Chapter 6 - Cash and Receivables

Cash

• Most liquid asset
• Standard medium of exchange
• Basis for measuring and accounting for all items
• Current asset
• Examples:
  • Coin, currency
  • Available funds on deposit at the bank
  • Money orders, certified checks, cashier’s checks, personal checks, bank drafts
  • Savings accounts

Cash Equivalents

• Short-term, highly liquid investments that are both:
  • Readily convertible to cash
  • So near their maturity that they present insignificant risk of changes in value
• Examples:
  • Treasury bills, certificates of deposit, commercial paper, and money market funds.

Reporting Cash

• Restricted Cash
  • When material in amount, companies segregate restricted cash from “regular” cash.
  • Examples, restricted for:
    • Plant expansion
    • Retirement of long-term debt
    • Contractual agreement with a bank

Restricted Cash

• Compensating Balance
  • Another type of restricted cash is a compensating balance.
  • A compensating balance is a minimum balance that must be maintained in a bank account, which is used to offset the cost incurred by the bank to set up a loan.
  • Compensating balances against short-term borrowings should be reported in current assets as “cash and cash equivalents.”
  • Compensating balances against long-term borrowings should be reported as noncurrent assets in either the investments or other assets sections, using a caption such as “Cash on deposit maintained as compensating balance.”

Compensating Balance Example

• FACTS
  • Borrowing $200,000$ for one year for a Subway franchise.
  • Interest at 6% on the loan.
  • Bank requires keeping $20,000$ in the bank as a compensating balance.
• QUESTION
  • Why does the bank require a compensating balance?
• SOLUTION
  • Reasons for compensating balance:
    • Collection problems: Bank has your $20,000$.
    • Loan-servicing costs: Bank is effectively charging more than 6%.
      • Paying $12,000$ ($.06 \times 200,000$) for a loan of $180,000$, which equates to an interest rate of 6.7% ($12,000 ÷ 180,000$).

Reporting Cash

• Bank Overdrafts
  • Company writes a check for more than the amount in its cash account.
  • Reported as a current liability (as part of accounts payable).
  • If material, disclose separately on the balance sheet or in the related notes.
  • Offset against other cash accounts only when accounts are with the same bank.

Receivables

• Claims held against customers and others for money, goods, or services.
• Classified in the balance sheet as:
  • Current or noncurrent
  • Trade or nontrade
    • Accounts receivable
    • Notes receivable

Nontrade Receivables

• Advances to officers and employees.
• Advances to subsidiaries.
• Deposits paid to cover potential damages or losses.
• Deposits paid as a guarantee of performance or payment.
• Dividends and interest receivable.
• Claims against insurance companies for casualties sustained, for tax refunds, or for damaged or lost goods.

Receivables Balance Sheet Presentations

• Examples of balance sheet presentations of recievables for Molson Coors Brewing Company and Seaboard Corporation.
  • Items include: cash and cash equivalents, accounts and notes receivable, trade recivables, due from foreign affilliates, current notes recievable and other recievables, allowance for doubtful accounts, inventories, deferred income taxes and other current assets.

Recognition of Accounts Receivables

• Accounts receivable generally arise as part of a revenue arrangement.
• Revenue recognition principle indicates that a company should recognize revenue when it satisfies its performance obligation by transferring the good or service to the customer.

Recognition of Accounts Receivables Example

• Lululemon sells a yoga outfit to Jennifer Burian for $100$ on account.
  • Yoga outfit is transferred when Jennifer obtains control.
  • Lululemon should recognize an account receivable and sales revenue.
• Lululemon Entry:
  • Accounts Receivable $100$
  • Sales Revenue $100$

Recognition of Accounts Receivables Key Indicators Control Has Been Transferred

• Lululemon has the right to payment from the customer.
• Lululemon has passed legal title to the customer.
• Lululemon has transferred physical possession of the goods.
• Lululemon no longer has significant risks and rewards of ownership of the goods.
• Jennifer has accepted the asset.

