Chapter 2


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Chapter 2

  1. 1. Chapter 2 Cash and Receivables
  2. 2. Outline 1. Cash and Cash Equivalents 2. Short-term Investments 3. Accounts Receivable 4. Notes Receivable 5. Inventories
  3. 3. 1. Cash and Cash Equivalents 1.1 Definition 1.2 Petty cash 1.3 Bank Reconciliation 1.4 Restricted cash and compensating balances 3
  4. 4. 1.1 Definition  Cash - Cash on hand: Currency and Coins - Cash in bank: Balances in checking accounts, and items acceptable for deposit in these accounts (e.g. checks, money orders received from customers) These forms of cash represent amounts readily available to pay off debt or to use in operations without any legal or contractual restriction. 4
  5. 5. 1.1 Definition (cont)  Cash equivalents - Treasury bills - Commercial paper These investments must have a maturity date no longer than three months from the date of purchase. 5
  6. 6. 1.2 Petty cash  Small amount on cash on hand to pay for low- cost items such as postage, office supplies, delivery charges, and entertainment expenses. 6
  7. 7. Illustration  On May 1, 2003, the Hawthorne Manufacturing Company established a $200 petty cash fund. John Ringo is designated as the petty cash fund custodian. The fund will be replenished at the end of each month. On May 1, 2003, a check is written for $200 made out to John Ringo, petty cash custodian. During the month of May, John paid bills totaling $160 summarized as follows: 7
  8. 8.  Postage $40  Office supplies 35  Delivery charges 55  Entertainment 30 Total $160 8
  9. 9. Journal entries  May 1, 2003 A petty cash fund is established by writing a check to the custodian.  May 31, 2003 The appropriate expense accounts are debited when the petty cash fund is reimbursed. 9
  10. 10. 1.3 Bank Reconciliation  Differences between the cash book and bank balance occur due to differences in the timing of recognition of certain transactions and errors.  Step 1: Adjust the bank balance to the corrected cash balance  Step 2: Adjust the book balance to the corrected cash balance 10
  11. 11. Step 1: Adjustments to Bank Balance Bank balance Book balance + Deposits outstanding + Collections by bank - Check outstanding - Service charges - NSF checks +/- Errors +/- Errors ----------------------- ----------------------- Corrected balance Corrected balance The two corrected balances must equal. 11
  12. 12. 1.4 Restricted cash and compensating balances  Restricted cash Cash that is restricted in some way and not available for current use usually is reported as investments and funds or other assets.  Compensating balances The borrower us asked to maintain a specified balance in a low-interest or noninterest-bearing account at the bank to compensate the bank for granting the loan or extending the line of credit. 12
  13. 13. 2. Accounts Receivable 2.1 Classification 2.2 Initial valuation of accounts receivable 2.3 Subsequent valuation of accounts receivable 13
  14. 14. 2.1 Classification  Accounts receivable are current assets because, by definition, they will be converted to cash within the normal operating cycle. 14
  15. 15. 2.2 Initial valuation of accounts receivable  The typical accounts receivable is valued at the amount expected to be received, not the present value of that amount.  Trade Discount  Cash Discount (sales discount) 15
  16. 16. Trade Discount  Usually a percentage reduction from the list price to change prices or to give quantity discount to large customers  The discount is recognized indirectly by recording the sale at the net of discount price, not at the list price. 16
  17. 17. Cash Discount (sales discount)  Reduce the amount to be paid if remittance is made within a specified short period of time.  Represent reduction not in the selling price of good or service but in the amount to be paid within a specified period of time to provide incentive for quick payment 17
  18. 18. Cash discount: journal entries The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days. Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On October 5, 2003, Hawthorne sold merchandise at a price of $20,000. The customer paid $13,720 ($14,000 less the 2% cash discount) on October 14 and the remaining balance of $6,000 on November 4. 18
  19. 19. Cash discount: journal entries  By either method, net sales is reduced by discount taken  Discounts not taken are included in sales revenue using the gross method and interest revenue using the net method 19
  20. 20. 2.3 Subsequent Valuation Two situations possibly could cause the cash collected to be less than the initial valuation of the receivable: 1. Sales returns: The customer could return the product. 2. Uncollectible Accounts Receivable: The customer could default and not pay the agreed on sales price. 20
  21. 21. Sales returns  Recognizing sales returns when they occur could result in an overstatement of income in the period of the related sale.  To avoid misstating the financial statements, when amounts are material, when amount are material, returns should be anticipated by subtracting an allowance for estimated returns. 21
  22. 22. Illustration During 2003, its first year of operations, the Hawthorne Manufacturing Company sold merchandise on account for $2,000,000. This merchandise cost $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be returned. Customers returned $130,000 in sales during 2003, prior to making payment. The entries to record sales and merchandise returned during the year, assuming that a perpetual inventory system is used, are as follows: 22
  23. 23.  If sales returns are material, they should be estimated and recorded in the same period in the same as the related sales  The allowance for sales returns is a contra account to accounts receivable. When returns actually occur in the following reporting period, the allowance for sales returns is debited. In this way, income is not reduced in the return period but in the period of the sales revenue. 23
  24. 24. Uncollectible Accounts Receivable  Income statement approach Estimate bad debt expense as a percentage of each period’s net sales. The balance sheet amount is an indirect outcome of estimating bad dent expense.  Balance sheet approach Determine bad debt expense by estimating the net realizable value of accounts receivable to be reported in the balance sheet. 24
  25. 25. Illustration The Hawthorne Manufacturing Company sells its products offering 30 days’ credit to its customers. During 2003, its first year of operations, the following events occurred: Sales on credit $1,2000,000 Cash collections from credit customers (895,000) Accounts receivable, end of year $305,000 There were no specific accounts determined to be uncollectible in 2003. The company anticipates that 2% of all credit sales will ultimately become uncollectible. 25