1. Receivables/Cash Cycle
The Revenue/
Receivables/Cash Cycle

2. Learning Objectives Explain the normal operating cycle of a business.
Prepare journal entries to record sales revenue, including the accounting for bad debts and warranties for service or replacement.
Analyze accounts receivable to measure how efficiently a firm is using this operating asset.

3. Learning Objectives
Discuss the composition, management, and control of cash, including the use of a bank reconciliation.
Recognize appropriate disclosures for presenting sales and receivables in the financial statements.

4. Learning Objectives
EXPANDED MATERIAL:
Explain how receivables may be used as a source of cash through secured borrowing or sale.
Describe proper accounting and valuation of notes receivable.
Understand the impact of uncollectible accounts on the statement of cash flows.
Use a petty cash fund.

5. Revenue/Receivables/ Cash Time Line
DELIVER a product or service
COLLECT cash (includes discounts)
RETURNS
ACCEPT returned products
STRUGGLE
with nonpaying customers
PROVIDE
continuing service

6. The Operating Cycle of a Business
Cash
Accounts Receivable
Inventory 2

7. Credit Sale and Collection
Assume that John purchased $1,000 of equipment on account. What entries are made?
When the inventory is sold on account:
Accounts Receivable ,000
Sales ,000
Sold equipment to John on account.
When the collection takes place:
Cash ,000
Accounts Receivable ,000
Payment from John for equipment
purchased.
Assume that John purchased $1,000 of equipment on account. What entries are made?
When the inventory is sold on account:
Accounts Receivable ,000
Sales ,000
Sold equipment to John on account.
Assume that John purchased $1,000 of equipment on account. What entries are made? 13 3

8. Receivables
Receivables are all claims against other entities. They are usually settled in cash.
Trade receivables: Receivables arising from normal operating activities.
Nontrade receivables: All receivables arising from activities other than normal operations. 7

9. Sales Discounts--Gross Method
Assume $1,000 of equipment is sold on account. The terms of the agreement are 2/10, n/30. What are the collection entries?
If paid within the discount period:
Cash
Sales Discounts
Accounts Receivable ,000
If not paid within the discount period:
Cash … ,000
Accounts Receivable ,000 17 8

10. Sales Returns and Allowances
Felton Company sold $1,000 of merchandise. When delivered, it was determined that the wrong color had been sent. The customer agrees to keep the merchandise for a reduction in price of $100. What are the journal entries?
Sales entry:
Accounts Receivable (Cash)....… 1,000
Sales … ,000
Sales allowance entry:
Sales Returns and Allowances..…
Accounts Receivable (Cash)

11. Sales Returns and Allowances
Felton Company sold $1,000 of merchandise. One week later, when it was delivered, $100 in merchandise (cost, $60) was the wrong color. With Felton’s approval, it was returned. What are the journal entries?
Sales entry:
Accounts Receivable (Cash)....… 1,000
Sales … ,000
Sales return entry:
Sales Returns and Allowances..…
Accounts Receivable (Cash)
Inventory…………………………
Cost of Goods Sold…………

12. Sales Discounts and Sales Returns and Allowances
Income Statement
Sales … $1,000
Less: Sales Discounts $ 20
Sales Returns and Allowances (120)
Net Sales $ 880 24 11

13. Bad Debts
Occur when customers do not pay for items or services purchased on credit.
Bad debts are uncollectible accounts receivable.
Bad Debt Expense is reported as a selling or general and administrative expense.
Accounts receivable are reported on the balance sheet at their net realizable value. 25 13

14. Accounting for Uncollectible Receivables (Direct Method)
Write Off:
Bad Debts Expense……………. 400
Accounts Receivable………
To write off an uncollectible account.
This entry is made when the account has been determined uncollectible. Since this determination was made after the period in which the sale takes place, the matching principle is violated. This method is not accepted under GAAP. 32 14

15. Accounting for Uncollectible Receivables (Allowance Method)
In this method, an estimate of the total uncollectible accounts is made at the end of the period, and an expense is recognized.
Bad Debts Expense………………… ,000
Allowance for Doubtful Accounts.. 2,000
To record estimated uncollectible accounts.
GAAP requires use of the “Allowance Method” for determining bad debts expense. 33 16

16. Accounting for Uncollectible Receivables (Allowance Method)
When the account is then determined to be uncollectible, the write-off entry is:
Allowance for Doubtful Accounts……
Accounts Receivable………………
To write off an uncollectible account. 34 17

17. Accounting for Uncollectible Receivables (Allowance Method)
(1) The Allowance for Doubtful Accounts is a contra asset account which is subtracted from Accounts Receivable on the balance sheet.
2) The actual write-off entry does not reduce net receivables, as shown below:
Accts. Receivable $100, Accts. Receivable $99,600
Less Allowance for Less Allowance for
Doubtful Accounts , Doubtful Accounts ,600
Net Receivables $ 98,000 Net Receivables $98,000 36 18

