C 7 Cash and Receivables hapter Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University COPYRIGHT © 2010 South-Western/Cengage Learning

Objectives Identify items of cash (and cash equivalents). Understand the importance of cash management. Discuss revenue recognition when the right of return exists. Understand the credit policies and internal control related to accounts receivable. Explain the gross and net methods to account for cash discounts. 2 2 2 4

Objectives Estimate and record bad debts using a percentage of sales. Estimate and record bad debts using an aging analysis. Explain pledging, assignment, and factoring of accounts receivable. Account for short-term notes receivable. Understand a petty cash fund (Appendix). Prepare a bank reconciliation (Appendix).

4 Show Me the Money! Cash is the lifeblood for companies, and infusions are coming more frequently from nontraditional sources. According to a recent Federal Reserve Payments Study, noncash payments grew by 4.6% over the previous three years and had a total value of $75.8 trillion. Of these noncash payments, more than two-thirds were made electronically, with debit cards being the most frequently used electronic payment type.

Show Me the Money! Debit and credit cards are used most frequently. 5 Show Me the Money! Debit and credit cards are used most frequently. The automated clearing house (ACH) is an electronic network that provides for the interbank clearing of electronic payments. ACH payments currently represent 91% of the value of all electronic payments.

Automated Clearing House (ACH) 6 Automated Clearing House (ACH) ACH payments include: Direct deposit of payroll and social security Electronic payments of bills Mortgages Utility bills Insurance premiums The conversion of checks by businesses

Number and Value of Noncash Payments

Electronic Banking Accounts receivable conversion (ARC) 8 Electronic Banking 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 21st Century Act (Check 21) Gives legal status to substitute checks Allows merchants to scan and transmit checks to the bank

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

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

Cash Equivalents 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 Management Control Over Receipts The person opening the mail or the salesperson using the cash register should count the receipts immediately. All cash receipts are recorded daily in the accounting records. All receipts are deposited daily in the company’s bank account.

Cash Management Control Over Payments Make all payments by check or electronic payment (except petty cash items) so that a record exists for every company expenditure. Authorize and sign all checks only after an expenditure is verified and approved. Periodically reconcile the cash balance in the bank statement with the company’s accounting records.

Receivables 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

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. The sales price is known at the date of sale. The buyer has paid or will pay the seller, and the obligation is not contingent upon the resale of the product. The buyer’s obligation to the seller would not be changed by theft or damage to the product. Continued

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. The buyer has an economic substance apart from the seller. The seller does not have significant obligations to help the buyer sell the product. The seller can reasonably estimate the amount of future returns.

Internal Control Procedures for Accounts Receivable Prenumbered sales invoices Separation of the sales function from the cash collection responsibilities

Sales Discounts Increase sales Encourage prompt payment Increase likelihood of collection

Calculation of Sales Discounts 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).

Alternative Methods of Accounting for Sales Discounts Sold $8,000 of merchandise to various customers on December 4, 2010, with terms of 2/10, n/EOM: Gross Price Method Net Price Method Accounts Receivable 8,000 Sales 8,000 Accounts Receivable 7,840 Sales 7,840 $8,000 – ($8,000 × 0.02)

Sales Discounts Alternative Methods of Accounting for Sales Discounts On December 13, received payment on goods originally billed at $5,500: Gross Price Method Net Price Method Cash 5,390 Sales Disc. Taken 110 Accounts Receivable 5,500 Cash 5,390 Accounts Receivable 5,390 $5,500 – ($5,500 × 0.02)

Alternative Methods of Accounting for Sales Discounts Received payment on goods billed at $1,500 on December 30 (after the discount period): Gross Price Method Net Price Method Cash 1,500 Accounts Receivable 1,470 Sales Discounts Not Taken 30 Cash 1,500 Accounts Receivable 1,500 $1,500 – ($1,500 × 0.02) Reported in “Other Items” on the income statement

Sales Discounts Alternative Methods of Accounting for Sales Discounts Year-end adjustment at the end of the period. Gross Price Method Net Price Method No entry required Accounts Receivable 20 Sales Discounts Not Taken 20

Sales Returns and Allowances 25 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.

Loss Contingencies 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. The amount of the loss can be reasonably estimated. …recorded as reductions in assets or as liabilities when both of these conditions are met. GAAP requires that estimated losses from loss contingencies be accrued against income and…

Estimated Bad Debts Method Bad debts can be estimated based on sales or on accounts receivable.

