© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin 7-1 financial assets chapter 7

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

7-1

Financial Assets

Chapter

7


7-2

How Much Cash Should a Business Have?


$

Every business

needs enough

cash to pay its bills!


7-3



Cash

Short-term Investments

Receivables

Financial Assets


7-4



Accounts

receivable

Marketable securities (short-term

investments)

Cash (and cash equivalents)

Collections from

customers Cash payments

“Excess” cash is

invested temporarily

Investments are sold as

cash is needed


7-5

The Valuation of Financial AssetsThe Valuation of Financial Assets

Type of Financial AssetsBasis for Valuation in

the Balance SheetCash (and cash equivalents) Face amountShort-term investments (marketable securities)

Current market value

Receivables Net realizable value

Estimated collectible amountEstimated collectible amount


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.


7-7

Combined with cash on balance sheet

Reporting Cash in the Balance Sheet


Liquid short-term

investments

Stable market values

Matures within 90 days of acquisition

Cash Equivalents


7-8

Not available for paying

current liabilities



Not a current asset

Listed as an investment

“Restricted” Cash


7-9

Bank agrees in advance to lend

money.



Liability is incurred when line of credit is used.

Unused line of credit is disclosed

in notes.

Lines of Credit


7-10

The Statement of Cash FlowsThe Statement of Cash Flows

Summarizes cash transactions for an accounting period.

Summarizes cash transactions for an accounting period.

Includes cash and cash equivalents.

Includes cash and cash equivalents.

Statement of Cash Flows


7-11

Cash ManagementCash Management

Accurately account for cash.

Prevent theft and fraud.

Assure the availability of adequate amounts of cash.

Prevent unnecessarily large amounts of idle cash.

Accurately account for cash.

Prevent theft and fraud.

Assure the availability of adequate amounts of cash.

Prevent unnecessarily large amounts of idle cash.


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

may be distributed to the company’s stockholders.


7-13

Internal Control Over CashInternal Control Over Cash

• Segregate authorization, custody and recording of cash.

• Prepare a cash budget (or forecast).

• Prepare a control listing of cash receipts.

• Require daily deposits.

• Make all payments by check.

• Verify every expenditure before payment.

• Promptly reconcile bank statements.

• Segregate authorization, custody and recording of cash.

• Prepare a cash budget (or forecast).

• Prepare a control listing of cash receipts.

• Require daily deposits.

• Make all payments by check.

• Verify every expenditure before payment.

• Promptly reconcile bank statements.


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 drawerwas counted and found to be $10 over.


7-15

Bank StatementsBank Statements

Shows the beginning bank balance, deposits made, checks paid, other

debits and credits in the month, and the ending bank balance.

Bank Statement


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.


7-17


Balance per Bank

+ Deposits in Transit

- Outstanding Checks

± Bank Adjustments

= Adjusted Balance

Balance per Depositor

+ Deposits by Bank (credit memos)

- Service Charge - NSF Checks

± Book Adjustments

= Adjusted Balance


7-18


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 Adjustments

= Adjusted Balance


7-19


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.


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.


7-21



7-22


GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Jul 31 Cash 30

Interest Revenue 30

31 Supplies Inventory 28

Accounts Receivable 225

Cash 253


7-23

Used for minor expenditures.

Petty Cash FundsPetty Cash Funds

Has one custodian.

Replenished periodically.

Petty Cash Funds


7-24

Short-Term InvestmentsShort-Term Investments

Bond Investments

Capital Stock

Investments

Current Assets

Almost As Liquid As

Cash

Readily Marketable

Marketable Securities

are . . .


7-25

Accounting for Marketable Securities

Accounting for Marketable Securities

Most short-term investments in marketable securities are classified as available for sale and appear on the

balance sheet at their current market value.

Classification Management's IntentTreatment of Unrealized

Holding Gains and LossesAvailable-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

Not reported. Securities are reported on balance sheet at amortized cost.

