?The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Chapter 7
Financial Assets
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
How Much Cash Should a Business
Have?
$
Every
business
needs
enough
cash to pay
its bills!
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
How Much Cash Should a Business
Have?
Cash
Short-term
Investments
Receivables
Financial
Assets
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
How Much Cash Should a Business
Have?
Accounts
receivable
Marketable
securities
(short-term
investments)
Cash (and cash
equivalents)
Collections
from
customers Cash
payments
揈
xcess?cash
is invested
temporarily.
Investments
are sold as
cash is
needed.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Valuation of Financial Assets
Ty pe of Fi na nc i a l A s s e t
B a s i s f or V a l ua t i on i n
t he B a l a nc e S he e t
C a s h ( a nd c a s h e qui v a l e nt s ) Fa c e a m oun t
S hor t - t e r m i nv e s t m e nt s
( m a r k e t a bl e s e c ur i t i e s )
C ur r e nt m a r k e t v a l ue
R e c e i v a bl e s N e t r e a l i z a bl e v a l ue
Estimated collectible amount
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Cash
Coins and
paper
money
Checks
Money orders
Travelers?checks
Bank credit
card sales
Cash is
defined as
any deposit
banks will
accept.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Combined
with cash on
balance sheet
Reporting Cash in the Balance
Sheet
Liquid short-
term
investments
Stable
market
values
Matures
within 90 days
of acquisition
Cash
Equivalents
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Not available
for paying
current
liabilities
Reporting Cash in the Balance
Sheet
Not a current
asset
Listed as an
investment
揜
estricted?Ca
sh
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Bank agrees in
advance to lend
money.
Reporting Cash in the Balance
Sheet
Liability is
incurred when use
line of credit.
Unused line of
credit is disclosed
in notes.
Lines of
Credit
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Statement of Cash Flows
Summarizes cash
transactions for an
accounting period.
Statement of Cash Flows
Includes cash and cash
equivalents.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
?Accurately account for cash.
?Prevent theft and fraud.
?Assure the availability of
adequate amounts of cash.
?Avoid unnecessarily large
amounts of idle cash.
Cash Management
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Using Excess Cash Balances
Efficiently
Cash available for
long-term investment
may be used to finance
growth and expansion
of the business,or to
repay debt.
Cash not needed for
business purposes
should be distributed
to the company’s
stockholders.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Internal Control Over Cash
? Segregate authorization,custody and recording of
cash,
? Prepare a cash budget.
? Prepare a control listing of cash receipts.
? Require daily deposits.
? Make all payments by check.
? Verify every expenditure before payment.
? Promptly reconcile bank statements.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Cash Over and Short
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
M a y 5 C a s h 10
C a s h O v e r a n d S h o rt 10
Cash Over and Short is debited for shortages
and credited for overages.
On May 5,XBAR,Inc.抯 cash drawer was
counted and found to be $10 over.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Bank Statements
Shows the beginning bank balance,
deposits made,checks paid,other
debits and credits in the month,and
the ending bank balance,
Bank
Statement
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositor抯 accounting
records.
Provides information for
reconciling journal entries.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
Bank Errors
= Adjusted Balance
Balance per Depositor
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
Book Errors
= Adjusted Balance
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
All
reconciling
items on the
book side
require an
adjusting
entry to the
cash account.
Balance per Depositor
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
Book Errors
= Adjusted Balance
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Example
Prepare a July 31 bank reconciliation
statement and the resulting journal entries
for the Simmons Company,The July 31
bank statement indicated a cash balance of
$9,610,while the cash ledger account on
that date shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next page.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
?Outstanding checks totaled $2,417.
?A $500 check mailed to the bank for deposit
had not reached the bank at the statement date.
?The bank returned a customer抯 NSF check for
$225 received as payment of an account
receivable.
?The bank statement showed $30 interest
earned on the bank balance for the month of
July.
?Check 781 for supplies cleared the bank for
$268 but was erroneously recorded in our
books as $240.