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

Estimated Bad Debts Method 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 Expense 10,500 Allowance for Doubtful Accounts 10,500 $525,000 × 0.02

Estimated Bad Debts Method 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 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? 14,500 (required adjustment) Allowance for Doubtful Accounts 4,500 (current balance) 19,000 (required ending balance) 14,500 (required adjustment)

Estimated Bad Debts Method 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 Expense 14,500 Allowance for Doubtful Accounts 14,500

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

Aging of Accounts Receivable 34 Aging of Accounts Receivable

Aging of Accounts Receivable Age Under 60 days $ 53,500 60–120 days 34,500 121–240 days 3,600 241–360 days 15,700 Over 1 year 14,500 $121,800 × 2 × 8 × 15 × 30 × 50 % = $ 1,070 = 2,760 = 540 = 4,710 = 7,250 $16,330 Estimated Percentage Uncollectible Estimated Amounts Uncollectible

Aging of Accounts Receivable 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 If the firm has a current $1,350 debit balance, the required adjusting entry would be: Bad Debt Expense 17,680 Allowance for Doubtful Accounts 17,680 $16,330 + $1,350

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

Net Realizable Value Write-off Before Write-off After Write-off 39 Net Realizable Value Write-off Before Write-off After Write-off Accounts receivable Less: Allowance for doubtful accounts Net realizable value $175,000 (8,750) $166,250 $(1,000) 1,000 $174,000 (7,750) $166,250

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 Receivable 300 Allowance for Doubtful Accounts 300 Cash 300 Accounts Receivable 300

Average Net Receivables 41 Ratio Analysis Activity Ratios Receivables turnover indicates how many times receivables are “turned over” or collected each period. Net Credit Sales Average Net Receivables

Ratio Analysis Activity Ratios 42 Ratio Analysis Activity Ratios Receivables turnover indicates how many times receivables are “turned over” or collected each period. $35,510 ($5,032 + $4,707) 2 365 7.29 = 7.29 times or 50.1 days

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

Accounts Receivable Financing Agreements 44 Accounts Receivable Financing Agreements

Financing with Accounts Receivable

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

Assignment 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 On December 1, 2010, the Trussel Company assigns $60,000 of its accounts to a finance company. The finance company advances 80% of the accounts receivable assigned less a service charge of $500. It also charges an annual interest of 12% on any outstanding loan balance. Cash 47,500 Assignment Service Charge Expense 500 Notes Payable 48,000 ($60,000 × 0.80) – $500 $60,000 × 0.80 Accounts Receivable Assigned 60,000 Accounts Receivable 60,000

Assignment On December 31, 2010, Trussel collects $10,000 on assigned accounts. This amount along with the 12% interest for 1 month is paid to the finance company. Cash 10,000 Accounts Receivable Assigned 10,000 Notes Payable 10,000 Interest Expense 480 Cash 10,480 $48,000 × 0.12 × 1/12

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

Factoring Farber Corporation sells $80,000 of accounts receivable to a factor, receives 90% of the value of the factored accounts, and is charged a 15% commission based on the gross amount of factored accounts receivable. Cash 60,000 Receivables from Factor 8,000 Factoring Expense 12,000 Accounts Receivable 80,000 ($80,000 × .90) – $12,000 $80,000 × 0.10 $80,000 × 0.15

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.

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: Cash 1,425 Credit Card Expense 75 Sales 1,500

Notes Receivable A note receivable is an unconditional written agreement to collect a certain sum of money on a specific date.

Notes Receivable Notes receivable generally have two attributes that are not found in accounts receivable.

Notes Receivable They are negotiable instruments, which means that they are legally transferable among parities and may be used to satisfy debts by the holders of these instruments. They usually involve interest, requiring the separation of the receivable into its principal and interest components.

Notes Receivable Interest-Bearing Received a $5,000, 60-day, 12% note on October 1, 2010: Notes Receivable 5,000 Sales 5,000 Received maturity value on December 1, 2010: Cash 5,100 Notes Receivable 5,000 Interest Revenue 100 $5,000 × 0.12 × 60/360

Non-Interest-Bearing Notes Receivable Non-Interest-Bearing Received a $5,100, 60-day, non-interest-bearing note on October 1, 2010: Notes Receivable 5,100 Interest Revenue 100 Sales 5,000 Received maturity value on December 1, 2010: Cash 5,100 Notes Receivable 5,100

Notes Receivable Discounted On August 31, 2010, the Kasper Corporation discounts a customer’s note at its bank at a 14% discount rate. The note was received from the customer on August 1, is for 90 days, has a face value of $5,000, and carries an interest rate of 12%.

