1. McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. CASH AND RECEIVABLES Chapter 7

2. Slide 2 7-2 Cash and Cash Equivalents Balances in checking accounts Currency and coins Cash equivalents are short-term, highly liquid investments that can be readily converted to cash. Money market funds Treasury bills Commercial paper Cash Items for deposit such as checks and money orders from customers

3. Slide 3 7-3 Internal Control Encourages adherence to company policies and procedures Promotes operational efficiency Minimizes errors and theft Enhances the reliability and accuracy of accounting data

4. Slide 4 7-4 Internal Control Procedures Cash Receipts Separate responsibilities for handling 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 handling 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 Separate responsibilities for cash disbursement documents, check writing, check signing, check mailing, and record keeping. All disbursements, except petty cash, made by check. Cash Disbursements Separate responsibilities for cash disbursement documents, check writing, check signing, check mailing, and record keeping. All disbursements, except petty cash, made by check.

5. Slide 5 7-5 Restricted Cash and Compensating Balances Restricted Cash Management’s intent to use a certain amount of cash for a specific purpose – future plant expansion, future payment of debt. Compensating Balance Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank. Restricted Cash Management’s intent to use a certain amount of cash for a specific purpose – future plant expansion, future payment of debt. Compensating Balance Minimum balance that must be maintained in a company’s bank account as support for funds borrowed from the bank.

6. Slide 6 7-6 Credit sales require: maintaining a separate account receivable account for each customer. accounting for bad debts and sales returns that result from credit sales. Credit sales require: maintaining a separate account receivable account for each customer. accounting for bad debts and sales returns that result from credit sales. Amounts due from customers for credit sales. Accounts Receivable Credit sales and the resulting accounts receivable are recorded net of trade discounts, not at list price.

7. Slide 7 7-7 increase sales encourage early payment increase likelihood of collections Cash discounts Cash Discounts

8. Slide 8 7-8 2/10,n/30 Number of days discount is available Otherwise, net (or all) is due Credit period Discount percent Cash Discounts

9. Slide 9 7-9 Cash Discounts Sales are recorded at the invoice amounts. Sales discounts are recorded 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 if payment is received after the discount period. Net Method

10. Slide 10 7-10 On May 10, Eddy, Inc. sold $5,000 of merchandise to a customer subject to a cash discount of 1/10, n/30. Prepare the journal entry to record the sale if Eddy uses: (a) the gross method; (b) the net method. On May 10, Eddy, Inc. sold $5,000 of merchandise to a customer subject to a cash discount of 1/10, n/30. Prepare the journal entry to record the sale if Eddy uses: (a) the gross method; (b) the net method. Cash Discounts

11. Slide 11 7-11 Assume that on May 19, Eddy, Inc. received a check in full payment of the sale made on May 10. Prepare the journal entry to record the cash receipt if Eddy uses (a) the gross method; (b) the net method. Assume that on May 19, Eddy, Inc. received a check in full payment of the sale made on May 10. Prepare the journal entry to record the cash receipt if Eddy uses (a) the gross method; (b) the net method. Cash Discounts

12. Slide 12 7-12 Instead of the payment on May 19, now assume that Eddy, Inc. received a check on May 31, in full payment of the sale made on May 10. Prepare the journal entry to record the cash receipt if Eddy uses: (a) the gross method; (b) the net method. Cash Discounts

13. Slide 13 7-13 Sales Returns Merchandise returned by a customer to a supplier. Sales Allowances A reduction in the cost of defective merchandise. Sales Returns and Allowances

14. Slide 14 7-14 On June 1, a customer of LarCo returns $750 of merchandise. The merchandise had been purchased on account and the customer had not yet paid. LarCo uses the periodic method to account for inventory. Record the journal entry for the return of merchandise. On June 1, a customer of LarCo returns $750 of merchandise. The merchandise had been purchased on account and the customer had not yet paid. LarCo uses the periodic method to account for inventory. Record the journal entry for the return of merchandise. Sales Returns Sales Returns is a contra account that reduces Sales Revenue in the current accounting period.

15. Slide 15 7-15 Uncollectible Accounts Receivable Bad debts result from credit customers who are unable to pay the amount they owe, regardless of continuing collection efforts. PAST DUE In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in which the sales related to the uncollectible account were recorded.

16. Slide 16 7-16 Uncollectible Accounts Receivable Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period. Normally classified as a selling expense and closed at year-end. Contra asset account to Accounts Receivable.

