1. Chapter 7
Cash and Receivables

2. Click to explore financial news on Nike.
Managing Cash at Nike
Poised to become a $20 billion company by the end of the decade
Cash provided by operations = $1.8 billion in fiscal 2007
Effective use of supply-chain management system
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As you study this chapter, consider the issues involved with collection of accounts receivable and protecting cash.
Click to explore financial news on Nike.
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3. LO1: Managing Cash and Receivables
Cash needs
Credit policies
Level of accounts receivable
Financing receivables
Ethical estimates of credit losses
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4. Cash Considerations Most liquid of all assets
Central to operating cycle
Consists of:
Currency and coins on hand
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Checks and money orders from customers
Cash may include a compensating balance—a minimum amount required by a bank for a credit-granting agreement.
Deposits in checking and savings accounts
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5. Seasonal Cash Needs
Cycles of business activities require different levels of cash needs
Plan for these cash activities:
Cash inflows
Cash outflows
Borrowing
Investing
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6. Cash Requirements
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7. Accounts Receivable (A/R)
Short-term financial assets
Result from extending credit to an individual or a business, also called trade credit
Retailers like Sears, Lowe’s, and JCPenney offer credit terms to customers
Wholesalers and manufacturers also provide credit terms to their customers for purchases
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8. Credit Policies
To increase the likelihood of selling to customers who will pay on time, companies develop control procedures and maintain a credit department
The credit department:
Examines the financial resources and debts of the credit applicant
Asks for personal references
Gets credit rating from credit bureaus
Determines the extent to which the company can grant credit, if any
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9. Evaluating the Level of Accounts Receivable
How many times, on average, does a company turn its receivables into cash during an accounting period?
How long, on average, does it take a company to collect its accounts receivables?
Days’ Sales Uncollected
Receivable Turnover
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10. Average Net Accounts Receivable
Receivable Turnover
Reflects the relative size of a company’s accounts receivable and the success of its credit and collection policies
Receivable Turnover =
Net Sales
Average Net Accounts Receivable
$16,325.9
($2, $2,382.9) ÷ 2
Nike’s Receivable
Turnover for 2007
(Amounts in Millions) =
= times
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11. Days’ Sales Uncollected
To interpret a company’s ratios, take into consideration the industry in which it operates
Days’
Sales Uncollected =
365 days
Receivable Turnover
Nike’s Days’
Sales Uncollected =
365 days
6.7
= days
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12. Receivable Turnover for Selected Industries
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13. Financing Receivables
Money tied up in receivables is something that many companies seek to avoid
Companies may use one or more of these methods
so that they can receive cash faster:
Set up a separate finance company
Borrow money
and pledge A/R
Factor
A/R
Ford Ford Motor Credit Company GM General Motors Acceptance Corp. Sears Sears Roebuck Acceptance Corp.
In case of default on loan, A/R (collateral) can be taken and converted to cash to satisfy the loan
Sale or transfer of A/R; the buyer may bear risk of collection (factoring without recourse) or the seller may bear risk of collection (factoring with recourse)
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14. How Factoring Works
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15. Factoring Details What fees are charged?
Typically 2% of total A/R for sales with recourse; Higher fee for sales without recourse
What does the seller of receivables with recourse report in financials?
Reports a contingent liability (a potential debt that can develop if customers don’t pay receivables)
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16. Discounting The sale of promissory notes held as notes receivable Bank
Company X
Holds $20,000 note from Company Z; Note will pay $1,200 in interest
Bank
Buys the note for $19,200
If Company X pays, bank will receive $21,200 and realize a $2,000 profit
If Company X defaults, Company X is liable for the note
Company X should disclose the contingent liability (in the amount of note plus interest) in notes to its financial statements
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17. Estimating Uncollectibles
There will always be customers who do not pay their accounts, called uncollectible accounts, or bad debts
Match these expenses of selling on credit to the revenues they help generate
Estimate the uncollectible expense in the fiscal year in which the sales are made
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18. Estimating Uncollectibles and Ethics
Because estimations are involved, earnings may be easily manipulated…
If the amount of losses from uncollectible accounts are understated,
earnings are overstated.
If the amount of losses from uncollectible accounts are overstated,
earnings are understated.
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19. Discussion: Ethics in the World
WorldCom increased revenues and hid losses by continuing to bill customers for service for years after the customers had stopped paying.
Q. What impact do you think WorldCom’s actions had on Accounts Receivable and Sales?
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20. Stop & Review Q. What is a compensating balance?
