In this chapter, we begin our study of assets by looking at cash and receivables-the two assets typically listed first in a balance sheet. Internal control and classification in the balance sheet are key issues we address in consideration of cash. For receivables, the key issues are valuation and the related income statement effects of transactions involving accounts receivable and notes receivable.
Chapter CASH AND RECEIVABLES © 2013 The McGraw-Hill Companies, Inc Cash and Cash Equivalents Cash Cash Currency Currency and and coins coins Balances Balances in in current current bank bank accounts accounts Items Items for for deposit deposit such such as as checks checks and and money money orders orders from from customers customers Cash Cash equivalents equivalents are are short-term, short-term, highly highly liquid liquid investments investments that that can can be be readily readily converted converted to to cash cash 7-2 Money Money market market funds funds Treasury Treasury bills bills Commercial Commercial paper paper Internal Control Encourages Encourages adherence adherence to to company company policies policies and and procedures procedures Promotes Promotes operational operational efficiency efficiency Minimizes Minimizes errors errors and and theft theft Enhances Enhances the the reliability reliability and and accuracy accuracy of of accounting accounting data data 7-3 Internal Control Procedures Cash Cash Receipts Receipts •• Separate Separate responsibilities responsibilities for for receiving receiving cash, cash, recording recording cash cash transactions, transactions, and and reconciling reconciling cash cash balances balances •• Match Match the the amount amount of of cash cash received received with with the the amount amount of of cash cash deposited deposited •• Close Close supervision supervision of of cash-handling cash-handling and and cash-recording cash-recording activities activities Cash Cash Disbursements Disbursements •• All All disbursements, disbursements, except except petty petty cash, cash, made made by by check check •• Separate Separate responsibilities responsibilities for for cash cash disbursement disbursement •• 7-4 documents, documents, check check authorization, authorization, check check signing, signing, and and record record keeping keeping Checks Checks should should be be signed signed only only by by authorized authorized individuals individuals Restricted Cash and Compensating Balances Restricted Restricted Cash Cash Management’s Management’s intent intent to to use use aa certain certain amount amount of of cash cash for for aa specific specific purpose purpose –– future future plant plant expansion, expansion, future future payment payment of of debt debt Compensating Compensating Balance Balance Minimum Minimum balance balance that that must must be be maintained maintained in in aa company’s company’s bank bank account account as as support support for for funds funds borrowed borrowed from from the the bank bank 7-5 U.S GAAP vs IFRS In general, cash and cash equivalents are treated similarly under IFRS and U.S GAAP One difference is highlighted below • 7-6 Bank overdrafts are treated as liabilities • Bank overdrafts may be offset against other cash accounts Accounts Receivable Result from the credit sales of goods or services to customers Are classified as current assets Are recorded net of trade discounts 7-7 Cash Discounts Cash Cash discounts discounts 7-8 Cash Discounts 2/10,n/30 Discount Discount percent percent 7-9 Number Number of of days days discount discount is is available available Otherwise, Otherwise, net net (or (or all) all) is is due due Credit Credit period period Cash Discounts Gross Method Net Method Sales Sales are are recorded recorded at at the the invoice invoice amounts amounts Sales Sales are are recorded recorded at at the the invoice invoice amount amount less less the the discount discount Sales Sales discounts discounts are are recorded recorded as as reduction reduction of of revenue revenue ifif payment payment is is received received within within the the discount discount period period - 10 Sales Sales discounts discounts forfeited forfeited are are recorded recorded as as interest interest revenue revenue ifif payment payment is is received received after after the the discount discount period period Appendix 7-B: Methods for Estimating Future Bad Debts Bad Bad debts debts result result from from credit credit customers customers who who are are unable unable to to pay pay the the amount amount they they owe, owe, regardless regardless of of continuing continuing collection collection efforts efforts In In conformity conformity with with the the matching matching principle, principle, bad bad debt debt expense expense should should be be recorded recorded in in the the same same accounting accounting period period in in which which the the sales sales related related to to the the uncollectible uncollectible account account were were recorded recorded - 38 PAST DUE Appendix 7-B: Methods for Estimating Future Bad Debts Most Most businesses businesses record record an an estimate estimate of of the the bad bad debt debt expense expense by by an an