Learning Objectives

No substantial departures from the text, Chapter 7. and Receivables

Chapter 7

Slide Slide 7-1 UCSB, Anderson 7-2 UCSB, Anderson

Nature and Composition of Cash Additional Cash Issues

Cash is classified as a ...... Current  Bank Overdrafts (means negative cash) – Happens when outstanding checks exceeds cash at bank plus To be reported as CASH: deposits in transit (or when the Company has overdraft protection)  Must be readily available for the payment of – Is this an asset? current obligations, and ....… NO!!- current liability called “bank  it must be free from any contractual restriction overdraft” that limits its use in satisfying .  Restricted Cash- such as cash held as collateral for bank. – Requires disclosure  Cash Equivalents • Some companies include investments which are readily converted to cash within 90 days as a “cash equivalent”- requires disclosure. Hence their presentation for the cash line reads: “cash and cash equivalents”.

Slide Slide 7-3 UCSB, Anderson 7-4 UCSB, Anderson Classification Account Classification

Items Account Items Account

a. Coins and currency Cash i. Savings account Cash b. U.S. Treasury bonds Temporary investments j. Petty cash Cash c. Certificate of deposit Temporary investments k. Stamps Postage d. NSF check (customer) Accounts receivable l. Travel advances Prepaid e. Postdated checksNOTE: Treasury Receivablebills are 1 year f. Cash to be usedOr less, for but treasuryLong-term bonds always investments bond retirement 1 year or more(bond sinking fund) g. Deposits in transit Cash h. Shares of AOL stock Investments (ST or LT?)

Slide Slide 7-5 UCSB, Anderson 7-6 UCSB, Anderson

Cash Controls

Why are cash controls important? Reconciling Items:  Cash is most susceptible asset to theft.  unrecorded by bank, but recorded by entity  Because ultimately everything culminates in cash,  recorded by bank, but not by entity consequently other problems frequently manifest  errors by the bank or the entity themselves as unknown “reconciling items” when the bank reconciliation is performed. CRUTCH TOOL What do you think are the two most important cash Reconciling From A to B (A at top of reconciliation): controls to have?   Segregation of duties (forces collusion) Recorded by A but NOT B: Opposite direction in reconciliation  Check signing authority (have to get the cash out of the bank in order to steal it!  Recorded by B but NOT A: Same direction in reconciliation.

Slide Slide 7-7 UCSB, Anderson 7-8 UCSB, Anderson BANK RECONCILIATION CRUTCH Bank Reconciliation Example

For example: XYZ Company. The following relevant information RECONCILING RECORDED BY exists: FROM BOTH X & Y X BUT NOT Y Y BUT NOT X  The bank balance is $250,000 as of December 31, 200X while X No opposite direction same direction your general shows cash at $200,000. Careful adjustment Increase= negative Increase= positive examination of activity reveals the following: Decrease=positive Decrease= negative – There are $20 in bank fees which were not recorded in the ; Y – XYZ received checks and posted the entry for $95,000 during the last week of December which did not get deposited to the bank. – XYZ wrote checks during the last week of December totaling $175,000 which have not yet cleared the bank. –There was a $29,980 un-located reconciling item (general ledger exceeding bank) on every bank statement sense the beginning of the year.

Slide Slide 7-9 UCSB, Anderson 7-10 UCSB, Anderson

Bank reconciliation to example on previous slide: Claims held against customers and others for money, goods, or services. Receivables Balance per bank 250,000 Bank charges not recorded 20 entry required to Gl Deposit in transit 95,000 Oral promises of the Written promises to pay Outstanding checks (175,000) purchaser to pay for a certain sum of Other misc. 29,980 Possible error! goods and services money on a specified sold. future date. 200,000 Accounts Notes Receivable Receivable “Trade receivables” if from their primary activities.