18. Estimating the Allowance for Uncollectible Accounts
Percentage of credit sales.
Percentage of accounts receivable.
Aging receivables. 40 20

19. Percentage of Credit Sales
Example: Doubtful Accounts Expense
The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,500. The allowance for doubtful accounts balance is $350 (Cr.). Historically, 3 percent of the credit sales are not collected.
What is the entry to record estimated bad debts? 41 21

20. Percentage of Credit Sales
Example: Doubtful Accounts Expense
The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,500. The allowance for doubtful accounts balance is $350 (Cr.). Historically, 3 percent of the credit sales are not collected.
Bad Debt Expense…………………… 3,000
Allowance for Doubtful Accounts .. 3,000
To record estimated uncollectible
accounts for the year.

21. Percentage of Credit Sales
Example: Doubtful Accounts Expense
Allowance for Doubtful Accounts
Balance 350
Adjusting 3,000
Dec. 31, Bal. 3,350

22. Percentage of Accounts Receivable
Example: Doubtful Accounts Expense
The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 5 percent of accounts receivable are not collectible.
Bad Debt Expense…………………… ,175
Allowance for Doubtful Accounts… ,175
To record estimated uncollectible
accounts for the year.
What is the entry to record estimated bad debts?
($30,500 x .05) - $350

23. Percentage of Accounts Receivable
Allowance for Doubtful Accounts
Balance 350
Adjusting 1,175
Dec. 31, Bal. 1,525

24. Percentage of Accounts Receivable
Allowance for Doubtful Accounts
What if the allowance account had a debit balance of $300?
Adjusting 1,875
Dec. 31, Bal. 1,525
Balance 350

25. Aging Receivables
The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,500. The allowance for doubtful accounts balance is $350. The firm ages the accounts to determine the expected uncollectibles.
Remember, because receivables are involved, the amount derived from aging provides the desired balance of the allowance account. 44 24

26. Aging Receivables Percentage Estimated to be
Age Balance Uncollectible Amount
Current $21, $ 315
1-30 days ,
31-90 days ,
Over 90 days ,
$30, $1,755 45 25

27. Allowance for Doubtful Accounts
Aging Receivables
Allowance for Doubtful Accounts
Balance 350
Adjusting 1,405
Dec. 31, Bal. 1,755

28. Accounting for Warranties
Edna’s Appliances sells washers and dryers with a one-year warranty. Past experience indicates that 15% of the appliances sold will need repairs before the warranty expires. The average repair cost is $80. In 2001, 500 washers and dryers were sold. Actual repair costs for the year totaled $3,400.

29. Accounting for Warranties
To record estimated warranty expense:
Warranty Expense……………………….. 4,000
Estimated Liability Under Warranties ,000
To record estimated warranty expense
based on units sold (500 x $80).
Estimated Liability Under Warranties… ,400
Cash…………………………………. 3,400
To record cost of actual repairs in 2001.
To record estimated warranty expense:

30. Assessing Management of Receivables
Average Collection Period: The average number of days that elapse between the time that a sale is made and the time that cash is collected. It is calculated by dividing the average receivables by the average daily sales. The amount for average daily sales is determined by dividing net sales by 365. 48 29

31. Assessing Management of Receivables
The Wheeler Company had net sales of $150,000 during Accounts receivable increased $35,000 to $40,000 during the same time. Calculate the average collection period.
Average Collection Period:
Average Accounts Receivable $37,500
Average Daily Sales ($150,000/365)
Average collection period = days 51 30

32. Composition of Cash Undeposited coins and currency (change funds)
Demand deposits
Petty cash funds
Cashiers’ checks
Personal checks

33. Composition of Cash
Many companies report investments in very short-term, interest-earning securities as cash equivalents in the balance sheet.

34. Composition of Cash
A credit balance in the cash account is known as a cash overdraft and should be reported as a current liability.

35. Control of Cash
Specifically assigned responsibilities for handling cash receipts.
Separation of handling and recording receipts.
Daily deposit of all cash received.
Voucher system to control cash payments
Internal audits at irregular intervals.
Double record of cash (bank and book) with reconciliation performed by someone outside the accounting function. 33

36. Bank Reconciliation
A comparison of the bank balance with the book’s balance by means of a summary is a bank reconciliation.

