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Chapter 2
Cash and Receivables
Outline
1.
2.
3.
4.
5.
Cash and Cash Equivalents
Short-term Investments
Accounts Receivable
Notes Receivable
Inventories
1. Cash and Cash Equivalents
1.1 Definition
1.2 Petty cash
1.3 Bank Reconciliation
1.4 Restricted cash and compensating balances
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1.1 Definition
Cash
- Cash on hand: Currency and Coins
- Cash in bank: Balances in checking accounts, and
items acceptable for deposit in these accounts (e.g.
checks, money orders received from customers)
These forms of cash represent amounts readily available
to pay off debt or to use in operations without any
legal or contractual restriction.
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1.1 Definition (cont)
Cash equivalents
- Treasury bills
- Commercial paper
These investments must have a maturity date no
longer than three months from the date of
purchase.
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1.2 Petty cash
Small amount on cash on hand to pay for lowcost items such as postage, office supplies,
delivery charges, and entertainment expenses.
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Illustration
On May 1, 2003, the Hawthorne Manufacturing
Company established a $200 petty cash fund.
John Ringo is designated as the petty cash fund
custodian. The fund will be replenished at the
end of each month. On May 1, 2003, a check is
written for $200 made out to John Ringo, petty
cash custodian. During the month of May, John
paid bills totaling $160 summarized as follows:
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Postage
$40
Office supplies
35
Delivery charges
55
Entertainment
30
Total
$160
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Journal entries
May 1, 2003
A petty cash fund is established by writing a
check to the custodian.
May 31, 2003
The appropriate expense accounts are debited
when the petty cash fund is reimbursed.
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1.3 Bank Reconciliation
Differences between the cash book and bank
balance occur due to differences in the timing
of recognition of certain transactions and errors.
Step 1: Adjust the bank balance to the corrected
cash balance
Step 2: Adjust the book balance to the corrected
cash balance
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Step 1: Adjustments to Bank Balance
Bank balance
+ Deposits outstanding
- Check outstanding
Book balance
+ Collections by bank
- Service charges
- NSF checks
+/- Errors
+/- Errors
--------------------------------------------Corrected balance
Corrected balance
The two corrected balances must equal.
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1.4 Restricted cash and
compensating balances
Restricted cash
Cash that is restricted in some way and not available for
current use usually is reported as investments and
funds or other assets.
Compensating balances
The borrower us asked to maintain a specified balance in
a low-interest or noninterest-bearing account at the
bank to compensate the bank for granting the loan or
extending the line of credit.
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2. Accounts Receivable
2.1 Classification
2.2 Initial valuation of accounts receivable
2.3 Subsequent valuation of accounts receivable
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2.1 Classification
Accounts receivable are current assets because,
by definition, they will be converted to cash
within the normal operating cycle.
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2.2 Initial valuation of accounts
receivable
The typical accounts receivable is valued at the
amount expected to be received, not the present
value of that amount.
Trade Discount
Cash Discount (sales discount)
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Trade Discount
Usually a percentage reduction from the list
price to change prices or to give quantity
discount to large customers
The discount is recognized indirectly by
recording the sale at the net of discount price,
not at the list price.
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Cash Discount (sales discount)
Reduce the amount to be paid if remittance is
made within a specified short period of time.
Represent reduction not in the selling price of
good or service but in the amount to be paid
within a specified period of time to provide
incentive for quick payment
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Cash discount: journal entries
The Hawthorne Manufacturing Company offers credit
customers a 2% cash discount if the sales price is paid
within 10 days. Any amounts not paid within 10 days
are due in 30 days. These repayment terms are stated
as 2/10, n/30. On October 5, 2003, Hawthorne sold
merchandise at a price of $20,000. The customer paid
$13,720 ($14,000 less the 2% cash discount) on
October 14 and the remaining balance of $6,000 on
November 4.
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Cash discount: journal entries
By either method, net sales is reduced by
discount taken
Discounts not taken are included in sales
revenue using the gross method and interest
revenue using the net method
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2.3 Subsequent Valuation
Two situations possibly could cause the cash
collected to be less than the initial valuation of
the receivable:
1. Sales returns: The customer could return the
product.
2. Uncollectible Accounts Receivable: The
customer could default and not pay the agreed
on sales price.
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Sales returns
Recognizing sales returns when they occur
could result in an overstatement of income in
the period of the related sale.
To avoid misstating the financial statements,
when amounts are material, when amount are
material, returns should be anticipated by
subtracting an allowance for estimated returns.
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Illustration
During 2003, its first year of operations, the Hawthorne
Manufacturing Company sold merchandise on account
for $2,000,000. This merchandise cost $1,200,000
(60% of the selling price). Industry experience
indicates that 10% of all sales will be returned.
