1. Chapter 7 Cash and Receivables
Financial Accounting, 11e
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2. Learning Objectives
Identify and explain the management and ethical issues related to cash and receivables.
Define cash equivalents and explain methods of controlling cash, including bank reconciliations.
Apply the allowance method of accounting for uncollectible accounts.
Define promissory note and make common calculations for promissory notes receivable.
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3. Management Issues Related to Cash and Receivables
Cash Management
On the balance sheet, cash usually consists of
currency and coins on hand,
checks and money orders from customers, and
deposits in checking and savings accounts.
Compensating balance: A minimum amount that a bank requires a company to keep in its bank account as part of a credit-granting arrangement.
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4. Seasonal Cycles and Cash Requirements for an Athletic Sportswear Company
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5. Accounts Receivable as a Percentage of Total Assets for Selected Industries
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6. Accounts Receivable and Credit Policies
Accounts receivable and notes receivable are major types of short-term financial assets.
Accounts receivable: Short-term financial assets that arise from credit sales made in the ordinary course of business.
Trade credit: Credit sales made in the ordinary course of business.
Terms of trade credit usually range from 5 to 60 days.
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7. Financial Ratio: Receivable Turnover
Receivable turnover shows how many times, on average, a company turned its receivables into cash during an accounting period.
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8. Financial Ratio: Days’ Sales Uncollected
Days’ sales uncollected: Shows, on average, how long it takes to collect accounts receivable.
HP’s receivable turnover was calculated as 6.8 times.
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9. Financing Receivables
Factoring
Securitization
Discounting
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10. Factoring
Factoring: The sale or transfer of accounts receivable to a factor (i.e., the purchaser).
With recourse: Seller of the receivables is liable to the factor if a receivable cannot be collected.
Without recourse: The factor bears any losses from unpaid accounts.
Contingent liability: A potential liability that can develop into a real liability if a particular event occurs.
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11. How Factoring Works
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12. Securitization & Discounting
Securitization: A process in which a company groups its receivables in batches and sells them at a discount to other companies or investors.
Discounting: A method of financing receivables by selling promissory notes held as notes receivable to a financial lender (usually a bank).
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13. Ethics and Estimates in Accounting for Receivables
Uncollectible accounts: Accounts of credit customers who cannot or will not pay.
To match these expenses (losses) to the revenues they help generate, they should be recognized at the time credit sales are made.
Losses are estimated from uncollectible accounts. The estimate becomes an expense in the fiscal year in which the sales are made.
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14. Ricotta Company has cash of $20,000, net accounts receivable of $60,000, and net sales of $500,000. Last year’s net accounts receivable were $40,000. Compute Ricotta’s receivable turnover and days’ sales uncollected.
SOLUTION
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15. Cash Equivalents and Cash Control
Cash equivalents: Investments that have a term of 90 days or less when they are purchased.
Cash Control Methods
Imprest Systems
Banking Services
Bank Reconciliations
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16. Imprest Systems & Banking Services
Imprest system: A system for controlling small cash disbursements by establishing a fund at a fixed amount and periodically reimbursing the fund to the original balance.
Example: petty cash fund (used as source of currency on hand).
Banking Services
Safe depositories for cash and valuable documents
Checking accounts
Agents in a variety of transactions
Electronic funds transfer (EFT): A method of conducting business transactions that does not involve the actual transfer of cash.
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17. Bank Reconciliations
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.
Transactions on the company’s records that do not yet appear on the bank statement:
Outstanding checks
Deposits in transit
Transactions on a bank statement that do not yet appear on the company’s records:
Service charges (SC)
NSF (nonsufficient funds) checks
Miscellaneous debits and credits
Interest income
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18. Bank Reconciliation
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19. At year end, Tipi Company had currency and coins in cash registers of $1,100, money orders from customers of $2,000, deposits in checking accounts of $12,000, U.S. Treasury bills due in 80 days of $50,000, certificates of deposit at the bank that mature in six months of $200,000, and U.S. Treasury bonds due in one year of $100,000. Calculate the amount of cash and cash equivalents that will be shown on the company’s year-end balance sheet.
