Cash and ReceivablesInsert Book Cover Picture7Copyright © 2007 by The McGraw-Hill Companies, ppt

7-29 Uncollectible Accounts Receivable Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period.. 31 Bad Debts Ex pense 2,400

Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved

Cash and Receivables

Coins and

currency

Petty cash

Cashier’s checks Certified checks

Money orders

7-3

Cash Equivalents

Items very near cash but

not in negotiable form

Money market

funds

Treasury bills

Commercial paper

Learning Objectives

Define what is meant by internal control and

describe some key elements of an internal

control system for cash receipts and

Enhances the reliability

and accuracy of

accounting data

7-6

Control of Cash Receipts

Separate responsibility for

§ handling cash,

§ recording cash transactions, and

§ reconciling cash balances.

Agreed cash amounts deposited with cash

amounts received

Close supervision of handling and

cash-recording activities

Control of Cash Disbursements

Separate responsibilities for

§ cash disbursement documents,

Explain the possible restrictions on cash and

their implications for classification in the

Management’s intent to use a certain amount

of cash for a specific purpose – future plant

expansion, future payment of debt

Compensating Balance

Minimum balance that must be maintained

in a company’s account as support for

funds borrowed from the bank

Learning Objectives

Distinguish between the gross and net

methods of accounting for cash discounts

§ Accounting for bad debts

that result from credit

sales.

Amounts due from

customers for credit sales.

Increase likelihood of collections.

Cash discounts

Number of Days Discount is

Available

Otherwise, Net (or All)

is Due

Credit Period

invoice

amounts.

Sales discounts are recorded if payment is received within

the discount period.

Gross

Method

7-15

Cash Discounts

Sales are recorded at the

invoice amount less the

Cash Discounts

On May 10, Eddy, Inc sold $5,000 of

merchandise to a customer subject to a cash

discount of 1/10, n/30

Prepare the journal entry to record the sale if

Eddy uses:

(a) thegrossmethod

(b) thenetmethod

Assume that on May 19, Eddy, Inc received a

check in full payment of the sale made on

May 10

Prepare the journal entry to record the cash

receipt if Eddy uses:

(a) thegross method

(b) thenetmethod

Instead of the payment on May 19, now assume

that Eddy, Inc received a check on May 31, in

full payment of the sale made on May 10

Prepare the journal entry to record the cash

receipt if Eddy uses:

(a) thegrossmethod

(b) thenet method

Sales Returns and Allowances

7-24

Sales Returns and Allowances

On June 1, a customer of LarCo returns

$750 of merchandise The merchandise

had been purchased on account and the

customer had not yet paid LarCo uses

the periodic method to account for

inventory.

Record the journal entry for the return of

merchandise.

Sales Returns and Allowances

Date Description

Post

Ref Debit Credit

Jun 1 Sales Returns and Allowances 750

Sales Returns and Allowances is a contra

account that reduces Sales Revenue in the

current accounting period.

7-26

Learning Objectives

Describe the accounting treatment of

anticipated uncollectible accounts receivable.

7-27

Uncollectible Accounts Receivable

Bad debts result from credit customers who

are unable to pay the amount they owe,

regardless of continuing collection efforts.

PAST DUE

Uncollectible Accounts Receivable

In conformity with the matching principle ,

bad debt expense should be recorded in

the same accounting period in which the

sales related to the uncollectible account

were recorded.

7-29

Uncollectible Accounts Receivable

Most businesses record an estimate of the

bad debt expense by an adjusting entry

at the end of the accounting period.

Post

Ref Debit Credit

Accounts

7-30

Uncollectible Accounts Receivable

Post

Ref Debit Credit

Allowance for Uncollectible Accounts

Net realizable value is the amount of the

accounts receivable that the business

expects to collect.

Accounts Receivable

Less: Allowance for Uncollectible Accounts

Net Realizable Value

7-32

Learning Objectives

Describe the two approaches

to estimating bad debts.

7-33

pIncome Statement Approach

pBalance Sheet Approach

Income Statement Approach

pFocuses on past credit sales to make

estimate of bad debt expense.

pEmphasizes the matching principle by

estimating the bad debt expense associated

with the current period’s credit sales.

= Estimated Bad Debts Expense

Income Statement Approach

7-36

In 2006, MusicLand has

credit sales of $400,000 and

estimates that 0.6% of credit

sales are uncollectible.

What is Bad Debts Expense

for 2006?