Receivables Measurement of the Transaction Price

• The transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods or services.
• Variable Consideration
  • In some cases, the price of a good or service is dependent on future events.
  • These future events often include such items as discounts, returns and allowances, rebates, and performance bonuses.

Variable Consideration

• Trade Discounts
  • Reductions from the list price
  • Not recognized in the accounting records
  • Customers are billed net of discounts

Variable Consideration

• Cash Discounts (Sales Discounts)
  • Offered to induce prompt payment
  • Presented in terms
    • 2/10, n/30
    • 2/10, E.O.M.,
    • net 30, E.O.M.
  • Gross Method vs. Net Method

Cash Discounts Example

• FACTS
  • Armour Company sells goods for $10,000$ to Ohara Inc. on April 1 with terms 1/10, net 15.
• QUESTION
  • How should Armour record this transaction using (a) the gross method, and (b) the net method?
• SOLUTION
  • Gross method:
    • Accounts Receivable $10,000$
    • Sales Revenue $10,000$
  • Net method:
    • Accounts Receivable [$10,000 – ($.01 \times 10,000$)] $9,900$
    • Sales Revenue $9,900$
  • Armour records the accounts receivable and related sales revenue at $10,000$ (gross) or $9,900$ (net).

Discount Not Taken Example

• FACTS
  • March 1: Hanley Company sells goods for $10,000$ to Murdoch Inc. with terms 2/10, net 30.
  • March 8: Hanley receives a payment of $3,920$ from Murdoch related to the sale on March 1.
  • March 26: Hanley receives $6,000$ related to the sale on March 1.
• QUESTION
  • What entries should Hanley in March make regarding the sale to Murdoch using the gross method and the net method?

Discount Not Taken Example Solution

• The total amount of income reported on the income statement from this transaction is the same under the gross and net method, the presentation is different.
  • Gross method: net sales revenue of $9,920$ ($10,000$ − $80$) is shown in operating income.
  • Net method: net sales revenue of $9,800$ is shown in operating income, while $120$ of discounts forfeited is shown as “Other revenues and gains,” below operating income.
• Under each method, the total increase to net income is $9,920$.

Variable Consideration

• Sales Returns and Allowances
  • Contra revenue account to Sales Revenue
  • Allowance for Sales Returns and Allowances is a contra asset account to Accounts Receivable
  • Use of both Sales Returns and Allowances and Allowance for Sales Return and Allowances accounts is helpful to identify potential problems associated with inferior merchandise, inefficiencies in filling orders, or delivery or shipment mistakes

Valuation of Accounts Receivable

• Record credit losses as debits to Bad Debt Expense
  • Normal and necessary risk of doing business on credit
• Two methods to account for uncollectible accounts:
  • Direct write-off method
  • Allowance method

Valuation of Accounts Receivable Methods of Accounting for Uncollectible Accounts

• Direct Write-Off
  • Theoretically deficient
  • No matching
  • Receivable not stated at cash realizable value
  • Not GAAP when material in amount
• Allowance Method
  • Losses are estimated
  • Percentage-of-sales
  • Percentage-of-receivables
  • GAAP requires when material in amount

Valuation of Accounts Receivable Direct Write-Off Method for Uncollectible Accounts

• When a company determines a particular account to be uncollectible, it charges the loss to Bad Debt Expense.
• Example
  • On December 10, Cruz Co. writes off as uncollectible Yusado’s $8,000$ balance.
  • Entry:
    • Bad Debt Expense $8,000$
    • Accounts Receivable (Yusado) $8,000$

Valuation of Accounts Receivable Allowance Method for Uncollectible Accounts

• Involves estimating uncollectible accounts at end of each period
• Ensures that companies state receivables on balance sheet at net realizable value
• Companies estimate uncollectible accounts and net realizable value using information about past and current events as well as forecasts of future collectability