SOLUTION
Currency and coins $ 1,100
Money orders 2,000
Checking accounts 12,000
U.S. Treasury bills (due in 80 days) ,000
Cash and cash equivalents $65,100
The certificates of deposit and U.S. Treasury bonds mature in more than 90 days and thus are not cash equivalents.
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20. Uncollectible Accounts
Direct charge-off method: Recognize a loss at the time it is determined that an account is uncollectible by reducing Accounts Receivable and increasing Uncollectible Accounts Expense.
Allowance method: Losses from bad debts are matched against the sales they help to produce.
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21. EXAMPLE: The Allowance Method
Edwards Corporation made most of its sales on credit during its first year of operation, At the end of the year, accounts receivable amounted
to $200,000. On December 31, 2011, management reviewed the collectible status of the accounts receivable. Approximately $12,000 of the $200,000 of accounts receivable were estimated to be uncollectible. This adjusting entry would be made on December 31 of that year:
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22. Disclosure of Uncollectible Accounts
Allowance for Uncollectible Accounts
Appears on the balance sheet as a contra account
Deducted from accounts receivable.
Reduces the accounts receivable to the amount of cash estimated to be collectible (net realizable value)
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23. Estimating Uncollectible Accounts Expense
Percentage of net sales method: How much of this year’s net sales will not be collected?
Accounts receivable aging method: How much of the ending balance of accounts receivable will not be collected?
Aging of accounts receivable: The process of listing each customer’s receivable account by due date.
If account past due, there is a possibility that it will not be paid.
Possibility increases as the account extends further beyond the due date.
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24. EXAMPLE: Percentage of Net Sales Method (slide 1 of 2)
The following balances represent Robin Inc.’s ending figures for December 2013:
Sales: $322,500; Sales Returns and Allowances: $20,000; Sales Discounts: $2,500; Allowances for Uncollectible Accounts: $1,800 (credit)
The following are Robin’s actual losses from uncollectible accounts for the past
three years:
Year Net Sales Losses from Percentage
Uncollectible Accounts
$260,000 $ 5,
, ,
, ,
Total $850,000 $17,
Robin’s management believes that its uncollectible accounts will continue to average about 2 percent of net sales.
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25. EXAMPLE: Percentage of Net Sales Method (slide 2 of 2)
The uncollectible accounts expense for the year 2013 is therefore estimated as follows:
0.02 x ($322,500 - $20,000 - $2,500) = 0.02 x $300,000 = $6,000
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26. EXAMPLE: Accounts Receivable Aging Method (slide 1 of 2)
Assuming Mayer has a credit balance of $1,600 in “Allowance for Uncollectible Accounts”, the uncollectible accounts expense is recorded as follows:
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27. EXAMPLE: Accounts Receivable Aging Method (slide 2 of 2)
Assuming Mayer has a debit balance of $1,600 in “Allowance for Uncollectible Accounts”, the uncollectible accounts expense is recorded as follows:
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28. Analysis of Accounts Receivable by Age
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29. Two Methods of Estimating Uncollectible Accounts
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30. Writing Off Uncollectible Accounts
Regardless of the method used to estimate uncollectible accounts, the total of accounts receivable written off in an accounting period will rarely equal the estimated uncollectible amount.
When it becomes clear that a specific account receivable will not be collected, the amount should be written off to Allowance for Uncollectible Accounts.
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31. Rock Instruments, Inc. , sells its merchandise on credit
Rock Instruments, Inc., sells its merchandise on credit. In the company’s last fiscal year, which ended July 31, it had net sales of $7,000,000. At the end of the fiscal year, it had accounts receivable of $1,800,000 and a credit balance in Allowance for Uncollectible Accounts of $11,200. In the past, the company has been unable to collect on approximately 1 percent of its net sales. An aging analysis of accounts receivable has indicated that $80,000 of current receivables are uncollectible.