A. A minimum amount kept on account required by a bank in accordance with a credit granting agreement.
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21. Stop & Review
Q. If you owned a snow cone business with kiosks operating on three boardwalks along the New Jersey shore, what seasonal cash needs might you anticipate?
A. Cash inflows and outflows might be greatest in the summer months, while the fall and winter months will not yield much cash, nor will much be required for operations.
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22. Stop & Review
Q. Does the buyer or seller bear the risk of collection if receivables are sold with recourse?
A. The seller bears the risk of collection because the buyer may return to the seller for payment if customers do not pay on their accounts.
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23. Stop & Apply
Q. Slippery Elm Homeopathic Drug Store has net sales of $85,355. The year began with Accounts Receivable of $15,385 and ended with $19,358. What is the company’s receivable turnover? A.
$85,355
($19,358 + $15,385) ÷ 2
= 4.9 times
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24. Stop & Review
Q. How might a company use uncollectible estimates to manipulate earnings?
A. If the company underestimated uncollectibles, it would overstate earnings. If the company wanted to minimize earnings, it could overestimate uncollectibles for the period.
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25. LO2: Cash Equivalents
Investments like time deposits or certificates of deposit (CDs) that have a term of 90 days or less
Nike’s Annual Report
Cash and equivalents represent cash and short-term, highly liquid investments with maturities of three months or less at date of purchase. The carrying amounts reflected in the consolidated balance sheet for cash and equivalents approximate fair value.
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26. Cash Control: Imprest Systems
Petty Cash Fund
Established at a fixed amount
Reimbursed periodically, based on documented expenditures
Total cash and receipts must equal the original amount
One person should be made responsible for the accuracy and security of the fund
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27. Cash Control: Electronic Funds Transfer (EFT)
Method of conducting business transactions
in which funds are transferred electronically
from one bank to another bank
Wal-Mart makes 75% of its payments to suppliers using EFT
Electronic Banking
ATM transactions
Debit and credit card purchases
Online bill-pay
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28. Cash Control: Bank Reconciliations
The bank statement is reconciled to the company’s Cash account to account for any difference between the two balances
What items might appear in the company’s records that do not appear on the bank statement?
What items might appear on the bank statement that do not appear in the company’s records?
Service charges
NSF (nonsufficient funds) checks
Miscellaneous debits or credits
Interest income
Errors
Outstanding checks
Deposits in transit
Errors
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29. Illustration: Bank Reconciliation
1. A $ deposit was mailed to the bank on August 31 and has not been recorded by the bank.
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30. Bank Reconciliation (cont’d)
2. Five checks issued in August or earlier have not been paid by the bank.
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31. Bank Reconciliation (cont’d)
3. A deposit on August 6 was incorrectly recorded in the company’s books as $ The bank correctly recorded the deposit as $
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32. Bank Reconciliation (cont’d)
4. A credit memorandum was enclosed with the bank statement showing a note had been collected in the amount of $ along with interest of $ A debit memorandum was enclosed for the $2.50 collection fee.
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33. Bank Reconciliation (cont’d)
5. An NSF check was returned with the statement for $ The NSF check from Austin Chase was not reflected in the company’s books.
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34. Bank Reconciliation (cont’d)
6. A debit memorandum for the monthly $6.25 service charge was enclosed with the bank statement.
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35. Bank Reconciliation (cont’d)
7. Interest earned by the company on its average balance was $7.81.
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36. Bank Reconciliation (cont’d)
After all items have been listed on the reconciliation, total the columns. The adjusted bank balance should equal the adjusted book balance.
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37. Stop & Review Q. What are cash equivalents?
A. Investments like time deposits or CDs that have a term of 90 days or less.
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38. Stop & Review
Q. Why are electronic funds transfers considered to be a form of cash control?
A. Because no money actually changes hands, there is less likelihood of theft or error.
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39. Stop & Review
Q. What types of items will be added to the balance per books when performing a bank reconciliation?
Deposits in transit
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40. Stop & Review
Q. What types of items will be deducted from the balance per books when performing a bank reconciliation?
Charges and fees like service charges, check charges, and NSF checks
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41. LO3: Direct Charge-Off Method for uncollectibles
Recognize a loss at the time it is determined that an account is uncollectible
Tax law requires use of this method when computing taxable income
Date
Uncollectible Accounts Expense
XXX
Accounts Receivable
Most companies do not use this method for financial reporting purposes because it does not conform to GAAP.
