Cash, Short-term Investments And Accounts Receivable Chapter 4 Cash, Short-term Investments And Accounts Receivable Chapter 4

Chapter 4: Objectives Account for the major types of transactions involving cash, short-term investments, and accounts receivable. Prepare a bank reconciliation and related entries. Estimate and record bad debts for accounts receivable. Use ratios and other analysis techniques to make decisions about cash, short-term investments, and accounts receivable. Chapter 4

Cash and Cash Equivalents To qualify as a cash equivalent, an item must be readily convertible into a specific amount of cash and have very little risk of a change in value from the time it is acquired to the time it is changed back into cash. To qualify as a cash equivalent, an item must be readily convertible into a specific amount of cash and have very little risk of a change in value from the time it is acquired to the time it is changed back into cash Chapter 4

Petty Cash Most organizations keep a limited amount of petty cash on hand (in a petty cash box, for example) to pay for small items. What issues are of concern when a petty cash fund is in use? Chapter 4

Bank Reconciliations Deposits in Transit Outstanding Checks Deposits Unknown to Firm Bank Fees NSF Checks Errors (on the part of the Bank or Firm) Chapter 4

Graphic Organizer 4.1 Categorizing items for the bank reconciliation           Graphic Organizer 4.1 Categorizing items for the bank reconciliation   Found on Bank Stmt (Adjust Cash Ledger) Found on Cash Ledger (Adjust Bank Balance) Increase Interest Earned Direct Deposits Company errors Deposits in Transit Bank Errors Decrease Service Charges NSF Charges Drafts Outstanding Checks Chapter 4

EXHIBIT 4.2 Bank Reconciliation   Book Balance Bank Balance As stated, 6/1 $6,450 As stated, 6/1 $4,343 Add: Interest earned 33 Add: Deposit in transit 3,000 Error - Lali 250 Deduct: Printing charge (20) Deduct: Outstanding checks (1,580) NSF check - Dow (360) Error - A/P amount(90) Correct balance, 6/30 Correct balance, 6/30 $6,013 $6,013 Note: Remember to make the appropriate journal entries for any adjustment to the book balance. Chapter 4

Sales Discounts Sales Returns and Allowances Accounts Receivable Sales Discounts Sales Returns and Allowances What are Contra revenue accounts? How and why are they used? Chapter 4

Uncollectable Accounts CREDIT TERMS Uncollectable Accounts Chapter 4

Recording Bad Debts Direct Write-Off Allowance Method Easy Not GAAP Violates Matching Accurate Allowance Method Not so Easy GAAP Matches Expense/Revenue Requires Estimation Chapter 4

Direct Write-Off NOT GAAP Sept. 18 Uncollectible Accounts Expense 300 Accounts Receivable - D. Duck 300 To write off account receivable. Chapter 4

Allowance Method Dec 31 Uncollectible Accounts Expense 27,000 Allowance for Uncollectible Accounts 27,000 To record an estimate for bad debts related to 2002 credit sales. Feb. 18 Allowance for Uncollectible Accounts 2,300 Accounts Receivable – Kent Pai 2,300 To write off an accounts receivable. Chapter 4

Reinstating Accounts Receivable May 15 Accounts Receivable – Kent Pai 920 Allowance for Uncollectible Accounts 920 To write on an previous write off.   May 15 Cash 920 Accounts Receivable – Kent Pai 920 Chapter 4

Credit Card Receivables   Feb. 20 Credit Cards Receivable 6,000 Sales Revenue 6,000 To record Visa sales. Feb. 22 Cash 5,850 Credit Card Expense 150 Credit Cards Receivable 6,000 To record Visa deposit and related service charge. What are the costs and benefits of accepting credit cards? Chapter 4

Financial Ratios Financial ratios are measures that express the relationship or interrelationships between, or among, two or more financial statement items. Liquidity refers to an entity's ability to finance its day-to-day operations and to pay its liabilities as they mature. Quick assets generally include cash and cash equivalents, short-term investments, and the net amount of current notes and accounts receivable. Chapter 4

Relevant Financial Ratios Quick ratio = Quick Assets ÷ Current Liabilities A/R turnover ratio = Net credit sales ÷ Average A/R Age of receivables = 360 days ÷ A/R turnover ratio Chapter 4

Alternative Method for A/R Turnover One Day’s Sales = Sales ÷ 360 days A/R turnover = Average A/R ÷ One Day’s Sales Chapter 4

Turnover Example EXHIBIT 4.5 Accounts Receivable Turnover Ratio and Age of Receivables   Net credit sales for 2002 $704,250 Accounts receivable, 1/1/02 $ 82,000 Accounts receivable, 12/31/02 $ 74,500 Average Accounts Receivable = ($82,000 + $74,500) ¸ 2 = $78,250 A/R Turnover Ratio = $704,250 ¸ $78,250 = 9 Age of Receivables = 360 days ¸ 9 = 40 days If normal credit terms are 2/10, n/30, the company is not doing a very good job of collecting its accounts receivable (in the 30 days expected). On average, the accounts are 10 days overdue. Chapter 4