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This document discusses various aspects of accounting for cash and receivables. It begins by explaining how businesses need sufficient cash on hand to pay bills and covers common types of financial assets like cash, short-term investments, and accounts receivable. It then discusses how these assets are valued on the balance sheet and issues related to cash management, internal controls over cash, bank reconciliations, and estimating and accounting for uncollectible accounts receivable.

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© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-1 FINANCIAL ASSETSChapter 7
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-2 How Much Cash Should a Business Have? How Much Cash Should a Business Have? $ Every business needs enough cash to pay its bills!
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-3 How Much Cash Should a Business Have? How Much Cash Should a Business Have? Cash Short-term Investments Receivables Financial Assets
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-4 How Much Cash Should a Business Have? How Much Cash Should a Business Have? Accounts receivable Marketable securities Cash (and cash equivalents) Collections from customers Cash payments “Excess” cash is invested temporarily. Investments are sold as cash is needed.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-5 The Valuation of Financial AssetsThe Valuation of Financial Assets Type of Financial Asset Basis for Valuation in the Balance Sheet Cash (and cash equivalents) Face amount Short-term investments (marketable securities) Current market value Receivables Net realizable value Estimated collectible amountEstimated collectible amount
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-6 CashCash Coins and paper money Checks Money orders Travelers’ checks Bank credit card sales Cash is defined as any deposit banks will accept.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-7 Combined with cash on balance sheet Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Liquid short- term investments Stable market values Matures within 90 days of acquisition Cash Equivalents
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-8 Not available for paying current liabilities Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Not a current asset Listed as an investment “Restricted” Cash
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-9 Bank agrees in advance to lend money. Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Liability is incurred when line of credit is used. Unused line of credit is disclosed in notes. Lines of Credit
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-10 The Statement of Cash FlowsThe Statement of Cash Flows Summarizes cash transactions for an accounting period. Statement of Cash Flows Includes cash and cash equivalents.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-11 Cash ManagementCash Management Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash. Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-12 Using Excess Cash Balances Efficiently Using Excess Cash Balances Efficiently Cash available for long-term investment may be used to finance growth and expansion of the business, or to repay debt. Cash not needed for business purposes should be distributed to the company’s stockholders.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-13 Internal Control Over Cash Segregate authorization, custody and recording of cash. Prepare a cash budget. Prepare a control listing of cash receipts. Require daily deposits. Make all payments by check. Verify every expenditure before payment. Promptly reconcile bank statements. Internal Control Over Cash Segregate authorization, custody and recording of cash. Prepare a cash budget. Prepare a control listing of cash receipts. Require daily deposits. Make all payments by check. Verify every expenditure before payment. Promptly reconcile bank statements.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-14 Cash Over and ShortCash Over and Short Cash Over and Short is debited for shortages and credited for overages. Cash Over and Short is debited for shortages and credited for overages. On May 5, XBAR, Inc.’s cash drawer was counted and found to be $10 over.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-15 Bank StatementsBank Statements Shows the beginning bank balance, deposits made, checks paid, other debits and credits during the month, and the ending bank balance. Bank Statement
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-16 Reconciling the Bank StatementReconciling the Bank Statement Explains the difference between cash reported on bank statement and cash balance in depositor’s accounting records. Provides information for reconciling journal entries.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-17 Reconciling the Bank StatementReconciling the Bank Statement Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors = Adjusted Balance Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-18 Reconciling the Bank StatementReconciling the Bank Statement All reconciling items on the book side require an adjusting entry to the cash account. Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-19 Reconciling the Bank Statement Example Reconciling the Bank Statement Example Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicated a cash balance of $9,610, while the cash ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next page.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-20  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment of an account receivable.  The bank statement showed $30 interest earned on the bank balance for the month of July.  Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.  A $486 deposit by Acme Company was erroneously credited to our account by the bank.  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment of an account receivable.  The bank statement showed $30 interest earned on the bank balance for the month of July.  Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.  A $486 deposit by Acme Company was erroneously credited to our account by the bank.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-21 Reconciling the Bank Statement Example Reconciling the Bank Statement Example Reconciling the Bank Statement Example Reconciling the Bank Statement Example Balance per bank statement, July 31 9,610$ Additions: Deposit in transit 500 Deductions: Bank error 486$ Outstanding checks 2,417 2,903 Adjusted cash balance 7,207$ Balance per depositor's records, July 31 7,430$ Additions: Interest 30 Deductions: Recording error 28$ NSF check 225 253 Adjusted cash balance 7,207$
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-22 Reconciling the Bank Statement Example Reconciling the Bank Statement Example GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Jul 31 Cash 30 Interest Revenue 30 31 Supplies Inventory 28 Accounts Receivable 225 Cash 253
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-23 Used for minor expenditures. Petty Cash FundsPetty Cash Funds Has one custodian. Replenished periodically. Petty Cash Funds
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-24 Short-Term InvestmentsShort-Term Investments Bond Investments Capital Stock Investments Current Assets Almost As Liquid As Cash Readily Marketable Marketable Securities are . . .