Income Statement Approach

GENERAL JOURNAL Page 95

Post Ref Debit Cre dit Dec 31 Bad Debts Ex pense 2,400

Allow ance for

Income Statement Approach

7-38

Balance Sheet Approach

pFocuses on the collectibility of accounts

receivable to make the estimate of uncollectible

accounts

pInvolves the direct computation of the desired

balance in the allowance for uncollectible

accounts

7-39

ΠCompute the desired balance in the Allowance for

Uncollectible Accounts.

• Bad Debts Expense is computed as:

Year-end Accounts Receivable × Bad Debt %

Balance Sheet Approach

Composite Rate

What is MusicLand’s Bad Debts

On Dec 31, 2006, MusicLand

has $50,000 in Accounts

Receivable and a $200 credit

balance in Allowance for

Desired balance in Allowance

for Uncollectible Accounts

Balance Sheet Approach

Composite Rate

7-42

Now, let’s look at the accounts receivable aging approach!

ŒYear-end Accounts Receivable is

broken down into age classifications.

•Each age grouping has a different

likelihood of being uncollectible.

ŽCompute desired uncollectible amount.

Balance Sheet Approach

Aging of Receivables

•Compare desired uncollectible amount

with the existing balance in the

allowance account.

7-44

EastCo, Inc.

Schedule of Accounts Receivable by Age

Decembe r 31, 2006

Days Past Due

Accounts Rece ivable

Ba lance

Estima ted Bad De bts Perce nt

Estimate d Uncollectible Amount

Current $ 45,000 1% $ 450

1 - 30 15,000 3% 450

31 - 60 5,000 5% 250

Over 60 2,000 10% 200

67,000 $ $ 1,350 Œ • Ž At December 31, 2006, the receivables for EastCo, Inc were categorized as follows: Balance Sheet Approach Aging of Receivables 7-45 GENERAL JOURNAL Page 95 Date Description Post Ref De bit Cre dit EastCo’s unadjusted balance in the allowance account is $500 Per the previous computation, the desired balance is $1,350 500

1,350

Allowance for Uncollectible Accounts

Prepare the entry to record bad debts

expense at Dec 31, 2006

•

Balance Sheet Approach

Aging of Receivables

500 850

1,350

Allowance for Uncollectible Accounts

GENERAL JOURNAL Page 95

Post Ref De bit Cre dit

De c 31 Bad Debts Expense 850

Allowance for

Uncolle ctible Accounts 850

Balance Sheet Approach

Aging of Receivables

EastCo’s unadjusted balance

in the allowance account is

$500.

Per the previous computation,

the desired balance is $1,350.

•

7-47

Balance Sheet Approach Emphasis on Realizable Value

Exp.

Methods to Estimate Bad Debts

7-48

Uncollectible Accounts

As accounts become uncollectible, the

following entry is made:

GENERAL JOURNAL Page 69

Post

Ref Debit Credit

of the accounts receivable?

GENERAL JOURNAL Page 69

When a customer makes a payment after an

account has been written off, two journal

entries are required.

Date

If uncollectible accounts are immaterial, bad

debts are simply recorded as they occur

(without the use of an allowance account)

Direct Write-off Method

7-51

Learning Objectives

Describe the accounting treatment of

short-term notes receivable.

PROMISSORY NOTE

after date I promise to pay to the order of

Westward, Inc

Dollars plus interest at the annual rate of

One year

12%

Twenty-five thousand and

no/100 -Janet Lee , Winn,Co.

Maker

Payee Principal

Interest Rate

Date of Note

On November 1, 2006, Westward, Inc loans

$25,000 to Winn, Co The note bears

interest at 12% and is due on November 1,

2007.

Prepare the journal entry on November 1,

2006, December 31, 2006, (year-end) and

November 1, 2007 for Westward.

§ Cash proceeds equal facevalue of note less discount.

Noninterest-Bearing Notes

On January 1, 2006, Westward, Inc accepted

a $25,000 noninterest-bearing note from

Winn, Co as payment for a sale The note is

discounted at 12% and is due on December

31, 2006.

Prepare the journal entries on January 1,

2006, and December 31, 2006 for Westward.

Differentiate between the use of receivables

in financing arrangements accounted for

as a secured borrowing and those

accounted for as a sale.

Financing With Receivables

Secured borrowing

or

Sale of receivables

Method depends on the

surrender of control over

the receivables transferred.

7-62

Secured Borrowing – Assigning

Reclassify Accounts Receivable as Accounts

pThe use of specific receivables for collateral,

and the promise that any failure to repay

debt will result in proceeds from specific

accounts receivable collections being used

to repay the debt.

pReclassify Accounts Receivable as Accounts

Receivable Assigned

7-63

Secured Borrowing – Pledging

pReceivables in general are pledged as

collateral for loans

pPledged receivables are disclosed in notes

to the financial statements.

