Chapter 8, Accounts Receivable , A/R Financing

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March 18, 2002

For next time: Chapter 8, accounts receivable , A/R financing HW: e8-11,P8-8,P8-14 In class 19 - print and bring with you

Today: Start Accts Receivable - in class problem

Petty cash accounts: Most transactions are handled by check but sometimes the small day-to-day expenditures can best be managed with a petty cash account (sometimes this is actual cash in a box and sometimes it is a separate checking account). The balance in the petty cash account in the general ledger only changes when the total amount funded increases or decreases. In other words, the day-to-day transactions in the petty cash account are not recorded as debits or credits to the petty cash account. Here is an example of how it works:

Allison decides that Allicorp could reduce its bank charges by cutting down on the number of small checks written out of the main operating account to cover such things as postage, pens, staples, candy for the front desk, etc. She decides to withdraw $1000 to set up a petty cash account (also known as an imprest fund) to cover these small items and appoints the assistant controller as the keeper of the cash.

ENTRY to set up petty cash account:

Petty cash $1000 Cash $1000 To record the establishment of a petty cash fund.

Each time someone needs to run to the office supply store, he or she goes to the assistant controller and fills out a request (a voucher) for the amount of cash. The sum of cash in the box and the amount on all of the vouchers should add up to $1000 all the time.

At the end of the month, there is $450 in the box and the following vouchers are in the box: Candy for the front desk $150.00 Postage $180 Flowers for clients $80.00 Donations to the girl scouts (cookies) $120.00 Total vouchers $530 This means that there is a $20 short-fall or Cash over and short

ENTRY to record activity: Postage expense $180 Office supplies $150 Contributions $120 Miscellaneous expense $80 Cash over and short $20 Cash $550 To record the cash disbursed in the month via the petty cash account.

The actual cash amount of $550 goes into the petty cash box to bring the total amount up to $1000. Bank reconciliations - why are they necessary? Because as you know from your personal bank accounts, rarely will your records match those of the bank. Why is there a difference? Several possibilities: 1) Timing differences : You have recorded the deposits that you made, but the bank might not show these in your balance yet OR You have written checks that have not yet cleared the bank. 2) Bank charges that the bank takes directly out of your account. 3) Sometimes you have made mistakes AND sometimes the bank's records are in error.

What does the bank reconciliation do? It isolates the differences between your books and the bank 's records - this is an important control over your cash.

A Bank Reconciliation example (IN CLASS EXAMPLE) what you need to have: BANK: Bank statement showing the following: 1. Detail of deposits for the period, 2. Detail of the checks cleared for the period, 3. Detail of service charges, 4. Detail of any direct collections (the Bank sometimes collects cash for the company) 5. Detail of any NSF checks. 6. The balance at the beginning of the period. BOOKS: Book cash account information as follows: 1. General ledger (for the beginning and ending balance) 2. Deposits for the month, 3. Checks for the month (check register). 4. Last month's bank reconciliation. Use example to go through the steps.

Steps to reconcile: 1. Start with the ending balance on the bank statement and in the general ledger. 2. Additions to the bank balance (are there any cash or deposits that are not shown?) a. Cash on hand (this would be any cash that you have not yet deposited but received before the end of the month -- this should not be a very big amount, maybe just one day's undeposited checks.) b. Deposits in transit are deposits made too late to clear for the bank statement - the bank doesn't always credit your account on the same day that you make the deposit >how do you know what the amount of Deposits in transit is?

Deposits in transit last month + Total deposits made this month per the books - total deposits made this month per the bank statement = Deposits in transit this month

3. Deductions from the bank balance (are there checks we have written that are not shown?) a. Outstanding checks are checks that we have written and mailed but that have not cleared our bank account (either because the payee has not deposited the check or because the check is still clearing the banking system) >how do you know the amount of the Outstanding checks?

Outstanding checks last month (from last month's bank rec.)+ Total checks written per the books (from the cash disbursements detail) - Total checks cleared per the bank statement = Outstanding checks at the end of this month

4. (1)+(2)-(3) = The correct cash balance. 5. Start again with the book ending balance 6. Additions to the book balance (did the bank make any additions that we are unaware of or did we make any errors in recording?) a. Notes or Accounts collected by the bank b. Errors (you would find these by comparing deposits per books to the deposits on the bank statement)

7. Deductions from the book balance (are there any charges that the bank has taken from our account?) a. Bank service charges (shown on the bank statement) b. NSF checks (usually returned with the bank statement)

8. (5) +(6) - (7) = The correct cash balance = (4) above.

