Chapter 8--Learning Objectives

1. Chapter 8--Learning Objectives • 1. Understand the composition and control of cash

2. What is cash ?

3. What is cash ? • For accounting purposes, cash includes: • Currency and coins (including petty cash) • Demand deposits (checking accounts) • Checks, drafts and money orders • Readily usable foreign currency • Savings accounts (technically investments)

4. What is NOT cash ? • Postage stamps • Post-dated checks • Certificates of deposit • IOUs and notes receivable

5. Cash equivalents • Must be readily convertible to cash • Must be close to maturity • Cash equivalents frequently include: • Treasury bills • Commercial paper • Certificates of deposit • (within 90 days of maturity)

6. Internal control • Procedures used to safeguard assets • Probably cannot prevent theft altogether • But can make the potential crook’s job more difficult • Separate duties • Create paper trails

7. Cash Control • Record and deposit receipts promptly • Separation of duties • No unauthorized or undocumented disbursements • Job rotation • Imprest funds • Internal and external audits • Bank reconciliations

8. Petty cash fund • Known as imprest (advanced) fund • Establish fund with set amount • Debit “Petty Cash” when fund set up • Subsequent entries debit various expenses and credit “Cash” • Shortages debited to “Cash Over and Short,” treated as misc. expense

9. Bank reconciliation • Prepared when statements received • Start with “balance per bank” and “balance per books” • Bring both numbers to “corrected cash” or “true cash” • Adjust books for items on “books” side of reconciliation

10. Typical items on“bank” side of reconciliation • Balance per bank XXX • Deposits in transit + XXX • Outstanding checks - XXX • Errors by bank + or - XXX • Corrected cash balance XXX

11. Typical items on“books” side of reconciliation • Balance per books XXX • Interest earned on account + XXX • Items collected by bank + XXX • Bank service charges - XXX • NSF checks - XXX • Errors on books + or - XXX • Corrected cash balance XXX

12. Typical bank reconciliationadjusting entry Acct. Receivable--Ima Deadbeat XXX Service Charge Expense XXX Interest Income XXX Cash XXX • Note handling of NSF check from Ima Deadbeat, one of our customers.

13. Chapter 8--Learning Objectives • 2. Record and value accounts receivable

14. Trade Receivables • Result from sales of goods or services on account • Balance Sheet Measurement: • Net Realizable Value • Discounts • Trade Discounts • Cash Discounts

15. Net Realizable Value • Amount expected to be realized (collected) • Gross Accounts Receivable, net of • Expected returns & Allowances • Cash discounts expected to be taken • Expected uncollectible amounts

16. Trade Discounts • Used to determine prices for different types of customers • e.g., builder’s discount

17. Cash Discounts • Offered to encourage early payment • Examples • 2, 10, net 30 • 2, 10, eom • Accounting approaches • Gross Method • Net Method

18. Terms and discounts 2 / 10 , n / 30 means that a 2 percent discount is available if paid within 10 days and that the balance is due in 30 days

19. Recording sales discountsThe gross method Assume a $100 sale, terms 2/10, n/30 The sale is recorded: Accounts Receivable 100 Sales 100

20. Recording sales discountsThe gross method • If paid within 10 days: Cash 98 Sales Discounts 2 Accounts Receivable 100 • “Sales Discounts” is a contra-account to “Sales Revenue”

21. Recording sales discountsThe gross method • If paid after 10 days: Cash 100 Accounts Receivable 100

22. Recording sales discountsThe net method • Assume a $100 sale, terms 2/10, n/30 • The sale is recorded: Accounts Receivable 98 Sales 98

23. Recording sales discountsThe net method • If paid within 10 days: Cash 98 Accounts Receivable 98

24. Recording sales discountsThe gross method • If paid after 10 days: Cash 100 Accounts Receivable 98 Sales Discounts Forfeited 2 • “Sales Discounts Forfeited” is a miscellaneous revenue account

25. BAD DEBTS If you do business on credit, the question is not “whether” but “how much” Some people cannot or will not pay their bills You know that they are out there You just don’t know who they are

26. Accounts receivable entries • Making a credit sale Accounts Receivable XXX Sales XXX

27. Accounts receivable entries • Collecting from a credit customer • Cash XXX • Accounts Receivable XXX

28. Accounts receivable entries • Writing off an uncollectible account • Allowance for Bad Debts XXX • Accounts Receivable XXX

