Chapter 7 Cash and Receivables Notes

Cash and Cash Equivalents

  • Cash: Amounts readily available to pay off debt or to use in operations. Examples include:
    • Currency and coins
    • Balances in checking accounts
  • Cash Equivalents: Short-term, highly liquid investments that are readily convertible to cash with little risk of loss. Characteristics include:
    • Maturity date no longer than three months from the date of purchase
    • Examples: Money market funds, treasury bills, and commercial paper

Disclosure of Cash Equivalents

  • Companies have flexibility in designating cash equivalents.
  • Example: Walgreen Boots Alliance, Inc. includes cash and cash equivalents with an original maturity of three months or less in their financials, settling credit and debit card receivables in two to seven business days.

Restricted Cash

  • Defined as cash that is restricted and not available for current use. Uses include:
    • Future plant expansion
    • Specific purposes determined by debt instruments, which require setting aside funds.
    • Classification:
    • Current Restricted Cash: Debt is current.
    • Noncurrent Restricted Cash: Debt is noncurrent.

Accounts Receivable

  • Definition: Created when sellers recognize revenue from a credit sale. Revenue and the related receivable are recognized at the point of delivery of goods or services.
  • Most businesses provide credit to customers, with typical arrangements supported by invoices, normally due in 30 to 60 days.
  • Classified as current assets given their collection period is within the operating cycle.

Sales Returns and Allowances

  • Occurs when merchandise is returned for a refund or credit for future purchases.
  • Sales returns are accrued at the time of sale to prevent overstated income in the sale period and understated income in the return period.
  • Example Scenario: Merchandise sold for $10,000 with a cost of $6,000 leads to a gross profit of $4,000. If all merchandise is returned the next year, it results in overstatements in income and assets.

Accounting for Sales Returns Example (Hawthorne Manufacturing)

  • Sales: $2,000,000, COGS: $1,200,000, returns of $130,000;
    • Accounting for Sales Returns:
    • Cash: $2,000,000
    • Sales Revenue: $2,000,000
    • COGS: $1,200,000
    • Inventory: $1,200,000
    • Recognize Sales Returns of $130,000 as:
    • Sales Returns: $130,000;
    • Cash: $130,000;
    • Inventory: $78,000;
    • COGS: $78,000.

Accounting for Sales Returns (Estimates)

  • If estimated returns are incorrect, adjust in the next period.
  • Example: Actual returns are $60,000 instead of $70,000; adjust entries accordingly.

Subsequent Valuation of Accounts Receivable

  • Credit losses (bad debts) are normal costs of extending credit.
  • Recognition approaches:
    • Direct Write-Off Method: Not GAAP; write off directly when deemed uncollectible, resulting in overstated receivables until then.
    • Allowance Method (GAAP): Use a contra-asset to reflect expected collections.

Allowance Method (GAAP)

  • Involves recording bad debt expense based on estimates, reducing assets.
  • Example Entry:
    • Bad debt expense: $25,000 credited to allowance for uncollectible accounts.

Notes Receivable

  • Classification: Current or non-current based on expected collection date.
    • Short-term: Less than one year.
    • Long-term: More than one year.

Interest-Bearing Notes

  • Interest calculation example:
    • extInterest=extFaceAmountimesextAnnualRateimesextFractionofAnnualPeriodext{Interest} = ext{Face Amount} imes ext{Annual Rate} imes ext{Fraction of Annual Period}
  • As in the example of the Stridewell Wholesale Shoe Company, calculations for interest owed on notes at maturity.

Noninterest-Bearing Notes

  • Although they are classified as noninterest-bearing, they have implied interest that is deducted at issuance, creating a discount on the note.

Long-Term Notes Receivable

  • Example of long-term notes receivable involving accounting for discounting and interest revenue recognition over time.

Receivables Management Ratios

  • Receivables Turnover Ratio: extNetSales/extAverageAccountsReceivable(net)ext{Net Sales} / ext{Average Accounts Receivable (net)}
  • Average Collection Period: 365extdays/extReceivablesTurnoverRatio365 ext{ days} / ext{Receivables Turnover Ratio}
  • Used to measure efficiency in receivables management.