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-25 Mark-to-Market: A Principle of Asset Valuation Mark-to-Market: A Principle of Asset Valuation Short-term investments in marketable securities appear on the balance sheet at their current market value as of the balance sheet date. Classification Management's Intent Treatment of Unrealized Holding Gains and Losses Available-for- sale securities Held for short-term resale (often 6 to 18 months) Reported in stockholders' equity section of the balance sheet Trading securities Held for immediate resale (often within hours or days) Reported in "other" revenue (expense) section of the income statement Held to maturity securities Debt securities intended to be held until they mature Reported in stockholders' equity section of the balance sheet
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-26 Let’s turn our attention to accounts receivable.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-27 Uncollectible AccountsUncollectible Accounts If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. PAST DUE
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-28 Reflecting Uncollectible Accounts in the Financial Statements Reflecting Uncollectible Accounts in the Financial Statements At the end of each period, record an estimate of the uncollectible accounts. At the end of each period, record an estimate of the uncollectible accounts. Contra-asset accountContra-asset accountSelling expenseSelling expense
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-29 The Allowance for Doubtful Accounts The Allowance for Doubtful Accounts Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable The net realizable value is the amount of accounts receivable that the business expects to collect.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-30 Writing Off an Uncollectible Account Receivable 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. When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-31 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he owes. K-Max would make the following entry.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-32 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Doubtful Accounts balance was $2,500. Let’s see what effect the write-off had on these accounts.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-33 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Before Write-Off After Write-Off Accounts receivable 10,000$ 9,500$ Less: Allow. for doubtful accts. 2,500 2,000 Net realizable value 7,500$ 7,500$ Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-34 Recovery of an Account Receivable Previously Written Off Recovery of an Account Receivable Previously Written Off GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Accounts Receivable (X Customer) $$$$ Allowance for Doubtful Accounts $$$$ Cash $$$$ Accounts Receivable (X Customer) $$$$ Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded. Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-35 Monthly Estimates of Credit LossesMonthly Estimates of Credit Losses At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate. At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-36 At December 31, 2005, MusicLand’s accounting records indicate the following: Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit) Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Uncollectible Accounts Expense for 2005? At December 31, 2005, MusicLand’s accounting records indicate the following: Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit) Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Uncollectible Accounts Expense for 2005? Monthly Estimates of Credit Losses Example Monthly Estimates of Credit Losses Example
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-37 Desired balance in Allowance for Doubtful Accounts. Monthly Estimates of Credit Losses Example Monthly Estimates of Credit Losses Example
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-38 Let’s look at another way to estimate the uncollectible accounts! Let’s look at another way to estimate the uncollectible accounts!
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-39 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach  Year-end Accounts Receivable is broken down into age classifications.  Year-end Accounts Receivable is broken down into age classifications.  Each age grouping has a different likelihood of being uncollectible.  Each age grouping has a different likelihood of being uncollectible.  Compute a separate allowance for each age grouping.  Compute a separate allowance for each age grouping.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-40 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-41 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-42 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-43 EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-44 Guess What! There is another alternative to estimate the uncollectible accounts! Guess What! There is another alternative to estimate the uncollectible accounts!
