7–17–1 Chapter 7 Cash and Receivables. 7–27–2 Copyright © Cengage Learning. All rights reserved. Managing Cash at Nike Poised to become a $20 billion

7–1

Chapter 7

Cash and Receivables

7–2Copyright © Cengage Learning. All rights reserved.

Managing Cash at Nike

Poised to become a $20 billion company by the end of the decade

Cash provided by operations = $1.8 billion in fiscal 2007

Effective use of supply-chain management system

Click to explore financial news on Nike.

As you study this chapter, consider the issues involved with collection of accounts receivable and protecting cash.

© Royalty Free PhotoDisc/ Getty Images


LO1: Managing Cash and Receivables

1. Cash needs

2. Credit policies

3. Level of accounts receivable

4. Financing receivables

5. Ethical estimates of credit losses



Cash Considerations

Consists of: Currency and coins on

hand

Most liquid of all assets Central to operating

cycle

Checks and money orders from customers

Deposits in checking and savings accounts

Cash may include a compensating balance—a minimum amount required

by a bank for a credit-granting agreement.



Seasonal Cash Needs

Cycles of business activities require different levels of cash needs

Cash inflows Cash outflows

Borrowing Investing

Plan for these cash activities:


Cash Requirements


Accounts Receivable (A/R)

Short-term financial assets Result from extending credit to an individual or a business, also called trade credit

Retailers like Sears, Lowe’s, and JCPenney

offer credit terms to customers

Wholesalers and manufacturers also

provide credit terms to their customers for

purchases © Royalty Free PhotoDisc/ Getty Images


Credit Policies

The credit department: Examines the financial resources and debts of the

credit applicant Asks for personal references Gets credit rating from credit bureaus Determines the extent to which the company can

grant credit, if any

To increase the likelihood of selling to customers who will pay on time, companies develop control procedures and

maintain a credit department


Evaluating the Level of Accounts Receivable

How many times, on average, does a company turn its receivables into

cash during an accounting period?

How long, on average, does it take a company to collect its accounts receivables?

Receivable Turnover Days’ Sales Uncollected


Receivable Turnover

Reflects the relative size of a company’s accounts receivable and the success of its credit and

collection policies

Receivable Turnover = Net Sales

Average Net Accounts Receivable

$16,325.9

($2,494.7 + $2,382.9) ÷ 2

Nike’s ReceivableTurnover for 2007

(Amounts in Millions)

=

= 6.7 times


Nike’s Days’ Sales Uncollected =

Days’ Sales Uncollected

Days’ Sales Uncollected =

365 days

Receivable Turnover

365 days

6.7

= 54.5 days

To interpret a company’s ratios, take into consideration the industry in which it operates


Receivable Turnover for Selected Industries


Financing Receivables

Money tied up in receivables is something that many companies seek to avoid

Companies may use one or more of these methods so that they can receive cash faster:

Set up a separate finance company

Borrow money and pledge A/R

In case of default on loan, A/R (collateral) can be taken and converted to cash to satisfy the loan

FactorA/R

Sale or transfer of A/R; the buyer may bear risk of collection (factoring without recourse) or the seller may bear risk of collection (factoring with recourse)

Ford Ford Motor Credit CompanyGM General Motors Acceptance Corp. Sears Sears Roebuck Acceptance Corp.


How Factoring Works


Factoring Details

Reports a contingent liability (a potential debt that can develop if customers don’t pay receivables)

What does the seller of receivables with recourse report in financials?

Typically 2% of total A/R for sales with recourse; Higher fee for sales without recourse

What fees are charged?


Discounting

The sale of promissory notes held as notes receivable

Company XHolds $20,000 note from

Company Z; Note will pay $1,200 in interest If Company X pays,

bank will receive $21,200 and realize a $2,000 profit

If Company X defaults, Company X is liable for the note

Company X should disclose the contingent liability (in the amount of note plus interest) in notes to its financial statements

BankBuys the note for

$19,200


Estimating Uncollectibles

There will always be customers who do not pay their accounts, called uncollectible accounts, or bad debts

Match these expenses of selling on credit to the revenues they help generate

Estimate the uncollectible expense in the fiscal year in which

the sales are made



Estimating Uncollectibles and Ethics

Because estimations are involved, earnings may be easily manipulated…

earnings are understated.