1. Calculate the amount of uncollectible accounts expense and use T accounts to determine the resulting balance of Allowance for Uncollectible Accounts under the percentage of net sales method and the accounts receivable aging method.
2. How would your answers change if Allowance for Uncollectible Accounts had a debit balance of $11,200 instead of a credit balance?
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32. SOLUTION
1. Percentage of net sales method: Accounts receivable aging method:
2. Under the percentage of net sales method, the amount of the expense is the same in (1) and (2), but the ending balance will be $58,800 ($70,000 – $11,200). Under the accounts receivable aging method, the ending balance is the same, but the amount of the expense will be $91,200 ($80,000 + $11,200).
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33. Notes Receivable
Promissory note: An unconditional promise to pay a definite sum of money on demand or at a future date
A payee (the entity to whom payment is to be made) includes all the promissory notes it holds that are due in less than one year in notes receivable in the current assets section of its balance sheet.
A maker (the person or company that signs the note and thereby promises to pay) includes them in notes payable in the current liabilities section of its balance sheet.
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34. A Promissory Note
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35. Maturity Date
Maturity date: The date on which a promissory note must be paid.
A specific date (November 14, 2011)
A specific number of months after the date of the note (three months after November 14, 2011)
A specific number of days after the date of the note (60 days after November 14, 2011)
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36. Duration of a Note
Duration of a note: Time between promissory note’s issue date and its maturity date.
Example: Assume that a note issued on May 10 matures on August 10. The duration is 92 days:
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37. Interest and Interest Rate
Interest: The cost of borrowing money or the return on lending money.
Based on three factors:
Principal (the amount of money borrowed or lent)
Rate of interest
Loan’s length of time
Principal × Rate of Interest × Time = Interest
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38. Maturity Value
Maturity value: Total proceeds of a promissory note—face value plus interest—at the maturity date.
Maturity Value = Principal + Interest
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39. Accrued Interest
A promissory note received in one accounting period may not be due until a later period.
Interest accrues on a note by a small amount each day of the note’s duration.
Principal × Rate of Interest × Time = Interest

40. EXAMPLE: Accrued Interest
A $1,000, 90-day, 8 percent note was received on August 31 and that the fiscal year ended on September 30. In this case, 30 days’ interest would be $6.58, calculated as follows:
Principal ×Rate of Interest ×Time = Interest
$1,000 × 8/100 × 30/365 = $6.58
The remainder of the interest income would be $13.15:
$1,000 × 8/100 × �60/365 = $13.15
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41. Dishonored Note Dishonored note: A note not paid at maturity.
Total amount due (including interest income) from Notes Receivable to an individual account receivable for the debtor.
Only notes that have not matured and are presumably collectible in the Notes Receivable account.
Establishes a record showing that the customer has dishonored a note receivable.
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42. 1. What is the maturity date of the note?
Assume that on December 1, 2011, a company receives a 90-day, 8 percent, $5,000 note and that the company prepares financial statements monthly.
1. What is the maturity date of the note?
2. How much interest will be earned on the note if it is paid when due?
3. What is the maturity value of the note?
4. If the company’s fiscal year ends on December 31, describe the adjusting entry that would be made, including the amount.
5. How much interest will be earned on this note in 2011?
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43. 1. Maturity date is February 29, 2012, determined as follows:
SOLUTION
1. Maturity date is February 29, 2012, determined as follows:
Days remaining in December (31 – 1) 30
Days in January 31
Days in February 28
Days in March
Total days 90
2. Interest: $5,000 × 8/100 × 90/365 =� $98.63
3. Maturity value: $5, × $98.63 �= $5,098.63
4. An adjusting entry to accrue 30 days of interest income in the amount of $32.88 ($5,000 × 8/100 × 30/365) would be needed to debit Interest Receivable and credit Interest Income.
5. Interest earned in 2012: $65.75 ($98.63 – �$32.88)
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