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-45 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales. Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-46 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses Net Credit Sales × % Estimated Uncollectible Amount of Journal Entry
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-47 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses In 2005, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s accounts have been uncollectible. For 2005, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600) Now, prepare the adjusting entry for December 31, 2005.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-48 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-49 Uncollectible Accounts Summary Uncollectible Accounts Summary % of Receivables% of Receivables Emphasis on Realizable Value Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Balance Sheet Focus Aging of Receivables Aging of Receivables Emphasis on Realizable Value Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Balance Sheet Focus % of Sales% of Sales Emphasis on Matching Emphasis on Matching Sales Uncoll. Accts. Exp. Income Statement Focus Income Statement Focus
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-50 Direct Write-Off MethodDirect Write-Off Method This method makes no attempt to match revenue with the expense of uncollectible accounts.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-51 Income Tax Regulations and Financial Reporting Income Tax Regulations and Financial Reporting Direct write-off method required to calculate taxable income. Taxable Income Financial Statement Income GAAP GAAP GAAP GAAP Allowance methods better match expenses with revenues.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-52 Internal Controls for ReceivableInternal Controls for Receivable Separate the following duties: Maintenance of the accounts receivable subsidiary ledger. Custody of cash receipts.  Authorization of accounts receivable write- offs. Maintenance of the accounts receivable subsidiary ledger. Custody of cash receipts.  Authorization of accounts receivable write- offs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-53 Management of Accounts Receivable Management of Accounts Receivable Credit Terms Minimize Accounts Receivable Extending credit encourages customers to buy from us . . . . . . but it ties up resources in accounts receivable.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-54 Ways to Minimize Amounts in Accounts Receivable Ways to Minimize Amounts in Accounts Receivable Selling Accounts Receivable Credit Card Sales
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-55 Financial AnalysisFinancial Analysis Accounts Receivable Turnover Ratio This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Accounts Receivable Turnover Ratio This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Net Sales Average Accounts Receivable
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-56 Financial AnalysisFinancial Analysis Avg. Number of Days to Collect A/R This ratio helps judge the liquidity of a company’s accounts receivable. Avg. Number of Days to Collect A/R This ratio helps judge the liquidity of a company’s accounts receivable. Days in Year Accounts Receivable Turnover Ratio
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-57 Concentration of Credit RiskConcentration of Credit Risk A concentration of credit risk exists when many of a business’s credit customers can be affected in a similar manner by certain changes in economic conditions. A concentration of credit risk exists when many of a business’s credit customers can be affected in a similar manner by certain changes in economic conditions. The FASB requires companies to disclose all significant concentrations of credit risk in the notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from changes in specific economic conditions. The FASB requires companies to disclose all significant concentrations of credit risk in the notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from changes in specific economic conditions.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-58 End of Chapter 7End of Chapter 7

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Williams07

  • 1.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-1 FINANCIAL ASSETSChapter 7
  • 2.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-2 How Much Cash Should a Business Have? How Much Cash Should a Business Have? $ Every business needs enough cash to pay its bills!
  • 3.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-3 How Much Cash Should a Business Have? How Much Cash Should a Business Have? Cash Short-term Investments Receivables Financial Assets
  • 4.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-4 How Much Cash Should a Business Have? How Much Cash Should a Business Have? Accounts receivable Marketable securities Cash (and cash equivalents) Collections from customers Cash payments “Excess” cash is invested temporarily. Investments are sold as cash is needed.
  • 5.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-5 The Valuation of Financial AssetsThe Valuation of Financial Assets Type of Financial Asset Basis for Valuation in the Balance Sheet Cash (and cash equivalents) Face amount Short-term investments (marketable securities) Current market value Receivables Net realizable value Estimated collectible amountEstimated collectible amount
  • 6.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-6 CashCash Coins and paper money Checks Money orders Travelers’ checks Bank credit card sales Cash is defined as any deposit banks will accept.
  • 7.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-7 Combined with cash on balance sheet Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Liquid short- term investments Stable market values Matures within 90 days of acquisition Cash Equivalents
  • 8.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-8 Not available for paying current liabilities Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Not a current asset Listed as an investment “Restricted” Cash
  • 9.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-9 Bank agrees in advance to lend money. Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Liability is incurred when line of credit is used. Unused line of credit is disclosed in notes. Lines of Credit
  • 10.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-10 The Statement of Cash FlowsThe Statement of Cash Flows Summarizes cash transactions for an accounting period. Statement of Cash Flows Includes cash and cash equivalents.
  • 11.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-11 Cash ManagementCash Management Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash. Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash.
  • 12.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-12 Using Excess Cash Balances Efficiently Using Excess Cash Balances Efficiently Cash available for long-term investment may be used to finance growth and expansion of the business, or to repay debt. Cash not needed for business purposes should be distributed to the company’s stockholders.
  • 13.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-13 Internal Control Over Cash Segregate authorization, custody and recording of cash. Prepare a cash budget. Prepare a control listing of cash receipts. Require daily deposits. Make all payments by check. Verify every expenditure before payment. Promptly reconcile bank statements. Internal Control Over Cash Segregate authorization, custody and recording of cash. Prepare a cash budget. Prepare a control listing of cash receipts. Require daily deposits. Make all payments by check. Verify every expenditure before payment. Promptly reconcile bank statements.
