Ch 6 Acc

6.0 Cash and Receivables

Learning Objectives

• Describe cash and receivables, and explain their critical role in accounting and business operations.

• Describe cash and cash equivalents, detailing how they are measured, recognized, and reported in financial statements.

• Explain the purpose and key activities of internal control for cash, emphasizing its importance in safeguarding assets and ensuring accurate financial reporting.

• Describe receivables, identifying the different types (such as accounts and notes receivable), explaining their accounting treatment, and preparing relevant journal entries.

• Discuss accounts receivable, including initial and subsequent measurement, recognition, and reporting protocols.

• Describe notes receivable, focusing on initial recognition, subsequent measurement, and reporting standards.

• Explain derecognition of receivables, including various strategies (e.g., factoring or sales of receivables) businesses utilize to shorten the credit-to-cash cycle.

• Identify how receivables are disclosed on the balance sheet and within accompanying notes, ensuring compliance with relevant financial reporting frameworks.

• Analyze cash and receivables using financial ratios and methodologies.

• Explain the differences between IFRS and ASPE related to recognition, measurement, and reporting for cash and receivables.

Introduction to the Role of Cash and Receivables

• Importance of Cash Management: Effective management of cash and receivables is crucial for maintaining business liquidity and solvency. Companies must regularly assess the turnover time from receivables to cash to safeguard their financial health and operational capability. This monitoring aids in identifying potential liquidity issues before they negatively impact the business.Example: A retail company regularly reviews its accounts receivable aging schedule and identifies that customers usually take 45 days to pay. By improving collection processes, they aim to reduce this to 30 days, enhancing cash flow.

• Financial Reporting Use: Management relies on financial reporting to analyze the credit-to-cash conversion cycle, assessing available liquid assets to fulfill short-term obligations and strategizing for future financial planning.Example: A company uses financial statements to project cash needs for the upcoming quarter, determining how much cash reserve is necessary to cover expenses while waiting for receivables to be collected.

Chapter Organization

• The discussion will encompass a comprehensive examination of cash, cash equivalents, receivables, including accounting treatment, measurement, reporting methods, and analytical techniques for effective management.

6.1 Overview

• Definition of Financial Assets: Financial assets such as cash, cash equivalents, accounts receivable, and notes receivable represent claims that provide future economic benefits. They can take multiple forms:

  • Cash: Considered the most liquid asset.

  • Contractual Rights: Rights to receive cash or other financial resources from various entities.Example: A company has contractual rights to receive a series of payments due from a client under a service agreement.

• Derivation of Value: The value of financial assets predominantly arises from contractual rights that guarantee identifiable amounts, setting them apart from physical assets where cash value may fluctuate based on market conditions.

6.2 Cash and Cash Equivalents

• Recognition, Measurement, and Disclosure

  • Definition of Cash: Cash is the most liquid form of asset, classified as a current asset, which includes:

    • Coins, currency, demand deposits, and negotiable instruments.Example: A company with $20,000 in cash and cash equivalents on its balance sheet can quickly meet short-term obligations.

  • Long-term Designation: Cash may occasionally be classified as a long-term asset if it is earmarked for specific future projects or the retirement of long-term debt.Example: A firm segregates $150,000 of cash reserves for a future expansion project, reporting it as a long-term asset.

  • Exclusions from Cash: Certain items, such as post-dated cheques, travel advances, and postage stamps, are categorized as receivables or prepaid expenses rather than cash.

  • Restricted Cash Reporting: Any significant restrictions on cash must be reported separately, depending on their nature and duration to enhance transparency to stakeholders.Example: If a company has $50,000 set aside in a savings account for a future lawsuit settlement, it would report this as restricted cash on the balance sheet.

  • Foreign Currencies: All foreign currency amounts must be translated into Canadian dollars based on prevailing exchange rates at the balance sheet date, ensuring accuracy in financial reporting.Example: A company holds €10,000, which it must convert to CAD at the current exchange rate for proper reporting.

  • Bank Overdrafts: Treated as current liabilities unless they are offset against positive bank balances.

• Cash Equivalents: These are short-term, highly liquid investments that can be quickly converted to cash, such as treasury bills, which must be reported at fair value alongside cash assets.Example: The company holds $30,000 in treasury bills, considered cash equivalents due to their quick convertibility to cash.

Summary of Cash and Cash Management

• Effective Cash Management Strategies: Best practices in cash management comprise:

  • Establishing robust internal controls.

  • Segregating duties to prevent fraud.

  • Making daily cash deposits to enhance liquidity.

  • Leveraging technology for efficient cash collections through electronic transfer methods.

6.3 Receivables

• Definition and Classification of Receivables

  • Nature of Receivables: These represent claims against customers for future cash flows and fall into specific categories:

    • Accounts Receivable: Funds owed by customers from credit sales, which should be reported at net realizable value to reflect potential uncollectibles.Example: A furniture store has $100,000 in accounts receivable, but estimates $5,000 may not be collectible due to customer defaults; thus, they report it at $95,000.