Customers returned $130,000 in sales during 2003,
prior to making payment. The entries to record sales
and merchandise returned during the year, assuming
that a perpetual inventory system is used, are as
follows:
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If sales returns are material, they should be
estimated and recorded in the same period in
the same as the related sales
The allowance for sales returns is a contra
account to accounts receivable. When returns
actually occur in the following reporting period,
the allowance for sales returns is debited. In this
way, income is not reduced in the return period
but in the period of the sales revenue.
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Uncollectible Accounts Receivable
Income statement approach
Estimate bad debt expense as a percentage of each
period’s net sales. The balance sheet amount is an
indirect outcome of estimating bad dent expense.
Balance sheet approach
Determine bad debt expense by estimating the net
realizable value of accounts receivable to be reported
in the balance sheet.
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Illustration
The Hawthorne Manufacturing Company sells its
products offering 30 days’ credit to its customers.
During 2003, its first year of operations, the following
events occurred:
Sales on credit
$1,2000,000
Cash collections from credit customers
(895,000)
Accounts receivable, end of year
$305,000
There were no specific accounts determined to be
uncollectible in 2003. The company anticipates that
2% of all credit sales will ultimately become
uncollectible.
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[...]... 17 Cash discount: journal entries The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days Any amounts not paid within 10 days are due in 30 days These repayment terms are stated as 2/ 10, n/30 On October 5, 20 03, Hawthorne sold merchandise at a price of $20 ,000 The customer paid $13, 720 ($14,000 less the 2% cash discount) on October 14 and. .. for granting the loan or extending the line of credit 12 2 Accounts Receivable 2. 1 Classification 2. 2 Initial valuation of accounts receivable 2. 3 Subsequent valuation of accounts receivable 13 2. 1 Classification Accounts receivable are current assets because, by definition, they will be converted to cash within the normal operating cycle 14 2. 2 Initial valuation of accounts receivable The typical... estimated returns 21 Illustration During 20 03, its first year of operations, the Hawthorne Manufacturing Company sold merchandise on account for $2, 000,000 This merchandise cost $1 ,20 0,000 (60% of the selling price) Industry experience indicates that 10% of all sales will be returned Customers returned $130,000 in sales during 20 03, prior to making payment The entries to record sales and merchandise returned... Deposits outstanding - Check outstanding Book balance + Collections by bank - Service charges - NSF checks +/- Errors +/- Errors Corrected balance Corrected balance The two corrected balances must equal 11 1.4 Restricted cash and compensating balances Restricted cash Cash that is restricted in some way and not available for current use usually is reported as investments and funds... credit to its customers During 20 03, its first year of operations, the following events occurred: Sales on credit $1 ,20 00,000 Cash collections from credit customers (895,000) Accounts receivable, end of year $305,000 There were no specific accounts determined to be uncollectible in 20 03 The company anticipates that 2% of all credit sales will ultimately become uncollectible 25 ... October 14 and the remaining balance of $6,000 on November 4 18 Cash discount: journal entries By either method, net sales is reduced by discount taken Discounts not taken are included in sales revenue using the gross method and interest revenue using the net method 19 2. 3 Subsequent Valuation Two situations possibly could cause the cash collected to be less than the initial valuation of the receivable:... during 20 03, prior to making payment The entries to record sales and merchandise returned during the year, assuming that a perpetual inventory system is used, are as follows: 22 If sales returns are material, they should be estimated and recorded in the same period in the same as the related sales The allowance for sales returns is a contra account to accounts receivable When returns actually occur in... possibly could cause the cash collected to be less than the initial valuation of the receivable: 1 Sales returns: The customer could return the product 2 Uncollectible Accounts Receivable: The customer could default and not pay the agreed on sales price 20 Sales returns Recognizing sales returns when they occur could result in an overstatement of income in the period of the related sale To avoid misstating... the sales revenue 23 Uncollectible Accounts Receivable Income statement approach Estimate bad debt expense as a percentage of each period’s net sales The balance sheet amount is an indirect outcome of estimating bad dent expense Balance sheet approach Determine bad debt expense by estimating the net realizable value of accounts receivable to be reported in the balance sheet 24 Illustration The... received, not the present value of that amount Trade Discount Cash Discount (sales discount) 15 Trade Discount Usually a percentage reduction from the list price to change prices or to give quantity discount to large customers The discount is recognized indirectly by recording the sale at the net of discount price, not at the list price 16 Cash Discount (sales discount) Reduce the amount to be paid ...Outline Cash and Cash Equivalents Short-term Investments Accounts Receivable Notes Receivable Inventories Cash and Cash Equivalents 1.1 Definition 1 .2 Petty cash 1.3 Bank Reconciliation... Reconciliation 1.4 Restricted cash and compensating balances 1.1 Definition Cash - Cash on hand: Currency and Coins - Cash in bank: Balances in checking accounts, and items acceptable for deposit... terms are stated as 2/ 10, n/30 On October 5, 20 03, Hawthorne sold merchandise at a price of $20 ,000 The customer paid $13, 720 ($14,000 less the 2% cash discount) on October 14 and the remaining