  • 14.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-14 Cash Over and ShortCash Over and Short Cash Over and Short is debited for shortages and credited for overages. Cash Over and Short is debited for shortages and credited for overages. On May 5, XBAR, Inc.’s cash drawer was counted and found to be $10 over.
  • 15.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-15 Bank StatementsBank Statements Shows the beginning bank balance, deposits made, checks paid, other debits and credits during the month, and the ending bank balance. Bank Statement
  • 16.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-16 Reconciling the Bank StatementReconciling the Bank Statement Explains the difference between cash reported on bank statement and cash balance in depositor’s accounting records. Provides information for reconciling journal entries.
  • 17.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-17 Reconciling the Bank StatementReconciling the Bank Statement Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors = Adjusted Balance Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance
  • 18.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-18 Reconciling the Bank StatementReconciling the Bank Statement All reconciling items on the book side require an adjusting entry to the cash account. Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance
  • 19.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-19 Reconciling the Bank Statement Example Reconciling the Bank Statement Example Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicated a cash balance of $9,610, while the cash ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next page.
  • 20.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-20  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment of an account receivable.  The bank statement showed $30 interest earned on the bank balance for the month of July.  Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.  A $486 deposit by Acme Company was erroneously credited to our account by the bank.  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment of an account receivable.  The bank statement showed $30 interest earned on the bank balance for the month of July.  Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.  A $486 deposit by Acme Company was erroneously credited to our account by the bank.
  • 21.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-21 Reconciling the Bank Statement Example Reconciling the Bank Statement Example Reconciling the Bank Statement Example Reconciling the Bank Statement Example Balance per bank statement, July 31 9,610$ Additions: Deposit in transit 500 Deductions: Bank error 486$ Outstanding checks 2,417 2,903 Adjusted cash balance 7,207$ Balance per depositor's records, July 31 7,430$ Additions: Interest 30 Deductions: Recording error 28$ NSF check 225 253 Adjusted cash balance 7,207$
  • 22.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-22 Reconciling the Bank Statement Example Reconciling the Bank Statement Example GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Jul 31 Cash 30 Interest Revenue 30 31 Supplies Inventory 28 Accounts Receivable 225 Cash 253
  • 23.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-23 Used for minor expenditures. Petty Cash FundsPetty Cash Funds Has one custodian. Replenished periodically. Petty Cash Funds
  • 24.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-24 Short-Term InvestmentsShort-Term Investments Bond Investments Capital Stock Investments Current Assets Almost As Liquid As Cash Readily Marketable Marketable Securities are . . .
  • 25.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-25 Mark-to-Market: A Principle of Asset Valuation Mark-to-Market: A Principle of Asset Valuation Short-term investments in marketable securities appear on the balance sheet at their current market value as of the balance sheet date. Classification Management's Intent Treatment of Unrealized Holding Gains and Losses Available-for- sale securities Held for short-term resale (often 6 to 18 months) Reported in stockholders' equity section of the balance sheet Trading securities Held for immediate resale (often within hours or days) Reported in "other" revenue (expense) section of the income statement Held to maturity securities Debt securities intended to be held until they mature Reported in stockholders' equity section of the balance sheet
  • 26.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-26 Let’s turn our attention to accounts receivable.
  • 27.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-27 Uncollectible AccountsUncollectible Accounts If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. PAST DUE
  • 28.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-28 Reflecting Uncollectible Accounts in the Financial Statements Reflecting Uncollectible Accounts in the Financial Statements At the end of each period, record an estimate of the uncollectible accounts. At the end of each period, record an estimate of the uncollectible accounts. Contra-asset accountContra-asset accountSelling expenseSelling expense
  • 29.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-29 The Allowance for Doubtful Accounts The Allowance for Doubtful Accounts Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable The net realizable value is the amount of accounts receivable that the business expects to collect.
  • 30.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-30 Writing Off an Uncollectible Account Receivable 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. When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off.
  • 31.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-31 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he owes. K-Max would make the following entry.
  • 32.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-32 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Doubtful Accounts balance was $2,500. Let’s see what effect the write-off had on these accounts.
  • 33.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-33 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Before Write-Off After Write-Off Accounts receivable 10,000$ 9,500$ Less: Allow. for doubtful accts. 2,500 2,000 Net realizable value 7,500$ 7,500$ Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts.
  • 34.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-34 Recovery of an Account Receivable Previously Written Off Recovery of an Account Receivable Previously Written Off GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Accounts Receivable (X Customer) $$$$ Allowance for Doubtful Accounts $$$$ Cash $$$$ Accounts Receivable (X Customer) $$$$ Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded. Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
  • 35.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-35 Monthly Estimates of Credit LossesMonthly Estimates of Credit Losses At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate. At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate.
