1. 7–17–1 Chapter 7 Cash and Receivables

2. 7–27–2 Copyright © Cengage Learning. All rights reserved. Pivotal Issues When Managing Cash and Receivables 1.Cash needs 2.Credit policies 3.Level of accounts receivable 4.Financing receivables 5.Ethical estimates of credit losses © Royalty Free PhotoDisc/ Getty Images

3. 7–37–3 Copyright © Cengage Learning. All rights reserved. Cash Considerations Consists of:  Currency and coins on hand  Most liquid of all assets  Central to operating cycle  Checks and money orders from customers  Deposits in checking and savings accounts Cash may include a compensating balance—a minimum amount required by a bank for a credit- granting agreement. © Royalty Free PhotoDisc/ Getty Images

4. 7–47–4 Copyright © Cengage Learning. All rights reserved. Seasonal Cash Needs Cycles of business activities require different levels of cash needs Cash inflows Cash outflows BorrowingInvesting Plan for these cash activities:

5. 7–57–5 Copyright © Cengage Learning. All rights reserved. Cash Requirements

6. 7–67–6 Copyright © Cengage Learning. All rights reserved. Cash Equivalents example SE3, hwk E5 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. © Royalty Free PhotoDisc/ Getty Images

7. 7–77–7 Copyright © Cengage Learning. All rights reserved. Cash Control: Imprest Systems 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 Petty Cash Fund © Royalty Free C Squared Studios/ Getty Images

8. 7–87–8 Copyright © Cengage Learning. All rights reserved. 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

9. 7–97–9 Copyright © Cengage Learning. All rights reserved. Cash Control: Bank Reconciliations The bank statement is reconciled to the company’s Cash account to account for any difference between the two balances Outstanding checks Deposits in transit Errors Service charges NSF (nonsufficient funds) checks Miscellaneous debits or credits Interest income Errors 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?

10. 7–10 Copyright © Cengage Learning. All rights reserved. Illustration: Bank Reconciliation 1. A $138.00 deposit was mailed to the bank on August 31 and has not been recorded by the bank.

11. 7–11 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) 2. Five checks issued in August or earlier have not been paid by the bank.

12. 7–12 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) 3. A deposit on August 6 was incorrectly recorded in the company’s books as $165.00. The bank correctly recorded the deposit as $150.00.

13. 7–13 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) 4. A credit memorandum was enclosed with the bank statement showing a note had been collected in the amount of $140.00 along with interest of $10.00. A debit memorandum was enclosed for the $2.50 collection fee.

14. 7–14 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) 5. An NSF check was returned with the statement for $64.07. The NSF check from Austin Chase was not reflected in the company’s books.

15. 7–15 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) 6. A debit memorandum for the monthly $6.25 service charge was enclosed with the bank statement.

16. 7–16 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) 7. Interest earned by the company on its average balance was $7.81.

17. 7–17 Copyright © Cengage Learning. All rights reserved. Bank Reconciliation (cont’d) Example SE 4, hwk E6 After all items have been listed on the reconciliation, total the columns. The adjusted bank balance should equal the adjusted book balance.

18. 7–18 Copyright © Cengage Learning. All rights reserved. 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 © Royalty Free PhotoDisc/ Getty Images

19. 7–19 Copyright © Cengage Learning. All rights reserved. Credit Policies 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 To increase the likelihood of selling to customers who will pay on time, companies develop control procedures and maintain a credit department

20. 7–20 Copyright © Cengage Learning. All rights reserved. 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? Receivable Turnover Days’ Sales Uncollected

21. 7–21 Copyright © Cengage Learning. All rights reserved. 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 ($2,494.7 + $2,382.9) ÷ 2 Nike’s Receivable Turnover for 2007 (Amounts in Millions) = = 6.7 times

22. 7–22 Copyright © Cengage Learning. All rights reserved. Nike’s Days’ Sales Uncollected = Days’ Sales Uncollected example SE2, hwk E4 Days’ Sales Uncollected = 365 days Receivable Turnover 365 days 6.7 = 54.5 days To interpret a company’s ratios, take into consideration the industry in which it operates

23. 7–23 Copyright © Cengage Learning. All rights reserved. Receivable Turnover for Selected Industries

24. 7–24 Copyright © Cengage Learning. All rights reserved. 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 © Royalty Free PhotoDisc/ Getty Images

25. 7–25 Copyright © Cengage Learning. All rights reserved. Estimating Uncollectibles and Ethics Because estimations are involved, earnings may be easily manipulated… earnings are understated. If the amount of losses from uncollectible accounts are overstated, earnings are overstated. If the amount of losses from uncollectible accounts are understated,

26. 7–26 Copyright © Cengage Learning. All rights reserved. Uncollectible Accounts Accounts owed by customers who will not or cannot pay Losses may be recognized using –Direct charge-off method –Allowance method © Royalty Free PhotoDisc/ Getty Images

27. 7–27 Copyright © Cengage Learning. All rights reserved. Direct Charge-Off Method Recognize a loss at the time it is determined that an account is uncollectible DateUncollectible Accounts ExpenseXXX Accounts ReceivableXXX Tax law requires use of this method when computing taxable income Most companies do not use this method for financial reporting purposes because it does not conform to GAAP.

28. 7–28 Copyright © Cengage Learning. All rights reserved. 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 Most companies use this method for financial reporting purposes because it conforms to GAAP.