If the amount of losses from uncollectible accounts

are overstated,

earnings are overstated. If the amount of losses

from uncollectible accounts are understated,


Discussion: Ethics in the World

WorldCom increased revenues and hid losses by continuing to bill customers for service for years after the customers had stopped paying.

Q. What impact do you think WorldCom’s actions had on Accounts Receivable and Sales?


Stop & Review

Q. What is a compensating balance?

A. A minimum amount kept on account required by a bank in accordance with a credit granting agreement.


Stop & Review

Q. If you owned a snow cone business with kiosks operating on three boardwalks along the New Jersey shore, what seasonal cash needs might you anticipate?

A. Cash inflows and outflows might be greatest in the summer months, while the fall and winter months will not yield much cash, nor will much be required for operations.


Stop & Review

Q. Does the buyer or seller bear the risk of collection if receivables are sold with recourse?

A. The seller bears the risk of collection because the buyer may return to the seller for payment if customers do not pay on their accounts.


Stop & Apply

Q. Slippery Elm Homeopathic Drug Store has net sales of $85,355. The year began with Accounts Receivable of $15,385 and ended with $19,358. What is the company’s receivable turnover?

A. $85,355

($19,358 + $15,385) ÷ 2

= 4.9 times


Stop & Review

Q. How might a company use uncollectible estimates to manipulate earnings?

A. If the company underestimated uncollectibles, it would overstate earnings. If the company wanted to minimize earnings, it could overestimate uncollectibles for the period.


LO2: Cash Equivalents

Investments like time deposits or certificates of deposit (CDs) that have a term of 90 days or less

Nike’s Annual ReportCash and equivalents represent cash and short-term, highly liquid investments with maturities of three months or less at date of purchase. The carrying amounts reflected in the consolidated balance sheet for cash and equivalents approximate fair value.



Cash Control: Imprest Systems

Established at a fixed amount

Reimbursed periodically, based on documented expenditures

Total cash and receipts must equal the original amount

One person should be made responsible for the accuracy and security of the fund

Petty Cash Fund

© Royalty Free C Squared Studios/ Getty Images


Cash Control: Electronic Funds Transfer (EFT)

Method of conducting business transactions in which funds are transferred electronically

from one bank to another bank

Wal-Mart makes 75% of its

payments to suppliers using

EFT

Electronic Banking

ATM transactionsDebit and credit card purchases

Online bill-pay


Cash Control: Bank Reconciliations

The bank statement is reconciled to the company’s Cash account to account for any difference between

the two balances

Outstanding checksDeposits in transit Errors

Service chargesNSF (nonsufficient funds)

checks Miscellaneous debits or creditsInterest incomeErrors

What items might appear in the company’s records that do not appear on the

bank statement?

What items might appear on the bank statement

that do not appear in the company’s records?


Terry Services Company Bank Reconciliation

August 31, 2010 Balance per bank, August 31 $1,735.35 Balance per books, August 31 $1,207.95

Add deposit of August 31 in transit 138.00

Illustration: Bank Reconciliation

1. A $138.00 deposit was mailed to the bank on August 31 and has not been recorded by the bank.



August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 Balance per books, August 31 $1,207.95

Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59

Bank Reconciliation (cont’d)

2. Five checks issued in August or earlier have not been paid by the bank.




August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59 Balance per books, August 31 $1,207.95

3. A deposit on August 6 was incorrectly recorded in the company’s books as $165.00. The bank correctly recorded the deposit as $150.00.

Less: Overstatement of deposit of October 6 $ 15.00



Terry Service Company Bank Reconciliation

August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59 Balance per books, August 31 $1,207.95 Less: Overstatement of deposit of August 6 $ 15.00

4. A credit memorandum was enclosed with the bank statement showing a note had been collected in the amount of $140.00 along with interest of $10.00. A debit memorandum was enclosed for the $2.50 collection fee.

Add: Note receivable collected by bank $140.00 Interest income on note 10.00 Collection fee 2.50



August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59 Balance per books, August 31 $1,207.95 Add: Note receivable collected by bank $140.00 Interest income on note 10.00 Less: Overstatement of deposit of August 6 $ 15.00 Collection fee 2.50

NSF check of Austin Chase 64.07


5. An NSF check was returned with the statement for $64.07. The NSF check from Austin Chase was not reflected in the company’s books.


