MGMT 120A Ch 7 Notes Cash, Receivabbles

Cash

most liquid assset

cash equivalents

• highly liquidable

• maturity date <= 3 months from purhcase date

• US treasury bills, N/P from corps, CDs, Money market funds

CASH + CE REPORTED AS ONE LINE ITEM ON B/S

Restricted cash

• cant freely use

• money set aside for a specific purpose

• cannot use for daily operations

• if material, must be reported on b/s seperately from regualr cash

• can be s/t or l/t

compensating balance

• can freely use but must be quickly replenished

• minimum cash balance firms are required to maintain in their bank accounts

• if material, must be reported on b/s seperately from regular cash

• bank says: “if you want our loan, you must have $x in your account at all times”

line of credit

preapproved amount the bank is willing to lend a customer

Bank overdrafts

• write a check more than u have to offer

• REPORTED AS CURRENT LIABILITY ON B/S `

• IF MATERIAL, MUST DISCLOSE SEPERATELY ON B/S

  • bank overdrafts usually are not off set against cash. However, if cash is available in another accounta at the smae bank, then offseting is required

Internal Control of Cash

Internal control

Seperation of duties

Internal Control

a company’s plan to encourage adherence to company policies nad procedures, promote operational efficiency, minimize errors nad theft, and enhance the relaiability and accuracy of accounting data

Seperation of Duties

require more than one person to complete a task to prevent ffraud and error

Cash Short and Over

beg cash + cash sales = expected amount

expected amount - actual amount = difference

• if + difference (aka expected > actual) » shortage

  • Dr Cash

  • Dr cash short and over

    • Cr sales

• if - difference (aka expected < actual) » surplus

  • Dr cash

    • Cr cash short and over

    • Cr sales

At the end of the acounting period:

• if Cash Short & Over has a debit balance (shortage) » Misc Administrative expenses on I/S

• if Cash Short & Over has a credit balance (surplus) » Other Income or Misc Revenue on I/S

Petty Cash

initially established by trasnferring a specified amount of cash from the company’s checking account to an employee designated as the custodian of the petty cash fund

• the sum of the cash on hand + the tickets should equal the inital petty cash balance at all times

• the fund is periodically replenished andreset to its original amount by CREDITING CASH

• throughout the entire process, the petty cash account maintains its initial balance at all times

• NoJe are made each time payment are made from the fund.

• the JE for Petty Cash expenses i s recorded only when the fund is later replenished
  
  

• The only time you tamper (dr,cr) Petty Cash is when you first create the fund (when you create the company) or when you Increase or Decrease the amount

  • When you buy something with cash, you do not Cr. Petty Cash, you Cr Cash instead `

Book

amount shown in the cash account in the company’s general ledger B

Bank

the amount that is shown on the bank statement

Bank side Reconciliation

do not need to do JEs

timing issues (checks/deposits not cleared yet)

±bank errors

-outstanding checks

+deposits in transit

book side reconcilaition

ONLY HAVE TO RECORD JES FOR BOOK SIDE, NOT BANK SIDE

things bank did that you haven’t recordedd yet

±book errors

+bank collections (lock box system)

+EFTs

-service charges

-NSF Checks

-EFT Payments

lock box system

part of bank collections (add to starting book balance)

customers pay the bank directly tro reduce theft and speed up cash deposits

only have to record journal entries for book side reconcilations

true

only have to record JEs for bank side reconcilations

false

Receivables

monetary claims against businesses and individuals

trade receivables

receivables from selling goods and serivces on acocunt

sub classified into a/r and n/r

nontrade receivables

any receivables other than trade receivables -

• advances to officers and employees

• tax refund claims owed to the company by the govenrment

• interest receivables

A/R

verbal agreement

…

…

should techinally be recorded at present value of future cash receipts but since the difference between future and present values is usually immaterial, GAAP excludes a/r from the general rule that receivables be recorded at present value. thus they are valued at the amount expected to be received, not the present value of that amount

n/r

written agreement

can be current or long term

may be used to settle accounts receivable that cannot be paid on time

2 WAYS OF ACCOUNTING FOR UNCOLLECTIBLE RECEIVABLES/BAD DEBT EXPENSE

direct write-off method

allowance method

Direct write off

• recognizes expense only whe naccounts are judged to be worthless. hence, expenses fail to match up to related revenue