Slide Slide 7-11 UCSB, Anderson 7-12 UCSB, Anderson A/R Measurement A/R Measurement

Cash Discounts Trade Discounts  Inducements for prompt payment  Reductions from the list – 2/10, n/30 means: 2% discount if paid within 10 price days, all of it if you don’t! 10 %  Not recognized in the  Can account for it using the Discount Gross Method or Net Method records (Illustration 7-4 pg. 321) Payment for new  Customers are billed net  Gross Method is more practical terms are Retail and common. of discounts 2/10, n/30 Store Customers

Slide Slide 7-13 UCSB, Anderson 7-14 UCSB, Anderson

Sales Discounts: Gross VS Net Accounts Receivable Valuation

Gross Method- MOST COMMON Net Method Valued at Net Realizable Value of $10,000, terms 2/10, n/30 Accounts Receivable 10,000 Accounts Receivable 9,800 Sales 10,000 Sales 9,800 Methods of Accounting for Uncollectible Accounts

Payment of $3,920 received WITHIN discount period (10 days) Cash 3,920 Cash 3,920 Accounts receivable 4,000 Accounts receivable 3,920 Allowance Method Sales discounts 80 Direct Write-Off Losses are Estimated: Theoretically undesirable: Payment of $6,000 received AFTER discount period (10 days)  Percentage-of-sales Cash 6,000 A/R 120  no matching  Accounts receivable 6,000 Sales discounts forfeited 120 Percentage-of-receivables Cash 6,000  receivable not stated at  Other means Accounts receivable 6,000 net realizable value  ALWAYS have to assess whether the methodology  Allowable if immaterial utilized is reasonable (judment comes into play again!)

Slide Slide 7-15 UCSB, Anderson 7-16 UCSB, Anderson Accounting for A/R and Bad Debts Current Assets: How are these accounts presented on the Balance Cash $ 346 Sheet? Accounts receivable 500 Less allowance for doubtful accounts 25 475 Inventory 812 Prepaids _ 40 Allowance for Total current assets 1,673 Accounts Receivable Doubtful Accounts Fixed Assets: Beg. 500 25 Beg. Office equipment 5,679 Furniture & fixtures 6,600 Less: Accumulated (3,735) Total fixed assets 8,544 Total Assets $10,217 End. 500 25 End.

Slide Slide 7-17 UCSB, Anderson 7-18 UCSB, Anderson

Assets Accounting for A/R and Bad Debts Current Assets: Cash $ 346 Journal entry for credit sale of $100? Accounts receivable, net of $25 allowance Accounts receivable 100 for doubtful accounts 475 Sales 100 Inventory 812 Prepaids _ 40 Allowance for Total current assets 1,673 Accounts Receivable Doubtful Accounts Fixed Assets: Office equipment 5,679 Beg. 500 25 Beg. Furniture & fixtures 6,600 Less: Accumulated depreciation (3,735) Total fixed assets 8,544 Total Assets $10,217 End. 500 25 End.

Slide Slide 7-19 UCSB, Anderson 7-20 UCSB, Anderson Accounting for A/R and Bad Debts Accounting for A/R and Bad Debts

Journal entry for credit sale of $100 ? Collected of $333 on account ? Accounts receivable 100 Cash 333 Sales 100 Accounts receivable 333

Allowance for Allowance for Accounts Receivable Doubtful Accounts Accounts Receivable Doubtful Accounts Beg. 500 25 Beg. Beg. 500 25 Beg. Sale 100 Sale 100

End. 600 25 End. End. 600 25 End.

Slide Slide 7-21 UCSB, Anderson 7-22 UCSB, Anderson

Accounting for A/R and Bad Debts Accounting for A/R and Bad Debts

Collected of $333 on account ? Adjustment of $15 for estimated Bad-Debts ? Cash 333 Bad expense 15 Accounts receivable 333 Allowance for Doubtful Accounts 15

Allowance for Allowance for Accounts Receivable Doubtful Accounts Accounts Receivable Doubtful Accounts Beg. 500 25 Beg. Beg. 500 25 Beg. Sale 100 333 Coll. Sale 100 333 Coll.

End. 267 25 End. End. 267 25 End.

Slide Slide 7-23 UCSB, Anderson 7-24 UCSB, Anderson Accounting for A/R and Bad Debts Accounting for A/R and Bad Debts

Adjustment of $15 for estimated Bad-Debts ? Write-off of uncollectible accounts for $10 ? expense 15 Allowance for Doubtful accounts 10 Allowance for Doubtful Accounts 15 Accounts receivable 10

Allowance for Allowance for Accounts Receivable Doubtful Accounts Accounts Receivable Doubtful Accounts Beg. 500 25 Beg. Beg. 500 25 Beg. Sale 100 333 Coll. 15 Est. Sale 100 333 Coll. 15 Est.

