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Cash and Receivables

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  1. Insert Book Cover Picture Cash and Receivables 7

  2. Cash Coins and currency Petty cash Cashier’s checks Certified checks Amounts on deposit with financial institutions Money orders

  3. Cash Equivalents Items very near cash but not in negotiable form Money marketfunds Treasury bills Commercialpaper

  4. Learning Objectives Define what is meant by internal control and describe some key elements of an internal control system for cash receipts and disbursements. LO1

  5. Internal Control of Cash Encourages adherence to company policies and procedures Promotes operational efficiency Enhances the reliability and accuracy of accounting data Minimizes errorsand theft

  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 cash-handling and cash-recording activities.

  7. Control of Cash Disbursements Separate responsibilities for • cash disbursement documents, • check writing, • check signing, • check mailing, and • record keeping. All disbursements, except petty cash, made by check.

  8. Learning Objectives Explain the possible restrictions on cash and their implications for classification in the balance sheet. LO2

  9. Restricted Cash andCompensating Balances Restricted Cash • Management’s intent to use a certain amountof cash for a specific purpose – future plant expansion, future payment of debt. Compensating Balance • Minimum balance that must be maintainedin a company’s account as support forfunds borrowed from the bank.

  10. Learning Objectives Distinguish between the gross and net methods of accounting for cash discounts LO3

  11. Accounts Receivable Credit sales require: • Maintaining a separate account receivable for each customer. • Accounting for bad debts that result from credit sales. Amounts due from customers for credit sales.

  12. Increase sales. Encourage early payment. Increase likelihood of collections. Cash Discounts Cash discounts . . .

  13. Discount Percent Number of Days Discount is Available Otherwise, Net (or All) is Due CreditPeriod Cash Discounts 2/10,n/30

  14. Sales are recorded at theinvoice amounts. Sales discounts are recorded if payment is receivedwithinthe discount period. Cash Discounts Gross Method

  15. Sales are recorded at theinvoice amount less the discount. Sales discounts forfeited are recorded if payment is receivedafter the discount period. Cash Discounts Net Method

  16. 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.

  17. Cash Discounts

  18. Cash Discounts 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.

  19. Cash Discounts

  20. Cash Discounts 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.

  21. Cash Discounts

  22. Learning Objectives Describe the accounting treatment for merchandise returns. LO4

  23. Sales Returns and Allowances Sales Returns Sales Allowances Merchandise returned by a customer to a supplier. A reduction in the cost of defective merchandise.

  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 theperiodic method to account for inventory. Record the journal entry for the return of merchandise.

  25. Sales Returns and Allowances Sales Returns and Allowances is a contra account that reduces Sales Revenue in the current accounting period.

  26. Learning Objectives Describe the accounting treatment of anticipated uncollectible accounts receivable. LO5

  27. PAST DUE Uncollectible Accounts Receivable Bad debtsresult from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts.

  28. Uncollectible Accounts Receivable In conformity with thematching principle, bad debt expense should be recorded in thesameaccounting period in which the sales related to the uncollectible account were recorded.

  29. Uncollectible Accounts Receivable Most businesses record anestimateof thebad debt expenseby an adjusting entry at the end of the accounting period.

  30. Normally classified asaselling expenseandclosed at year-end. Contra assetaccount toAccounts Receivable. Uncollectible Accounts Receivable

  31. 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

  32. Learning Objectives Describe the two approaches to estimating bad debts. LO6

  33. PAST DUE Estimating Bad Debts • Income Statement Approach • Balance Sheet Approach • Composite Rate • Aging of Receivables

  34. Income Statement Approach • Focuses on pastcredit salesto make estimate of bad debt expense. • Emphasizes thematching principleby estimating thebad debt expenseassociated with the current period’s credit sales.

  35. Income Statement Approach Bad debts expense iscomputed as follows:

  36. Income Statement Approach 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?

  37. Income Statement Approach MusicLand computes estimated Bad Debts Expense of $2,400.

  38. Balance Sheet Approach • Focuses on the collectibility of accounts receivable to make the estimate of uncollectible accounts. • Involves the direct computation of the desired balance in the allowance for uncollectible accounts.

  39. Balance Sheet ApproachComposite Rate • Compute the desired balance in the Allowance for Uncollectible Accounts. • Bad Debts Expense is computed as:

  40. Balance Sheet ApproachComposite Rate On Dec. 31, 2006, MusicLand has$50,000 in Accounts Receivableand a$200 credit balance in Allowance for Uncollectible Accounts. Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Bad Debts Expense for 2006?

  41. Balance Sheet ApproachComposite Rate Desired balance in Allowancefor Uncollectible Accounts

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

  43. Balance Sheet Approach Aging of Receivables • Year-end Accounts Receivable is broken down into age classifications. • Each age grouping has a different likelihood of being uncollectible. • Compute desired uncollectible amount. • Compare desired uncollectible amount with the existing balance in theallowance account.

  44. Balance Sheet Approach Aging of Receivables At December 31, 2006, the receivables for EastCo, Inc. were categorized as follows:

  45. 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. Prepare the entry to record bad debts expense at Dec. 31, 2006.

  46. 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.

  47. Sales Accts. Rec. Bad Debts Exp. All. for Uncoll. Accts. Methods to Estimate Bad Debts Income Statement Approach Balance Sheet Approach Emphasis on Matching Emphasis on Realizable Value Income Statement Focus Balance Sheet Focus

  48. Uncollectible Accounts As accounts become uncollectible, the following entry is made: So what happens if someone pays after a write-off of the accounts receivable?

  49. Collection of PreviouslyWritten-Off Accounts When a customer makes a payment after an account has been written off,twojournal entries are required.

  50. Direct Write-off Method If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account).