29. Accounts receivable entries • Reinstating an account previously written off Accounts Receivable XXX Allowance for Bad Debts XXX Cash XXX Accounts Receivable XXX

30. Accounts receivable entries • The provision for bad debts • (an adjusting entry) Bad Debt Expense XXX Allowance for Bad Debts XXX

31. Valuation of accounts receivableor estimating bad debt expense Two methods will be examined: 1. The percentage of sales method (also known as the income statement method) 2. The percentage of receivables method (also known as the balance sheet method)

32. Percentage of sales method • An income statement approach • The more you sell--the more you can expect to lose • Consistent with matching principle • Select a percentage based on past experience or industry averages • Multiply the percentage by total credit sales

33. Percentage of sales method • Assume $1,000,000 sales and 3% estimated bad debts Bad Debt Expense 30,000 Allow. for Bad Debts 30,000

34. Percentage of receivables • Based on “aging” the individual accounts receivable • The later they are in paying--the less likely they are to pay up • Percentages likely to default are assigned to each age category • The result is the balance needed in the “Allowance for Bad Debts” account

35. Assume that an aging schedule yields the following information: Percent Amount likely to likely to Status Amount default default Current $ 70,000 0 $ -0- 30-60 days overdue 40,000 5 2,000 60-90 days overdue 30,000 10 3,000 90-180 days overdue 30,000 25 7,500 Over 180 days 10,000 30 3,000 Totals $180,000 $15,500

36. Allowance for Bad Debts The $15,500 is the total amount needed in the “Allowance” account • Assume that the “Allowance for Bad Debts” account has a $3,000 credit balance prior to adjustment 3,000

37. The $15,500 is the total amount needed in the “Allowance” account • To go from a $3,000 credit to a $15,500 credit will require a $12,500 credit Allowance for Bad Debts 3,000 12,500 15,500

38. $12,500 is the amount needed to adjust the “Allowance” account • The necessary entry is: Bad Debt Expense 12,500 Allow. for Bad Debts 12,500

39. Account write-offs do not reduce total assets ! • Assume $10,000 of Accts. Receivable and a $1,000 Allowance for Bad Debts • Net collectible receivables are $9,000 Accounts receivable $10,000 Less: AFBD 1,000 Net receivables $ 9,000

40. Now assume we write off a $100 account • The entry to write off the account is • Allowance for Bad Debts 100 • Account Receivable 100 Accts. Rec. AFBD 1,000 10,000

41. Now assume we write off a $100 account • The entry to write off the account is • Allowance for Bad Debts 100 • Account Receivable 100 • Posting the entry has this result: Accts. Rec. AFBD 10,000 100 100 1,000 9,900 900

42. Note that net collectible receivables are: Accounts receivable $ 9,900 Less: AFBD 900 Net receivables $ 9,000 BEFORE = $9,000 AFTER = $9,000 Accts. Rec. AFBD 10,000 100 100 1,000 9,900 900

43. DIRECT WRITE-OFF METHOD

44. DIRECT WRITE-OFF METHOD

45. Chapter 8--Learning Objectives • 3. Demonstrate how accounts receivable are used as the basis for financing

46. Receivables can be used as an immediate source of cash • Assigning accounts receivable means using them as collateral for a loan • Factoring accounts receivable means selling them • Factoring can be with recourse or without recourse • Recourse refers to ultimate responsibility for payment

47. Factoring with recourse When accounts are factored with recourse, uncollectible accounts are absorbed by the transferor Transaction is treated as a sale if all of the following conditions are met: 1. Risks, rewards & benefits are transferred 2. Future cash flows are estimable at time of transfer 3. Transferee cannot require transferor to repurchase receivables except under recourse provisions

48. Factoring with recourseas a borrowing • If all conditions for treatment as a sale are not meant, factoring with recourse is treated as a borrowing

49. Chapter 8--Learning Objectives • 4. Record and value notes receivable

50. Notes receivable • Formal, written promises to pay • Negotiable • Provide legal evidence of debt • Usually interest bearing, but may be noninterest bearing • Should be valued at present value of future cash inflows