• method is used when:

  • it is impossible to estimate the uncollectibles at the end of a period OR

  • the business only has an immaterial amount of accounts receivable
    
    

Sale:

Dr A/R 10k

• Cr Sales 10k

Company you were waiting paytment from goes bankrupt:

Dr. Bad Debt Expense 10k

• Cr A/R 10k

That same company beats bankruptcy (redemption):

Dr. A/R 10k

• Cr Bad Debt Expense 10k

Dr. Cash 10k

• Cr AlR 10k

Allowance Method

The process of presetting a set amount of a/r tyhat they deem to be uincollectible called ALLOWANCE FOR DOUBTFUL ACCOUNTS (this is a contra asset » increases with credit)

GAAP prefered

2 methods:

1. estimate based on sales

2. estimates based on analysis of receivables

Net Realizabble Value

a/r - allowance for doubtful accounts

(the amount the company expects to collect in cash or “realize” )

Allowance Method; Estimate Based on Sales (aka percentage-of-sales or Income Statement Approach

estimates allowance for doubtful accounts based on previous year’s net sales

emphasizes matching of uncollectible accounts expense with related sales of the period

emphasizes more on income statment over balance sheet

GOAL: calculate adjustment to BEGINNING BALANCE

i.e. Company X wants to make the necessary adjustments to account for bad debt using estimates based on sales. Assume that credit sales of Company X for a period were 100k. also assume that past experience shows that 2% of all credit sale4s were uncollectible

AJE to set up the allowance:
Dec 31

Dr. Bad Debt Expense (.02 × 100k) 2k

• Cr Allowance for Doubtful accounts 2k
  

Write off: later on, when a specific customer account is identified as a being uncollectible, it is written off against the allowance account:

Feb 26

Dr. Allowance for doubtful accounts 100
- Cr A/r 100

Recovery: if John Doe later, on march 15, pays company X, make a reversing entry:

Mar 15

Dr. A/r 100

• Cr Allowance for doubtful accounts 100

Dr. Cash 100

• Cr a/r 100

Allowance Method; Estimates based on Analysis of REceivables (aka aging of receivables)

emphasizes on receivables

emphasizes more on BALANCE SHEET than INCOME STATEMENT

Goal: use chart to caluclate what ENDING BALANCE SHOULD BE, THEN PLUG IN THE DIFFERENCE “PLUG”

^^make journal entry to reflect the difference between the beginning and ending balances should be using the “plug”

Step 1: make chart

Step 2: find totals » this becomes WHAT YOUR ENDING BALANCE IN ALLOWANCE FOR DOUBTFUL ACCOUNTS SHOULD BE

• chart gives us a total of 37650 » this is what our ending balance in ADA should be equal to

Step 3: make adjusting journal entry that shows the difference between beginning and ending

• beginning balance for ADA = credit balance of 800

• New/ending balance that we calculated from before = 37650

• Plug = 37650 - 800 = 36850

• JE:

  • Dr Bad Debt Expense 36850

    • Cr Allowance for Doubtful Accounts 36850
      
      

Write off (same as estimates based on sales)

When customer demmed uncollectible

Feb 10

Dr. Allowance for Doubtful accounts 200

• Cr A/r 200

\

Recovery (same as estimates based on sales)

When customer beats bankruptcy and is pays us off

Mar 10

Dr A/r 200

• Cr Allowance for Doubtful Accounts 200

Dr Cash 200

• Cr A/r 200

Notes Receivable

Recorded at PRESENT VALUE (the value today of future cash flows, discounted using the market interest rate) NOT FACE VALUE (the amount written on the note or bond that will be repaid at maturity) of the cash they expect to collect

come from:

1. customers who need to extend the payment period of an outstanding receivable

2. high-risk or new customers

3. loans to employees and subsidaries

4. sales of PPE

5. In some industries (pleasure and sport boat industry), notes support all credit sales

Notes only compound annually (bonds compound semiannually)

recognition of (interest bearing) note receivable

1. Record LONG TERM NOTES RECEIVABLE at PRESENT VALUE (the value today of future cash flows, discounted using the market interest rate) NOT FACE VALUE (the amount written on the note or bond that will be repaid at maturity) of the cash they expect to collect

