Chapter 7 Financial Assets Chapter 7: Financial Assets

How Much Cash Should a Business Have? Every business needs enough cash to pay its bills! $ How much cash should a business have? Every business needs enough cash to pay its bills. However, a business that has too much cash on hand is losing the ability to earn a return by investing their cash.

How Much Cash Should a Business Have? Financial Assets Financial assets include cash, short-term investments, and receivables. Businesses manage the amounts in each of these categories to ensure they have enough cash to pay their bills and earn a return when possible. Receivables Cash Short-term Investments

How Much Cash Should a Business Have? Accounts receivable Marketable securities (short-term investments) Cash (and cash equivalents) Collections from customers Cash payments “Excess” cash is invested temporarily Investments are sold as cash is needed Cash needs can be met by collections on accounts receivable and by selling investments. Because most accounts receivable have payment due dates, businesses know when to expect payments from customers on their accounts. Businesses use this timetable for expected payments to help plan for future cash needs. When a business has excess cash on hand, it is typically invested. If the cash will be needed in the near future, then short-term investments are made. Some businesses have enough excess cash on hand to warrant overnight investing. Investing in short-term investments helps a business use its excess cash to earn a return until the cash is needed. Then the short-term investment is sold, and the cash is available for use.

The Valuation of Financial Assets On the balance sheet, cash and cash equivalents are reported at their face amount. Short-term investments are reported at their current market value. Accounts receivable are reported at their net realizable value. Net realizable value is the amount of the accounts receivable the business estimates it will actually collect. Now, let’s see what is included in the cash category. Estimated collectible amount

Cash is defined as any deposit banks will accept. Examples of Cash Coins and paper money Checks Cash is defined as any deposit banks will accept. Bank credit card sales Money orders Cash includes much more than what we typically think of as currency. It includes the typical items such as paper money and coins, but it also includes bank credit card sales, travelers’ checks, money orders, and checks. Cash is defined as any deposits banks will accept. Travelers’ checks

Reporting Cash in the Balance Sheet Combined with cash on balance sheet Cash Equivalents Matures within 90 days of acquisition Liquid short-term investments Cash equivalents are short-term investments, usually with a maturity date of less than three months, that have little risk of market value changes. Cash equivalents are combined with cash on the balance sheet. Stable market values

Reporting Cash in the Balance Sheet Not available for paying current liabilities Restricted cash is cash that has been set aside for a particular use and is not available for paying current liabilities. Restricted cash is not a current asset, rather it is classified as an investment on the balance sheet. “Restricted” Cash Not a current asset Listed as an investment

Reporting Cash in the Balance Sheet Bank agrees in advance to lend money. Lines of Credit A line of credit is an agreement between a bank and a business where the bank agrees in advance to lend a specific amount of money to the business. When the business borrows from the line of credit, the business receives cash and incurs a liability. The business can continue to borrow up to the limit on the line of credit. The business can also make a payment to reduce the liability at any time. Any unused line of credit must be disclosed in the notes to the financial statements. Liability is incurred when line of credit is used. Unused line of credit is disclosed in notes.

Cash Management – Basic Objectives Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Prevent unnecessarily large amounts of idle cash. Cash management is a comprehensive system that helps accurately account for cash, helps prevent theft of cash and fraud, helps assure the availability of adequate amounts of cash, and helps avoid having unnecessarily large amounts of idle cash on hand. Many businesses have large departments that have the responsibility of properly managing the business’s cash needs.

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. Cash not needed for business purposes may be distributed to the company’s stockholders. Excess cash, not currently needed by a business, can be used efficiently by investing it to earn a return or by returning it to the stockholders through a dividend.

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. An internal control system is a collection of policies and procedures that protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies. Because Cash is easily susceptible to theft, the internal controls over Cash are extremely important. Internal controls for cash include Segregation of duties such as authorization, custody, and recording of cash transactions. Preparing a cash budget. Preparing a control listing of cash receipts. Requiring daily deposits. Making all payments by check. Verifying every expenditure before payment, and Promptly reconciling bank statements.