Allowance Method for Uncollectibles Recording Uncollectible Accounts

• Assume that Brown Furniture in 2025, its first year of operations, has credit sales of $1,800,000$.
  • At December 31, 2025, the company reported accounts receivable of $150,000$ from those sales.
  • The credit manager estimates that $10,000$ of these sales will be uncollectible.
• Adjusting entry to record the estimated uncollectibles (assuming a zero balance in the allowance account):
  • Bad Debt Expense $10,000$
  • Allowance for Doubtful Accounts $10,000$

Recording Estimated Uncollectable Presentation of Allowance for Doubtful Accounts

• Brown reports Bad Debt Expense in the income statement as an operating expense.
• Thus, Brown records the increased estimated uncollectible as bad debt expense in the period of credit deterioration.
• The company deducts the allowance account from accounts receivable in the current assets section of the balance sheet.
  • Example presentation:
    • Brown Furniture Balance Sheet (partial)
      • Current assets
        • Cash $15,000$
        • Accounts receivable $150,000$
          • Less: Allowance for doubtful accounts $10,000$ $140,000$
        • Inventory $300,000$
        • Prepaid insurance $25,000$
      • Total current assets $480,000$
• $140,000$ represents the net realizable value of the accounts receivable at the statement date.

Allowance Method for Uncollectibles Recording the Write-Off of an Uncollectible Account

• When companies have exhausted all means of collecting a past-due account and collection appears impossible, the company should write off the account
• In the credit card industry, for example, it is standard practice to write off accounts that are 210 days past due.

Recording the Write-Off of an Uncollectible Account

• The financial vice president of Brown Furniture authorizes a write-off of the $1,000$ balance owed by Randall Co. on March 1, 2026.
• The entry to record the write-off is:
  • Allowance for Doubtful Accounts $1,000$
  • Accounts Receivable (Randall Co.) $1,000$

Account Balances After Write-Off

• After posting the entry to write-off the Randall Co. account, the general ledger accounts appear as follows. (Not included here)

Cash Realizable Value

• A write-off affects only balance sheet accounts—not income statement accounts.
• The write-off of the account reduces both Accounts Receivable and Allowance for Doubtful Accounts.
• Cash realizable value in the balance sheet, therefore, remains the same.
• Example:
  • Before Write-Off
    • Accounts Receivable $150,000$
    • Allowance for Doubtful Accounts $10,000$
    • Cash realizable value $140,000$
  • After Write-Off
    • Accounts Receivable $149,000$
    • Allowance for Doubtful Accounts $9,000$
    • Cash realizable value $140,000$

Allowance Method for Uncollectibles Recovery of an Uncollectible Account Example

• FACTS
  • On July 1, 2026, Randall Co. pays the $1,000$ amount that Brown Furniture had written off on March 1.
• QUESTION
  • What entry (entries) should Brown make to record this recovery?
• SOLUTION
  • July 1, 2026
    • To reverse write-off of account:
      • Accounts Receivable (Randall Co.) $1,000$
      • Allowance for Doubtful Accounts $1,000$
    • To record collection of the Randall account:
      • Cash $1,000$
      • Accounts Receivable (Randall Co.) $1,000$
• The recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet accounts.
• The net effect of the two entries above is a debit to Cash and a credit to Allowance for Doubtful Accounts for $1,000$.

Allowance Method for Uncollectibles Estimating the Allowance Percentage-of-Receivables Approach

• Reports estimate of receivables at realizable value
• Companies may apply this method using
  • one composite rate, or
  • an aging schedule using different rates

Accounts Receivable Aging Schedule

• An aging schedule also serves as a control device by identifying which accounts require special attention based on how long they have been past due.
• Aloha Coffee reports a balance of $26,610$ in Allowance for Doubtful Accounts.
• If there is no beginning balance in its allowance account, the company will debit bad debt expense for this same amount.

Aging Schedule for Aloha Coffee Company

Included in the transcript.