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42. The Allowance Method
Losses from bad debts are matched against the sales they help generate
At the time of sale, management cannot identify which customers will not pay
To observe the matching rule, losses from uncollectible accounts must be estimated
The estimate becomes an expense in the fiscal year in which the sales are made
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43. Alternate Account Names
Allowance for Uncollectible Accounts
Uncollectible Accounts Expense
Allowance for Doubtful Accounts
Allowance for Bad Debts
Reserve for Bad Debts (not used in modern practice)
Bad Debts Expense
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44. Estimating Uncollectible Accounts
Estimated loss should be:
Realistic
Based on objective information
Based on past experience
Based on current economic conditions
Two commonly used methods for estimating loss
1. Percentage of net sales method
2. Accounts receivable aging method
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45. Percentage of Net Sales Method
How much of this year’s net sales will not be collected?
The answer determines the amount of uncollectible accounts expense for the year
The amount is actually based on the company’s historic losses
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46. Percentage of Net Sales Method
Dec. 31, 2012: Account balances: Sales, $322,500; Sales Returns and Allowances, $20,000; Sales Discounts, $2,500; Allowance for Uncollectible Accounts, $1,800. Management estimates that uncollectible accounts will average about 2 percent of net sales.
After the above entry is posted, Allowance for Uncollectible Accounts will have a credit balance of $7,800
Allowance for Uncollectible Accounts
Dec ,800
Dec. 31 adj ,000
Dec. 31 bal ,800
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47. Accounts Receivable Aging Method
The ending balance of Allowance for Uncollectible Accounts is determined directly through an analysis of accounts receivable
How much of the ending balance of accounts receivable will not be collected?
The difference between the amount determined to be uncollectible and the actual balance of Allowance for Uncollectible Accounts is the expense for the period.
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48. Analysis of Accounts Receivable by Age
The total past due for each category is multiplied by the estimated percentage uncollectible
The sum of the totals for each category is the estimated balance of Allowance for Uncollectible Accounts
Notice that the estimated percentage uncollectible increases as accounts become further past due. 48

49. Accounts Receivable Aging Method (Case 1)
Dec. 31, 2010: Management has estimated that $4,918 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a credit balance of $1,600.
Allowance for Uncollectible Accounts
Dec ,600
Dec. 31 adj ,318
Dec. 31 bal ,918
The target balance for the account is $4,918
A credit adjustment of $3,318 will bring the account to its target balance
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50. Accounts Receivable Aging Method (Case 2)
Dec. 31, 20x6: Management has estimated that $4,918 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a debit balance of $1,600.
Allowance for Uncollectible Accounts
Dec ,600
Dec. 31 adj ,518
Dec. 31 bal ,918
The target balance for the account is $4,918
A credit adjustment of $6,518 will bring the account to its target balance
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51. Comparison of Two Methods
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52. Estimates Differ from Write-Offs?
Accounts receivable written off during a period will rarely equal the estimated uncollectible amount
Allowance for Uncollectible Accounts
Shows a debit balance when the total of accounts written off is greater than the estimated uncollectible amount
Shows a credit balance when the total of accounts written off is less than the estimated uncollectible amount
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53. Writing Off an Uncollectible Account
When it becomes clear an account will not be collected, the amount should be written off to Allowance for Uncollectible Accounts
The uncollectible amount was already accounted for as an expense when the allowance was established
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54. Writing Off an Uncollectible Account
Jan. 15, 2011: TV GO, who owes Gomez Company $500, is declared bankrupt by federal court.
Allowance for Uncollectible Accounts
Accounts Receivable
Dec ,918
Dec ,800
Jan
Jan
Bal ,418
Bal ,300
Net realizable value of A/R
Before write-off
$88,800 – $4,918 = $83,882
The write-off does not affect the estimated net realizable value of accounts receivable
After write-off
$88,300 – $4,418 = $83,882 54

55. Stop & Review
Q. Why do most companies use the allowance method instead of the direct write-off method to account for uncollectible accounts?
A. The direct write-off method does not conform to the matching rule and therefore does not adhere to GAAP. The allowance method matches losses from bad debts against the sales they helped produce.
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56. Stop & Review
Q. Where does the Allowance for Uncollectible Accounts account appear in the financial statements?
A. On the balance sheet as a contra account to Accounts Receivable.
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57. Stop & Apply
Q. Write Brothers Office Supplies had the following account balances at year end: Sales $620,000; Sales Returns and Allowances $35,000; Sales Discounts, $2,000; Allowance for Uncollectible Accounts, $2,400. Uncollectible accounts is estimated at 3 percent of net sales. What amount will be debited to Uncollectible Accounts Expense if the company uses the percentage of net sales method?
A. .03 x ($620,000 - $35,000 - $2,000) = $17,490
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58. Stop & Apply
Q. Management estimates that $2,707 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a credit balance of $1,200. If the company uses the aging method, what journal entry should be prepared?