Cash Over and Short On May 5, XBAR, Inc.’s cash drawer was counted and found to be $10 over. When a cash drawer is over or short, the account Cash Over and Short is used to record the difference. Management monitors the balance in the Cash Over and Short account to determine if there is a problem with cash shortages or overages. The account is debited for cash shortages and credited for cash overages. Cash Over and Short is debited for shortages and credited for overages.

Bank Statements Shows the beginning bank balance, deposits made, checks paid, other debits and credits in the month, and the ending bank balance. Companies, as well as anyone who has a personal bank account, should prepare a bank reconciliation on a regular basis. Because humans are involved in business and personal accounting, it’s likely that errors may occur, and a bank reconciliation helps identify these errors and how to correct them. Bank Statement

Reconciling the Bank Statement Explains the difference between cash reported on bank statement and cash balance in depositor’s accounting records. The bank reconciliation explains the difference between Cash reported on the bank statement and Cash recorded in the ledger account. Why are the balances different on the bank statement and on the Cash ledger? Because of timing differences. Let’s look at how to prepare a bank reconciliation in more detail. It also provides information for reconciling journal entries.

Reconciling the Bank Statement Balance per Bank Balance per Depositor + Deposits by Bank (credit memos) + Deposits in Transit - Service Charge - NSF Checks - Outstanding Checks There are two sides to a bank reconciliation. The bank side starts with the balance on the bank statement and is adjusted for deposits in transit, outstanding checks, and errors made by the bank. The book side begins with the Cash balance in the ledger and is adjusted for collections made by the bank on the company’s behalf, interest earned, bank service charges, customer checks drawn on accounts that were insufficient, and errors made. Examples of collections made by the bank on a company’s behalf are when the bank acts as a collection box for customer payments or when the bank collects a note receivable from a customer. ± Bank Adjustments ± Book Adjustments = Adjusted Balance = Adjusted Balance

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 All reconciling items on the book side require an adjusting entry to the Cash account. Now, let’s look at an example of a bank reconciliation. ± Book Adjustments = Adjusted Balance

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. On July 31st, Simmons Company’s bank statement listed a balance of nine thousand six hundred ten dollars. Their Cash account had a balance on that date of seven thousand four hundred thirty dollars. Additional information necessary for the reconciliation is shown on the next screen.

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. Take a minute and read over these six items before proceeding. As you read each item, determine if it is a bank reconciling item or a book reconciling item. Each one will be discussed on the next slide.

Now lets look at what a finished Bank Statement looks like!

Reconciling the Bank Statement First, let’s start with the bank side. Begin with the given balance on the bank statement. Add deposits in transit of five hundred dollars. These are deposits that were made that do not appear on the bank statement. Next, the bank made a mistake and added Acme Company’s deposit to our account. As a result, we must subtract the erroneous four hundred eighty-six dollars. We also need to subtract the outstanding checks of two thousand four hundred seventeen dollars. These are checks that have been written but that had not cleared the bank by the bank statement date. After these adjustments, the adjusted bank balance is seven thousand two hundred seven dollars. Next, it’s time for the book side. Start with the given Cash balance from the ledger. Add the thirty dollars of interest earned on the bank account. A recording error of twenty-eight dollars was made when check number seven eighty one was recorded. The entry was made for twenty-eight dollars less than the actual amount of the check. To correct this error, subtract twenty-eight dollars from the book balance. Next, a check that was accepted from a customer turned out to be drawn on an account that did not have sufficient funds. When the check was received it increased our cash balance, so now two hundred twenty-five dollars must be subtracted from our cash balance. After these adjustments, the adjusted book balance is seven thousand two hundred seven dollars. Let’s look at the journal entries required.

Reconciling the Bank Statement Entries are only made for items on the book side of the reconciliation. First, debit Cash and credit Interest Revenue for the amount of the revenue earned. Second, debit Supplies Inventory and Accounts Receivable and credit Cash. The debit to Supplies Inventory is to correct the error made earlier. The debit to Accounts Receivable creates an account for the amount of the insufficient fund check received from a customer.

Used for minor expenditures. Replenished periodically. Petty Cash Funds Used for minor expenditures. Petty Cash Funds Sometimes, a quick disbursement is needed for an immediate need. Trying to go through all of the approval processes needed to have a check prepared is too time consuming, so companies usually keep a petty cash amount on hand to use for small, immediate needs. Has one custodian. Replenished periodically.

