chapter seven cash and receivables. copyright © houghton mifflin company.all rights reserved.7 - 2...

Chapter Seven

Cash and Receivables

Copyright © Houghton Mifflin Company.All rights reserved. 7 - 2

What Items Qualify as Cash and Cash Equivalents?

• Bank deposits• Currency and coins• Checks from

customers

• Money market funds• Commercial paper • Tax-exempt notes

and bonds• U.S. government

agency securities

Cash:Cash: Cash Equivalents:Cash Equivalents:


Types of Restricted Cash

• Cash earmarked by management for a specific purpose

• Cash restricted as a result of a credit-granting agreement, called a compensating balance


Foreign Currencies

• Remeasure foreign currency against the U.S. dollar at each balance sheet date

• Recognize any exchange gain or loss

• Example: Monitor, Inc. received 100,000 Mexican pesos on Oct. 15, 2005. (At this date, the exchange rate was 1 peso = U.S. $.09.) The funds remained on deposit in pesos at December 31, 2005. (At year end, the exchange rate was 1 peso = U.S. $.11.)

• Record the gain as follows:

Cash [100,000 x ($.11 - $.09)] 2,000 Foreign Exchange Gain 2,000


Cash Controls

• Limit the number of persons who handle cash.

• Separate tasks involving cash between different employees.

• Bond employees who handle cash or cash records.

• Use a cash register and safe.

• Use a checking account for all cash payments to provide a separate record of all transactions.

• Deposit cash receipts in a timely fashion.

• Reconcile the bank account regularly.

Cash must be protected from loss, waste, and theft:


Critical Thinking

• Discussion: What tools do you use to protect your personal cash and liquid assets?

• Consider how you transact business when making payments or receiving cash. Do you utilize debit cards, checks, or electronic methods? Do you choose these methods for the paper trail they provide? PINs and passwords are often used for cash transaction protection.


Why Reconcile the Bank Account?

• Deposits in transit • Outstanding checks • Direct collection of

receivables• Interest

• Direct charges and payments

• Errors• Insufficient funds

checks

Differences between the cash balance reported by the bank and the cash balance in

the general ledger result from:


Reconciling the Bank Statement

$ Cash bal. per ledger + interest income + receivables collected- bank fees - returned checks

$ Bal. per bank statement

+ deposits in transit - outstanding checks

+/- errors made by bank

$ Adj. ledger balance$ Adj. bank balance


Reconciling the Bank Statement: Illustration

Relevant Data: • Dogwood Co. Cash account = $60,645 at 8/31/05• Bank statement balance = $71,980 at 8/31/05• Bank fees $60 • Receivables collected by bank: $6,500 & $10,000

(Collection fee $250) • Returned check $1,900 • Dogwood Co. account earned $185 interest• Outstanding checks = $4,560 • Outstanding deposit = $5,000• Bank recorded a deposit as $300 instead of $3,000


Balance per bank statement $71,980Add: Deposits in transit $5,000 Bank error 2,700 7,700Subtract: Outstanding checks (4,560) Cash balance at August 31, 2005 $75,120 Balance per ledger $60,645Add: Receivables collected $16,500 Interest income 185

16,685Subtract: Bank fees (310) Returned check (1,900)

(2,210)Cash balance at August 31, 2005

$75,120

Bank Reconciliation: Dogwood Corporation

Require

journal

entries


Journal Entries for Bank Reconciliation

Cash 16,500 Accounts Receivable 16,500

Cash 185 Interest Income 185

Miscellaneous Bank Exp. 310 Cash 310

Accounts Receivable 1,900 Cash 1,900

To record receivables collected by the bank:

To record interest earned on the account:

To record bank charges:

To record returned check:


Classifying Receivables on the Balance Sheet

• Accounts Receivable • Result from the sale of goods or services on credit

• Other Receivables

• Notes Receivable

• Tax refund claims, insurance claims, advances to employees

• Written contract promising to pay certain amounts on specific dates


Recording Accounts Receivable

• Home Depot sells a hammer to a customer in exchange for a promise to pay $25 within 30 days. How will Home Depot record this transaction?