End. 267 40 End. End. 267 40 End.

Slide Slide 7-25 UCSB, Anderson 7-26 UCSB, Anderson

Accounting for A/R and Bad Debts Assets Current Assets: Write-off of uncollectible accounts for $10 ? Cash $ 346 Allowance for Doubtful accounts 10 Accounts receivable, net of $30 allowance for doubtful accounts 227 Accounts receivable 10 Inventory 812 Prepaids _ 40 Allowance for Total current assets 1,673 Accounts Receivable Doubtful Accounts Fixed Assets: Beg. 500 25 Beg. Office equipment 5,679 Sale 100 333 Coll. 15 Est. Furniture & fixtures 6,600 Less: Accumulated depreciation (3,735) 10 W/O W/O 10 Total fixed assets 8,544 Total Assets $10,217 End. 257 30 End.

Slide Slide 7-27 UCSB, Anderson 7-28 UCSB, Anderson Estimating Uncollectible Accounts: Comparison of Methods The Allowance Methods Percentage of Sales Percentage-of-sales method Income Percentage-of-receivable method: Matching Statement Approach  Ending Accounts Receivable Sales --- Bad Debt Expense  Aging of Accounts Receivable

Percentage of Receivables Balance Net Realizable Value Sheet Approach Receivables - Allowance for Bad Debt

Slide Slide 7-29 UCSB, Anderson 7-30 UCSB, Anderson

Estimating Bad Debt Expense Percentage-of-Sales Approach

Data Charge sales $500,000 Charge sales $500,000 Estimated percentage x 1.25% Estimated % of charge sales not collected 1.25% ------Accounts receivable balance $72,500 Estimated expense $ 6,250 Estimated % of A/R not collected 8% ======Allowance for Doubtful Accounts: $150 (credit What should the ending balance be for the balance) allowance account?

Slide Slide 7-31 UCSB, Anderson 7-32 UCSB, Anderson Percentage-of-Sales Approach Percentage-of-Receivables Approach

Accounts receivable $72,500 Actual balance (150) Estimated percentage x 8% Adjustment (6,250) ------Ending balance (6,400) Desired balance $ 5,800 Journal entry: Bad debt expense 6,250 Allowance for D.A. 6,250

Slide Slide 7-33 UCSB, Anderson 7-34 UCSB, Anderson

Percentage-of-Receivables Approach Notes Receivable

Actual balance 150 Cr.  Represent claims from borrowers evidenced by a Desired balance 5,800 Cr. document referred to as the “note” or “note agreement”; Amount of expense 5,650  Journal entry: Can be secured or unsecured; Bad debt expense 5,650  Must be properly valued- meaning that Allowance for D.A. 5,650 impairments to their value must be reflected;  All notes should be recorded using a reasonable market rate: – There is NO such thing as a zero percent note (except for from your parents, and actually they expect you to care for them when they are old and feeble) – This results in note premiums and discounts.

Slide Slide 7-35 UCSB, Anderson 7-36 UCSB, Anderson Interest-Bearing Note Interest-Bearing Note

Date: January 1, 2001 Present Value at 12% Market Rate: Marie Co. made a to Don. Co. and received in $5,000 x 0.71178 = $3,558.90 exchange a 3-year, $5,000 note bearing $600 x 2.40183 = 1,441.10 interest at 12%. $5,000.00 Journal Entry at Issuance: Notes receivable 5,000.00 NOTE: Unless stated otherwise in the slides or in the text, the assumption is that any premium or discount on a note is granted as Cash 5,000.00 an addition/ deduction from the cash given on the note.