adjusting adjusting entry entry at at the the end end of of the the accounting accounting period period Normally classified as a selling expense and closed at year-end Contra asset account to Accounts Receivable Bad debt expense Allowance for uncollectible accounts - 39 xxx xxx Allowance for Uncollectible Accounts Accounts Accounts Receivable Receivable Less: Less: Allowance Allowance for for Uncollectible Uncollectible Accounts Accounts Net Net Realizable Realizable Value Value Net realizable value is the amount of the accounts receivable that the business expects to collect Income Income Statement Statement Approach Approach Balance Balance Sheet Sheet Approach Approach ◦ ◦Composite Composite Rate Rate ◦ ◦Aging Aging of of Receivables Receivables - 40 Income Statement Approach •• Focuses Focuses on on past past credit credit sales sales to to make make estimate estimate of of bad bad debt debt expense expense •• Emphasizes Emphasizes the the matching matching principle principle by by estimating estimating the the bad bad debt debt expense expense associated associated with with the the current current period’s period’s credit credit sales sales Bad Bad debt debt expense expense is is computed computed as as follows: follows: - 41 Income Statement Approach In 2013, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit sales are uncollectible What is Bad Debt Expense for 2013? MusicLand computes estimated Bad Debt Expense of $2,400 Bad debt expense Allowance for uncollectible accounts - 42 2,400 2,400 Balance Sheet Approach •• Focuses Focuses on on the the collectability collectability of of accounts accounts receivable receivable to to make make the the estimate estimate of of uncollectible uncollectible accounts accounts •• Involves Involves the the direct direct computation computation of of the the desired desired balance balance in in the the allowance allowance for for uncollectible uncollectible accounts accounts Compute the desired balance in the Allowance for Uncollectible Accounts Bad Debt Expense is computed as: - 43 Balance Sheet Approach Composite Rate On On Dec Dec 31, 31, 2013, 2013, MusicLand MusicLand has has $50,000 $50,000 in in Accounts Accounts Receivable Receivable and and aa $200 $200 credit credit balance balance in in Allowance Allowance for for Uncollectible Uncollectible Accounts Accounts Past Past experience experience suggests suggests that that 5% 5% of of receivables receivables are are uncollectible uncollectible What What is is MusicLand’s MusicLand’s Bad Bad Debt Debt Expense Expense for for 2013? 2013? - 44 Balance Sheet Approach Composite Rate Desired balance in Allowance for Uncollectible Accounts Bad debt expense Allowance for uncollectible accounts - 45 2,300 2,300 Balance Sheet Approach Aging of Receivables Year-end Year-endAccounts AccountsReceivable Receivableis isbroken broken down downinto intoage ageclassifications classifications Each Eachage agegrouping groupinghas hasaadifferent differentlikelihood likelihood of ofbeing beinguncollectible uncollectible Compute Computedesired desireduncollectible uncollectibleamount amount Compare Comparedesired desireduncollectible uncollectibleamount amountwith with the theexisting existingbalance balancein inthe the allowance allowanceaccount account - 46 Balance Sheet Approach Aging of Receivables At December 31, 2013, the receivables for EastCo, Inc were categorized as follows: - 47 Balance Sheet Approach Aging of Receivables •• EastCo’s EastCo’sunadjusted unadjustedbalance balance in inthe theallowance allowanceaccount accountis is $500 $500 •• Per Perthe theprevious previouscomputation, computation, the thedesired desiredbalance balanceis is$1,350 $1,350 Bad debt expense Allowance for uncollectible accounts - 48 850 850 Uncollectible Accounts As accounts become uncollectible, this entry is made: Allowance for uncollectible accounts Accounts receivable 500 500 When a customer makes a payment after an account has been written off, two journal entries are required Accounts receivable Allowance for uncollectible accounts 500 Cash 500 Accounts receivable - 49 500 500 Direct Write-off Method IfIf uncollectible uncollectible accounts accounts are are immaterial, immaterial, bad bad debts debts are are simply simply recorded recorded as as they they occur occur (without (without the the use use of of an an allowance allowance account) account) Bad debts expense Accounts receivable - 50 xxx xxx Appendix 7-C: Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowing Under U.S.GAAP Does the transfer meet the requirements for derecognition? - 51 End of Chapter ... amount of of cash cash deposited deposited •• Close Close supervision supervision of of cash- handling cash- handling and and cash- recording cash- recording activities activities Cash Cash Disbursements... receiving cash, cash, recording recording cash cash transactions, transactions, and and reconciling reconciling cash cash balances balances •• Match Match the the amount amount of of cash cash received... (Transferee) - 25 A A factor factor is is aa financial financial institution institution that that buys buys receivables receivables for for cash, cash, handles handles the the billing billing and and