?A $486 deposit by Acme Company was
erroneously credited to our account by the
bank.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
ExampleB a l a nc e pe r ba nk s t a t e m e nt,J ul y 3 1 9,6 1 0$
A ddi t i ons,
D e pos i t i n t r a ns i t 500
D e duc t i ons,
B a nk e r r or 486$
O ut s t a ndi ng c he c k s 2,4 1 7 2,9 0 3
A dj us t e d c a s h ba l a nc e 7,2 0 7$
B a l a nc e pe r de pos i t or ' s r e c or ds,J ul y 3 1 7,4 3 0$
A ddi t i ons,
I nt e r e s t 30
D e duc t i ons,
R e c or di ng e r r or 28$
N S F c he c k 225 253
A dj us t e d c a s h ba l a nc e 7,2 0 7$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Example
B a l a nc e pe r ba nk s t a t e m e nt,J ul y 3 1 9,6 1 0$
A ddi t i ons,
D e pos i t i n t r a ns i t 500
D e duc t i ons,
B a nk e r r or 486$
O ut s t a ndi ng c he c k s 2,4 1 7 2,9 0 3
A dj us t e d c a s h ba l a nc e 7,2 0 7$
B a l a nc e pe r de pos i t or ' s r e c or ds,J ul y 3 1 7,4 3 0$
A ddi t i ons,
I nt e r e s t 30
D e duc t i ons,
R e c or di ng e r r or 28$
N S F c he c k 225 253
A dj us t e d c a s h ba l a nc e 7,2 0 7$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
J u l 31 C a s h 30
I n t e r e s t R e v e n u e 30
31 S u p p l i e s I n v e n t o r y 28
A c c o u n t s R e c e i v a b l e 225
C a s h 253
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Used for minor
expenditures.
Petty Cash Funds
Has one
custodian.
Replenished
periodically.
Petty Cash
Funds
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Short-Term Investments
Bond
Investments
Capital
Stock
Investments
Current Assets
Almost As
Liquid As
Cash
Readily
Marketable
Marketable
Securities
are,,,
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Mark-to-Market,A New Principle
of Asset Valuation
Short-term investments in marketable securities
appear on the balance sheet at their current market
value as of the balance sheet date.
C l a s s i f i c a t i o n M a n a g e m e n t ' s I n t e n t
T r e a t m e n t o f U n r e a l i z e d
H o l d i n g G a i n s a n d L o s s e s
A v a i l a b l e f o r
s a l e s e c u r i t i e s
H e l d f o r s h o r t - t e r m
r e s a l e ( o f t e n 6 t o 1 8
m o n t h s )
R e p o r t e d i n s t o c k h o l d e r s '
e q u i t y s e c t i o n o f t h e
b a l a n c e s h e e t
T r a d i n g
s e c u r i t i e s
H e l d f o r i m m e d i a t e
r e s a l e ( o f t e n w i t h i n
h o u r s o r d a y s )
R e p o r t e d i n " o t h e r " r e v e n u e
( e x p e n s e ) s e c t i o n o f t h e
i n c o m e s t a t e m e n t
H e l d t o m a t u r i t y
s e c u r i t i e s
D e b t s e c u r i t i e s
i n t e n d e d t o b e h e l d
u n t i l t h e y m a t u r e
R e p o r t e d i n s t o c k h o l d e r s '
e q u i t y s e c t i o n o f t h e
b a l a n c e s h e e t
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Let’s turn our
attention to accounts
receivable.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Uncollectible Accounts
If a company makes
credit sales to
customers,some
accounts inevitably will
turn out to be
uncollectible,PAST DUE
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
U n c o l l e c t i b l e A c c o u n t s E x p e n s e $$$$
A l l o w a n c e f o r D o u b t f u l A c c o u n t s $$$$
Reflecting Uncollectible Accounts
in the Financial Statements
At the end of each period,record
an estimate of the uncollectible
accounts.
Contra-asset accountSelling expense
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Allowance for Doubtful
Accounts
A c c oun t s r e c e i v a bl e
Le s s, A l l ow a nc e f or dou bt f ul a c c oun t s
N e t r e a l i z a bl e v a l ue of a c c oun t s r e c e i v a bl e
The net realizable value is the amount of
accounts receivable that the business
expects to collect.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
When an account is determined to be
uncollectible,it no longer qualifies as an asset
and should be written off.