Classification Management's IntentTreatment of Unrealized

Holding Gains and LossesAvailable-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

Not reported. Securities are reported on balance sheet at amortized cost.


7-26

Purchase of Marketable SecuritiesPurchase of Marketable Securities

Foster Corporation purchases as a short-term investment 4,000 shares of The Coca-Cola

Company on December 1. Foster paid $43.98 per share, plus a brokerage commission of $80.

Foster Corporation purchases as a short-term investment 4,000 shares of The Coca-Cola

Company on December 1. Foster paid $43.98 per share, plus a brokerage commission of $80.

Total Cost: (4,000 × $43.98) + $80 = $176,000

Cost per Share: $176,000 ÷ 4,000 = $44.00


7-27

Recognition of Investment RevenueRecognition of Investment Revenue

On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000

shares of Coca-Cola.

On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000

shares of Coca-Cola.

4,000 × $0.30 = $1,200


7-28

Sales of InvestmentsSales of Investments

On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission.

On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission.

Sales Proceeds: (500 × $46.04) - $20 = $23,000

Cost Basis: 500 × $44 = $22,000

Gain on Sale: $23,000 - $22,000 = $1,000


7-29

Adjusting Marketable Securities to Market Value

Adjusting Marketable Securities to Market Value

On December 31, Foster Corporation’s remaining shares of Coca-Cola capital stock have a current

market value of $42,000. Prior to any adjustment, the company’s Marketable Securities account has a

balance of $44,000 (1,000 × $44 per share).

On December 31, Foster Corporation’s remaining shares of Coca-Cola capital stock have a current

market value of $42,000. Prior to any adjustment, the company’s Marketable Securities account has a

balance of $44,000 (1,000 × $44 per share).

Unrealized Loss: $42,000 - $44,000 = ($2,000)


7-30

Accounts ReceivableAccounts Receivable

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


7-31

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


7-32

The Allowance for Doubtful Accounts

The Allowance for Doubtful Accounts

Accounts receivableLess: Allowance for doubtful accountsNet realizable value of accounts receivable

The net realizable value is the amount of accounts receivable that the business

expects to collect.


7-33

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.


7-34



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.


7-35



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.


7-36



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.


7-37

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.

Two Approaches to Estimating Credit Losses:

1. Balance Sheet Approach

2. Income Statement Approach


7-38

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.


7-39



At December 31, the receivables for EastCo, Inc. were categorized as follows:


7-40





7-41





7-42

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.




7-43

Let’s look at another way to estimate

credit losses!

Let’s look at another way to estimate

credit losses!


7-44

Estimating Credit Losses — The Income Statement Approach


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.


7-45



Net Credit Sales% Estimated Uncollectible

Amount of Journal Entry

Net Credit Sales% Estimated Uncollectible

Amount of Journal Entry


7-46



In 2007, EastCo had credit sales of $60,000.

Historically, 1% of EastCo’s credit sales has been uncollectible.

For 2007, the estimate of uncollectible accounts expense is $600.

($60,000 × .01 = $600)

Now, prepare the adjusting entry for December 31, 2007.

In 2007, EastCo had credit sales of $60,000.

Historically, 1% of EastCo’s credit sales has been uncollectible.

For 2007, the estimate of uncollectible accounts expense is $600.

($60,000 × .01 = $600)

Now, prepare the adjusting entry for December 31, 2007.


7-47




7-48

Uncollectible AccountsSummary

Uncollectible AccountsSummary

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 Credit Sales% of Credit Sales

Emphasis on Matching

Emphasis on Matching

SalesUncoll. Accts. Exp.

Income Statement

Focus

Income Statement

Focus


7-49

Concentrations of Credit RiskConcentrations of Credit Risk

Concentrations of credit risk occur if a significant portion of a company’s receivables are due from a few major customers or from customers operating in the same

industry or geographic region.

Concentrations of credit risk occur if a significant portion of a company’s receivables are due from a few major customers or from customers operating in the same

industry or geographic region.

