1. Financial Assets
Chapter 7
Chapter 7: Financial Assets 1

2. Learning objectives:
After studying this chapter, you should be able to:
Define financial assets and explain their valuation in the B/S
The objectives of cash management and internal control over cash
Prepare bank reconciliation and explain its purpose
Describe how short-term investments are reported in the B/S and account for transactions involving marketable securities
Account for uncollectable receivables using the allowance and direct write-off methods
Explain, compute, and account for notes receivable and interest revenue

3. Cash is defined as any deposit banks will accept.
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 3

4. Cash Management
It refers to planning, controlling, and accounting for cash transactions and cash balance
The basic objectives of cash management: provide accurate accounting for cash receipts, cash disbursements, and cash balances; prevent or minimize losses from theft or fraud; anticipate the need for borrowing and assure the availability of adequate amounts of cash for conducting business operations; prevent unnecessarily large amounts of cash from sitting idle in bank accounts that produce no revenue.

5. Internal Control over Cash
Separate the function of handling cash from the maintenance of acounnting records.
Prepare cash budgets of planned cash receipts, cash payments, and cash balances, sheduled month-by-month for the coming year.
Prepare a control listing of cash receipts at the time and place the money is received.
Require that all cash receipts be deposited daily in the bank.
Make all payments by check(exception).
Require that every expenditures be verified before a check is issued in payment.
Promptly reconcile bank statements with the accounting records.

6. 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.
Estimated collectible amount 6

7. Cash over and short Cash over Dr Cash XX Cr Cash over and short XX
Cash short
Dr Cash over and short XX
Cr Cash XX

8. Reconciling the Bank Statement
It refers a schedule explaining any differences between the balance shown in the bank statement and the balance shown in the depositor’s accounting records.
Normal differences between bank records and accounting records.
Steps in preparing a bank reconciliation.

9. 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. All reconciling items on the book side require an adjusting entry to the Cash account.
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 9

10. Illustration of a bank reconciliation
Page

11. 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. Due to their liquidity, investments in marketable securities are listed immediately after Cash in the balance sheet and are most often classified as available for sale.
Almost As Liquid As Cash 11

12. Accounting for marketable securities
Purchase of marketable securities
Dr Marketable securities XX
Cr Cash XX
Recognition of investment revenue
Dr Cash XX
Cr Dividend revenue XX
Sale of investment (sold at a gain)
Cr Marketable securities XX
Gain on sale of investment XX

13. Accounting for marketable securities
Sale of investment (sold at a loss)
Dr Cash XX
Loss on sale of investment XX
Cr Marketable securities XX
Adjusting marketable securities to market value
Dr Unrealized holding loss on investment XX

14. Accounts receivable
Accounts receivable are shown in the B/S at the estimated collectible amount - net realizable value.
Once it has been determined to be uncollectible, it is no longer an asset, rather, it is an expense – uncollectible accounts expense.

15. The Allowance for Doubtful Accounts
The net realizable value is the amount of accounts receivable that the business expects to collect.
On the balance sheet, the Allowance for Doubtful Accounts is subtracted from the Accounts Receivable balance. The reported value is called net realizable value and is the amount of Accounts Receivable that will likely be collected. 15

16. Account for uncollectable receivables by allowance method
Estimate uncollectable receivables
Dr Uncollectible accounts expense XX
Cr Allowance for doubtful accounts XX
Written off uncollectable receivables
Dr Allowance for doubtful accounts XX
Cr Accounts receivable XX

17. Writing Off an Uncollectible Account Receivable
When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off.
Now, let’s see what happens when it’s been determined that a specific customer will not be able to pay the amount owed.
When using the allowance method, write off an uncollectible account to Allowance for Doubtful Accounts.
The company debits Allowance for Doubtful Accounts and credits Accounts Receivable. Now that the specific customer involved is known, the customer is noted in the transaction so the proper entry in the Accounts Receivable ledger can be made.
Now assume that before this write-off entry the balance in Accounts Receivable was $10,000 and the balance in Allowance for Doubtful Accounts was $2,500. Let’s see what effect the write-off had on these accounts. 17

18. Writing Off an Uncollectible Account Receivable
After the $500 write-off, the Accounts Receivable balance is reduced to $9,500 and the Allowance for Doubtful Accounts balance is reduced to $2,000. Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts.
Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts. 18

19. Account for uncollectable receivables by allowance method
Monthly estimates of credit losses
Dr Uncollectable accounts expense XX
Cr Allowance for doubtful accounts XX
Estimate credit losses – the balance sheet approach
Estimate credit losses – the income statement approach

20. Estimating Credit Losses — The Balance Sheet Approach
Year-end Accounts Receivable is broken down into age classifications.
Each age grouping has a different likelihood of being uncollectible.
When using the Balance Sheet Approach, first classify the Accounts Receivable by age. Second, for each age group determine the likelihood of being uncollectible. Third, for each age group calculate a separate allowance amount. Finally, add up all the allowance amounts to get the balance in the Allowance for Doubtful Accounts.
Compute a separate allowance for each age grouping. 20

21. Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
Part I
First, EastCo’s accounts receivable have been broken up into aged categories such as current, 1 to 30 days past due, 31 to 60 days past due, and so on.
Part II
Then, for each of these age groups, it was determined how much would be uncollectible. For the current age group, one percent is expected to be uncollectible. For the 1 to 30 days past due age group, three percent is expected to be uncollectible, and so on. Notice that the older the age group the higher the uncollectible percentage.
Part III
Next, the balance of each age group is multiplied by its uncollectible percentage. Then, all of the uncollectible amounts are added up to $1,350, and this should be the balance in the Allowance for Doubtful Accounts. 21

22. Estimating Credit Losses — The Balance Sheet Approach
EastCo’s unadjusted balance in the allowance account is $500.
Per the previous computation, the desired balance is $1,350.
Assume EastCo already had a $500 balance in Allowance for Doubtful Accounts.
Since the balance should be $1,350, the account will need to be credited for $850.
The entry would be to debit Uncollectible Accounts Expense and credit Allowance for Doubtful Accounts for $850. 22

23. Estimating Credit Losses — The Income Statement Approach
Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales.
When using the Income Statement Approach, the estimate at the end of the period is determined by taking current period sales and multiplying by an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. The sales transactions included in this computation are typically only the credit sales. There are not any collection issues to consider for cash sales transactions. The credit loss estimate is calculated as net credit sales times the estimated uncollectible percentage. 23

24. Estimating Credit Losses - The Income Statement Approach
In 2009, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s credit sales has been uncollectible. For 2009, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600)
Part I
EastCo has credit sales of $60,000 in Management estimates that one percent of credit sales will eventually prove to be uncollectible. What is East Company’s adjusting entry for uncollectible accounts in 2009?
Part II
EastCo would debit Uncollectible Accounts Expense and credit Allowance for Doubtful Accounts for $600, which is one percent of $60,000 in credit sales. 24

25. Account for uncollectable receivables by allowance method
Recovery of previously written off receivables
Dr Accounts receivable XX
Cr allowance for doubtful accounts XX
Dr Cash XX
Cr Accounts receivable XX

26. Recovery of an Account Receivable Previously Written Off
Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
Sometimes after an account receivable has been written off, a customer will send in a payment. If this happens, should the customer’s payment be returned since the account has been written off? Of course not.
When this happens, two entries are necessary. The first entry is required to reverse the write-off and re-establish the account receivable. It includes a debit to Accounts Receivable an a credit to Allowance for Doubtful Accounts.
The second entry records the receipt of cash with a debit to Cash and a credit to Accounts Receivable. 26

27. Account for uncollectable receivables by direct write-off method
No attempt to match revenue with the expense of uncollectible accounts.
Once a customer’s account is determined to be uncollectable, it is written off directly to uncollectible accounts expense:
Dr Uncollectible accounts expense XX
Cr Accounts receivable XX

28. Notes Receivable and Interest Revenue
The interest formula includes three variables:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
Part I
Most Notes Receivable have an interest rate associated with them. Interest is a charge made for the use of money. For the borrower, this is the interest expense they will incur and for the lender, this is the interest revenue they will receive.
Interest is calculated as Principal times the Interest Rate times the Time the note was outstanding.
Part II
When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction. 28

29. Notes Receivable and Interest Revenue
On November 1, Hall Company loans $10,000 to Porter Company on a 90-day note earning 12 percent interest. On December 31st, Hall Company needs an adjusting entry to record the interest revenue on the Porter Company note.
On November 1, Hall Company loans $10,000 to Porter Company on 90-day note earning 12 percent interest. On December 31st, Hall Company needs an adjusting entry to record the interest revenue on the Porter Company note. This entry is a debit to Interest Receivable and a credit to Interest Revenue for $100.
The $200 in interest is calculated as the original note amount of $10,000 times the interest rate of 12 percent times the outstanding time of 60 days over 360 days.
$10,00012% 60/360 = $200 29

30. Notes Receivable and Interest Revenue
What entry would Hall Company make on the maturity date?
$10,00012% 90/360 = $300
Part I
What entry would Hall Company make on the maturity date of the note?
Part II
The maturity date of the note is January 30th of the next year.
On January 30th, Hall Company would debit Cash for $10,300. That is the original note amount of $10,000 plus the interest of $300. They would credit Notes Receivable for $10,000. The interest is divided between two accounts. Interest Receivable is credited for $200. Remember, this is removing the Interest Receivable created in the previous adjusting entry. Interest Revenue is credited for $100. This is the interest revenue Hall Company earned in the current year.
If Porter Company defaulted on the note, Hall Company would make a similar entry, except instead of debiting Cash they would debit Accounts Receivable for the entire amount. 30