Chapter 7

Cash and Receivables

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

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. 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)

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

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
Coins and currency Checking accounts Savings accounts Negotiable checks Bank drafts

Excluded from Cash

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 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 companys bank account.

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Cash Management
Control Over Payments 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 companys accounting records.

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Receivables
Those receivables expected to be collected or Those receivables expected to be collected or satisfied within one year or the current satisfied within one year or the current operating cycle, whichever is longer, are operating cycle, whichever is longer, are classified as current assets; the remainder are classified as current assets; the remainder are classified as noncurrent. classified as noncurrent.

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Receivables
Each of the following criteria must be satisfied Each of the following criteria must be satisfied when the right of return exists in order to when the right of return exists in order to recognize revenue at the time of sale. recognize revenue at the time of sale. 1. The sales price is known at the date of sale. 2. The buyer has paid or will pay the seller, and the obligation is not contingent upon the resale of the product. 3. The buyers obligation to the seller would not be changed by theft or damage to the product.
Continued Continued

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Receivables
Each of the following criteria must be satisfied Each of the following criteria must be satisfied when the right of return exists in order to when the right of return exists in order to recognize revenue at the time of sale. recognize revenue at the time of sale. 4. The buyer has an economic substance apart from the seller. 5. The seller does not have significant obligations to help the buyer sell the product. 6. The seller can reasonably estimate the amount of future returns.

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

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Sales Discounts
Increase sales Encourage prompt payment Increase likelihood of collection

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Calculation of Sales Discounts

2/10, n/30 A 2% discount may be subtracted from the A 2% discount may be subtracted from the invoice price if payment is made within 10 invoice price if payment is made within 10 days, otherwise the total amount is due within days, otherwise the total amount is due within 30 days (net of returns and allowances). 30 days (net of returns and allowances).

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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.

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Loss Contingencies
1. Information available 1. Information available prior to the issuance of prior to the issuance of the financial statements the financial statements indicates that it is indicates that it is probable that an asset probable that an asset has been impaired or a has been impaired or a liability has been liability has been incurred at the date of incurred at the date of the financial statements. the financial statements. 2. The amount of the loss 2. The amount of the loss can be reasonably can be reasonably estimated. estimated.
recordedrequires that in GAAP as reductions recordedrequires that in GAAP as reductions assets or aslosses fromwhen estimated liabilities when assets or aslosses fromloss estimated liabilities loss both of these conditions are contingencies be accrued both of these conditions are contingencies be accrued met. against income and met. against income and

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Estimated Bad Debts Method

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

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Estimated Bad Debts Method

1. Relationship to sales (income statement approach):
Percentage of sales Percentage of net credit sales

1. Relationship to accounts receivable (balance sheet approach):

Percentage of outstanding accounts receivable Aging of accounts receivable

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Aging of Accounts Receivable

1. Review the unpaid invoices in each customers account. 2. Classify the invoice amounts according to the length of time the invoice has been outstanding. 3. Multiply the total amount in each age group by the applicable estimated uncollectible percentage. 4. Make a journal entry to bring the balance in Allowance for Doubtful Accounts to the amount calculated in Step 3.

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

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Accounts Receivable Financing Agreements

There are three basic forms of There are three basic forms of financing agreements to financing agreements to obtain cash from accounts obtain cash from accounts receivable. receivable.

1. 1. 2. 2. 3. 3.

Pledging Pledging Assigning Assigning Factoring Factoring

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

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Assignment
When a company assigns its accounts receivable When a company assigns its accounts receivable to a financial institution, it enters into a lending to a financial institution, it enters into a lending agreement with the institution to receive cash on agreement with the institution to receive cash on specific customer accounts. specific customer accounts.

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

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Credit Card Sales

Many retail companies accept national credit cards, such as VISA, MasterCard, American Express, and Diners 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.

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

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

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Notes Receivable
1. 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. 2. They usually involve interest, requiring the separation of the receivable into its principal and interest components.

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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

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Appendix: Petty Cash

1. An employee is 1. An employee is appointed petty cash appointed petty cash custodian. custodian.

Petty Cash Petty Cash Cash Cash

500 500

500 500

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Appendix: Petty Cash

2. Petty cash vouchers are 2. Petty cash vouchers are printed, prenumbered, and printed, prenumbered, and given to the custodian of the given to the custodian of the fund. fund.

At all times the total of At all times the total of the cash in the fund plus the cash in the fund plus the amounts of the amounts of expenditure vouchers expenditure vouchers should be equal to $500 should be equal to $500 (in this case). (in this case).

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Appendix: Petty Cash

3. When the amount of cash in 3. When the amount of cash in the vouchers are sorted into the petty cashare sorted into the vouchers fund becomes the petty cash fund becomes expense categories and the expense categories and the low at the end of counted. low at the end is counted. remaining cashof accounting remaining cashis accounting period, period,

Assume that a count at Assume that a count at the end of the month the end of the month shows $67.54 remaining shows $67.54 remaining in the petty cash fund. in the petty cash fund.

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Appendix: Petty Cash

The sorting of vouchers indicates the following The sorting of vouchers indicates the following costs were incurred during the month: costs were incurred during the month: Office supplies Office supplies Postage Postage Transportation Transportation Miscellaneous Miscellaneous Total expenses Total expenses $ 34.16 $ 34.16 178.00 178.00 132.14 132.14 83.76 83.76 $428.06 $428.06

The fund is short by $4.40 ($71.94 $67.54).

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Appendix: Petty Cash

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

432.46 432.46

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Appendix: Bank Reconciliation

Procedures for Preparing a Bank Reconciliation Compare the deposits listed in the companys records with the deposits shown on the bank statement. Compare the checks listed in the companys records with the checks shown on the bank statement.

Continued Continued

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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 companys records. Determine the effect of any errors. Complete the bank reconciliation.

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Appendix: Bank Reconciliation

Causes of the difference between the cash balance and the companys bank statement balance:
Outstanding checks Deposits in transit Charges made directly by the bank Deposits made directly by the bank Errors

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Chapter 7

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