1 Practical Issues in Cash and Receivable Instructor Adnan Shoaib PART II: Corporate Accounting Concepts and Issues Lecture 08

Identify items considered cash Indicate how to report cash and related items Define receivables and identify the different types of receivables Explain accounting issues related to recognition of accounts receivable Explain accounting issues related to valuation of accounts receivable. Learning Objectives

3 What is cash? Reporting cash Summary of cash-related items Cash Special Issues Recognition of notes receivable Valuation of notes receivable Cash and Receivables Accounts Receivable Notes Receivable Recognition of accounts receivable Valuation of accounts receivable Fair value option Disposition of accounts and notes receivable Presentation and analysis

4  Most liquid asset  Standard medium of exchange  Basis for measuring and accounting for all items  Current asset  Examples: coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts. What is Cash? LO 1 Identify items considered cash. Cash

5 Short-term, highly liquid investments that are both Reporting Cash LO 2 Indicate how to report cash and related items. Cash Equivalents (a)readily convertible to cash, and (b)so near their maturity that they present insignificant risk of changes in interest rates. Examples: Treasury bills, Commercial paper, and Money market funds.

6 Companies segregate restricted cash from “regular” cash. Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances. Reporting Cash LO 2 Restricted Cash Illustration 7-1

7 Company writes a check for more than the amount in its cash account. Reporting Cash LO 2 Indicate how to report cash and related items. Bank Overdrafts  Generally reported as a current liability.  Offset against other cash accounts only when accounts are with the same bank.

8 Summary of Cash-Related Items LO 2 Illustration 7-2

9 Internal Control Encourages adherence to company policies and procedures Promotes operational efficiency Minimizes errors and theft Enhances the reliability and accuracy of accounting data

10 Internal Control Procedures Cash Receipts Separate responsibilities for receiving cash, recording cash transactions, and reconciling cash balances. Match the amount of cash received with the amount of cash deposited. Close supervision of cash-handling and cash-recording activities. Cash Receipts Separate responsibilities for receiving cash, recording cash transactions, and reconciling cash balances. Match the amount of cash received with the amount of cash deposited. Close supervision of cash-handling and cash-recording activities. Cash Disbursements All disbursements, except petty cash, made by check. Separate responsibilities for cash disbursement documents, check authorization, check signing, and record keeping. Checks should be signed only by authorized individuals. Cash Disbursements All disbursements, except petty cash, made by check. Separate responsibilities for cash disbursement documents, check authorization, check signing, and record keeping. Checks should be signed only by authorized individuals.

11 Compensating Balances Compensating Balance Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank. Compensating Balance Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank.

12 Accounts Receivable LO 3 Define receivables and identify the different types of receivables. Written promises to pay a sum of money on a specified future date. Receivables - Claims held against customers and others for money, goods, or services. Oral promises of the purchaser to pay for goods and services sold. Accounts Receivable Notes Receivable

13 Nontrade Receivables 1.Advances to officers and employees. 2.Advances to subsidiaries. 3.Deposits to cover potential damages or losses. 4.Deposits as a guarantee of performance or payment. 5.Dividends and interest receivable. 6.Claims against: Insurance companies for casualties sustained; defendants under suit; governmental bodies for tax refunds; common carriers for damaged or lost goods; creditors for returned, damaged, or lost goods; customers for returnable items (crates, containers, etc.). Accounts Receivable LO 3 Define receivables and identify the different types of receivables.

14 Nontrade Receivables Accounts Receivable LO 3 Define receivables and identify the different types of receivables. Illustration 7-3

15 Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable.   Reductions from the list price   Not recognized in the accounting records   Customers are billed net of discounts 10 % Discount for new Retail Store Customers Trade Discounts

16 Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable.   Inducements for prompt payment   Gross Method vs. Net Method Cash Discounts Payment terms are 2/10, n/30

17 Cash Discounts Sales are recorded at the invoice amounts. Sales discounts are recorded as reduction of revenue if payment is received within the discount period. Gross Method Sales are recorded at the invoice amount less the discount. Sales discounts forfeited are recorded as interest revenue if payment is received after the discount period. Net Method

18 Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable. Cash Discounts (Sales Discounts) Illustration 7-4

19 Merchandise may be returned by a customer to a supplier. A special price reduction, called an allowance, may be given as an incentive to keep the merchandise. Sales Returns To avoid misstating the financial statements, sales revenue and accounts receivable should be reduced by the amount of returns in the period of sale if the amount of returns is anticipated to be material.

20 Sales Returns. During the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). Industry experience indicates 10% return rate. During the year $130,000 was returned prior to customer payment. Record the returns and the end of the year adjustment. Actual Returns Sales returns130,000 Accounts receivable 130,000 Inventory 78,000 Cost of goods sold (60%) 78,000 Adjusting Entries Sales returns 70,000 Allowance for sales returns 70,000 Inventory-estimated returns 42,000 Cost of goods sold (60%) 42,000

21 E7-5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the gross method. Sales 2,000 Accounts receivable 2,000June 3 Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable. Cash ($2,000 x 98%) 1,960 Sales discounts 40 Accounts receivable 2,000 June 12

22 E7-5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method. Sales 1,960 Accounts receivable 1,960June 3 Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable. Cash ($2,000 x 98%) 1,960 Accounts receivable 1,960 June 12

23 E7-5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b. shipping point. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method, and Arquette did not remit payment until July 29. Sales 1,960 Accounts receivable 1,960June 3 Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable. Cash 2,000 Accounts receivable 1,960 Sales Discounts Forfeited40 June 12

24 A company should measure receivables in terms of their present value. Non-Recognition of Interest Element LO 4 Explain accounting issues related to recognition of accounts receivable. In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period. Recognition of Accounts Receivables

25 How are these accounts presented on the Balance Sheet? Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Recognition of Accounts Receivables LO 4 Explain accounting issues related to recognition of accounts receivable.

