1. Chapter 7: Cash and Receivables
Fundamentals of Intermediate Accouting
Weygandt, Kieso, and Warfield
Chapter 7: Cash and Receivables
Prepared by
Bonnie Harrison, College of Southern Maryland
LaPlata, Maryland

2. Chapter 7 Cash and Receivables
After studying this chapter, you should be able to:
Identify items considered cash.
Indicate how cash and related items are reported.
Define receivables and identify the different types of receivables.
Explain accounting issues related to recognition of accounts receivable.
Explain accounting issues related to valuation of accounts receivable. 1 2 3 4 5

3. Chapter 7 Cash and Receivables
After studying this chapter, you should be able to:
Explain accounting issues related to recognition of notes receivable.
Explain accounting issues related to valuation of notes receivable.
Explain accounting issues related to disposition of accounts and notes receivable.
Explain how receivables are reported and analyzed. 6 7 8 9

4. Part 1: Cash
and Cash Equivalents

5. Cash and Cash Equivalents: Issues
Definition of “cash” : various items that comprise cash.
Management and control of cash : the importance of internal control of cash
Reporting of cash in the balance sheet

6. Items Comprising “Cash”
Cash must be readily available and be free of restrictions
Cash consists of coins, currency and available funds
Deposits (CDs) and short term paper are classified as temporary investments
Post dated checks, travel advances and stamps on hand are not classified as cash

7. Management and Control of Cash
Since cash is the most liquid asset, internal control of cash is imperative.
Controls must prevent unauthorized use of cash
Management must have necessary information for proper use of cash

8. Reporting of Cash The reporting of cash depends upon whether it is:
restricted cash
a bank overdraft or
a cash equivalent 1 2 3

9. Restricted Cash Compensating balances:
are amounts maintained by a corporation with a bank in support of existing borrowing arrangements.
are identified as current assets separate from cash, if they relate to short- term loans.
are identified as non-current assets separate from cash, if they relate to long-term loans.

10. Bank Overdrafts
Overdrafts represent checks written in excess of cash account.
Overdrafts may be offset against available cash in another account in the same bank.
Otherwise, such offsetting is not allowed.
An overdraft should be reported as a current liability.

11. Cash Equivalents
Short term highly liquid investment (original maturities of three months or less)
Readily convertible to known amounts of cash AND
So near maturity they present insignificant risk of changes in interest rates.

12. Part 2: Accounts Receivable

13. Accounts Receivable: Issues
Types of accounts receivable : current and non-current : trade and non-trade
Recognition of accounts receivable in the financial statements - cash discounts / interest
Valuation of accounts receivable : estimated bad debts and net realizable value
Disposition of receivable - transfers / sale

14. Accounts Receivable: Recognition
Trade or quantity discounts are not recorded in books of account.
Cash (sales) discounts are inducements to customers for prompt payment of amounts billed.
Cash discounts are recorded in books as reductions of sales revenue.

15. Accounts Receivable: Recording Cash Discounts
There are two methods: Gross and Net
Gross method records A/R at the gross amount of sale and records discounts when taken.
Net method records A/R at the net amount of the sale and captures sales discounts when not taken.

16. Accounts Receivable: Recording Cash Discounts
GROSS method
NET method
Record revenue at gross amount of sales
When customer takes the discount, record cash discounts
Cash discounts reduce gross sales revenue
Record revenue at gross amount of sales less cash discount
When customer forfeits discount, record discounts not taken.
Report discounts not taken as other revenue

17. Valuation of Accounts Receivable
Short term receivables are reported at their net realizable value (NRV)
The NRV is the net amount expected to be collected
The NRV is gross accounts receivable less estimated uncollectible accounts.

18. Estimating Uncollectible Receivables
Methods
Direct Write-Off
Allowance
Not based on the matching Based on the matching
principle principle 1
Accounts are written off Estimated bad debts are
when determined uncollectible matched against revenue 2
Appropriate only if Must be followed if
amounts are not material amounts are material 3

19. Estimating Uncollectible Accounts: the Allowance Method
The estimate of uncollectible accounts may be based on:
Percentage of sales OR
Percentage of outstanding receivables
These approaches are referred to as Income statement and Balance sheet approaches

20. The Allowance Method (Sales method-first year)
Indcom Company reports the following balances for the year 2003 (first year):
Net Sales: $50,000
Accounts Rec (Dec 31, 2003): $4,600
The company estimates bad debts at 2% of net sales.
Determine estimated uncollectible accounts expense for 2003.

21. The Allowance Method (Sales Method - First Year)
Est. uncollectible accounts (bad debts) expense:
$50,000 * 2% = $1,000 1 2
To record bad debts expense:
Estimated bad debts expense $1,000
Allowance for Uncollectible
accounts $1,000
2003: $1,000 closed
Bad debts expense
$1,000
Allowance

22. The Allowance Method (Sales Approach-Second year)
Indcom Company reports the following balances for the year 2004 (second year):
Net Sales: $70,000
Accounts Rec (Dec 31,2004): $5,700
The company estimates bad debts at 2% of net sales.
Determine estimated uncollectible accounts expense for 2004.