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
A l l o w a n c e f o r D o u b t f u l A c c o u n t s $$$$
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r) $$$$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
Assume that on January 5,K-Max
determined that Jason Clark would not
pay the $500 he owes.
K-Max would make the following entry,G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
J a n, 5 A l l o w a n c e f o r D o u b t f u l A c c o u n t s 500
A c c o u n t s R e c e i v a b l e ( J, C l a rk ) 500
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
Assume that before this entry,the
Accounts Receivable balance was
$10,000 and the Allowance for Doubtful
Accounts balance was $2,500.
Let抯 see what effect the write-off had on
these accounts.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
B e fo r e
W r i te -O ff
A fte r
W r i te -O ff
A c c o u n ts r e c e i v a b l e 1 0,0 0 0$ 9,5 0 0$
L e s s, A l l o w, fo r d o u b tfu l a c c ts, 2,5 0 0 2,0 0 0
N e t r e a l i z a b l e v a l u e 7,5 0 0$ 7,5 0 0$
Notice that the $500 write-off did not change the net
realizable value nor did it affect any income
statement accounts.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Recovery of an Account Receivable
Previously Written Off
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r ) $$$$
A l l o w a n c e f o r D o u b t f u l A c c o u n t s $$$$
C a s h $$$$
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r ) $$$$
Subsequent collections require that the original write-off
entry be reversed before the cash collection is recorded.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Monthly Estimates of Credit Losses
At the end of each
month,management
should estimate the
probable amount of
uncollectible accounts
and adjust the
Allowance for
Doubtful Accounts to
this new estimate.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
At December 31,2001,MusicLand抯 accounting
records indicate the following:
Accounts Receivable = $50,000
Allowance for Doubtful Accounts = $200 (credit)
Past experience suggests that 5% of receivables
are uncollectible,
What is MusicLand抯 Uncollectible Accounts
Expense for 2001?
Monthly Estimates of Credit Losses
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 U n c o l l e c t i b l e A c c o u n t s E x p e n s e 2,3 0 0
A l l o w a n c e f o r D o u b t f u l A c c o u n t s 2,3 0 0
5 0,0 0 0$
5, 0 0 %
= 2,5 0 0$
Desired balance in Allowance
for Doubtful Accounts.
200
2,3 0 0
2,5 0 0
A l l ow a nc e f or
D oub t f ul A c c oun t s
Monthly Estimates of Credit Losses
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Let’s look at
another way
to estimate
the
uncollectible
accounts!
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Estimating Credit Losses?The
balance Sheet?Approach
?Year-end Accounts Receivable is
broken down into age
classifications.
?Each age grouping has a
different likelihood of being
uncollectible.
?Compute a separate allowance
for each age grouping.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Estimating Credit Losses?The
balance Sheet?Approach
At December 31,2001,the receivables for
EastCo,Inc,were categorized as follows:
E a s t C o,I nc,
S c he dul e of A c c ount s R e c e i v a bl e by A ge
D e c e m be r 3 1,2 0 0 1
D a y s P a s t D ue
A c c ount s
R e c e i v a bl e
B a l a nc e
E s t i m a t e d
B a d D e bt s
P e r c e nt
E s t i m a t e d
U nc ol l e c t i bl e
A m ount
C u r r e n t 4 5,0 0 0$
1 - 3 0 1 5,0 0 0
3 1 - 6 0 5,0 0 0
O v e r 6 0 2,0 0 0
6 7,0 0 0$
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
E a s t C o,I nc,
S c he dul e of A c c ount s R e c e i v a bl e by A ge
D e c e m be r 3 1,2 0 0 1
D a y s P a s t D ue
A c c ount s
R e c e i v a bl e
B a l a nc e
E s t i m a t e d
B a d D e bt s
P e r c e nt
E s t i m a t e d
U nc ol l e c t i bl e
A m ount
C u r r e n t 4 5,0 0 0$ 1%
1 - 3 0 1 5,0 0 0 3%
3 1 - 6 0 5,0 0 0 5%
O v e r 6 0 2,0 0 0 10%
6 7,0 0 0$
Estimating Credit Losses?The
balance Sheet?Approach
At December 31,2001,the receivables for
EastCo,Inc,were categorized as follows:
??