37. Bank Reconciliation Common causes of differences: Deposits in transit.
Outstanding checks.
Bank debits for items such as service charges and NSF checks.
Bank credits for items such as the bank collecting a note for the depositor.
Accounting errors. 37 34

38. Lori’s Florist Bank Reconciliation March 31, 2002
Balance per bank $4,135
Additions to bank
balance:
Deposits in transit
Total $4,635
Deductions from bank
Outstanding checks:
$251
Adj. bank balance $4,184
Balance per books $3,950
Additions to bank
balance:
Direct deposit …
Interest …
Total … $4,471
Deductions from book
Service charge … $
NSF check … 100
Error in recording check
Adj. book balance $4,184 41 35

39. Bank Reconciliation
All adjustments made to the Balance per Books need to be recorded:
ADDITIONS:
Cash……………………………………. 521
Accounts Receivable………………. 450
Interest Revenue…………………… 71
DEDUCTIONS:
Accounts Receivable (NSF)…………… 100
Miscellaneous General Expense (SC)…. 7
Recording Error, Underwritten check*
Cash………………………………
* Debited to original account. 44 36

40. Accounts Receivable as a Source of Cash
As a sale (either with or without recourse).
As a secured borrowing. 37

41. Accounts Receivable as a Source of Cash
SFAS 125 specified conditions that must be met if a transfer of receivables is to be accounted for as a sale:
The transferred assets have been isolated from the transferor and its creditors cannot access the assets.
The transferee has the right to pledge or exchange the transferred assets.
The transferor does not maintain effective control over the assets through an agreement to repurchase them before their maturity.

42. Factoring Accounts Receivable
Payment of Accounts Receivable
Cash from Factoring Accounts Receivable
Factor
Sale of Accounts Receivable
Goods and Services Provided
Customers
Company
Accounts Receivable Established 39

43. Accounting for Factoring Accounts Receivable
Close sold receivables.
Close accompanying Allowance for Bad Debts.
Expense any factoring charges.
Establish a receivable for any sales price withheld by the factor.
Debit Cash for net proceeds of the sale.
Recognize a gain or loss from factoring. 43

44. Example: Factoring Accounts Receivable
Assume:
Factored Receivables $10,000
Allowance for Bad Debts $300
Factor Withholding %
Sales Price $8,500
Journalize this transaction. 44

45. Example: Factoring Accounts Receivable
Cash………………………………. 8,075
Receivable from Factor…………
Allowance for Bad Debts…………
Loss from Factoring Receivables ,200
Accounts Receivable…………. 10,000
Computations:
Cash: $8, = $8,075
Factor Receivable: $8,500 x 5% = $425
Factoring Loss: ($10, ) - $8,500 = $1,200 45

46. Sale of Receivables with Recourse
Sale of receivables with recourse is different from factoring, since factoring is normally sold on a nonrecourse basis.

47. Sale of Receivables with Recourse
Continuing the previous example, assume that the receivables were sold with recourse and it is estimated that the recourse obligation has a fair value of $500.
Cash Received $8,500
Estimated Value of Recourse Obligation
Net Proceeds $8,000
Book Value of the Receivables $9,700
Net Proceeds to be Received 8,000
Loss on Sale of Receivables $1,700

48. Sale of Receivables with Recourse
The entry to record the sale:
Cash………………………………. 8,075
Receivable from Factor…………
Allowance for Bad Debts………… 300
Loss on Sale of Receivables……... 1,700
Accounts Receivable……… ,000
Recourse Obligation………… 500

49. Secured Borrowing Assignment of Accounts Receivable
There are no special accounting problems involved.
Simply record the loan.
Specific Assignment:
Specified accounts receivable pledged.
Accounts receivable reclassified on balance sheet.
Notes disclosure of loan provisions required. 38

50. Notes Receivable
A promissory note is an unconditional written promise to pay a certain sum of money at a specified time.

51. Notes Receivable Initially recorded at present value. Two types:
Interest-bearing: Interest rate is stated on the note.
Non-interest-bearing: Interest rate is not specified on the note, but the face amount includes the interest charge. 48

52. Example: Notes Receivable
Assume:
Note Receivable $1,000
Interest Rate %
Time to Maturity years
Journalize this note as:
1. An interest-bearing note.
2. A noninterest-bearing note. 49

53. Example: Notes Receivable
Interest-Bearing Note:
Notes Receivable………………... 1,000
Sales ………………………….. 1,000
Noninterest-Bearing Note:
Notes Receivable……………….. 1,210
Sales………………………… ,000
Discount on Notes Receivable
(PV of 10% for 2 years = $1,210)

54. Discounting Notes Receivable
Discount Rate: The interest rate charged by the financial institution for buying a note receivable.
Discount Period: The time between the date a note is sold to a financial institution and its maturity date. 71 51

55. Formulas for Discounting Notes
Interest = Face Amount x Interest Rate x Interest Period
Maturity value = Face Amount + Interest
Discount = Maturity Value x Discount Period x Discount Rate
Proceeds = Maturity value - Discount 72 52

56. Example: Discounting
The original note is a 3-month, $1,000 note at 14% interest. What is the journal entry if the note was discounted after one month at 16%?
Interest = $1,000 x .14 x 3/12 = $
Maturity value = $1,000 + $35 = $1,035.00
Discount = $1,035 x .16 x 2/12 = $
Proceeds = $1,035 - $ = $1,007.40
Cash…………………………… ,007.40
Interest Revenue……………
Note Receivable…………… ,000.00 73 53

57. The End