    • Notes Receivable: Formal agreements obligating the buyer to pay a specified amount on a set date; they can be either interest-bearing or non-interest-bearing.Example: A company extends a note receivable of $10,000 to a customer, requiring repayment in six months, with a 5% interest rate.

    • Non-Trade Receivables: These include miscellaneous items, such as tax refunds and advances to employees or affiliated parties.

Management of Accounts Receivable

• Importance of Receivables Management: Efficient management of accounts receivable is vital for maintaining healthy cash flow and ensuring overall business stability. Poor management can lead to cash shortages and increased financing costs.

• Strategies for Effective Management: Recommended strategies for managing receivables include:

  • Offering Cash Discounts: Encouraging customers to pay early can improve cash flow.Example: A retailer provides a 2% discount for customers who pay their invoice within 10 days.

  • Establishing Credit Limits: Setting appropriate credit limits helps mitigate the risk of non-payment.

  • Sales Discounts: Implementing discounts on early payments to incentivize timely collections.Example: A software company offers a 10% discount on yearly subscriptions paid in advance.

• Analyzing Receivables: Essential activities involving receivables include conducting aging assessments of accounts and actively monitoring accounts that are overdue.Example: A business generates a monthly aging report identifying which invoices are overdue and follows up with customers based on their payment history.

Journal Entries Examples

1. Recording Credit SalesWhen a customer purchases goods on credit, the following entry is made:Journal Entry:

   • Debit: Accounts Receivable $50,000

   • Credit: Sales Revenue $50,000Explanation: This entry reflects the sale of goods to a customer on credit, increasing accounts receivable and sales revenue.

2. Receiving Payment from CustomerWhen the customer pays the amount owed:Journal Entry:

   • Debit: Cash $50,000

   • Credit: Accounts Receivable $50,000Explanation: This entry records the cash received from the customer, reducing both cash and accounts receivable.

3. Recognizing Bad DebtsIf a portion of accounts receivable is determined to be uncollectible:Journal Entry:

   • Debit: Bad Debt Expense $5,000

   • Credit: Allowance for Doubtful Accounts $5,000Explanation: This entry acknowledges the expense associated with accounts that are estimated to be uncollectible, adjusting for potential losses.

4. Issuing a Note ReceivableWhen a formal note is issued to a customer for their debt:Journal Entry:

   • Debit: Notes Receivable $10,000

   • Credit: Accounts Receivable $10,000Explanation: This entry records the transfer of receivables into a formal note, increasing notes receivable and decreasing accounts receivable.

6.4 Cash and Receivables: Analysis

• Analytical Tools

  • Accounts Receivable Aging Reports: These reports help businesses assess overdue accounts, providing insights into overall receivables health and collection efficiency.Example: An aging report may show that 25% of receivables are overdue by more than 60 days, prompting the finance team to revise collection strategies.

  • Trendline Analysis: Graphing outstanding balances allows for forecasting and predicting future receivables trends, facilitating better cash flow management.Example: A company reviews a trendline graph showing a steady increase in accounts receivable over the past year, prompting them to increase their collection efforts.

  • Ratio Analysis: Key metrics such as the quick ratio and accounts receivable turnover ratio are vital for assessing liquidity and financial health.

6.5 IFRS/ASPE Key Differences

• Key Differences

  • Initial Measurement and Impairment: There are minor variations between IFRS and ASPE concerning definitions, methodologies, and approaches to measurement and impairment.Example: Under IFRS, impairment techniques might differ slightly, considering expected credit losses, while ASPE may follow a different recognition pattern.

  • Long-term Notes Receivable: Specific distinctions exist in initial measurement processes, impairment assessments, and transaction cost accounting under the two frameworks.

6.6 Appendix A: Review of Internal Controls, Petty Cash, and Bank Reconciliations

• Internal Control Systems

  • Purpose of Internal Controls: These systems are crucial for protecting the company’s assets, ensuring accurate reporting of financial information, and driving operational efficiency across all business units.

  • Implementation Strategies: Effective controls include segregation of duties, timely transaction processing, and the maintenance of accurate records for all transactions.

6.7 Chapter Summary

• Key Learnings Recap

  • Role of Cash and Receivables: Their management is essential for achieving financial stability. Regular monitoring helps prevent excessive or insufficient accounts receivable, which can affect liquidity.

  • Management Strategies: Effective cash utilization maximizes interest income and minimizes associated financial risks.

  • Recognition and Measurement: Strict standards govern the recognition and measurement of cash and receivables to ensure compliance with accounting principles.

  • Receivables Management: Active engagement in credit policy formulation and uncollectible accounts estimation is key to efficient receivables management.