Service charge 6.25

Terry Service Company Bank Reconciliation

August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59 Balance per books, August 31 $1,207.95 Add: Note receivable collected by bank $140.00 Interest income on note 10.00 Less: Overstatement of deposit of August 6 $ 15.00 Collection fee 2.50 NSF check of Austin Chase 64.07


6. A debit memorandum for the monthly $6.25 service charge was enclosed with the bank statement.



August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59 Balance per books $1,207.95 Add: Note receivable collected by bank $140.00 Interest income on note 10.00 Less: Overstatement of deposit of August 6 $ 15.00 Collection fee 2.50 NSF check of Austin Chase 64.07 Service charge 6.25

Interest income 7.81


7. Interest earned by the company on its average balance was $7.81.



After all items have been listed on the reconciliation, total the columns. The adjusted bank balance should equal the adjusted book balance.


August 31, 2010 Balance per bank, August 31 $1,735.53 Add deposit of August 31 in transit 138.00 $1,873.53 Less outstanding checks: No. 551 $75.00 No. 576 20.34 No. 578 250.00 No. 579 185.00 No. 580 65.25 595.59 Adjusted bank balance, August 31,2010 $1,277.94 Balance per books $1,207.95 Add: Note receivable collected by bank $140.00 Interest income on note 10.00 Interest income 7.81 157.81 $1,365.75 Less: Overstatement of deposit of August 6 $ 15.00 Collection fee 2.50 NSF check of Austin Chase 64.07 Service charge 6.25 $87.82 Adjusted bank balance, August 31,2010 $1,277.94


Stop & Review

Q. What are cash equivalents?

A. Investments like time deposits or CDs that have a term of 90 days or less.


Stop & Review

Q. Why are electronic funds transfers considered to be a form of cash control?

A. Because no money actually changes hands, there is less likelihood of theft or error.


Stop & Review

Q. What types of items will be added to the balance per books when performing a bank reconciliation?

A. Deposits in transit


Stop & Review

Q. What types of items will be deducted from the balance per books when performing a bank reconciliation?

A. Charges and fees like service charges, check charges, and NSF checks


LO3: Direct Charge-Off Methodfor uncollectibles

Recognize a loss at the time it is determined that an account is uncollectible

Date Uncollectible Accounts Expense XXX

Accounts Receivable XXX

Tax law requires use of this method when computing taxable income

Most companies do not use this method for financial reporting purposes because it does not conform to GAAP.


The Allowance Method

Losses from bad debts are matched against the sales they help generate

At the time of sale, management cannot identify which customers will not pay

To observe the matching rule, losses from uncollectible accounts must be estimated

The estimate becomes an expense in the fiscal year in which the sales are made


Alternate Account Names

Allowance for Uncollectible Accounts

Uncollectible Accounts Expense

Allowance for Doubtful Accounts

Allowance for Bad Debts

Reserve for Bad Debts (not used in modern practice)

Bad Debts Expense



Estimating Uncollectible Accounts

• Estimated loss should be: Realistic Based on objective information Based on past experience Based on current economic conditions

Two commonly used methods for

estimating loss

1. Percentage of net sales method

2. Accounts receivable aging method


Percentage of Net Sales Method

How much of this year’s net sales will not be collected?

The answer determines the amount of uncollectible accounts expense for the year

The amount is actually based on the company’s historic losses



Dec. 31, 2012: Account balances: Sales, $322,500; Sales Returns and Allowances, $20,000; Sales Discounts, $2,500; Allowance for Uncollectible Accounts, $1,800. Management estimates that uncollectible accounts will average about 2 percent of net sales.

$6,000 $2,500)– $20,000– ($322,500 x .02 expense accounts bleUncollecti


Dec. 31 1,800

Dec. 31 adj. 6,000

Dec. 31 bal. 7,800

Percentage of Net Sales Method

After the above entry is posted, Allowance for

Uncollectible Accounts will have a credit balance of

$7,800

Dec. 31 Uncollectible Accounts Expense 6,000 Allowance for Uncollectible Accounts 6,000 To record the uncollectible accounts

expense at 2 percent of $300,000 net sales


Accounts Receivable Aging Method

How much of the ending balance of accounts receivable will not be collected?