Notes Receivable Discounted Face value of note $ 5,000.00 Interest to maturity ($5,000 × 0.12 × 90/360) 150.00 Maturity value of note $ 5,150.00 Discount ($5,150 × 0.14 × 60/360) (120.17) Proceeds $ 5,029.83 Accrued interest revenue: $50 ($5,000 × 0.12 × 30/360) Book value of note ($5,000 + $50) (5,050.00) Loss from discounting of note $ 20.17

Notes Receivable Discounted August 31, 2010 Cash 5029.83 Loss from Discounting of Note 20.17 Notes Receivable Discounted 5,000.00 Interest Revenue 50.00 October 30, 2010 Notes Receivable Discounted 5,000.00 Notes Receivable 5,000.00

Notes Receivable Discounted Assume instead that on November 2, 2010, the bank notified Kasper that the note had not been paid and also charged Kasper a $10 fee. Notes Receivable Dishonored 5,160 Notes Receivable Discounted 5,000 Notes Receivable 5,000 Cash 5,160

IFRS vs. U.S. GAAP Same Different Cash and cash equivalents 63 IFRS vs. U.S. GAAP Same Cash and cash equivalents Sales discounts Allowance for doubtful accounts Pledging, assignment, and factoring Different IFRS category loans and receivables not defined under GAAP IFRS allows receivables to be classified as “available-for-sale”

Appendix: Petty Cash An employee is appointed petty cash custodian.

Appendix: Petty Cash Petty cash vouchers are printed, prenumbered, and given to the custodian of the fund. At all times the total of the cash in the fund plus the amounts of expenditure vouchers should be equal to $500 (in this case).

Appendix: Petty Cash …the vouchers are sorted into expense categories and the remaining cash is counted. When the amount of cash in the petty cash fund becomes low at the end of accounting period,… Assume that a count at the end of the month shows $67.54 remaining in the petty cash fund.

The fund is short by $4.40 ($71.94 – $67.54). Appendix: Petty Cash The sorting of vouchers indicates the following costs were incurred during the month: Office supplies $ 34.16 Postage 178.00 Transportation 132.14 Miscellaneous 83.76 Total expenses $428.06 The fund is short by $4.40 ($71.94 – $67.54).

Appendix: Petty Cash The company records the actual expenses and the amount needed to replenish the fund. Office Supplies Expense 34.16 Postage Expense 178.00 Transportation Expense 132.14 Miscellaneous Expense 83.76 Cash Short and Over 4.40 Cash 432.46

Appendix: Bank Reconciliation 69 Appendix: Bank Reconciliation Procedures for Preparing a Bank Reconciliation Compare the deposits listed in the company’s records with the deposits shown on the bank statement. Compare the checks listed in the company’s records with the checks shown on the bank statement. Continued

Appendix: Bank Reconciliation 70 Appendix: Bank Reconciliation Procedures for Preparing a Bank Reconciliation Identify any deposits or charges made directly by the bank that are not included in the company’s records. Determine the effect of any errors. Complete the bank reconciliation.

Appendix: Bank Reconciliation Causes of the difference between the cash balance and the company’s bank statement balance: Outstanding checks Deposits in transit Charges made directly by the bank Deposits made directly by the bank Errors

Appendix: Bank Reconciliation Cash balance from company records: $6,925 Cash balance from bank statement: $7,218

Appendix: Bank Reconciliation Deposits in transit and cash received and recorded but not yet deposited total $629. Add: Receipts recorded on the company’s records but not reported on the bank statement 629 $7,847 Cash balance from bank statement $7,218

Appendix: Bank Reconciliation Outstanding checks total $516. Cash balance from bank statement $7,218 Add: Receipts recorded on the company’s records but not reported on the bank statement 629 $7,847 Deduct: Outstanding checks (516) Adjusted Cash Balance $7,331

Appendix: Bank Reconciliation Notes receivable totaling $700 and interest totaling $15 were collected by the bank. Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by the bank 715 $7,640

Appendix: Bank Reconciliation Bank service charge, $9 Cash balance from company records $6,925 Add: Notes receivable ($700) and interest ($15) collected by the bank 715 $7,640 Deduct: Bank service charge (9)

Appendix: Bank Reconciliation Customers’ checks were returned for lack of funds (NSF check), $300 Cash balance from company records $6,925 Add: Interest earned on the funds on deposit 715 $7,640 Deduct: Bank service charge (9) NSF checks (300) Adjusted Cash Balance $7,331

Appendix: Bank Reconciliation Adjusted cash balance per bank statement: $7,331 Adjusted cash balance per company records: $7,331

Appendix: Bank Reconciliation Journal Entries Cash 715 Notes Receivable (note collected) 700 Interest Revenue (interest collected) 15 Miscellaneous Expense (bank service charge) 9 Accounts Receivable (NSF check) 300 Cash 309

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