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
E a s t C o,I nc,
S c he dul e of A c c ount s R e c e i v a bl e by A ge
D e c e m be r 3 1,2 0 0 1
D a y s P a s t D ue
A c c ount s
R e c e i v a bl e
B a l a nc e
E s t i m a t e d
B a d D e bt s
P e r c e nt
E s t i m a t e d
U nc ol l e c t i bl e
A m ount
C u r r e n t 4 5,0 0 0$ 1% 450$
1 - 3 0 1 5,0 0 0 3% 450
3 1 - 6 0 5,0 0 0 5% 250
O v e r 6 0 2,0 0 0 10% 200
6 7,0 0 0$ 1,3 5 0$
Estimating Credit Losses?The
balance Sheet?Approach
At December 31,2001,the receivables for
EastCo,Inc,were categorized as follows:
???
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 U n c o l l e c t i b l e A c c o u n t s E x p e n s e 850
A l l o w a n c e f o r D o u b t f u l A c c o u n t s 850
EastCo抯 unadjusted balance
in the allowance account is
$500.
Per the previous computation,
the desired balance is $1,350.
500
850
1,3 5 0
A l l ow a nc e f or
D oub t f ul A c c oun t s
Estimating Credit Losses?The
balance Sheet?Approach
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Guess What!
There is
another
alternative to
estimate the
uncollectible
accounts!
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses
Uncollectible
accounts?percentage is based
on actual uncollectible accounts
from prior years?credit sales.
Focus is on determining the amount to
record on the income statement as
Uncollectible Accounts Expense,
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses
N e t C r e d i t S a l e s
? % E s t i m a t e d U n c o l l e c t i b l e
A m o u n t o f J o u r n a l E n t r y
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses
In 2001,EastCo had credit sales of $60,000.
Historically,1% of EastCo抯 accounts have
been uncollectible.
For 2001,the estimate of uncollectible
accounts expense is $600,
($60,000?.01 = $600)
Now,prepare the adjusting entry for
December 31,2001.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 U n c o l l e c t i b l e A c c o u n t s E x p e n s e 600
A l l o w a n c e f o r D o u b t f u l A c c o u n t s 600
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Uncollectible Accounts
Summary
% of Receivables
Emphasis on
Realizable Value
Accts,
Rec,All,for Doubtful
Accts.
Aging of
Receivables
Emphasis on
Realizable Value
Accts,
Rec,All,for Doubtful
Accts.
Balance Sheet
Focus
Balance Sheet
Focus
% of Sales
Emphasis on
Matching
Sales Uncoll,
Accts,
Exp.
Income
Statement
Focus
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Direct Write-Off Method
This method makes no attempt to
match revenue with the expense of
uncollectible accounts.
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
J u n e 15 U n c o l l e c t i b l e A c c o u n t s E x p e n s e $$$$
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r) $$$$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Income Tax Regulations and
Financial Reporting
Direct write-off method
required to calculate
taxable income.
Taxable Income
Financial
Statement Income
Allowance methods
better match expenses
with revenues.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Internal Controls for Receivable
Separate the following duties:
?Maintenance of the accounts receivable
subsidiary ledger.
?Custody of cash receipts.
?Authorization of accounts receivable
write-offs.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Management of Accounts
Receivable
Credit Terms
Minimize
Accounts
Receivable
Extending credit encourages
customers to buy from us,,,
.,, but it ties up resources
in accounts receivable,
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Ways to Minimize Amounts in
Accounts Receivable
Selling
Accounts
Receivable
Credit
Card
Sales
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Evaluating the Quality of Accounts
Receivable
Accounts Receivable Turnover Rate
This ratio provides useful information for
evaluating how efficient management
has been in granting credit to produce
revenue.
Net Sales
Average Accounts Receivable
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Evaluating the Quality of Accounts
Receivable
Avg,Number of Days to Collect A/R
This ratio helps judge the liquidity of a
company’s accounts receivable.
Days in Year
Accounts Receivable Turnover Ratio
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
End of Chapter 7
Chapter 7
Financial Assets
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
How Much Cash Should a Business
Have?
