1. 1 Chapter 7: Cash and Receivables

2. 2 Part 1: Cash Included in cash – Coin, currency and available funds on deposit. – Money orders, certified checks, cashier’s checks, savings deposits. Not included in cash – Postdated checks and IOUs (receivables). – Travel advances (receivables or prepaids). – Restricted cash – separate class., if material. Cash equivalents – most companies use combined classification; includes: – Short term, highly liquid investments, readily convertible to cash, and near maturity (90 days). – Examples: money market funds, T-bills, commercial paper

3. 3 Petty Cash Appendix 7A Petty cash is created for small expenditures that might require cash (like C.O.D.s) or where it is easier to send cash versus a check/credit card etc. An Imprest Petty Cash fund has a preset balance, and is reimbursed to that balance, including any amounts that might be unaccounted for; these are labeled as “Cash short or over”.

4. 4 Bank Reconciliation Bank Reconciliation Performed to reconcile the checking account to the bank’s balance. Items found in Bank Statement – Deposits – recorded by the bank when deposited by the company. – Cancelled checks (checks that have been written by the company and routed through the bank system back to the company). – NSF Checks (Not Sufficient Funds) – reductions in the company’s bank balance because a customer’s check was returned NSF (the customer now owes the company again).

5. 5 Bank Reconciliation Bank Reconciliation Items found in bank statement: – Service charge – bank charge for monthly activity. – Interest earned – bank payment to the company for interest earned by the company. – Bank collections for the company – direct deposits by the bank for collection of receivables owed to the company. Items NOT found in bank statement: – Outstanding checks (still not cleared the bank) – Deposits in transit (not yet recorded by the bank) Other issues in the reconciliation – errors by company or by bank.

6. 6 Bank Reconciliation Bank Reconciliation Process is similar to personal bank reconciliations, except that the company must reconcile, and correct, the general ledger balance. General format is to reconcile to a “true cash” or “correct cash” balance. Start with “Balance from Bank” and “Balance from Books” (or general ledger) at the end of the month.

7. 7 Reconciliation of Bank Balance Balance per bank at end of month $ xx Add: Deposits in transit xx Subtract: Outstanding checks xx Add/Subtract errors by the bank not yet reflected in bank balance. xx Correct balance at end of month $ xx Outstanding deposits should show up on the next reconciliation, and are usually posted within a few days of the current reconciliation. Outstanding checks may take longer to “clear” but should be posted within the next two or three bank statements.

8. 8 Reconciliation of “Book” Balance Balance per books at end of the month $ xx Add/Subtract errors and postings postings not yet recorded on books (including bank charges) xx Correct balance at end of month $ xx Note: any items included in this page of the reconciliation represent errors in the cash account, and must also be posted to the general ledger (correcting journal entries).

9. 9 Part 2: Accounts Receivable Accounts receivable arise from selling goods or services to customers on account. Recorded at face amount to be collected. However, we must also reflect the fact that a portion of A/R may not be collected. Two ways to account for the uncollectibles: – Direct Write-Off method – Allowance method

10. 10 Direct Write-Off Method (not GAAP) Assume $100,000 is recorded in sales on account in 2012; one of the customers defaults on collection in 2013. Record sale in 2012: A/R100,000 Sales Revenue 100,000 Record default in 2013: Bad Debt Expense 1,000 A/R 1,000 Note: this is called the direct method, and is not the preferred method for most companies for several reasons.

11. 11 Problems with Direct Method Problem: the direct method, on the previous slide, does not achieve matching (revenues recognized in 2012, but a related expense was recognized in 2013). Problem: the direct method does not correctly value the asset, A/R. The assets are overvalued until 2013, when the receivable is finally written off. Solution: create a contra to A/R, called Allowance for Doubtful Accounts (ADA) and estimate the A/R that will not be collected.

12. 12 Solution: the Allowance Method In the year of sale, the AJE to record estimate for all future uncollectibles in 2012 (ex: 4% of sales): Bad Debt Expense4,000 ADA 4,000 The General JE during 2013, when a specific A/R is deemed uncollectible (this is called the write- off of a specific A/R): ADA1,000 A/R 1,000 (Other uncollectible accounts would also be written off against the allowance account.) When are the income statement and balance sheet affected?

13. 13 Estimation of Uncollectibles The AJE requires estimation in the year of the sale. There are two methods to estimation: 1. Percentage of sales 2. Percentage of accounts receivable Either method is acceptable; the percentage of sales method is simpler, but the percentage of A/R method is more comprehensive.

14. 14 1. Percentage of Sales Method Usually based on credit sales, but may use total sales or net sales as basis. Calculation: Sales x % = Bad Debt Expense (focus on the debit side of the AJE) Called the Income Statement approach, because: revenues x % = expense.

15. 15 2. Percentage of A/R Method Based on ending A/R and ending Allowance account. Calculation: Ending A/R x % = Ending Allowance (focus on the credit side of the AJE) Called Balance Sheet approach, because: ending asset x % = ending contra asset. Requires the analysis of the Allowance account before preparing the AJE. May be based on one percentage or multiple percentages - see the aging schedule. An aging schedule of A/R is the most accurate way to estimate uncollectibles (see p. 357).

