1 Cash and Receivables C hapter 6

2 1.Understand the importance of cash management. 2.Prepare a bank reconciliation. 3.Discuss revenue recognition when the right of return exists. 4.Understand the credit policies relates to accounts receivable. 5.Explain the gross and net methods to account for cash discounts. Objectives

3 6.Estimate and record bad debts using a percentage of sales. 7.Estimate and record bad debts using an aging analysis. 8.Explain pledging, assignment, and factoring of accounts receivable. 9.Account for short-term notes receivable. 10.Prepare a proof of cash. Objectives

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

5 Cash Management The person opening the mail or the sales person 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. Control Over Receipts

6 Cash Management Make all payments by check (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 statements with the company’s accounting records. Control Over Payments

7 Petty Cash First: An employee is appointed petty cash custodian. Petty Cash500 Cash500 Petty Cash500 Cash500

8 Petty Cash Second: 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).

9 Petty Cash Third: When the amount of cash in the petty cash fund becomes low and/or 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 vouchers are sorted into expense categories and the remaining cash is counted.

10 Petty Cash The sorting of vouchers indicated the following costs were incurred during the month: Office supplies$ Postage Transportation Miscellaneous Total expenses$ The sorting of vouchers indicated the following costs were incurred during the month: Office supplies$ Postage Transportation Miscellaneous Total expenses$ The fund is short $4.40 ($ $67.54).

11 Petty Cash The company records the actual expenses and the amount needed to replenish the fund. Office Supplies Expense34.16 Postage Expense Transportation Expense Miscellaneous Expense83.76 Cash Short and Over4.40 Cash The company records the actual expenses and the amount needed to replenish the fund. Office Supplies Expense34.16 Postage Expense Transportation Expense Miscellaneous Expense83.76 Cash Short and Over4.40 Cash432.46

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

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

14 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 Bank Reconciliation Deposits in transit and cash received but not yet deposited totaled $629. Cash balance from bank statement$7,218

15 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 Bank Reconciliation Outstanding checks totaled $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)

16 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 Bank Reconciliation

17 Cash balance from company records$6,925 Bank Reconciliation Cash balance from company records$6,925 Add: Interest earned on the funds on deposit. 715 Interest earned on the funds on deposit. Cash balance from company records$6,925 Add: Interest earned on the funds on deposit. 715 $7,640

18 Cash balance from company records$6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Cash balance from company records$6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct:Bank service charge(9) Bank Reconciliation Bank service charge, $9.

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

20 Bank Reconciliation Cash balance from company records$6,925 Add: Interest earned on the funds on deposit. 715 $7,640 Deduct:Bank service charge(9) 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

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

22 Receivables Trade Receivables Revenue Recognition and Valuation Normal circumstances Right of return Valuation Cash discounts Sales returns and allowances Uncollectible accounts Financing arrangements Recording and Reporting Accounts Receivable Interest- bearing Non-interest- bearing Discounted Recording and Reporting Notes Receivable

23  The sales price is fixed or determinable 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. Receivables Right of Return Each of the following criteria must be satisfied when the right of return exists in order to recognize revenue at the time of sale. ContinuedContinued

24  The buyer has an economic substance apart from the seller.  The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer.  The seller can reasonably estimate the amount of future returns. Receivables Right of Return

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

26 Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method Sold $8,000 of merchandise to various customers on December 4, 2000 with terms of 2/10, n/EOM Accounts Receivable 8,000 Sales8,000 Accounts Receivable 7,840 Sales7,840 $8,000 - ($8,000 x 0.02)

27 Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method On December 12 received payment on goods originally billed at $5,500. Cash 5,390 Sales Disc. Taken110 Accts. Receivable5,500 Cash5,390 Accts. Receivable5,390 $5,500 - ($5,500 x 0.02)

28 Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method Received payment on goods billed at $1,500 on December 30 (after the discount period). Cash 1,500 Accts. Receivable1,500 Cash1,500 Accts. Receivable1,470 Sales Discounts Not Taken30 $1,500 - ($1,500 x 0.02) Classified as” Other Items” on the income statement

29 Sales Discounts Alternative Methods of Accounting for Sales Discounts Gross Price Method Net Price Method No entry requiredAccounts Receivable20 Sales Discounts Not Taken20 Year-end adjustment at the end of the period.

30 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.  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. FASB Statement No. 5 requires that estimated losses from loss contingencies be accrued against income and... … recorded as reductions in assets or as liabilities when both of these conditions are met.