$
Every
business
needs
enough
cash to pay
its bills!
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
How Much Cash Should a Business
Have?
Cash
Short-term
Investments
Receivables
Financial
Assets
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
How Much Cash Should a Business
Have?
Accounts
receivable
Marketable
securities
(short-term
investments)
Cash (and cash
equivalents)
Collections
from
customers Cash
payments
揈
xcess?cash
is invested
temporarily.
Investments
are sold as
cash is
needed.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Valuation of Financial Assets
Ty pe of Fi na nc i a l A s s e t
B a s i s f or V a l ua t i on i n
t he B a l a nc e S he e t
C a s h ( a nd c a s h e qui v a l e nt s ) Fa c e a m oun t
S hor t - t e r m i nv e s t m e nt s
( m a r k e t a bl e s e c ur i t i e s )
C ur r e nt m a r k e t v a l ue
R e c e i v a bl e s N e t r e a l i z a bl e v a l ue
Estimated collectible amount
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Cash
Coins and
paper
money
Checks
Money orders
Travelers?checks
Bank credit
card sales
Cash is
defined as
any deposit
banks will
accept.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Combined
with cash on
balance sheet
Reporting Cash in the Balance
Sheet
Liquid short-
term
investments
Stable
market
values
Matures
within 90 days
of acquisition
Cash
Equivalents
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Not available
for paying
current
liabilities
Reporting Cash in the Balance
Sheet
Not a current
asset
Listed as an
investment
揜
estricted?Ca
sh
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Bank agrees in
advance to lend
money.
Reporting Cash in the Balance
Sheet
Liability is
incurred when use
line of credit.
Unused line of
credit is disclosed
in notes.
Lines of
Credit
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Statement of Cash Flows
Summarizes cash
transactions for an
accounting period.
Statement of Cash Flows
Includes cash and cash
equivalents.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
?Accurately account for cash.
?Prevent theft and fraud.
?Assure the availability of
adequate amounts of cash.
?Avoid unnecessarily large
amounts of idle cash.
Cash Management
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Using Excess Cash Balances
Efficiently
Cash available for
long-term investment
may be used to finance
growth and expansion
of the business,or to
repay debt.
Cash not needed for
business purposes
should be distributed
to the company’s
stockholders.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Internal Control Over Cash
? Segregate authorization,custody and recording of
cash,
? Prepare a cash budget.
? Prepare a control listing of cash receipts.
? Require daily deposits.
? Make all payments by check.
? Verify every expenditure before payment.
? Promptly reconcile bank statements.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Cash Over and Short
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
M a y 5 C a s h 10
C a s h O v e r a n d S h o rt 10
Cash Over and Short is debited for shortages
and credited for overages.
On May 5,XBAR,Inc.抯 cash drawer was
counted and found to be $10 over.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Bank Statements
Shows the beginning bank balance,
deposits made,checks paid,other
debits and credits in the month,and
the ending bank balance,
Bank
Statement
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositor抯 accounting
records.
Provides information for
reconciling journal entries.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
Bank Errors
= Adjusted Balance
Balance per Depositor
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
Book Errors
= Adjusted Balance
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
All
reconciling
items on the
book side
require an
adjusting
entry to the
cash account.
Balance per Depositor
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
Book Errors
= Adjusted Balance
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Example
Prepare a July 31 bank reconciliation
statement and the resulting journal entries
for the Simmons Company,The July 31
bank statement indicated a cash balance of
$9,610,while the cash ledger account on
that date shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next page.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
?Outstanding checks totaled $2,417.
?A $500 check mailed to the bank for deposit
had not reached the bank at the statement date.
?The bank returned a customer抯 NSF check for
$225 received as payment of an account
receivable.
?The bank statement showed $30 interest
earned on the bank balance for the month of
July.
?Check 781 for supplies cleared the bank for
$268 but was erroneously recorded in our
books as $240.