Accounts Receivable 25 Sales 25


Cash Discounts

• Offered to encourage customers to pay bills quickly

• Payment terms that discount the cost of the purchase if paid within a certain time period

Record full amount

of sale and

account for

discount

when taken

Record full amount

of sale and

account for

discount

when taken

Sales revenues

recorded at

net amount,

less

discount

Gross Method Net Method

Record cash discounts using either method:


Recording a Cash Discount—Gross Method

Accounts Receivable 200 Sales 200

Example: Catalpa Co. sells products to Juniper Corp. for $200 with payment terms of 2/10, net 30.

Cash 196Cash Discounts 4 Accounts Receivable 200

Record the sale:

If payment received within 30 days, record the receipt and discount taken:


Valuation of Accounts Receivable

Most companies report receivables at their net realizable value (what the company expects to receive)

Balance Sheet

Accounts receivable, net $535,350

Accounts Receivable $589,050

Allowance for Uncollectibles (53,700)

Net Realizable Value =

Gross Receivables – Estimated Uncollectibles


Accounts Receivable and Uncollectibles

Allowance Method:Allowance Method:• Adjustment is made

at the end of a period to reduce accounts receivable and to create a bad debt expense for the estimated amount of uncollectibles

Direct Write-Off Method:Direct Write-Off Method:• No entries are made until

a customer defaults on an account

• Used when impossible to estimate uncollectibles or when amounts are immaterial


Estimating Uncollectibles

• Percentage-of-Sales Method: Base estimate on historically determined percentage of each period’s credit sales

• Percentage-of-Receivables Method: Base estimate on historically determined percentage of gross receivables; adjust allowance account

Historical Percentage x Current Month Credit Sales = Estimate

1. Percentage x A/R balance = New balance of Allowance account2. Prior bal. of Allowance – New balance of Allowance =

Adjustment amount


Recording Interest-Bearing Notes Receivable

Example: Fly Fishing Suppliers accepts a $4,000, 12-month, 10 percent note from Fishing Vacations on Jan. 1, 2005. Interest is payable at maturity.

Jan. 1 Notes Receivable 4,000 Sales 4,000

Dec. 31 Cash 4,400 Interest Income 400 Notes Receivable 4,000

To record the note:

To record the payment:


Recording Non-Interest-Bearing Notes Receivable

Example: On January 1, Linden Corp. sells equipment for $1,000 in exchange for a 12-month non-interest-bearing note receivable with a discount rate of 10 percent.

Jan. 1 Notes Receivable 1,000 Discount on Notes Receivable 100 Sales 900

Dec. 31 Cash 1,000 Discount on Notes Receivable 100 Interest Income 100

Notes Receivable 1,000

To record the note and subsequent payment:


Critical Thinking

• Discussion: Why do you think companies agree to accept notes receivable from customers and clients?

• Notes receivable transactions afford the opportunity for earning interest revenue. They also provide additional financing options to customers who may otherwise not be able to make purchases.


What Techniques Do Companies Use To Accelerate the Receipt of Cash?

Factoring

receivables

Securitization of

receivables

Lockboxes

Private-label

credit cards


Factoring Receivables

Transferring, or selling, of receivables

to a third party

With

Recourse

Without

Recourse

Seller guarantees payment to the buyer even if some receivables are uncollectible

Buyer assumes the risk of bad debts


Securitization of Receivables

• Transfer of receivables, either individually or pooled, to a trust account in which investors may purchase shares that entitle them to receive cash as receivables are paid

• Credit card companies

• Mortgage lenders

• Leasing companies

Often used by:


Lockboxes

• Payment lockboxes accelerate cash collections

• Bank is given access to box where customer payments are mailed

• Deposits are made daily and deposits thus earn interest more quickly

• Increases internal control over cash


Private Label Credit Cards

• Companies often offer private-label credit cards to their customers for credit purchases

• Lower transaction fees charged by companies like VISA or MasterCard

• Provide the company more control over the customer relationship and payment terms

• Provide ability to track customer buying habits


Liquidity Analysis: The Current Ratio

Current Assets Current Liabilities

Indicates how well a firm is able

to meet its current obligations

Home Depot calculations (in millions):

2001 Current Ratio = $7,777 $4,385 = 1.77

2002 Current Ratio = $10,361 $6,501 = 1.59

Comparisons:

Lowe’s = 1.43

Industry Average = 1.50


Quick Check

• Which is stronger: Lowe’s current ratio of 1.43 or Home Depot’s current ratio of 1.59? Why?