23. The Allowance Method (Sales Method - Second Year)
Est. uncollectible accounts (bad debts) expense:
$70,000 * 2% = $1,400 1 2
To record bad debts expense:
Estimated bad debts expense $1,400
Allowance for Uncollectible
accounts $1,400
2004: $1,400 closed
Bad debts expense
2003: 1,000
2004: 1,400
Allowance
Note: No accounts were written off during the year

24. The Allowance Method (Acct Rec Approach-First Year)
Indcom Company reports the following balances for the year 2003 (first year):
Net sales: $50,000
Accounts Rec (Dec 31,2003): $4,600
The company estimates bad debts at 10% of accounts receivable.
Determine estimated uncollectible accounts expense for 2003.

25. The Allowance Method (Acct Rec Approach - First Year)
Est. uncollectible accounts (bad debts) expense:
$4,600 * 10% = $460 1 2
To record bad debts expense:
Estimated bad debts expense $460
Allowance for Uncollectible
accounts $460
2003: $ closed
$ 460
Bad debts expense
Allowance

26. The Allowance method (Acct Rec approach-second year)
Indcom Company reports the following balances for the year 2004 (second year):
Net Sales: $70,000
Accounts Rec (Dec 31, 2004): $5,700
The company estimates bad debts at 10% of accounts receivable.
Determine estimated uncollectible accounts expense for 2004.

27. The Allowance Method (Acct Rec Approach - Second Year)
Est. uncollectible accounts (bad debts) expense:
$5,700 * 10% = $ 570 (required)
less: existing allowance = ($ 460)
Bad debts expense (2004) = $110 1 2
To record bad debts expense:
Estimated bad debts expense $110
Allowance for Uncollectible
accounts $110
**You must take into account the balance in “Allowance for Uncollectible Accounts”**

28. The Allowance Method (Acct Rec Approach - Second Year)
2004: $ closed
Bad debts expense
$ 460
$ 110
$ 570
Allowance
Required
ending
allowance
Adjusting entry:
Bad Debts expense $110
Allowance account $ 110

29. Balance Sheet Representation
Short term accounts receivable are shown at their net realizable value as follows:
Accounts Receivable (gross) : $ XXX less: Allowance : ($ XX) Net Realizable Value : $ XX

30. Part 3:
Notes Receivable

31. Notes Receivable: Issues
Recognition of Notes Receivable
issues at face value and issues not at face value
issues for cash / non-cash considerations
Valuation issues
Disposition of notes receivable

32. Recognition of Notes Receivable
Short term N/R
Long term N/R
Record at face value
less Allowance
Record at present value
of cash expected to
be collected
Issues at par
Issues not at par

33. Recognition of Notes Receivable
Notes receivable are issued at face value when the stated rate of interest is the same as the effective (market) rate.
When the rates are unequal, a discount on the note results.
The discount is amortized to interest revenue by the effective interest method.

34. Recognition of Notes Receivable
Issues NOT at face value
Non interest bearing
Interest bearing
1. Determine discount on
notes receivable at
implicit rate of interest
2. The discount is
amortized to interest
revenue by the
effective interest
method
1. Determine discount on
notes receivable at
the effective rate of
interest.
2. The discount is
amortized to interest
revenue by the
effective interest
method

35. Discount on notes receivable: Example
Assume Debrief Company issues a notes receivable (FV= $10,000) on 1/1/2003.
Stated Rate, 10%; Effective Rate, 12%
The discount is $480.
Assume that the discount to be amortized for 2003 is $ 142.
Show necessary journal entries.

36. Discount on notes receivable: Example
1/1/2003: Notes Receivable $10, Discount (N/R) $ Cash $ 9,520
December 31, 2003: Discount (N/R) $ Cash $ 1, Interest Revenue $1,142

37. Disposition of Accounts
Part 4:
Disposition of Accounts
and
Notes Receivable

38. Disposition of Accounts and Notes Receivable
The holder of accounts or notes receivable may transfer them for cash.
The transfer may be:
secured borrowing or
a sale of receivables
Holder retains ownership of receivables in a secured borrowing transaction.
Holder transfers ownership of receivables in a sale (transfers risks of collection)

39. Transfer of Receivables: Borrowing vs. Sale Treatment
Conditions
1. Are transferred assets isolated
from transferor? and
2. Does transferee have right to
pledge or sell assets? and
3. Has transferor divested itself of
control through repurchase
agreement?
Yes
Sale No
Borrowing
**All three conditions must be met for a sale to occur**

40. Accounting for Transfers of Receivables
Secured Borrowing
Sale
Without Recourse
With Recourse
Continuing involvement by
seller
No continuing
involvement by

41. Secured Borrowing (highlights)
Transferor records a finance charge.
Transferor collects accounts receivable.
Transferor records sales returns and sales discounts.
Transferor absorbs bad debts expense.
Transferor records interest expense on notes payable.
Transferor pays on the note periodically from collections.

42. Sales of Receivables(highlights)
Transferor transfers ownership of receivables to factor.
Factor records the (transferred) accounts as assets in its books.
Transferor records any amount retained by transferee as “due from factor”
Transferor records loss on sale of receivables
Transferor records any recourse liability (when appropriate)

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