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Cash and Receivables – Chapter 7

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1 Cash and Receivables – Chapter 7
Financial & Managerial Accounting, 8th Edition by Needles, Powers, Crosson

2 Key Concepts / Terms Cash: consists of currency and coins on hand, checks and money orders from customers, and deposits in checking and savings accounts. The most liquid of all assets. Accounts receivable: short-term financial assets that arise from sales on credit.

3 Key Concepts / Terms Two common measures of the effect of a company’s credit policies: Receivable turnover = Net sales ÷ Average accounts receivable. Shows how many times, on average, a company turned its receivables into cash during an accounting period. Days’ sales uncollected = 365 days ÷ Receivable turnover. Shows, on average, how long it takes to collect accounts receivable.

4 Key Concepts / Terms Cash equivalents: short-term investments that will revert to cash in 90 days or less from the time they are purchased (i.e., certificates of deposit, U.S. Treasury notes, etc.) Bank reconciliation: the process of accounting for the difference between the balance on a company’s bank statement and the balance in its Cash account.

5 Key Concepts / Terms Bank reconciliation (con’t)
Transactions that most commonly appear in a company’s records but not on its bank statement: outstanding checks; deposits in transit. Transactions that may appear on the bank statement but not the company’s records: service charges; NSF checks; miscellaneous debits and credits; interest income.

6 Key Concepts / Terms Uncollectible accounts: accounts that a company will not collect because their customers do not pay. Also called Bad Debts. Must be recorded in the same period in which the revenues are earned (for matching purposes). Management’s best estimate until actual accounts are not paid.

7 Key Concepts / Terms Uncollectible accounts (con’t)
Two methods: direct charge-off method (income tax purposes ONLY) and the allowance method. Allowance method: losses from uncollectible accounts are matched against the sales they helped to produce. Date Uncollectible Accounts Expense XXX Allowance for Uncollectible Accounts XXX

8 Key Concepts / Terms Allowance for uncollectible accounts: appears on the balance sheet as a contra account that is deducted from accounts receivable. Also called Allowance for Doubtful Accounts or Allowance for Bad Debts. Two methods: Percentage of net sales method Accounts receivable aging method

9 Comparison of Two Methods

10 Key Concepts / Terms Percentage of net sales method
Asks the question, “How much of this year’s net sales will not be collected?” The answer determines the amount of uncollectible accounts expense for the year. Income statement approach. It assumes that a certain proportion of sales will not be collected, and this proportion is the amount of Uncollectible Accounts Expense for the accounting period.

11 Key Concepts / Terms Aging accounts receivable method
Asks the question, “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. See Exhibit 2, page 398 and following journal entry and T-account. Balance sheet approach.

12 Key Concepts / Terms Promissory note: an unconditional promise to pay a definite sum of money on demand or at a future date. Maker: the person or company that signs the note and thereby promises to pay. Payee: the entity to whom payment is to be made. Payee records a notes receivable (short-term or long-term); the maker records a notes payable (short-term or long-term).

13 Key Concepts / Terms Maturity date: date on which a promissory note must be paid A specific date A specific number of months after the date of the note A specific number of days after the date of the note Duration of a note: the time between a promissory notes issue date and its maturity date. Important for calculating interest.

14 Key Concepts / Terms Interest: the cost of borrowing money or the return on lending money, depending if one is the borrower or lender. Will need to be accrued between accounting periods. Principal x Rate of Interest x Time = Interest Maturity value: total proceeds of a promissory note; principal + interest due on the maturity date.

15 Key Concepts / Terms Dishonored note: when the maker of a note does not pay the note at maturity. The payee either writes the amount no longer to be received off, or transfers to an accounts receivable that can possibly be turned over for collection.

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