2. when stated rate = interest rate: issue @ face value

3. when stated rate < interest rate: issue at discount

4. when stated rate > interest rate: issue at premium

   1. for discounts and premiums, record the difference and ammortize the difference over the life of the note to appromate the effective (market) interest rate

implicit interest rate (zero interest bearing notes)

fair value option

companies may elect the fair value option for n/r

receivables are reported at fair calue (current market value), not historical carrying value

any change in fair value each period is reocrded as a nunrealized holding g/l on the i/s
every reporting date, the receivable is adjusted to its current fair value

this choice can only be made:

• when the instrument is first recognized, or

• when a new accounting basis opccurs

once chosen, cannot switch until the instrument is no longer owned

if you no no elect initially, you cannot decide to use it later for that same instrument

• Fair value goes up → Debit Notes Receivable, Credit Unrealized Gain

• Fair value goes down → Debit Unrealized Loss, Credit Notes Receivable

• Election is made once and cannot be changed for that financial instrument

Financing with Receivables

1. selling receivables

   1. securitization

      1. a company first creates a special purpose entity SPE which is usually a trust or subsidiary.

      2. SPE buys receivables from the company

      3. SPE then sells bonds/commerical paper backed by those receivables

      4. Receivables » SPE » Investors

   2. factoring

      1. company sells receivables to a factor (usually a bank or finance company)

         1. The factor:

            • pays cash immediately

            • collects from customers later

            • charges a finance fee

         2. the factor usually holds back (retains) some money for possible (aka Receivable/Due from Factor):

            • sales returns

            • discounts

            • allowances

   3. 2 types of Factoring

      1. Without Recourse (buyer assumes the risk)

         1. if buyers don’t pay, seller owes nothing

         2. Seller JE:

            • Dr Cash

            • Dr Receivable from factor

            • Dr loss (loss = finance fee) on sale

              • Cr A/R

         3. Buyer’s (facoter’s) JE:

            • Cr A/R

              • Dr CAsh

              • Dr Due to Customer

              • Interest Rev

      2. With Recourse (seller guarantees payment if customers fail to pay)

         1. seller keeps some risk and records it as a recourse liability

         2. sller JE:

            • dr cash

            • dr receivable from factor

            • dr loss (finance fee + recourse liability) on sale of receivables (add entire reourse liabiltiy to this value)

              • cr a/r

              • cr recourse liability

         3. BUYER’S (FACOTR’S) je:

            • same as without recourse

            • dr a/r

              • cr due to customer

              • cr interest revenue

              • cash

using receivables as collateral for a loan

• secured borrowing: company keeps ownership of receivables and uses them as collateral for a loan

  1. company still collects customers’ payments

  2. records bad debts

  3. records sales discounts

  4. records returns

Example: On March 1, 2023, Howat Mills, Inc. pledges $700,000 of its accounts receivable to Citizens Bank as collateral for a $500,000 note. Under this arrangement…

• Howat Mills continues to collect the accounts receivable. The account debtors are not notified of the arrangement.

• Citizens Bank assesses a finance charge of 1% of the accounts receivable and interest on the note of 12%.

• Howat Mills makes monthly payments to the bank for all cash it collects on the receivables.

• Initial borrowing JE:

  1. Howat (Seller) JE:

     • Dr. Cash (500,000 - 7,000) 493,000

     • Dr Interest Expense (finance charge) (700,000 × 0.01) 7,000

       • Cr N/P 500,000

  2. Citizen bank (buyer) JE:

     • Dr Notes Receivables 500,000

       • cr Interest Rev (700,000 × 0.01) 7,000

       • cr cash (500,000 - 7,000) 493,000

• Seller collectrs on some of its accounts receivable. it collects $434,000 cash. however, there is also $6,000 of sales discounts plus receipt of $14,000 sales returns applied \

  • Howat (seller) JE

    • Dr cash 434,000

    • Dr sales discounts (for paying off early) 6,000

    • Dr Sales Returns and Allowances 14,000

      • Cr a/r (434,000 + 6,000 + 14,000) 454,000

  • Citizen bank (buyer) JE:

    • does not record any JE since it doesn’t affect them

pledging

when a company trasnfers the receivables for custodial purposes