  • 36.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-36 At December 31, 2005, MusicLand’s accounting records indicate the following: Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit) Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Uncollectible Accounts Expense for 2005? At December 31, 2005, MusicLand’s accounting records indicate the following: Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit) Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Uncollectible Accounts Expense for 2005? Monthly Estimates of Credit Losses Example Monthly Estimates of Credit Losses Example
  • 37.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-37 Desired balance in Allowance for Doubtful Accounts. Monthly Estimates of Credit Losses Example Monthly Estimates of Credit Losses Example
  • 38.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-38 Let’s look at another way to estimate the uncollectible accounts! Let’s look at another way to estimate the uncollectible accounts!
  • 39.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-39 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach  Year-end Accounts Receivable is broken down into age classifications.  Year-end Accounts Receivable is broken down into age classifications.  Each age grouping has a different likelihood of being uncollectible.  Each age grouping has a different likelihood of being uncollectible.  Compute a separate allowance for each age grouping.  Compute a separate allowance for each age grouping.
  • 40.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-40 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
  • 41.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-41 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
  • 42.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-42 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
  • 43.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-43 EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach
  • 44.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-44 Guess What! There is another alternative to estimate the uncollectible accounts! Guess What! There is another alternative to estimate the uncollectible accounts!
  • 45.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-45 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales. Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.
  • 46.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-46 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses Net Credit Sales × % Estimated Uncollectible Amount of Journal Entry
  • 47.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-47 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses In 2005, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s accounts have been uncollectible. For 2005, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600) Now, prepare the adjusting entry for December 31, 2005.
  • 48.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-48 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses
  • 49.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-49 Uncollectible Accounts Summary Uncollectible Accounts Summary % of Receivables% of Receivables Emphasis on Realizable Value Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Balance Sheet Focus Aging of Receivables Aging of Receivables Emphasis on Realizable Value Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Balance Sheet Focus % of Sales% of Sales Emphasis on Matching Emphasis on Matching Sales Uncoll. Accts. Exp. Income Statement Focus Income Statement Focus
  • 50.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-50 Direct Write-Off MethodDirect Write-Off Method This method makes no attempt to match revenue with the expense of uncollectible accounts.
  • 51.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-51 Income Tax Regulations and Financial Reporting Income Tax Regulations and Financial Reporting Direct write-off method required to calculate taxable income. Taxable Income Financial Statement Income GAAP GAAP GAAP GAAP Allowance methods better match expenses with revenues.
  • 52.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-52 Internal Controls for ReceivableInternal Controls for Receivable Separate the following duties: Maintenance of the accounts receivable subsidiary ledger. Custody of cash receipts.  Authorization of accounts receivable write- offs. Maintenance of the accounts receivable subsidiary ledger. Custody of cash receipts.  Authorization of accounts receivable write- offs.
  • 53.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-53 Management of Accounts Receivable Management of Accounts Receivable Credit Terms Minimize Accounts Receivable Extending credit encourages customers to buy from us . . . . . . but it ties up resources in accounts receivable.
  • 54.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-54 Ways to Minimize Amounts in Accounts Receivable Ways to Minimize Amounts in Accounts Receivable Selling Accounts Receivable Credit Card Sales
  • 55.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-55 Financial AnalysisFinancial Analysis Accounts Receivable Turnover Ratio This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Accounts Receivable Turnover Ratio This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Net Sales Average Accounts Receivable
  • 56.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-56 Financial AnalysisFinancial Analysis Avg. Number of Days to Collect A/R This ratio helps judge the liquidity of a company’s accounts receivable. Avg. Number of Days to Collect A/R This ratio helps judge the liquidity of a company’s accounts receivable. Days in Year Accounts Receivable Turnover Ratio
  • 57.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-57 Concentration of Credit RiskConcentration of Credit Risk A concentration of credit risk exists when many of a business’s credit customers can be affected in a similar manner by certain changes in economic conditions. A concentration of credit risk exists when many of a business’s credit customers can be affected in a similar manner by certain changes in economic conditions. The FASB requires companies to disclose all significant concentrations of credit risk in the notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from changes in specific economic conditions. The FASB requires companies to disclose all significant concentrations of credit risk in the notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from changes in specific economic conditions.
  • 58.
    © The McGraw-HillCompanies, Inc., 2003McGraw-Hill/Irwin Slide 7-58 End of Chapter 7End of Chapter 7