17. Slide 17 7-17 Allowance for Uncollectible Accounts Net realizable value is the amount of the accounts receivable that the business expects to collect. Accounts Receivable Less: Allowance for Uncollectible Accounts Net Realizable Value Accounts Receivable Less: Allowance for Uncollectible Accounts Net Realizable Value Income Statement Approach Balance Sheet Approach ◦ Composite Rate ◦ Aging of Receivables Income Statement Approach Balance Sheet Approach ◦ Composite Rate ◦ Aging of Receivables

18. Slide 18 7-18 Income Statement Approach Focuses on past credit sales to make estimate of bad debt expense. Emphasizes the matching principle by estimating the bad debt expense associated with the current period’s credit sales. Focuses on past credit sales to make estimate of bad debt expense. Emphasizes the matching principle by estimating the bad debt expense associated with the current period’s credit sales. Bad debt expense is computed as follows:

19. Slide 19 7-19 In 2009, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit sales are uncollectible. What is Bad Debt Expense for 2009? Income Statement Approach MusicLand computes estimated Bad Debt Expense of $2,400.

20. Slide 20 7-20 Balance Sheet Approach Focuses on the collectibility of accounts receivable to make the estimate of uncollectible accounts. Involves the direct computation of the desired balance in the allowance for uncollectible accounts. Focuses on the collectibility of accounts receivable to make the estimate of uncollectible accounts. Involves the direct computation of the desired balance in the allowance for uncollectible accounts.  Compute the desired balance in the Allowance for Uncollectible Accounts.  Bad Debt Expense is computed as:

21. Slide 21 7-21 On Dec. 31, 2009, MusicLand has $50,000 in Accounts Receivable and a $200 credit balance in Allowance for Uncollectible Accounts. Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Bad Debt Expense for 2009? On Dec. 31, 2009, MusicLand has $50,000 in Accounts Receivable and a $200 credit balance in Allowance for Uncollectible Accounts. Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Bad Debt Expense for 2009? Balance Sheet Approach Composite Rate

22. Slide 22 7-22 Desired balance in Allowance for Uncollectible Accounts Balance Sheet Approach Composite Rate

23. Slide 23 7-23  Year-end Accounts Receivable is broken down into age classifications.  Each age grouping has a different likelihood of being uncollectible.  Compute desired uncollectible amount. Balance Sheet Approach Aging of Receivables  Compare desired uncollectible amount with the existing balance in the allowance account.

24. Slide 24 7-24    At December 31, 2009, the receivables for EastCo, Inc. were categorized as follows: Balance Sheet Approach Aging of Receivables

25. Slide 25 7-25 EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350.  Balance Sheet Approach Aging of Receivables

26. Slide 26 7-26 Uncollectible Accounts As accounts become uncollectible, this entry is made: When a customer makes a payment after an account has been written off, two journal entries are required.

27. Slide 27 7-27 If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account). Direct Write-off Method

28. Slide 28 7-28 Uncollectible Accounts Receivable Example Penn Company accrues a monthly charge to bad debt expense equal to 2 percent of credit sales. At year end, the allowance for uncollectible accounts is adjusted by aging accounts receivable. Penn’s relevant financial information for the year is: An aging of accounts receivable at the end of the year indicates a required balance of $30,000. Determine (1) the balance in accounts receivable at year end, and (2) amount of the year-end adjustment to the allowance for uncollectible accounts.

29. Slide 29 7-29 Uncollectible Accounts Receivable Example Write-offs for the year Ending balance Monthly charge = 2% of $1,300,000 Amount needed to bring desired balance to $30,000

30. Slide 30 7-30 Notes Receivable A written promise to pay a specific amount at a specific future date. Even for maturities less than 1 year, the rate is annualized.

31. Slide 31 7-31 On November 1, 2008, West, Inc. loans $25,000 to Winn, Co. The note bears interest at 12% and is due on November 1, 2009. Prepare the journal entry on November 1, 2008, December 31, 2008, (year-end) and November 1, 2009 for West. Interest-Bearing Notes

32. Slide 32 7-32 Interest-Bearing Notes $25,000 × 12% = $3,000 - $500 = $2,500

33. Slide 33 7-33 Noninterest-Bearing Notes  Actually do bear interest.  Interest is deducted (discounted) from the face value of the note.  Cash proceeds equal face value of note less discount.