?A $486 deposit by Acme Company was
erroneously credited to our account by the
bank.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
ExampleB a l a nc e pe r ba nk s t a t e m e nt,J ul y 3 1 9,6 1 0$
A ddi t i ons,
D e pos i t i n t r a ns i t 500
D e duc t i ons,
B a nk e r r or 486$
O ut s t a ndi ng c he c k s 2,4 1 7 2,9 0 3
A dj us t e d c a s h ba l a nc e 7,2 0 7$
B a l a nc e pe r de pos i t or ' s r e c or ds,J ul y 3 1 7,4 3 0$
A ddi t i ons,
I nt e r e s t 30
D e duc t i ons,
R e c or di ng e r r or 28$
N S F c he c k 225 253
A dj us t e d c a s h ba l a nc e 7,2 0 7$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Example
B a l a nc e pe r ba nk s t a t e m e nt,J ul y 3 1 9,6 1 0$
A ddi t i ons,
D e pos i t i n t r a ns i t 500
D e duc t i ons,
B a nk e r r or 486$
O ut s t a ndi ng c he c k s 2,4 1 7 2,9 0 3
A dj us t e d c a s h ba l a nc e 7,2 0 7$
B a l a nc e pe r de pos i t or ' s r e c or ds,J ul y 3 1 7,4 3 0$
A ddi t i ons,
I nt e r e s t 30
D e duc t i ons,
R e c or di ng e r r or 28$
N S F c he c k 225 253
A dj us t e d c a s h ba l a nc e 7,2 0 7$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Reconciling the Bank Statement
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
J u l 31 C a s h 30
I n t e r e s t R e v e n u e 30
31 S u p p l i e s I n v e n t o r y 28
A c c o u n t s R e c e i v a b l e 225
C a s h 253
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Used for minor
expenditures.
Petty Cash Funds
Has one
custodian.
Replenished
periodically.
Petty Cash
Funds
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Short-Term Investments
Bond
Investments
Capital
Stock
Investments
Current Assets
Almost As
Liquid As
Cash
Readily
Marketable
Marketable
Securities
are,,,
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Mark-to-Market,A New Principle
of Asset Valuation
Short-term investments in marketable securities
appear on the balance sheet at their current market
value as of the balance sheet date.
C l a s s i f i c a t i o n M a n a g e m e n t ' s I n t e n t
T r e a t m e n t o f U n r e a l i z e d
H o l d i n g G a i n s a n d L o s s e s
A v a i l a b l e f o r
s a l e s e c u r i t i e s
H e l d f o r s h o r t - t e r m
r e s a l e ( o f t e n 6 t o 1 8
m o n t h s )
R e p o r t e d i n s t o c k h o l d e r s '
e q u i t y s e c t i o n o f t h e
b a l a n c e s h e e t
T r a d i n g
s e c u r i t i e s
H e l d f o r i m m e d i a t e
r e s a l e ( o f t e n w i t h i n
h o u r s o r d a y s )
R e p o r t e d i n " o t h e r " r e v e n u e
( e x p e n s e ) s e c t i o n o f t h e
i n c o m e s t a t e m e n t
H e l d t o m a t u r i t y
s e c u r i t i e s
D e b t s e c u r i t i e s
i n t e n d e d t o b e h e l d
u n t i l t h e y m a t u r e
R e p o r t e d i n s t o c k h o l d e r s '
e q u i t y s e c t i o n o f t h e
b a l a n c e s h e e t
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Let’s turn our
attention to accounts
receivable.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Uncollectible Accounts
If a company makes
credit sales to
customers,some
accounts inevitably will
turn out to be
uncollectible,PAST DUE
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
U n c o l l e c t i b l e A c c o u n t s E x p e n s e $$$$
A l l o w a n c e f o r D o u b t f u l A c c o u n t s $$$$
Reflecting Uncollectible Accounts
in the Financial Statements
At the end of each period,record
an estimate of the uncollectible
accounts.
Contra-asset accountSelling expense
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Allowance for Doubtful
Accounts
A c c oun t s r e c e i v a bl e
Le s s, A l l ow a nc e f or dou bt f ul a c c oun t s
N e t r e a l i z a bl e v a l ue of a c c oun t s r e c e i v a bl e
The net realizable value is the amount of
accounts receivable that the business
expects to collect.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
When an account is determined to be
uncollectible,it no longer qualifies as an asset
and should be written off.