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

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

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

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

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

36 Estimated Bad Debts Method Percentage of Outstanding Accounts Receivable If a company has determined that there has been a 4% relationship between actual bad debts and the year-end account receivable balance($475,000), what would be the required adjusting entry? Bad Debt Expense14,500 Allowance for Doubtful Accounts14,500

37 Aging of Accounts Receivable  Gather 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. Examine Exhibit 6-3 carefully.

38 x 2 x 8 x 15 x 30 x 50 % Aging of Accounts Receivable Under 60 days$ 53, days34, days3, 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

39 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

40 Writing Off Uncollectibles Allowance for Doubtful Accounts 8,750 Accounts Receivable 175,000 Net realizable value = $166,250 A customer’s account totaling $850 is determined to be uncollectible. Allowance for Doubtful Accounts850 Accounts Receivable850 Net realizable value = $166,

41 Collection of an Account Previously Written Off Later, a payment for $850 is received from the account that was written off in the previous slide. Accounts Receivable850 Allowance for Doubtful Accounts850 Cash850 Accounts Receivable850

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

43 Accounts Receivable Financing Agreements Retain Risks and Benefits of Ownership Pledge (Collateral for Loans) Transfer Some Risks and Benefits of Ownership Assign (Specific Receivables with Recourse) Transfer Risks and Benefits of Ownership Factor (Sale without Recourse)

44 Factoring  The transferred assets have been isolated from the transferor.  The transferee obtains the right to exchange.  The transferor does not maintain effective control over the transferred assets through an agreement that entitles and obligates the transferor to repurchase the transferred assets before their maturity. FASB Statement No. 125 states that a company records transfer of financial assets (e.g., accounts receivable) in which it surrenders control over the financial assets to another company as a sale when all the following conditions are met:

45 Assignment of Accounts Receivable On December 1, 2000 the Trussel Company assigned $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. Cash47,500 Assignment Service Charge Expense500 Notes Payable48,000 ($60,000 x 0.80) - $500 $60,000 x 0.80 Accounts Receivable Assigned60,000 Accounts Receivable60,000

46 Notes Payable10,000 Interest Expense480 Cash10,480 Assignment of Accounts Receivable On December 31, 2000 Trussel collects $10,000 on assigned accounts. This amount along with the 12% interest for one month is paid to the finance company. Cash10,000 Accounts Receivable Assigned10,000 $48,000 x 0.12 x 1/12

47 Factor 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. Factoring Cash60,000 Receivables from Factor8,000 Factoring Expense12,000 Accounts Receivable80,000 ($80,000 x.90) - $12,000 $80,000 x 0.10 $80,000 x 0.15

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

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

50  They are negotiable instruments, which means that they are legally and readily 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 receivables into its principal and interest components. Notes Receivable

51 Notes Receivable Interest-Bearing Received a $5,000, 60-day, 12% note on October 1, Notes Receivable5,000 Sales5,000 Received maturity value on December 1, Cash5,100 Notes Receivable5,000 Interest Revenue100 $5,000 x 0.12 x 60/360

52 Notes Receivable Non-Interest-Bearing Received a $5,100, 60-day, non-interest-bearing note on October 1, Notes Receivable5,100 Interest Revenue100 Sales5,000 Received maturity value on December 1, Cash5,100 Notes Receivable5,100

53 Notes Receivable Discounted On August 1, 2000, 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%.

54  Face value of note$5,  Interest to maturity ($5,000 x 0.12 x 90/360)  Maturity value of note$5,  Discount ($5,150 x 0.14 x 60/360) (120.17)  Proceeds$5,  Accrued interest revenue: $50  Book value of note ($5,000 + $50)(5,050.00)  Loss from discounting of note$ Notes Receivable Discounted

55 Notes Receivable Discounted October 30, 2000 Notes Receivable Discounted5, Notes Receivable5, Cash Loss from Discounting of Note20.17 Notes Receivable Discounted5, Interest Receivable50.00 August 31, 2000 Interest Receivable50.00 Interest Revenue50.00

56 Notes Receivable Discounted Assume instead that on November 3, 2000 the bank notified Kasper that the note had not been paid and also charged Kasper a $10 fee. Notes Receivable Dishonored5,160 Notes Receivable Discounted5,000 Notes Receivable5,000 Cash5,160

57 Appendix: Proof of Cash  The reconciliation of the bank balance and book balance for the previous month.  The reconciliation of the receipts recorded by the bank for the current month with the receipts recorded on the books.  The reconciliation of the payments recorded by the bank for the current month with the payments recorded on the books.  The reconciliation of the bank balance and book balance for the current month. The proof of cash provides four separate reconciliations.

58 C hapter 6