The FASB requires disclosure of all

significant concentrations of credit risk in the

notes to the financial statements.

The FASB requires disclosure of all

significant concentrations of credit risk in the

notes to the financial statements.


7-50

Recovery of an Account Receivable Previously Written Off

Recovery of an Account Receivable Previously Written Off

GENERAL JOURNAL

Date Account Titles and ExplanationPR 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.


7-51

Direct Write-Off MethodDirect Write-Off Method

This method makes no attempt to match revenues with the expense of

uncollectible accounts.


7-52

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

GA

AP

GA

AP

GA

AP

GA

AP Allowance methods

better match expenses with revenues.


7-53

Internal Controls for ReceivablesInternal Controls for Receivables

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.


7-54

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.


7-55



Factoring Accounts

Receivable

Credit Card

Sales


7-56

A promissory note is an unconditional promise in writing to pay on demand or at

a future date a definite sum of money.

A promissory note is an unconditional promise in writing to pay on demand or at

a future date a definite sum of money.

Notes Receivable and Interest Revenue


Maker—the person who signs the note and thereby promises to pay.

Payee—the person to whom payment is to be made.

Maker—the person who signs the note and thereby promises to pay.

Payee—the person to whom payment is to be made.


7-57



Porter Company is replacing an existing Accounts Receivable with this Note Receivable with Hall Company.

PROMISSORY NOTE

Location Date

after this date

promises to pay to the order of

the sum of with interest at the rate

of per annum.

signed

title

Miami, Fl Nov. 1, 2007

Ninety days Porter Company

John Caldwell

Hall Company

$10,000.00

12.0%

CFO, Porter Company


7-58

On November 1, 2007, Hall Companywould make the following entry.




7-59

• Interest is a charge made for the use of money.

• The borrower incurs interest expense.

• The lender earns interest revenue.

• Interest is a charge made for the use of money.

• The borrower incurs interest expense.

• The lender earns interest revenue.

Interest rates down!



Lender


7-60

The interest formula includes three variables:

The interest formula includes three variables:

Interest = Principal × Interest Rate × Time

When computing interest for one year, “Time” equals 1. When the computation period is less

than one year, then “Time” is a fraction.

When computing interest for one year, “Time” equals 1. When the computation period is less

than one year, then “Time” is a fraction.



For example, if we needed to compute interest for 3 months, “Time” would be 3/12.

For example, if we needed to compute interest for 3 months, “Time” would be 3/12.


7-61

What entry would Hall Company make on December 31, the fiscal year-end?

What entry would Hall Company make on December 31, the fiscal year-end?



$10,00012% 60/360 = $200

$10,00012% 60/360 = $200


7-62

What entry would Hall Companymake on the maturity date?

What entry would Hall Companymake on the maturity date?



$10,00012% 90/360 = $300

$10,00012% 90/360 = $300


7-63

If Porter Company defaulted on the note, Hall Company would make the following

entry on the maturity date.

If Porter Company defaulted on the note, Hall Company would make the following

entry on the maturity date.




7-64

Financial Analysis and Decision Making


Accounts Receivable Turnover Rate

This ratio provides useful information for evaluating how efficient management has

been in granting credit to produce revenue.

Accounts Receivable Turnover Rate

This ratio provides useful information for evaluating how efficient management has

been in granting credit to produce revenue.

Net Sales Average Accounts Receivable


7-65



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


7-66

Ethics, Fraud, andCorporate Governance

Ethics, Fraud, andCorporate Governance

Accounts receivable is a significant account for many companies. Accounts receivable is

particularly prone to misrepresentation because revenue often increases when accounts receivable

increase. Manipulating accounts receivable can result in the overstatement of both revenue and

income, which is the objective of many fraudulent financial reporting schemes.

© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin 7-1 financial assets chapter 7

Documents

cash budget

cash coins

cash transactions

cash management

cash equivalents collections

cash segregate authorization

statement of cash flows

excess cash balances