Ch7 PPT

Chapter 7: Cash and Receivables

7.1 Cash and Cash Equivalents

  • Cash

    • Amounts readily available to pay off debts or used in operations.

    • Examples: Currency and coins, checking account balances.

  • Cash Equivalents

    • Short-term, highly liquid investments that are convertible to cash.

    • Conditions: Maturity date ≤ 3 months from the date of purchase.

    • Examples: Money market funds, treasury bills, commercial paper.

7.2 Internal Control

  • Sarbanes-Oxley Act (Section 404)

    • Requires documentation/assessment of internal controls.

    • Auditors express opinions on management’s assessments.

  • Committee of Sponsoring Organizations (COSO)

    • Defines internal control as processes to achieve:

      • Effectiveness and efficiency of operations.

      • Reliability of financial reporting.

      • Compliance with laws and regulations.

7.3 Internal Control Procedures

Cash Receipts

  • Separation of Duties

    • Individuals with physical access should not have access to accounting records or responsibilities for reconciliation.

Cash Disbursements

  • Authorization

    • All expenditures must be authorized beforehand.

    • Checks signed only by authorized personnel.

  • Records

    • All disbursements must be documented with checks (not cash).

7.4 Restricted Cash

  • Cash not available for immediate use.

    • Examples: Funds set aside for future plant expansion or debt instruments.

    • Classification:

      • Noncurrent: Restricted cash not used within the year.

      • Current: Restricted cash set aside for obligations due within the year.

7.5 Compensating Balances

  • Requirements to maintain specific balances in accounts to compensate banks for lending.

    • This affects the effective interest rate that may be higher than the stated rate.

    • Example: A $10,000 loan at 12% requires a $2,000 noninterest-bearing balance leading to an effective rate of 15%.

7.6 Accounts Receivable

  • Informal credit arrangement with customers, typically due 30-60 days post-sale.

    • Part of the operating cycle, classified as current assets.

    • Potential complexities:

      • Time value of money.

      • Variable consideration.

7.7 Trade Discounts and Sales Discounts

  • Trade Discounts

    • Percentage reductions from list prices offered to large customers.

  • Sales Discounts

    • Reductions in amount owed for early payment.

    • Example: 2/10, n/30 means a 2% discount if paid within 10 days, full payment by 30 days.

7.8 Gross vs. Net Method

  • Gross Method

    • Record sales at the full price and reduce accounts receivable as discounts are taken.

    • Example: Invoice for $20,000 with a cash discount leads to accounts being recorded for $20,000.

  • Net Method

    • Record sales at the discounted amount.

    • Accounts receivable recorded at $19,600 for a $20,000 sale with a cash discount.

7.9 Sales Returns and Allowances

  • Sales Returns

    • Merchandise returned for refunds or credits.

    • Special price reductions incentivizing customers to keep merchandise are called allowances.

    • Must estimate/accrue returns at the point of sale to avoid overstating income in the sale period.

7.10 Accounting for Sales Returns

  • Recognizing returns in the period they occur can distort financial statements—overstated assets and income during the sale period.

  • Recording Sales Returns

    • Involves debiting sales returns and adjusting inventory and COGS accordingly while estimating unreturned amounts as a liability.

7.11 Allowance for Uncollectible Accounts

  • Direct Write-Off Method

    • Recognizes accounts when deemed uncollectible—impacts reported income and AR.

  • Allowance Method

    • Uses a contra-asset account to adjust the carrying value of accounts receivable to the amount expected to collect.

7.12 Estimating the Allowance for Uncollectible Accounts

  • Balance Sheet Approach

    • Calculates needed adjustments based on expected collectible amounts.

  • Income Statement Approach

    • Estimates Bad Debt Expense as a percentage of sales.

7.13 Combined Approaches

  • Use both approaches for accurate estimates of uncollectibles and to enhance forecasting reliability.

7.14 CECL (Current Expected Credit Loss) Model

  • Requires consideration of all receivables and forecasts for a better estimate of future credit losses and bad debts.

7.15 Receivables Management Ratios

  • Receivables Turnover Ratio

    • Indicates how often average accounts receivable are collected.

  • Average Collection Period

    • Estimates how long receivables remain outstanding.

7.16 Sale of Receivables

  • Involves selling accounts receivable for immediate cash, recognized as a gain or loss based on fair value adjustments.

7.17 Secured Borrowing Techniques

  • Pledging

    • Assigns receivables as collateral without changing collection responsibilities.

  • Assigning

    • Assigns specific receivables as collateral, typically with an up-front finance charge.