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
A l l o w a n c e f o r D o u b t f u l A c c o u n t s $$$$
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r) $$$$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
Assume that on January 5,K-Max
determined that Jason Clark would not
pay the $500 he owes.
K-Max would make the following entry,G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
J a n, 5 A l l o w a n c e f o r D o u b t f u l A c c o u n t s 500
A c c o u n t s R e c e i v a b l e ( J, C l a rk ) 500
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
Assume that before this entry,the
Accounts Receivable balance was
$10,000 and the Allowance for Doubtful
Accounts balance was $2,500.
Let抯 see what effect the write-off had on
these accounts.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Writing Off an Uncollectible
Account Receivable
B e fo r e
W r i te -O ff
A fte r
W r i te -O ff
A c c o u n ts r e c e i v a b l e 1 0,0 0 0$ 9,5 0 0$
L e s s, A l l o w, fo r d o u b tfu l a c c ts, 2,5 0 0 2,0 0 0
N e t r e a l i z a b l e v a l u e 7,5 0 0$ 7,5 0 0$
Notice that the $500 write-off did not change the net
realizable value nor did it affect any income
statement accounts.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Recovery of an Account Receivable
Previously Written Off
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r ) $$$$
A l l o w a n c e f o r D o u b t f u l A c c o u n t s $$$$
C a s h $$$$
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r ) $$$$
Subsequent collections require that the original write-off
entry be reversed before the cash collection is recorded.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Monthly Estimates of Credit Losses
At the end of each
month,management
should estimate the
probable amount of
uncollectible accounts
and adjust the
Allowance for
Doubtful Accounts to
this new estimate.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
At December 31,2001,MusicLand抯 accounting
records indicate the following:
Accounts Receivable = $50,000
Allowance for Doubtful Accounts = $200 (credit)
Past experience suggests that 5% of receivables
are uncollectible,
What is MusicLand抯 Uncollectible Accounts
Expense for 2001?
Monthly Estimates of Credit Losses
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 U n c o l l e c t i b l e A c c o u n t s E x p e n s e 2,3 0 0
A l l o w a n c e f o r D o u b t f u l A c c o u n t s 2,3 0 0
5 0,0 0 0$
5, 0 0 %
= 2,5 0 0$
Desired balance in Allowance
for Doubtful Accounts.
200
2,3 0 0
2,5 0 0
A l l ow a nc e f or
D oub t f ul A c c oun t s
Monthly Estimates of Credit Losses
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Let’s look at
another way
to estimate
the
uncollectible
accounts!
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Estimating Credit Losses?The
balance Sheet?Approach
?Year-end Accounts Receivable is
broken down into age
classifications.
?Each age grouping has a
different likelihood of being
uncollectible.
?Compute a separate allowance
for each age grouping.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Estimating Credit Losses?The
balance Sheet?Approach
At December 31,2001,the receivables for
EastCo,Inc,were categorized as follows:
E a s t C o,I nc,
S c he dul e of A c c ount s R e c e i v a bl e by A ge
D e c e m be r 3 1,2 0 0 1
D a y s P a s t D ue
A c c ount s
R e c e i v a bl e
B a l a nc e
E s t i m a t e d
B a d D e bt s
P e r c e nt
E s t i m a t e d
U nc ol l e c t i bl e
A m ount
C u r r e n t 4 5,0 0 0$
1 - 3 0 1 5,0 0 0
3 1 - 6 0 5,0 0 0
O v e r 6 0 2,0 0 0
6 7,0 0 0$
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
E a s t C o,I nc,
S c he dul e of A c c ount s R e c e i v a bl e by A ge
D e c e m be r 3 1,2 0 0 1
D a y s P a s t D ue
A c c ount s
R e c e i v a bl e
B a l a nc e
E s t i m a t e d
B a d D e bt s
P e r c e nt
E s t i m a t e d
U nc ol l e c t i bl e
A m ount
C u r r e n t 4 5,0 0 0$ 1%
1 - 3 0 1 5,0 0 0 3%
3 1 - 6 0 5,0 0 0 5%
O v e r 6 0 2,0 0 0 10%
6 7,0 0 0$
Estimating Credit Losses?The
balance Sheet?Approach
At December 31,2001,the receivables for
EastCo,Inc,were categorized as follows:
??