16. 16 T-Account Approach for Percentage of A/R Method Based on the analysis of the Allowance account. Calculate the “desired ending balance” based on an aging of A/R. Given the Beginning, Ending and Write-off amounts (including the effect of any write- off reversals), the T-account helps to calculate the amount of the current estimate that must be added to the Allowance account to achieve the “desired ending balance.”

17. 17 Allowance for Doubtful Accts. (T-account) Allowance for Doubtful Accts. 1. Beginning Balance 1. The allowance established in the prior period carries forward for current period write-offs.

18. 18 Allowance for Doubtful Accts. (T-account) Allowance for Doubtful Accts. Beginning Balance Accounts Receivable 2. Write-off of specific accounts receivable 2. Write-off of specific accounts receivable 2. As specific accounts are determined uncollectible during the year, they are written-off to the allowance account as shown. These write-offs may cause the allowance account to have a debit balance before the AJE if the prior year’s expense was underestimated.

19. 19 Allowance for Doubtful Accts. (T-account) Allowance for Doubtful Accts. Beginning Balance Accounts Receivable 3. Reversal of write-off 3. If a write-off is later collected, the write-off must first be reversed when any collection is recorded. Note that the collection is then recorded as any other collection. Write-offs

20. 20 Allowance for Doubtful Accts. (T-account) Allowance for Doubtful Accts. Beginning Balance Write-offs 4. Ending Balance 4. The “desired ending balance” in the allowance account is estimated using the percentage calculation or the aging schedule. Reversals

21. 21 Allowance for Doubtful Accts. (T-account) Allowance for Doubtful Accts. Beginning Balance 5. Recognition of bad debt expense Bad Debts Expense 5. Recognition of bad debt expense Write-offs Ending Balance 5.The AJE to record the estimate of uncollectibles is calculated based on the amount necessary to achieve the “desired ending balance” in the allowance account. The focus is on the Allowance account, with the offset to bad debt expense. Reversals

22. 22 Class Problem 1 Given the following information: At December 31, 2012, Company Z prepared an aging schedule to determine that the uncollectible accounts receivable at that date were $18,000. The balance in the Allowance for Doubtful Accounts at 1/1/12 was a $3,000 credit. During 2012, the company wrote off $6,000 of specific accounts receivable that were deemed to be uncollectible, and collected $1,000 on receivables that were previously written off. Required: prepare the AJE to record the estimated uncollectibles at 12/31/12.

23. 23 Solution to Class Problem 1 Allowance for Doubtful Accounts (1) Post the beginning balance, write-off, and reversal. (2) Post the desired ending balance. (3) Post the adjusting journal entry.

24. 24 Notes Receivable Short-term Notes Receivable (N/R) are similar to A/R, except they usually have a longer collection period, and also may include interest (discussion of long term notes omitted; similar treatment with long-term notes payable in ACCT 3305). To record N/R N/Rxx Sales Revenuexx To record interest at the end of the period: Int. Receivablexx Interest Revenuexx Calculation of the interest at the end of the period is based on the following formula: Principal x rate per year x time period P x R x T

25. 25 Class Problem 2 On November 1, 2012, Raider Red’s Western Gear performed services totaling $10,000 for the Orange Cow Company. Red’s accepted a note containing a 6 % annual interest rate, where interest and principal were to be repaid in 3 months, on January 31, 2013. Prepare the journal entries for Raider Red’s on the following dates: 1. Sale on November 1, 2012. 2. Interest accrual at December 31, 2012. 3. Collection of note and interest at January 31, 2013, assuming (a) reversing journal entries and (b) no reversing journal entries.

26. 26 Class Problem 2 1. Sale on November 1, 2012: 2. Interest accrual at December 31, 2012: 3. Collection of loan and interest at 1/31/13:

27. 27 Disposition of A/R and N/R 1. Secured Borrowing – receivables used as collateral (assigned or pledged), as part of a borrowing transaction. Journal Entry - Borrower: Cashxx Interest Expensexx Notes Payablexx (Receivable still on books; collateralized status indicated in the notes or parenthetically in the financials.)

28. 28 Disposition of A/R and N/R 2. Sale of receivables – usually to a factor, but may be a securitization with many investors involved. Recorded as a sale if three conditions met: (1)Transferred asset isolated from transferor. (2)Transferee has right to pledge or sell assets. (3)Transferor does not maintain control through repurchase agreement. If any of conditions not met, record as secured borrowing. Continuing involvement can complicate entry.

29. 29 Disposition of A/R and N/R 2. a. Sale without recourse – purchaser assumes risk and absorbs losses (remove receivable and recognize loss). Journal Entry (without recourse): Cashxx Due from Factorxx* Loss on Salexx Notes Receivablexx *Amount held back until transaction complete.

30. 30 Disposition of A/R and N/R 2.b. Sale with recourse – seller guarantees payment in event of debtor default. Values are assigned to components; each party recognizes assets and liabilities it controls. Sale of Notes Receivable (with recourse): Cashxx Due from Factorxx Loss on Salexx Notes Receivablexx Recourse Liabilityxx