivable Allowance for Doubtful Accounts 4,500 (current balance) 19,000 (required ending balance) 14,500 (required adjustment) If a company has determined that historically there has been a 4% relationship between actual bad debts and the year-end accounts receivable balance ($475,000), what would be the required year-end adjusting entry? Estimated Bad Debts Method 14,500 (required adjustment)

19 Percentage of Outstanding Accounts Receivable If a company has determined that historically there has been a 4% relationship between actual bad debts and the year-end accounts receivable balance ($475,000), what would be the required year-end adjusting entry? Bad Debt Expense14,500 Allowance for Doubtful Accounts 14,500 Estimated Bad Debts Method

20 Aging of Accounts Receivable 1.Review the unpaid invoices in each customer’s account. 2.Classify the invoice amounts according to the length of time the invoice has been outstanding. 3.Multiply the total amount in each age group by the applicable estimated uncollectible percentage. 4.Make a journal entry to bring the balance in Allowance for Doubtful Accounts to the amount calculated in Step 3.

Aging of Accounts Receivable 21

22 × 2 × 8 × 15 × 30 × 50 % Under 60 days$ 53,500 60–120 days34, –240 days3, –360 days15,700 Over 1 year 14,500 $121,800 Age Estimated Percentage Uncollectible Estimated Amounts Uncollectible = $ 1,070 = 2,760 = 540 = 4,710 = 7,250 $16,330 Aging of Accounts Receivable

23 If the firm has a current $1,350 debit balance, the required adjusting entry would be: Allowance for Doubtful Accounts 1,350 (current balance) 17,680 (required adjustment) 16,330 (required ending balance) Aging of Accounts Receivable

24 Bad Debt Expense17,680 Allowance for Doubtful Accounts17,680 If the firm has a current $1,350 debit balance, the required adjusting entry would be: Aging of Accounts Receivable $16,330 + $1,350

25 Writing Off Uncollectibles Allowance for Doubtful Accounts 8,750 Accounts Receivable 175,000 A customer’s account totaling $1,000 is determined to be uncollectible. Allowance for Doubtful Accounts1,000 Accounts Receivable1,000 Net realizable value = $166,250 1,000

26 Net Realizable Value Accounts receivable Less: Allowance for doubtful accounts Net realizable value Before Write-off After Write-off $175,000 (8,750) $166,250 $(1,000) 1,000 $174,000 (7,750) $166,250

27 Collection of an Account Previously Written Off Later, a payment for $300 is received from the account that was written off in the previous slide. Accounts Receivable300 Allowance for Doubtful Accounts300 Cash300 Accounts Receivable300

28 Accounts Receivable Financing Agreements 1.Pledging 2.Assigning 3.Factoring 1.Pledging 2.Assigning 3.Factoring There are three basic forms of financing agreements to obtain cash from accounts receivable.

29 When a company pledges its accounts receivable, it is using these accounts as collateral for a loan, and the servicing activities remain its responsibility. Pledging

30 When a company assigns its accounts receivable to a financial institution, it enters into a lending agreement with the institution to receive cash on specific customer accounts. Assignment

31 When a company factors its accounts receivable, it sells individual accounts to a financial institution (called a factor). Factoring

32 Credit Card Sales  Many retail companies accept national credit cards, such as VISA, MasterCard, American Express, and Diner’s Club.  The retailer either deposits the credit card receipts at the bank or receives an electronic transfer of funds from the credit card company.  The retailer is assessed a service charge by the credit card company.  This charge is accounted for as an operating expense.

33 Credit Card Sales Assume that Kerns Shoes sold $1,500 of merchandise on credit, which was billed to a national credit card company. If the collection fee is 5%, Kerns makes the following journal entry: Cash1,425 Credit Card Expense75 Sales1,500