A. $2,707 – $1,200 = $1,507
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59. LO4: Making and Paying Notes
A promissory note is an unconditional promise to pay a definite sum of money on demand at a future date
Maker
Person or company that signs the note and promises to pay the amount
Payee
Entity to whom payment is to be made
All promissory notes that the maker holds that are due in less than one year are categorized as notes payable in the current liability section of the balance sheet
All promissory notes that the payee holds that are due in less than one year are categorized as notes receivable in the current assets section of the balance sheet
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60. A Promissory Note Copyright © Cengage Learning. All rights reserved.60

61. Key Components of Promissory Notes
Maturity Date
Date on which the note must be paid
Duration
Length of time in days between the note’s issue date and its maturity date
Interest and Interest Rate
Cost of borrowing money or the return for lending money, usually stated on an annual basis
Maturity Value
Total proceeds of a note at maturity date (face value plus interest)
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62. Maturity Date Ways in which maturity date may be stated:
Due “November 14, 2010”
Due “three months after November 14, 2010”
Due “90 days after November 14, 2010”
Exclude the date of the note when computing the maturity date:
A note dated May 20 and due in 90 days would be due on August 18, determined as follows:
Days remaining in May (31 – 20) 11
Days in June 30
Days in July 31
Days in August Total days 90
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63. Duration of a Note Why is duration of a note important?
Interest is calculated on this basis
If maturity date is stated as a specific number of days from date of note…
duration is easy to calculate. Duration is the same as number of days.
If maturity date is stated as a specific date…
number of days must be calculated.
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64. Interest and Interest Rate
Amount of interest is based on:
Principal
Rate of interest
Loan’s length of time
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What is the interest on a 90-day, 8 percent, $1,000 note?
Principal x Rate of Interest x Time = Interest
$1,000 x x 90/365 = $19.73
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65. Maturity Value Total proceeds of loan 90-day 8 percent $1,000 loan
= Principal + Interest
= $1,000 + ($1,000 × 8/100 × 90/365)
= $1, $19.73
= $1,019.73
The maturity value of a non-interest-bearing note is the principal amount. In this case, the principal includes an implied interest cost
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66. Accrued Interest
A promissory note received in one accounting period may not be due until a later period
Accrue the interest applicable to the note at the end of the accounting period
$1,000 note, 90-day, 8 percent note was received on Aug. 31. The fiscal year ends on Sept. 30.
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30 days interest, or $6.58 ($1,000 × 8/100 × 30/365 = $6.58), is earned in the fiscal year that ends on Sept. 30
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67. Dishonored Notes
When the maker of a note does not pay at maturity, the note is said to be a dishonored note.
The holder, or payee, of the note should make an entry to transfer the amount due to an accounts receivable from the debtor.
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68. Stop & Apply
Q. On January 1, 20x6, Blake Company receives a 90-day, 9 percent, $5,000 note. The company prepares financial statements monthly. What is the maturity date of the note?
April 1
Days remaining in January (31 – 1) 30
Days in February
Days in March
Days in April
Total days
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69. Stop & Apply
Q. If Cheep Company extends a 90-day, $1,000 note, at 9 percent, what total proceeds will the company receive?
A. $1, ($1,000 x x 90/365 = $1, $ = $1,022.19
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70. Chapter Review Problem
JPG Company sells merchandise on account to its customers. During the year ended December 31, the company had net sales of $800,000. At the end of the year, it had Accounts Receivable of $220,000 and a debit balance in Allowance for Uncollectible Accounts of $3,100. In the past, approximately 2.0 percent of net sales have been uncollectible. Also, an aging analysis of accounts receivable reveals that $12,000 in accounts receivable appears to be uncollectible.
Required: Compute Uncollectible Accounts Expense, and
determine the ending balance of Allowance for Uncollectible
Accounts and the amount of Accounts Receivable, Net, under (a) the percentage of net sales method and (b) the accounts receivable aging method.
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71. Chapter Review Problem (Solution)
(a) Percentage of net sales method:
Uncollectible Accounts Expense = 2.0 percent × $800,000 = $16,000
Allowance for Uncollectible Accounts = $16,000 – $3,100 = $12,900
Accounts Receivable, Net = $220,000 – $12,900 = $207,100
(b) Accounts receivable aging method:
Uncollectible Accounts Expense = $3,100 + $12,000 = $15,100
Allowance for Uncollectible Accounts = $12,000
Accounts Receivable, Net = $220,000 – $12,000 = $208,000
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