Adjusting Entry to Record Estimate

• What entry would Ahola make assuming that the allowance account had a zero balance?
  • Bad Debt Expense $26,610$
  • Allowance for Doubtful Accounts $26,610$

Adjusting Entry to Record Estimate Credit Balance Before Adjustment

• What entry would Aloha make assuming the allowance account had a credit balance of $800$ before adjustment?
  • Bad Debt Expense ($26,610$ – $800$) $25,810$
  • Allowance for Doubtful Accounts $25,810$

Adjusting Entry to Record Estimate Debit Balance Before Adjustment

• What entry would Aloha make assuming the allowance account had a debit balance of $1,000$ before adjustment?
  • Bad Debt Expense ($26,610$ + $1,000$) $27,610$
  • Allowance for Doubtful Accounts $27,610$

Notes Receivable

• Supported by a Formal Promissory Note
  • Written promise to pay a certain sum of money at a specific future date
  • A negotiable instrument
  • Maker signs in favor of a payee
  • Interest-bearing (has a stated rate of interest) or
  • Zero-interest-bearing (interest included in face amount)

Notes Receivable Generally Originate From:

• Customers who need to extend payment period of an outstanding receivable
• High-risk or new customers
• Loans to employees and subsidiaries
• Sales of property, plant, and equipment
• Lending transactions (majority of notes)

Note Issued at Face Value

• Time Diagram for Note Issued at Face Value
  • Fjords Unlimited lends Scandinavian Imports $10,000$ in exchange for a $10,000$, three-year note bearing interest at 10% annually.
  • The market rate of interest for a note of similar risk is also 10%.

Note Issued at Face Value

Included in the transcript is a present value of an ordinary annuity table.

Note Issued at Face Value

Included in the transcript is a present value of principal table.

Present Value of Note—Stated and Market Rates the Same

• Face value of the note $10,000$
• Present value of the principal: $10,000$ (PVF3,10%) = $10,000 \times .75132$ $7,513$
• Present value of the interest: $1,000$ (PVF–OA3,10%) = $1,000 \times 2.48685$ $2,487$
• Present value of the note ($10,000$)
• Difference $0$
• Journal Entries
  • To record the receipt of the note:
    • Notes Receivable $10,000$
    • Cash $10,000$
  • To record the interest earned each year:
    • Cash $1,000$
    • Interest Revenue ($10,000 \times .10$) $1,000$

Presentation and Analysis Presentation of Receivables

• Segregate the different types of receivables that a company possesses, if material.
• Appropriately offset the valuation accounts against the proper receivable accounts.
• Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer.
• Disclose any loss contingencies that exist on the receivables.
• Disclose any receivables designated or pledged as collateral.
• Disclose the nature of credit risk inherent in the receivables.

Presentation and Analysis Disclosure of Receivables

• Example of PepsiCo, Inc. consolidated balance sheet
  • Includes: cash and cash equivalents, short-term investments, restriced cash, accounts and notes recievable, net, inventories, prepaid expenses and others current assets, and totoal current assets.

Presentation and Analysis Footnote Disclosure of Receivables

• Note 2 - Our Significant Accounting Policies (in part)
  • Our products are sold for cash or on credit terms.
  • Estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectability, write-off history, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general, and administrative expenses on our income statement.
  • Exposed to concentration of credit risk from our major customers, including Walmart.
• Note 15 - Supplemental Financial Information
  • Balance Sheet
    • Accounts and notes receivable
      • Trade receivable
      • Other receivable
      • Total
    • Allowance, beginning of year
    • Net amounts charged to expense
    • Deduction
    • Other
    • Allowance, end of year
    • Net receivable
  • Other assets
    • Noncurrent notes and accounts receivable

Decision Analysis of Receivables

• Accounts Receivable Turnover
  • Use to evaluate liquidity of accounts receivable
  • Measures number of times, on average, a company collects receivables during the period
• Average Days to Collect Receivables
  • General rule is that the average collection period should not greatly exceed the credit term period

Accounts Receivable Turnover Example

• Best Buy reported net sales of $39,403$ million, its beginning and ending accounts receivable balances were $1,347$ million and $1,162$ million, respectively.
• Further computation of its accounts receivable turnover and average days to collect receivables can be done (not included here).