To Create a Establish a Petty Cash Fund ****When you replenish the fund. The entry made DOES NOT include the petty cash account.***** ****Petty Cash is only used to create, increase or decrease the fund.****

Replenishing Petty Cash The custodian of the account makes all payments from this fund and prepares a Petty Cash Voucher. At the end of the period or when the fund runs low, a check is drawn payable to Petty Cash to replenish the fund for the expenditures made during the period. (Assume that $50 is left at the end of the period). Miscellaneous Expense 120 Office Supplies 20 Delivery Expense 10 Cash 150

Short-Term Investments Bond Investments Capital Stock Investments Marketable Securities are . . . Readily Marketable Current Assets Short-term investments are investments in bonds or stocks that are readily marketable. They are classified as current assets on the balance sheet. Almost As Liquid As Cash

Accounting for Marketable Securities Purchase of investment Receipt of a dividend Sales of securities owned End-of-period mark-to-market adjustments

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. 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. The entry to record this purchase is a debit to Marketable Securities and a credit to Cash for $176,000. The cost of the securities includes the price per share of $43.98 plus the $80 brokerage commission. Thus, the cost per share for the 4,000 securities is $44. Total Cost: (4,000 × $43.98) + $80 = $176,000 Cost per Share: $176,000 ÷ 4,000 = $44.00

Recognition of Investment Revenue On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000 shares of Coca-Cola. On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000 shares of Coca-Cola. The entry to record this dividend is a debit to Cash and a credit to Dividend Revenue for $1,200. The dividend amount is calculated as 4,000 shares time 30 cents per share. 4,000 × $0.30 = $1,200

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. On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission. The entry to record this sale includes a debit to Cash for $23,000 (500 shares times $46.04 minus the $20 commission) and a credit to Marketable Securities for $22,000 (500 times $44 cost basis) and a credit to Gain on Sale of Investment for $1,000 (the difference between the sales proceeds and the cost basis). The gain increases net income and is closed to Income Summary at the end of the period. If cash proceeds is less than the cost basis, the investments are sold at a loss. A loss is recorded as a debit to Loss on Sale of Investments. This account reduces net income and is closed to Income Summary at the end of the period. Sales Proceeds: (500 × $46.04) - $20 = $23,000 Cost Basis: 500 × $44 = $22,000 Gain on Sale: $23,000 - $22,000 = $1,000

Sales of Investments Now suppose Foster sold those 500 shares for $43 per share, less brokerage commission of $20 – Resulting in a LOSS On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission. The entry to record this sale includes a debit to Cash for $23,000 (500 shares times $46.04 minus the $20 commission) and a credit to Marketable Securities for $22,000 (500 times $44 cost basis) and a credit to Gain on Sale of Investment for $1,000 (the difference between the sales proceeds and the cost basis). The gain increases net income and is closed to Income Summary at the end of the period. If cash proceeds is less than the cost basis, the investments are sold at a loss. A loss is recorded as a debit to Loss on Sale of Investments. This account reduces net income and is closed to Income Summary at the end of the period. Sales Proceeds: (500 × $43) - $20 = $21,480 Cost Basis: 500 × $44 = $22,000 Loss on Sale: $21,480 - $22,000 = $520

Adjusting Marketable Securities to Market Value 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). Securities classified as available for sale are presented in the balance sheet at their current market value as of the balance sheet date. Hence, this valuation principle is often called mark-to-market. The adjustment of marketable securities to their current market value requires the use of an account entitled Unrealized Holding Gain (or Loss) on Investments. This account appears as a special stockholders’ equity account in the balance sheet. 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). The entry to record the current market value includes a debit to Unrealized Holding Loss on Investments and a credit to Marketable Securities for $2,000. The unrealized loss is the difference between the current market value of $42,000 and the cost basis of the shares of $44,000. The Unrealized Holding Loss on Investments account will appear on the balance sheet in the stockholders’ equity section as a reduction in equity. An Unrealized Holding Gain on Investment would appear in the same section but as a addition to equity. Unrealized Loss: $42,000 - $44,000 = ($2,000)