The ending balance of Allowance for Uncollectible Accounts is determined directly through an analysis of accounts receivable

The difference between the amount determined to be uncollectible and the actual balance of Allowance for Uncollectible Accounts is the expense for the period.

7–48

Notice that the estimated percentage uncollectible increases as accounts become further past due.

Analysis of Accounts Receivable by Age

The total past due for each category is multiplied by the estimated percentage uncollectible

The sum of the totals for each category is the estimated balance of Allowance for Uncollectible Accounts

Gail Mestas

Insert Exhibit 1, chapter 7, Financial Accounting,8e, Needles,titled "Analysis of Accounts REceivable by Age"Without the exhibit, it is difficult for me to tell where the two boxes should be placed on the slide. Please palce boxes where appropriateOrder of appearance:1. Exhibit2. Box - Bullets, no background or outline3. Box - Ornage and outlined


Accounts Receivable Aging Method (Case 1)

Dec. 31, 2010: Management has estimated that $4,918 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a credit balance of $1,600.


A credit adjustment of $3,318 will bring the account to its target balance

Dec. 31 1,600Dec. 31 adj. 3,318

Dec. 31 bal. 4,918

The target balance for the account is $4,918

Dec. 31 Uncollectible Accounts Expense 3,318 Allowance for Uncollectible Accounts 3,318 To bring the allowance for uncollectible

accounts to the level of estimated losses


Accounts Receivable Aging Method (Case 2)

Dec. 31, 20x6: Management has estimated that $4,918 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a debit balance of $1,600.


A credit adjustment of $6,518 will bring the account to its target balance

Dec. 31 1,600Dec. 31 adj. 6,518

Dec. 31 bal. 4,918

The target balance for the account is $4,918




Comparison of Two Methods


Estimates Differ from Write-Offs?

Accounts receivable written off during a period will rarely equal the estimated uncollectible amount

Shows a credit balance when the total of

accounts written off is less than the estimated uncollectible amount

Shows a debit balance when the total of

accounts written off is greater than the

estimated uncollectible amount



Writing Off an Uncollectible Account

When it becomes clear an account will not be collected, the amount should be written off to Allowance for Uncollectible Accounts

The uncollectible amount was already accounted for as an expense when the allowance was established

7–54

Jan. 15 Allowance for Uncollectible Accounts 500 Accounts Receivable 500 To write off receivable from TV GO as uncollectible

because of his bankruptcy

Bal. 4,418

Dec. 31 4,918

Writing Off an Uncollectible Account

Jan. 15, 2011: TV GO, who owes Gomez Company $500, is declared bankrupt by federal court.


Net realizable value of A/RBefore write-off $88,800 – $4,918 = $83,882

Jan. 15 500

The write-off does not affect the estimated net realizable value of accounts receivable

Accounts Receivable

Dec. 31 88,800

Jan. 15 500

Bal. 88,300

After write-off $88,300 – $4,418 = $83,882


Stop & Review

Q. Why do most companies use the allowance method instead of the direct write-off method to account for uncollectible accounts?

A. The direct write-off method does not conform to the matching rule and therefore does not adhere to GAAP. The allowance method matches losses from bad debts against the sales they helped produce.


Stop & Review

Q. Where does the Allowance for Uncollectible Accounts account appear in the financial statements?

A. On the balance sheet as a contra account to Accounts Receivable.


Stop & Apply

Q. Write Brothers Office Supplies had the following account balances at year end: Sales $620,000; Sales Returns and Allowances $35,000; Sales Discounts, $2,000; Allowance for Uncollectible Accounts, $2,400. Uncollectible accounts is estimated at 3 percent of net sales. What amount will be debited to Uncollectible Accounts Expense if the company uses the percentage of net sales method?

A. .03 x ($620,000 - $35,000 - $2,000) = $17,490


Stop & Apply

Q. Management estimates that $2,707 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a credit balance of $1,200. If the company uses the aging method, what journal entry should be prepared?