Slide Slide 7-37 UCSB, Anderson 7-38 UCSB, Anderson

Interest-Bearing Note Interest-Bearing Note

Present Value at 10% Market Rate: Present Value at 15% Market Rate: $5,000 x 0.75132 = $3,756.60 $5,000 x 0.65752 = $3,287.60 $600 x 2.48685 = 1,492.11 $600 x 2.28323 = 1,369.94 $5,248.71 $4,657.54

Journal Entry at Issuance: Journal Entry at Issuance: Notes receivable 5,000.00 Notes receivable 5,000.00 Premium on N/R 248.71 Discount on N/R 342.46 Cash 5,248.71 Cash 4,657.54

Slide Slide 7-39 UCSB, Anderson 7-40 UCSB, Anderson 12% Note Discounted at 15% JOURNAL ENTRY ACTIVITY OF 15% NOTE

Note rec. Discount Interest Cash Effective Un- OPENING ENTRY Balance Balance Income Cash Notes receivable 5,000 5,000 Interest Interest Discount Amort. PV of Note discount 342 (342) Date 12% 15% Amort. Balance Note Cash 4,658 (4,658) 5,000 (342) - (4,658) 1/1/2001 342 4,658

12/31/2001 600 699 99 243 4,757 END OF YEAR ONE PAYMENT ENTRY 12/31/2002 600 714 114 129 4,871 Cash 600 600 Interest income 699 (699) 12/31/2003 600 729 129 0 5,000 Note discount 99 99 5,000 (243) (699) (4,058) END OF YEAR TWO PAYMENT ENTRY Cash 600 600 Interest income 714 (714) Note discount 114 114 5,000 (130) (1,412) (3,458) END OF YEAR THREE PAYMENT ENTRY Cash 600 600 Interest income 729 (731) Note discount 129 131

Cash 5,000 5,000 Note receivable 5,000 (5,000) - 1 (2,143) 2,142

Slide Slide 7-41 UCSB, Anderson 7-42 UCSB, Anderson

Non-Interest-Bearing Note Computations for JE’s:

Marie Co. sold real estate to to Don. Co. for a purchase price of $1,000,000 payable as follows: $800,000 cash due at close of FACTS escrow and a $200,000 non-interest bearing note payable in one Cash 800,000 lump-sum at the end of 5 years. The cost basis of the real estate Future 200,000 Periods 5 sold is $750,000. Payment ‐ Rate 8% PRESENT VALUE RECEIVED Is the purchase price of the real estate equal to, more than or less than PV of Cash 800,000 $1,000,000? PV of note 136,117 936,117 AMORTIZATION TABLE Less than $1,000,000. Period Payment Interest Principle Balance ‐ 136,117 1 ‐ 10,889 10,889 147,006 Assuming a lender would charge 8% for this note, the present value of 2 ‐ 11,760 11,760 158,766 the $200,000 note is about $136,117, so what was the purchase 3 ‐ 12,701 12,701 171,468 price? 4 ‐ 13,717 13,717 185,185 5 ‐ 14,815 14,815 200,000 $936,117

Slide Slide 7-43 UCSB, Anderson 7-44 UCSB, Anderson Noninterest-Bearing Note Non-interest bearing note continued Discounted at 15% What is the entry to record the sale? Cash Effective Un- Interest Interest Discount Amort. PV of Date 0% 15% Amort. Balance Note 1/1/92 1,712 3,288 Cash $800,000 12/31/92 0 493 493 1,219 3,781 12/31/93 0 567 567 652 4,348 Note receivable $ 136,117 12/31/94 0 652 652 - 5,000 Real estate $750,000 Gain on sale of real estate $ 186,117 .

What will be recorded at the end of the first year (assuming annual compounding)? 49 11/12/96

Interest receivable $10,889 Interest income $10,889

At the end of the second year? (don’t forget that the $10,889 interest receivable now accrues interest!)

Interest receivable $11,760 Interest income $11,760

Same Journal entry in years 3,4 & 5 for $12,701, $3,717 and $14,815, respectively.

WHEN IT IS ALL FINISHED, THERE WILL BE $63,883 OF ACCRUED INTEREST AND WHEN THE PAYMENT IS RECEIVED, THE FOLLOWING ENTRY WILL BE RECORDED:

Cash $200,000 Note Receivable $ 136,117 Accrued interet rec. $ 63,883 Slide Slide 7-45 UCSB, Anderson 7-46 UCSB, Anderson