Sale of Accounts Receivable

FACTOR (Transferee)

SUPPLIER

1 Merchandise

2 Accounts Receivable

A factor is a financial institution that buys receivables

for cash, handles the billing and collection of the

receivables and charges a fee for the service.

7-65

Treat as a sale if allof these conditions are met:

ŒReceivables are isolated from transferor

•Transferee has right to pledge or exchange

receivables

ŽTransferor does not have control over the

receivables

§ Transferor cannot repurchase

receivable before maturity.

§ Transferor cannot require return

§ An ordinary sale of receivables to the factor

§ Factor assumes all risk of uncollectibility

§ Control of receivable passes to the factor

§ Receivables are removed from the books,

cash is received and a financing expense or

loss is recognized

§ Transferor (seller) retains risk of uncollectibility,

§ Must meet the three conditions of determining

surrender of control to be recognized as a sale

§ If the transaction fails to meet the three conditions

On December 31, Apex accepted a

nine-month 10 percent note for $200,000 from a

customer Three months later on March 31,

Apex discounted the note at its local bank

The bank’s discount rate 12 percent

Prepare the journal entry to record the

discounting of the note receivable as a sale.

7-69

GENERAL JOURNAL Page 69

Post

Discounting a Note

Before the preparing the journal entry to

record the discounting, Apex must record

the accrued interest on the note from

December 31 until March 31

$200,000 × 10% × 3/12

GENERAL JOURNAL Page 69

If the three conditions for sale treatment are

not met, the transaction would be recorded

as a secured borrowing

7-72

Learning Objectives

Describe the variables that influence a

company’s investment in receivables and

calculate the key ratios used by analysts

to monitor that investment.

Receivables Management

Product or

service sold

Credit and collection policies

Net Sales Average Accounts Receivable

365 Receivables Turnover Ratio

Compute the receivables turnover ratio

and the average collection period

for both companies.

Receivables Management

(All dollar amounts in millions)

2004 2003 2004 2003 Accounts receivable (net) $ 3,635 $ 2,586 $ 774 $ 766

Net sales 41,444 8,279

Receivables Management

Net Sales Average Accounts Receivable

365 Receivables Turnover Ratio

Bank Reconciliation

Provides information for

reconciling journal entries.

Explains the difference between cash

reported on bank statement and cash

balance on company’s books.

Let’s prepare a May 31 bank reconciliation

for the Hawthorne Company

pThe May 31 bank statement indicated a

balance of $34,680

pThe cash general ledger account on that date

shows a balance of $35,276

Additional information necessary for the

reconciliation is shown on the next screen

Bank Reconciliation

7-83

ΠCash receipts not yet deposited on May 31 totaled $2,965

• A $1,020 check mailed to the bank for deposit had not

reached the bank at the statement date.

Ž Outstanding checks totaled $5,536.

• A check written to pay for raw materials purchased on

account cleared the bank for $1,790 but was erroneously

recorded at $790.

• The bank statement showed $80 in service charges in May

‘ The bank returned NSF checks in the amount of $2,187

received as payment on accounts receivable.

’ The bank collected a note receivable for $1,120 that

included $120 of interest

Bank Reconciliation

7-84

Bank Reconciliation

Add: Deposit in transit* 3,985

Deduct: Outstanding checks (5,536)

Corrected cash balance $ 33,129

*$2,965 + $1,020 = $3,985

Bank Reconciliation

Add: Deposit in transit* 3,985

Deduct: Outstanding checks (5,536)

Corrected cash balance $ 33,129

Add: Note collected by bank 1,120

Petty Cash

Has one

custodian.

Replenished periodically.

Petty cash fund

Petty Cash

Hawthorne Co established a petty cash

fund on May 1 by writing a check for $200

to the petty cash custodian

Prepare the May1st journal entry to record the

establishment of the fund

GENERAL JOURNAL Page 64

Post

Ma y 1 Petty Ca sh 200

Cash 200

7-89 Petty Cash During May, the petty cash custodian paid bills using cash from the fund totaling $160 as follows: Postage $40 Office supplies 35 Delivery charges 55 Entertainment 30 Prepare the May 31 journal entry to record replenishing the fund. GENERAL JOURNAL Page 65 Date Description Post Ref Debit Credit May 31 Postage expense 40

Office supplies expense 35

Delivery expense 55

Entertainment e xpense 30

Cash 160

7-90

End of Chapter 7