A. $2,707 – $1,200 = $1,507




LO4: Making and Paying Notes

A promissory note is an unconditional promise to pay a definite sum of money on demand at a future date

MakerPerson or company that

signs the note and promises to pay the

amount

PayeeEntity to whom

payment is to be made

All promissory notes that the payee holds that are due in less than one year are categorized as notes receivable in the current

assets section of the balance sheet

All promissory notes that the maker holds that are due in less than one year are categorized as

notes payable in the current liability section of the balance

sheet


A Promissory Note


Key Components of Promissory Notes

Total proceeds of a note at maturity date (face value plus interest)

Maturity Value

Cost of borrowing money or the return for lending money, usually stated on an annual basis

Interest and Interest Rate

Length of time in days between the note’s issue date and its maturity date

Duration

Date on which the note must be paidMaturity Date


Maturity Date

Ways in which maturity date may be stated: Due “November 14, 2010”

Due “three months after November 14, 2010”

Due “90 days after November 14, 2010”

Exclude the date of the note when computing the maturity date:A note dated May 20 and due in 90 days would be due on August 18, determined as follows:

Days remaining in May (31 – 20) 11Days in June 30Days in July 31Days in August 18

Total days 90


Duration of a Note

Why is duration of a note important?

Interest is calculated on this basis

If maturity date is stated as a specific number of days from date of note… duration is easy to

calculate. Duration is the same as number of days.

If maturity date is stated as a specific date… number of days must be

calculated.


Interest and Interest Rate

Amount of interest is based on:

PrincipalRate of interestLoan’s length of time

What is the interest on a 90-day, 8 percent, $1,000 note?

Principal x Rate of Interest x Time = Interest

$1,000 x .08 x 90/365 = $19.73



Maturity Value

Total proceeds of loan

90-day 8 percent

$1,000 loan proceeds

= Principal + Interest

= $1,000 + ($1,000 × 8/100 × 90/365)

= $1,000.00 + $19.73

= $1,019.73

The maturity value of a non-interest-bearing note is the principal amount. In this case, the principal includes an

implied interest cost


Accrued Interest

A promissory note received in one accounting period may not be due until a later period

Accrue the interest applicable to the note at the end of the accounting period

$1,000 note, 90-day, 8 percent note was received on Aug. 31. The fiscal year ends on Sept. 30.

30 days interest, or $6.58 ($1,000 × 8/100 × 30/365 = $6.58), is earned in the fiscal year that ends on Sept. 30

© Royalty-Free/Corbis


Dishonored Notes

When the maker of a note does not pay at maturity, the note is said to be a dishonored note.

The holder, or payee, of the note should make an entry to transfer the amount due to an accounts receivable from the debtor. © Royalty Free PhotoDisc/ Getty Images


Stop & Apply

Q. On January 1, 20x6, Blake Company receives a 90-day, 9 percent, $5,000 note. The company prepares financial statements monthly. What is the maturity date of the note?

A. April 1 Days remaining in January (31 – 1) 30 Days in February 28 Days in March 31 Days in April 1

Total days 90


Stop & Apply

Q. If Cheep Company extends a 90-day, $1,000 note, at 9 percent, what total proceeds will the company receive?

A. $1,000 + ($1,000 x .09 x 90/365 = $1,000.00 + $22.19 = $1,022.19


Chapter Review Problem

JPG Company sells merchandise on account to its customers. During the year ended December 31, the company had net sales of $800,000. At the end of the year, it had Accounts Receivable of $220,000 and a debit balance in Allowance for Uncollectible Accounts of $3,100. In the past, approximately 2.0 percent of net sales have been uncollectible. Also, an aging analysis of accounts receivable reveals that $12,000 in accounts receivable appears to be uncollectible.

Required: Compute Uncollectible Accounts Expense, anddetermine the ending balance of Allowance for UncollectibleAccounts and the amount of Accounts Receivable, Net, under (a) the percentage of net sales method and (b) the accounts receivable aging method.


Chapter Review Problem (Solution)

(a) Percentage of net sales method: Uncollectible Accounts Expense = 2.0 percent × $800,000 = $16,000Allowance for Uncollectible Accounts = $16,000 – $3,100 = $12,900Accounts Receivable, Net = $220,000 – $12,900 = $207,100

(b) Accounts receivable aging method: Uncollectible Accounts Expense = $3,100 + $12,000 = $15,100Allowance for Uncollectible Accounts = $12,000Accounts Receivable, Net = $220,000 – $12,000 = $208,000

Documents

7–17–1 Chapter 7 Cash and Receivables. 7–27–2 Copyright © Cengage Learning. All rights reserved. Managing Cash at Nike Poised to become a $20 billion