29. 7–29 Copyright © Cengage Learning. All rights reserved. The Allowance Method Illustrated Dec. 31, 2010: Management estimated that approximately $12,000 of the $200,000 of accounts receivable was uncollectible. Uncollectible Accounts Expense appears on the income statement as an operating expense Allowance for Uncollectible Accounts appears on the balance sheet as a contra-asset account that is deducted from Accounts Receivable Accounts receivable may be shown “net,” with the amount of the Allowance for Uncollectible Accounts shown in a note to the financial statements

30. 7–30 Copyright © Cengage Learning. All rights reserved. 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 © Royalty Free C Squared Studios/ Getty Images

31. 7–31 Copyright © Cengage Learning. All rights reserved. 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

32. 7–32 Copyright © Cengage Learning. All rights reserved. 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 © Royalty Free C Squared Studios/ Getty Images

33. 7–33 Copyright © Cengage Learning. All rights reserved. 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. Allowance for Uncollectible Accounts Dec. 31 1,800 Dec. 31 adj. 6,000 Dec. 31 bal. 7,800 Percentage of Net Sales Method Illustrated After the above entry is posted, Allowance for Uncollectible Accounts will have a credit balance of $7,800 example SE5, hwk E7

34. 7–34 Copyright © Cengage Learning. All rights reserved. Accounts Receivable Aging Method How much of the ending balance of accounts receivable will not be collected? The ending balance of Allowance for Uncollectible Accounts is determined directly through an analysis of accounts receivable The difference between the amount determined to be uncollectible and the actual balance of Allowance for Uncollectible Accounts is the expense for the period.

35. 7–35 Notice that the estimated percentage uncollectible increases as accounts become further past due. 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

36. 7–36 Copyright © Cengage Learning. All rights reserved. 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 A credit adjustment of $3,318 will bring the account to its target balance Dec. 31 1,600 Dec. 31 adj. 3,318 Dec. 31 bal. 4,918 The target balance for the account is $4,918

37. 7–37 Copyright © Cengage Learning. All rights reserved. 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 A credit adjustment of $6,518 will bring the account to its target balance Dec. 31 1,600 Dec. 31 adj. 6,518 Dec. 31 bal. 4,918 The target balance for the account is $4,918 example SE6, hwk E8

38. 7–38 Copyright © Cengage Learning. All rights reserved. Comparison of Two Methods hwk E9

39. 7–39 Copyright © Cengage Learning. All rights reserved. Estimates Differ from Write-Offs? Accounts receivable written off during a period will rarely equal the estimated uncollectible amount Shows a credit balance when the total of accounts written off is less than the estimated uncollectible amount Shows a debit balance when the total of accounts written off is greater than the estimated uncollectible amount Allowance for Uncollectible Accounts

40. 7–40 Copyright © Cengage Learning. All rights reserved. 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 © Royalty-Free/Corbis

41. 7–41 Bal. 4,418 Dec. 31 4,918 Writing Off an Uncollectible Account Illustrated Jan. 15, 2011: TV GO, who owes Gomez Company $500, is declared bankrupt by federal court. Allowance for Uncollectible Accounts Net realizable value of A/R Before write-off $88,800 – $4,918 = $83,882 Jan. 15 500 The write-off does not affect the estimated net realizable value of accounts receivable Accounts Receivable Dec. 31 88,800 Jan. 15 500 Bal. 88,300 After write-off $88,300 – $4,418 = $83,882 example SE7, hwk E12

42. 7–42 Copyright © Cengage Learning. All rights reserved. Notes Receivable Unconditional promises to pay a definite sum of money on demand or at a future date. © Royalty Free PhotoDisc/ Getty Images

43. 7–43 Copyright © Cengage Learning. All rights reserved. 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 payee holds that are due in less than one year are categorized as notes receivable in the current assets section of the balance sheet 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

44. 7–44 Copyright © Cengage Learning. All rights reserved. A Promissory Note

45. 7–45 Copyright © Cengage Learning. All rights reserved. Key Components of Promissory Notes Total proceeds of a note at maturity date (face value plus interest) Maturity Value Cost of borrowing money or the return for lending money, usually stated on an annual basis Interest and Interest Rate Length of time in days between the note’s issue date and its maturity date Duration Date on which the note must be paidMaturity Date

46. 7–46 Copyright © Cengage Learning. All rights reserved. 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 June30 Days in July31 Days in August18 Total days90

47. 7–47 Copyright © Cengage Learning. All rights reserved. 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.

48. 7–48 Copyright © Cengage Learning. All rights reserved. Interest and Interest Rate hwk E13 Amount of interest is based on: Principal Rate of interest Loan’s length of time What is the interest on a 90-day, 8 percent, $1,000 note? Principal x Rate of Interest x Time = Interest $1,000 x.08 x 90/365 = $19.73 © Royalty Free PhotoDisc/ Getty Images

49. 7–49 Copyright © Cengage Learning. All rights reserved. Maturity Value example SE8, hwk E16 Total proceeds of loan 90-day 8 percent $1,000 loan proceeds = Principal + Interest = $1,000 + ($1,000 × 8/100 × 90/365) = $1,000.00 + $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

50. 7–50 Copyright © Cengage Learning. All rights reserved. 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. 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 © Royalty-Free/Corbis

51. 7–51 Copyright © Cengage Learning. All rights reserved. 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. © Royalty Free PhotoDisc/ Getty Images