2What is Cash? Most liquid asset Standard medium of exchange Basis for measuring and accounting for all itemsCurrent assetExamples: Coin, currency, available funds on deposit, money orders, certified checks, cashier’s checks, personal checks, bank drafts, and savings accounts.
3Control of Cash1) To establish proper controls to prevent any unauthorized transactions, and(2) To provide information necessary to the proper management of cash on hand and cash transactions.
4Restricted CashCompanies segregate restricted cash from “regular” cash for reporting purposes.Examples, restricted for:(1) Plant expansion, (2) Retirement of long-term debt, and (3) Compensating balances.
5Bank OverdraftsWhen a company writes a check for more than the amount in its cash account.Generally reported as a current liability.Offset against cash account only when available cash is present in another account in the same bank on which the overdraft occurred.
6Cash Equivalents Short-term, highly liquid investments that are both readily convertible to cash, andso near their maturity that they present insignificant risk of changes in interest ratesExamples: Treasury bills, Commercial paper, and Money market funds.
7ReceivablesClaims held against customers and others for money, goods, or services.Accounts Receivable: promises of the purchaser to pay for goods and services sold.Notes Receivable: Written promises to pay a sum of money on a specifiedfuture date.
8Non-trade Receivable Advances to officers and employees. Advances to subsidiaries.Deposits to cover potential damages or losses.Deposits as a guarantee of performance or payment.Dividends and interest receivable.
9Cash Discounts [Gross Method] Inducements for prompt paymentGross method vs. Net methodCommon payment terms are 2/10, n/30 [Gross Method]:Accounts Receivable ,000Sales 5,000Cash (5,000 x 98%) ,900Sales DiscountsAccounts Receivable 5,000
11Non-recognition of Interest A company should measure receivables in terms of their present value.In practice, companies ignore interest revenue related to accounts receivable because the amount of the discount is not usually material.
12Balance Sheet Presentation (including doubtful accounts) Assets Current assets: Cash $ 346 Accounts receivable, net of $25 allowance for doubtful accounts 475 Inventory 812 Prepaids _ 40 Total current assets 1,673 Fixed assets: Office equipment 5,679 Furniture & fixtures 6,600 Less: Accumulated depreciation (3,735) Total fixed assets 8,544 Total assets $10,217
13Valuing Receivables Reporting Receivables: Classification Valuation (net realizable value)Sales on account raise the possibility of accounts not being collected
14Uncollectible Accounts Direct Write-OffTheoretically undesirable:No matchingReceivable not stated at net realizable valueAllowance MethodLosses are Estimated:Percentage-of-salesPercentage-of-receivables
15Uncollectible Accounts Receivable Income Statement Approach:Percentage of SalesMatchingSales --- Bad Debt ExpenseBalance Sheet Approach:Percentage of ReceivablesNet Realizable ValueReceivables - Allowance for Bad Debt
16Uncollectible Accounts Receivable Example Data Credit sales $500,000 Estimated % of credit sales not collected 1.25% Accounts receivable balance $72,500 Estimated % of A/R not collected 8% Allowance for Doubtful Accounts: Case I $150 (credit balance)
17Uncollectible Accounts Receivable: Percentage of Sales Method Charge sales $500,000 Estimated percentage x 1.25% Estimated expense $ 6,250 =================================================== Journal Entry: Bad Debts Expense 6,250 Allowance for Doubtful Accounts 6,250
18Percentage of Sales Method The calculation is based on net sales.If gross sales is $12,000 and sales returns and allowances is $600, net sales is $11,400Assume bad debts is 2% of sales, then the adjusting entry is for $11,400 x 2% or $228:Bad Debts Expense Allowance for Uncollectible Accounts 228
19Uncollectible Accounts Receivable: Percent of Receivables Method What should the ending balance be for the allowance account? –Credit balance: $150 Actual Balance 150 Adjustments (6,250) Ending Balance 6,100
20Uncollectible Accounts Receivable: Percentage of Receivables Method Accounts receivable $ 72,500 Estimated percentage x 8% Desired balance $ 5,800 Balance 150 Desired Balance 5800 Adjustment 5650 Bad Debts Expense 5,650 Allowance for Doubtful Accounts 5,650
21Uncollectible Accounts Receivable Percent of Sales Approach:Bad debt expense estimate is related to a nominal account (Sales), balance in allowance account is ignored.Achieves a proper matching of cost and revenues.Percent of Receivables Approach:Results in a more accurate valuation of receivables on the balance sheet.Method may also be applied using an aging schedule.
22Notes Receivable A negotiable instrument Maker signs in favor of a payeeInterest-bearing (has a stated rate of interest) ORNoninterest-bearing (interest included in face amount)
23Notes Receivable Used When: Customers need to extend the payment period of an outstanding receivableHigh-risk or new customersLoans to employees and subsidiariesSales of property, plant, and equipmentLending transactions (the majority of notes)
24Notes Receivable Short-term: Record at Face Value, less allowance Long-term:Record at Present Valueof cash expected to be collected
25Note Issued at Face Value Present value of interest $ 31,942Present value of principal ,058Bond current market value $100,000
31Valuation of Notes Receivable Short-Term reported at Net Realizable Value (same as accounting for accounts receivable).Long-TermCompanies have option to use fair value.Receivables recorded at fair value.Unrealized gains or losses reported as part of net income.Impaired when it is probable that creditor will be unable to collect all amounts due (both principal and interest). Receivable should be written off and a loss recorded.
32Transferring Receivables Owner may transfer accounts or notes receivables to another company for cash.Reasons:Competition.Sell receivables because money is tight.Billing / collection are time-consuming and costly.Transfer accomplished by:Secured borrowing
33FactoringFactors are finance companies or banks that buy receivables from businesses for a fee.
34Selling Receivables Sale without recourse: Purchaser assumes risk of collectionTransfer is outright sale of receivableSeller records loss on saleSeller uses Due from Factor (receivable) account to cover discounts, returns, and allowancesSale with recourse:Seller guarantees payment to purchaserFinancial components approach used to record transfer
35Secured Borrowing Versus Sales The FASB concluded that a sale occurs only if the seller surrenders control of the receivables to the buyer. Three conditions must be met:
36Recording Receivables Segregate the different types of receivables that a company possesses, if material.Appropriately offset the valuation accounts against the proper receivable accounts.Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer.Disclose any loss contingencies that exist on the receivables.Disclose any receivables designated or pledged as collateral.Disclose all significant concentrations of credit risk arising from receivables.
37Account Receivable Turnover This ratio used to:Assess the liquidity of the receivables.Measure the number of times, on average, a company collects receivables during the period.
38Evaluating Receivables Related to credit sales; therefore, the amounts, changes in amount, and allowance for bad debts important considerationsAggressive revenue recognition would be associated with rising AR balances, often without increasing bad debts allowanceEvaluate sales, accounts receivable & allowance for bad debts together (i.e., they are interrelated)Large and growing receivables suggest declining credit termsPotential for factoring or “selling” to a special purpose entity (SPE)
39Bad Debts & Other Reserves Companies may have dozens or hundred of reserve accounts; an income smoothing (“cookie jar reserve”) issueAllowance for doubtful accounts is the only reserve account likely to be disclosed (plus loan loss reserves for financial institutions)The allowance should be a reasonable percent of sales & expected to stay relatively constantDoubtful accounts for the Dow 30 (24 disclosers) averaged 2% of receivablesLarge drops in this percentage are a potential signal of Earnings Manipulation (e.g., GM & Ford in 2005)