Once you know the correct cash balance, you can make any necessary entries to correct the books. All of these entries are generated from your Book to correct cash side of your reconciliation (see example). These are the ONLY adjusting entries involving cash (they are actually corrections to the cash account): Entries are necessary for: Collection by the bank (this would decrease a RECEIVABLE on our books) Errors in recording deposits or checks NSF Checks (this would increase a RECEIVABLE on our books) Bank charges (this would increase an EXPENSE account) Cash shortage or overage (this would impact an EXPENSE account ) - this is an IMMATERIAL plug to make the bank rec. balance. If the amount gets too large, then we need to further investigate the difference - it usually indicates that we have missed something unusual on the bank reconciliation.

Alternative format of the bank reconciliation: Start with the bank balance and adjust to the book balance.

What kind of controls would you suggest to protect cash? 1) separation of duties is the key: the person preparing the bank reconciliation should not have responsibility over deposits or disbursements. 2) bank reconciliations should be reviewed periodically 3) Limit the length of time that checks can be presented for payment (this helps manage the outstanding check amount) In class bank reconciliation example

Bank statement for March: Beginning balance, March 1 $6,000 Deposits $4,800 Checks cleared $6,500 Service charges for March $ 10 Collection by bank ($3000 note + interest) $3,100 NSF check returned for re-deposit $ 50 Ending balance $7.340

Book information Ending balance, March 31 $4,000 Checks written $6,700 Deposits $5,000

Last month bank rec info: Deposits in transit $ 500 Outstanding checks $ 800

What does the journal entry look like? ACCOUNTS RECEIVABLE What amount is the balance sheet supposed to show for Accounts Receivable? The future economic benefit, or the NET REALIZABLE VALUE. This is the most realistic estimate of the amount of cash the company expects to collect. It means that we have to consider all of the things that might make accounts receivable balance less than the total amount of credit sales at the gross selling price.

NOTE: The notes are closely tied to the in-class example. In-class example: Grandma's Great Foods. Grandma's sells frozen meals and desserts to college students and young professionals. Customers buy a week's or a month's worth of meals at a time. Each individual meal costs $10. Grandma's total credit sales for the month of September (the busiest month) consisted of $230,000 (23,000 total meals * $10 price per meal).

The basic entry: various dates A/receivable $230,000 Sales $230,000 To record credit sales of meals.

A. Now, suppose that as a way to motivate the customers to pay quickly, Grandma's offers a sales discount if the balance is paid within 10 days of the purchase.

Typical terms of a cash discount are 2/10 n/30 which means "you get a 2% discount if you pay off the entire balance within 10 days OR the full amount is due within 30 days. 2% doesn't initially sound like a big deal, but what kind of annual interest rate does the missed discount translate into? 2/98 = the % interest for the 20 days between day 10 and day 30. (2.04%) 365/20 = 18.25 is the number of 20 day periods in a year. 18.25*2.04% = 37.23%!!! Missing the discount essentially means that you are paying a finance charge of 37.23% on the discounted sales price for the 20 days between day 10 and day 30.

What should Grandma's do to reflect the cash discount? There are 2 options - Grandma's can use the GROSS method or the NET method to account for the discounts.

1. At the time of sale: the net method assumes that the discounts will be taken. 2. For payments received within the discount period: the gross method specifically identifies the sales discounts taken. 3. For payments received after the discount period: the net method specifically identifies the financing charge associated with sales discounts lost. Note that the Sales discount account under the Gross method REDUCES Sales on the income statement but that the Sales discounts forfeited account under the Net method INCREASES Sales on the income statement. 4. At year end, there is an entry necessary under the NET METHOD to account for lost discounts on accounts receivable that have not been collected but that are beyond the discount period. Under the GROSS METHOD, there is an adjustment necessary for any discounts estimated to be taken on outstanding accounts receivable (i.e. sales close to the end of the year that are still within the discount period), using an Allowance for Sales Discounts account. When cash is ultimately collected the Allowance for Sales Discounts account is removed.