34. Slide 34 7-34 On January 1, 2009, West, Inc. accepted a $25,000 noninterest-bearing note from Winn, Co as payment for a sale. The note is discounted at 12% and is due on December 31, 2009. Prepare the journal entries on January 1, 2009, and December 31, 2009 for West. On January 1, 2009, West, Inc. accepted a $25,000 noninterest-bearing note from Winn, Co as payment for a sale. The note is discounted at 12% and is due on December 31, 2009. Prepare the journal entries on January 1, 2009, and December 31, 2009 for West. Noninterest-Bearing Notes

35. Slide 35 7-35 Financing With Receivables Secured borrowing or sale of receivables Assigning The use of specific receivables for collateral, and the promise that any failure to repay debt will result in proceeds from specific accounts receivable collections being used to repay the debt. Reclassify Accounts Receivable as Accounts Receivable Assigned. Assigning The use of specific receivables for collateral, and the promise that any failure to repay debt will result in proceeds from specific accounts receivable collections being used to repay the debt. Reclassify Accounts Receivable as Accounts Receivable Assigned. Pledging Receivables in general are pledged as collateral for loans. Pledged receivables are disclosed in notes to the financial statements. Pledging Receivables in general are pledged as collateral for loans. Pledged receivables are disclosed in notes to the financial statements.

36. Slide 36 7-36 Sale of Receivables FACTOR (Transferee) SUPPLIER (Transferor) RETAILER 1. Merchandise 2. Accounts Receivable 3. Accounts Receivable 4. Cash 5. Cash A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables and charges a fee for the service.

37. Slide 37 7-37 Treat as a sale if all of these conditions are met:  receivables are isolated from transferor.  transferee has right to pledge or exchange receivables.  transferor does not have control over the receivables.  Transferor cannot repurchase receivable before maturity.  Transferor cannot require return of specific receivables. Treat as a sale if all of these conditions are met:  receivables are isolated from transferor.  transferee has right to pledge or exchange receivables.  transferor does not have control over the receivables.  Transferor cannot repurchase receivable before maturity.  Transferor cannot require return of specific receivables. Sale of Receivables

38. Slide 38 7-38 Sale of Receivables Without recourse An ordinary sale of receivables to the factor. Factor assumes all risk of uncollectibility. Control of receivable passes to the factor. Receivables are removed from the books, cash is received and a financing expense or loss is recognized. Without recourse An ordinary sale of receivables to the factor. Factor assumes all risk of uncollectibility. Control of receivable passes to the factor. Receivables are removed from the books, cash is received and a financing expense or loss is recognized. With recourse Transferor (seller) retains risk of uncollectibility. Must meet the three conditions of determining surrender of control to be recognized as a sale. If the transaction fails to meet the three conditions necessary to be classified as a sale, it will be treated as a secured borrowing. With recourse Transferor (seller) retains risk of uncollectibility. Must meet the three conditions of determining surrender of control to be recognized as a sale. If the transaction fails to meet the three conditions necessary to be classified as a sale, it will be treated as a secured borrowing.

39. Slide 39 7-39 On December 31, Apex accepted a nine-month 10 percent note for $200,000 from a customer. Three months later on March 31, Apex discounted the note at its local bank. The bank’s discount rate 12 percent. Prepare the journal entry to record the discounting of the note receivable as a sale. On December 31, Apex accepted a nine-month 10 percent note for $200,000 from a customer. Three months later on March 31, Apex discounted the note at its local bank. The bank’s discount rate 12 percent. Prepare the journal entry to record the discounting of the note receivable as a sale. Discounting a Note $200,000 × 10% × 3/12 Before the preparing the journal entry to record the discounting, Apex must record the accrued interest on the note from December 31 until March 31.

40. Slide 40 7-40 Discounting a Note $205,000 - $202,100

41. Slide 41 7-41 This ratio measures how many times a company converts its receivables into cash each year. Net Sales Average Accounts Receivable Receivables Turnover Ratio = This ratio is an approximation of the number of days the average accounts receivable balance is outstanding. 365 Receivables Turnover Ratio Average Collection Period = Receivables Management

42. Slide 42 7-42 Electronic Arts vs. Activision comparison Receivables Management (All dollar amounts in millions) Can you compute the receivables turnover ratio and the average collection period for these two companies?

43. Slide 43 7-43 Appendix 7 ─ Cash Controls Bank Balance + Deposits in Transit - Outstanding Checks ± Bank Errors = Corrected Balance Book Balance + Bank Collections - Service Charges - NSF Checks ± Book Errors = Corrected Balance Provides information for reconciling journal entries. A bank reconciliation explains the difference between cash reported on bank statement and cash balance on a company’s books. All reconciling items on the book side require an adjusting entry to the cash account.

44. Slide 44 7-44 Petty cash is used for minor expenditures. Has one custodian. Replenished periodically. Petty cash fund Appendix 7 ─ Cash Controls

45. McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. End of Chapter 7