Financial Accounting Chapter 7: Cash and Receivables

Key Issues with Cash

Internal controls. Classification in the balance sheet.

Cash

Amounts readily available to pay debt or to use in operations without any legal or contractual restrictions. Ex: Currency and coins, a balances in checking accounts, checks , money order

Cash Equivalents

Short-term highly liquid investments, readily convertible to cash with little risk of loss. Have a maturity date no longer than 3 months from purchase date. Ex: Money market funds, treasury bills, and commercial paper.

Internal Controls 

1. Encourage adherence to company policies and procedures.

2. Promote operational efficiency.

3. Minimize errors and theft.

4. Enhance the reliability and accuracy of accounting data.

Sarbanes-Oxley Act (Section 404) requires

1. A company to document its internal controls and asses their adequacy

2. Auditors to express an opinion on managements assessments

Committee of Sponsoring Organization (COSO)

Provides a framework for-designing an internal control system.

Separation of Duties

The cash reciepts process. The person entering into accounting department person should never handle the actual cash.

Cash Disbursements Objectives 

Prevent unauthorized payments. Ensure that disbursements are recorded properly. 

Cash Disbursements Important Elements

1. All disbursements should be made by check

2. All expenditures should be authorized before a check is prepared

3. Checks should be signed by authorized individuals

Restricted Cash

Not available for current use.

Cash can be restricted for

A specific purpose. Contractually imposed.

Compensating Balances 

An amount that compensates the bank for granting the loan or extending the line of credit. 

Under the arrangement of compensating balances

Borrower is asked to maintain a specified balance in a low interest or non-interest bearing account at the bank. Required balance equals some percentage of the committed amount. Borrower pays effective interest rate higher than the stated rate on the debt because they can’t use the cash being used as a compensating balance.

Current Receivables

A company’s claims to future collection of cash, other assets, or services.

Accounts Receivables

Receivables resulting from the sale of goods and services on account.

Non trade receivables are those other than trade receivables are 

Tax refunds, interest receivable, advance to employee

Trade Discount

A percentage reduction from the list price. Quantity discounts to large customers.

Sales Discount

Reductions in the amount to be paid by credit customer if paid within a specified a period of time. Intended to provide incentive for quick payment. 2/10, n/30. Meaning a 2% discount if paid within 10 days otherwise full payment is due within 30 days.

Gross method 

Uses gross amount

Net Method

Uses net amount.

Sales Discount

Contra revenue account

When using the net method you have an account called

Sales discount forfeited

Sales Return

Merchandise is returned for a refund or for credit to be applied to other purchases.

Special price reduction, called an ___________, may be given as an incentive for the customer to keep the merchandise rather than returning it.

Allowance

Sale of Receivables

Can be sold at a gain or loss like other assets.

Bank Reconciliations

One of the most important tools used in the control of cash. Its the difference between the cash books and bank balance occur to differences in:

-Timing of recognition of certain transactions

-Errors

Step 1: Adjust the Bank Balance

Add deposits outstanding. Deduct checks outstanding. Bank errors.

Step 2: Adjust the Book Balance 

Add collections made by the bank. Deduct service and other charges. Deduct NSF check (non sufficient funds). Company errors. 

For a bank reconciliation

You only make journal entries for the book balance.

Subsequent Valuations of Accounts Receivable

Credit losses (bad debts) are an inherent cost of granting credit. 

Direct Write-Off Method

Accounts are written off when deemed uncollectible. Not allowed by GAAP unless bad debt is immaterial. Required for income tax purposes for most companies.

Reasons why the Direct Write-Off Method is not allowed by GAAP

1. Overstates the balance in accounts receivable in the periods prior to the write-off.

2. Distorts net income by postponing recognition of any bad debt expense until the period in which the customer actually fails to pay.

Allowance Method 

Required by GAAP whenever the amount of bad debts is material. Companies use a contra-asset account, the allowance for uncollectible accounts, to reduce the carrying value of accounts receivable to the amount of cash they expect to collect.

Bad Debt Expense

Is not recognized when specific accounts are written off. Is recognized earlier, when accounts are estimated to be uncollectible and allowance is created.

Estimating the Allowance for Uncollectible Accounts

1. Income Statement Approach

2. Balance Sheet Approach. → Aging method and percent of receivables method

Income Statement Approach

Estimate bad debt expenses directly as a percentage of each periods net credit.

Balance Sheet Approach

Base bad debt expense on the appropriate carrying value of accounts receivable. Company estimates what the ending balance of the allowance for doubtful accounts should be and then records the amount of bad debt expense necessary to adjust the allowance to that desired balance. Estimates should consider all relevant information, including historical experiance, current conditions, and reasonable and supportable forecast.

Aging Schedule 

Breaks up everything they have in total into periods of time. Into different age categories so they know how old it is. 

The normal balance for allowance for doubtful accounts is

credit