• Home Depot’s ratio of 1.77 is stronger. A higher current ratio indicates that a company has more than enough current assets to cover its liabilities.


Liquidity Analysis: The Quick Ratio

Cash + Short-Term Investments + Receivables

Current Liabilities

Measures a firm’s ability to pay its short-term obligations from its most liquid assets


2001 = ($167 + $10 + $835) $4,385 = .23

2002 = ($2,477 + $69 + $920) $6,501 = .53

Comparisons:

Lowe’s = .4

Industry average= .6


Liquidity Analysis: Working Capital

Current Assets – Current Liabilities


2001 = $7,777 - $4,385 = $3,392

2002 = $10,361 - $6,501 = $3,860

Absolute dollar amounts are not as informative as ratios when making comparisons

Indicates what amount of current Assets on hand can be used to continue

business operations


Liquidity Analysis: Defensive Ratio

• Measures the number of days a business could operate without obtaining any additional cash, investments, or receivables

• Requires access to internal accounting data

Cash + Investments+Receivables

Average Daily Operating Cash Outflow


Receivables Analysis: Accounts Receivable Turnover Ratio

Net Sales Average Net Accounts Receivable

Oakley, Inc. calculations:Average Net A/R = ($68,116 + $74,775) 2 = $71,446A/R Turnover Ratio = $489,552 $71,446 = 6.85

Receivables are collected 6.85 times during the

fiscal year.

Average Net Accounts Receivable = (Beg. A/R + End A/R) 2

Where


Receivables Analysis: Days in Receivables

365 Accounts Receivable Turnover Ratio

Indicates the average number of days it takes a company to collect its accounts

receivables

Oakley, Inc. calculations:365 6.85 = 53.3 days


Check Your Understanding

Q List items that would be classified as cash and cash equivalents on a balance sheet.

A Bank deposits, currency and coins, checks from customers, money market accounts and certificates of deposit, commercial paper, and U.S. Treasury bills that have a term of 90 days or less from their date of purchase.



Q Name several internal controls over cash.

A (1) Limit number of employees who handle cash,

(2) Separate cash tasks between employees,

(3) Bond employees who handle cash,

(4) Use a cash register and a safe,

(5) Use a checking account,

(6) Deposit cash receipts in timely fashion,

(7) Reconcile the bank account regularly.



Q If a deposit is in transit, how should it be handled on the bank reconciliation?

A Add any deposits in transit to the bank statement balance.



Q Describe the difference between a note receivable and an account receivable.

A Notes receivable are backed by written contracts promising to pay specified amounts to the company on specified dates. Accounts receivable are not supported by such formal contracts but rise from the sale of goods on credit at the wholesale or the retail level in the normal course of business.



Q If your company uses the gross method for accounting for cash discounts, when is the discount recorded?

A The discount is recorded when the payment is received within the discount period, not when the sale is made (as is done with the net method).



Q When estimating uncollectibles, what two methods are often used?

A Percentage-of-sales method and percentage-of-receivables method



Q When recording an interest-bearing note receivable, how is interest calculated?

A Face amount x Annual interest rate x Time



Q Explain what factoring receivables without recourse means.

A Factoring is the transferring, or selling, of receivables to a third party. When a company factors its receivables with recourse, the buyer assumes all risks associated with collection of receivables. The transaction is an outright sale of the accounts receivable.



Q If you needed to assess the ability of a firm to meet its current obligations, which ratio would you employ? How is this ratio computed?

A Current ratio = Current Assets Current Liabilities

chapter seven cash and receivables. copyright © houghton mifflin company.all rights reserved.7 - 2...

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