26 LO 4 Explain accounting issues related to recognition of accounts receivable. Accounts Receivable

27 LO 4 Explain accounting issues related to recognition of accounts receivable. Accounts Receivable

28 Journal entry for credit sale of $100? Accounts receivable100 Sales 100 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

29 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale 100 Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable. Journal entry for credit sale of $100? Accounts receivable100 Sales 100

30 Collected of $333 on account? Cash333 Accounts receivable333 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale 100 Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

31 Collected of $333 on account? Cash333 Accounts receivable333 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale Coll. Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

32 Adjustment of $15 for estimated Bad-Debts? Bad debt expense15 Allowance for Doubtful Accounts15 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale Coll. Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

33 Adjustment of $15 for estimated Bad-Debts? Bad debt expense15 Allowance for Doubtful Accounts15 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale Coll. 15 Est. Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

34 Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts10 Accounts receivable10 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale Coll. 15 Est. Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

35 Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts10 Accounts receivable10 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End. Sale Coll. 15 Est. W/O W/O Accounts Receivable LO 4 Explain accounting issues related to recognition of accounts receivable.

36 LO 4 Explain accounting issues related to recognition of accounts receivable. Accounts Receivable

37 LO 5 Explain accounting issues related to valuation of accounts receivable. Valuation of Accounts Receivable An uncollectible account receivable is a loss of revenue that requires, through proper entry in the accounts,  a decrease in the asset accounts receivable and  a related decrease in income and stockholders’ equity. Uncollectible Accounts Receivable

38 LO 5 Explain accounting issues related to valuation of accounts receivable. Allowance Method Losses are Estimated: Percentage-of-sales. Percentage-of-receivables. GAAP requires when material in amount. Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically deficient: No matching. Receivable not stated at cash realizable value. Not GAAP when material in amount. Valuation of Accounts Receivable

39 LO 5 Explain accounting issues related to valuation of accounts receivable. Emphasis on the Income Statement relationships Emphasis on the Balance Sheet relationships Illustration 7-6 Valuation of Accounts Receivable

40 LO 5 Explain accounting issues related to valuation of accounts receivable. Percentage-of-Sales Approach  Percentage based upon past experience and anticipate credit policy.  Achieves proper matching of costs with revenues.  Existing balance in Allowance account not considered. Valuation of Accounts Receivable

41 LO 5 Illustration: Gonzalez Company estimates from past experience that about 1% of credit sales become uncollectible. If net credit sales are $800,000 in 2012, it records bad debt expense as follows. Bad Debt Expense 8,000 Allowance for Doubtful Accounts 8,000 Illustration 7-7 Valuation of Accounts Receivable

42 LO 5 Explain accounting issues related to valuation of accounts receivable. Percentage-of-Receivables Approach  Not matching.  Reports receivables at realizable value. Companies may apply this method using  one composite rate, or  an aging schedule using different rates. Valuation of Accounts Receivable

43 LO 5 Explain accounting issues related to valuation of accounts receivable. Bad Debt Expense 37,650 Allowance for Doubtful Accounts 37,650 What entry would Wilson make assuming that no balance existed in the allowance account? Illustration 7-8 Accounts Receivable Aging Schedule Valuation of Accounts Receivable

44 LO 5 Explain accounting issues related to valuation of accounts receivable. Bad Debt Expense ($37,650 – $800)36,850 Allowance for Doubtful Accounts 36,850 What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment? Illustration 7-8 Accounts Receivable Aging Schedule Valuation of Accounts Receivable

45 Valuation of Accounts Receivable LO 5 Explain accounting issues related to valuation of accounts receivable. E7-7 (Recording Bad Debts): Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable.

46 Valuation of Accounts Receivable LO 5 E7-7 (Recording Bad Debts): Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (a) 1% of net sales. Bad Debt Expense7,500 Allowance for Doubtful Accounts7,500 ($800,000 – $50,000) x 1% = $7,500 LO 5

47 Valuation of Accounts Receivable LO 5 E7-7 (Recording Bad Debts): Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 5% of accounts receivable. Bad Debt Expense6,000 Allowance for Doubtful Accounts6,000 ($160,000 x 5%) – $2,000) = $6,000 LO 5

48 Illustration: Assume that the financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. on March 1, The entry to record the write-off is: Allowance for Doubtful Accounts1,000 Accounts Receivable1,000 Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries: Accounts Receivable1,000 Allowance for Doubtful Accounts 1,000 Cash 1,000 Accounts Receivable1,000 Valuation of Accounts Receivable LO 5

49 End of Lecture 08