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
E a s t C o,I nc,
S c he dul e of A c c ount s R e c e i v a bl e by A ge
D e c e m be r 3 1,2 0 0 1
D a y s P a s t D ue
A c c ount s
R e c e i v a bl e
B a l a nc e
E s t i m a t e d
B a d D e bt s
P e r c e nt
E s t i m a t e d
U nc ol l e c t i bl e
A m ount
C u r r e n t 4 5,0 0 0$ 1% 450$
1 - 3 0 1 5,0 0 0 3% 450
3 1 - 6 0 5,0 0 0 5% 250
O v e r 6 0 2,0 0 0 10% 200
6 7,0 0 0$ 1,3 5 0$
Estimating Credit Losses?The
balance Sheet?Approach
At December 31,2001,the receivables for
EastCo,Inc,were categorized as follows:
???
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 U n c o l l e c t i b l e A c c o u n t s E x p e n s e 850
A l l o w a n c e f o r D o u b t f u l A c c o u n t s 850
EastCo抯 unadjusted balance
in the allowance account is
$500.
Per the previous computation,
the desired balance is $1,350.
500
850
1,3 5 0
A l l ow a nc e f or
D oub t f ul A c c oun t s
Estimating Credit Losses?The
balance Sheet?Approach
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Guess What!
There is
another
alternative to
estimate the
uncollectible
accounts!
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses
Uncollectible
accounts?percentage is based
on actual uncollectible accounts
from prior years?credit sales.
Focus is on determining the amount to
record on the income statement as
Uncollectible Accounts Expense,
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses
N e t C r e d i t S a l e s
? % E s t i m a t e d U n c o l l e c t i b l e
A m o u n t o f J o u r n a l E n t r y
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses
In 2001,EastCo had credit sales of $60,000.
Historically,1% of EastCo抯 accounts have
been uncollectible.
For 2001,the estimate of uncollectible
accounts expense is $600,
($60,000?.01 = $600)
Now,prepare the adjusting entry for
December 31,2001.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
An Alternative Approach to
Estimating Credit Losses G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 U n c o l l e c t i b l e A c c o u n t s E x p e n s e 600
A l l o w a n c e f o r D o u b t f u l A c c o u n t s 600
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Uncollectible Accounts
Summary
% of Receivables
Emphasis on
Realizable Value
Accts,
Rec,All,for Doubtful
Accts.
Aging of
Receivables
Emphasis on
Realizable Value
Accts,
Rec,All,for Doubtful
Accts.
Balance Sheet
Focus
Balance Sheet
Focus
% of Sales
Emphasis on
Matching
Sales Uncoll,
Accts,
Exp.
Income
Statement
Focus
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Direct Write-Off Method
This method makes no attempt to
match revenue with the expense of
uncollectible accounts.
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
J u n e 15 U n c o l l e c t i b l e A c c o u n t s E x p e n s e $$$$
A c c o u n t s R e c e i v a b l e ( X C u s t o m e r) $$$$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Income Tax Regulations and
Financial Reporting
Direct write-off method
required to calculate
taxable income.
Taxable Income
Financial
Statement Income
Allowance methods
better match expenses
with revenues.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Internal Controls for Receivable
Separate the following duties:
?Maintenance of the accounts receivable
subsidiary ledger.
?Custody of cash receipts.
?Authorization of accounts receivable
write-offs.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Management of Accounts
Receivable
Credit Terms
Minimize
Accounts
Receivable
Extending credit encourages
customers to buy from us,,,
.,, but it ties up resources
in accounts receivable,
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Ways to Minimize Amounts in
Accounts Receivable
Selling
Accounts
Receivable
Credit
Card
Sales
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Evaluating the Quality of Accounts
Receivable
Accounts Receivable Turnover Rate
This ratio provides useful information for
evaluating how efficient management
has been in granting credit to produce
revenue.
Net Sales
Average Accounts Receivable
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Evaluating the Quality of Accounts
Receivable
Avg,Number of Days to Collect A/R
This ratio helps judge the liquidity of a
company’s accounts receivable.
Days in Year
Accounts Receivable Turnover Ratio
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
End of Chapter 7
