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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-1
Financial Assets
Chapter
7
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-2
How Much Cash Should a Business Have?
Cash(face amount)
Short-term Investments(market value)
Receivables(net realizable)
Financial Assets
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-3
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., 2008McGraw-Hill/Irwin
7-4
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., 2008McGraw-Hill/Irwin
7-5
Not available for paying
current liabilities
Reporting Cash in the Balance Sheet
Not a current asset
Listed as an investment
“Restricted” Cash
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-6
Bank agrees in advance to lend
money.
Reporting Cash in the Balance Sheet
Liability is incurred when line of credit is used.
Unused line of credit is disclosed
in notes.
Lines of Credit
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-7
The Statement of Cash Flows
Summarizes cash transactions for an accounting period.
Includes cash and cash equivalents.
Statement of Cash Flows
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-8
Cash Management
Accurately account for cash.Prevent theft and fraud.Assure the availability of
adequate amounts of cash.Prevent unnecessarily large
amounts of idle cash.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-9
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
may be distributed to the company’s stockholders.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-10
Internal Control Over Cash• Segregate authorization, custody and
recording of cash. • Prepare a cash budget (or forecast).• 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., 2008McGraw-Hill/Irwin
7-11
Cash Over and Short
Cash Over and Short is debited for shortages and credited for overages.
On May 5, XBAR, Inc.’s cash drawerwas counted and found to be $10 over.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-12
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., 2008McGraw-Hill/Irwin
7-13
Reconciling the Bank Statement
Explains the difference between cash reported on bank statement and cash
balance in depositor’s accounting records.
Provides information for reconciling journal entries.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-14
Reconciling the Bank Statement
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
± Bank Adjustments
= Adjusted Balance
Balance per Depositor
+ Deposits by Bank (credit memos)
- Service Charge - NSF Checks
± Book Adjustments
= Adjusted Balance
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-15
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 Adjustments
= Adjusted Balance
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-16
Reconciling the Bank Statement 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 for the reconciliation is shown:
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’s 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., 2008McGraw-Hill/Irwin
7-17
Reconciling the Bank Statement
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-18
Reconciling the Bank Statement
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Jul 31 Cash 30Interest Revenue 30
31 Supplies Inventory 28Accounts Receivable 225
Cash 253
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Used for minor expenditures.
Petty Cash Funds
Has one custodian.
Replenished periodically.
Petty Cash Funds
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-20
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., 2008McGraw-Hill/Irwin
7-21
Accounting for Marketable Securities
Most short-term investments in marketable securities are classified as available for sale and appear on the
balance sheet at their current market value.
Classification Management's IntentTreatment of Unrealized
Holding Gains and LossesAvailable-for-sale securities
Held for short-term resale (often 6 to 18 months)
Reported in stockholders' equity section of the balance sheet
Trading securities
Held for immediate resale (often within hours or days)
Reported in "other" revenue (expense) section of the income statement
Held-to-maturity securities
Debt securities intended to be held until they mature
Not reported. Securities are reported on balance sheet at amortized cost.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Purchase of Marketable SecuritiesFoster Corporation purchases as a short-term
investment 4,000 shares of The Coca-Cola Company on December 1. Foster paid $43.98 per
share, plus a brokerage commission of $80.
Total Cost: (4,000 × $43.98) + $80 = $176,000
Cost per Share: $176,000 ÷ 4,000 = $44.00
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-23
Recognition of Investment Revenue
On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000
shares of Coca-Cola.
4,000 × $0.30 = $1,200
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-24
Sales of Investments
On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission.
Sales Proceeds: (500 × $46.04) - $20 = $23,000
Cost Basis: 500 × $44 = $22,000
Gain on Sale: $23,000 - $22,000 = $1,000
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Adjusting Marketable Securities to Market Value
On December 31, Foster Corporation’s remaining shares of Coca-Cola capital stock have a current
market value of $42,000. Prior to any adjustment, the company’s Marketable Securities account has a
balance of $44,000 (1,000 × $44 per share).
Unrealized Loss: $42,000 - $44,000 = ($2,000)
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Accounts Receivable
If a company makes credit sales to customers, some
accounts inevitably will turn out to be uncollectible.
PAST DUE
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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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., 2008McGraw-Hill/Irwin
7-28
The Allowance for Doubtful Accounts
Accounts receivableLess: Allowance for doubtful accountsNet realizable value of accounts receivable
The net realizable value is the amount of accounts receivable that the business
expects to collect.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-29
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.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-30
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.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-31
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 $2,500.
Let’s see what effect the write-off had on these accounts.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Writing Off an Uncollectible Account Receivable
Before Write-Off
After Write-Off
Accounts receivable 10,000$ 9,500$ Less: Allow. for doubtful accts. 2,500 2,000 Net realizable value 7,500$ 7,500$
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., 2008McGraw-Hill/Irwin
7-33
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.
Two Approaches to Estimating Credit Losses:
1. Balance Sheet Approach
2. Income Statement Approach
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-34
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., 2008McGraw-Hill/Irwin
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Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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EastCo’s unadjusted balance in the allowance account is
$500.
Per the previous computation, the desired balance is $1,350.
Estimating Credit Losses — The Balance Sheet Approach
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Estimating Credit Losses — The Income Statement Approach
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.
Net Credit Sales% Estimated Uncollectible
Amount of Journal Entry
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Estimating Credit Losses — The Income Statement Approach
In 2007, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s credit sales has been uncollectible. For 2007, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600)
Now, prepare the adjusting entry for December 31, 2007.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Uncollectible AccountsSummary
Aging of Receivables
Emphasis on Realizable Value
Accts. Rec. All. for
Doubtful Accts.
Balance Sheet Focus
% of Credit Sales
Emphasis on Matching
SalesUncoll. Accts. Exp.
Income Statement
Focus
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Concentrations of Credit Risk
Concentrations of credit risk occur if a significant portion of a company’s receivables are due from a few major customers or from customers operating in the same
industry or geographic region.
The FASB requires disclosure of all
significant concentrations of credit risk in the
notes to the financial statements.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Recovery of an Account Receivable Previously Written Off
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Accounts Receivable (X Customer) $$$$Allowance for Doubtful Accounts $$$$
Cash $$$$Accounts Receivable (X Customer) $$$$
Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Direct Write-Off Method
This method makes no attempt to match revenues with the expense of
uncollectible accounts.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Internal Controls for Receivables
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., 2008McGraw-Hill/Irwin
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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., 2008McGraw-Hill/Irwin
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A promissory note is an unconditional promise in writing to pay on demand or at
a future date a definite sum of money.
Notes Receivable and Interest Revenue
Maker—the person who signs the note and thereby promises to pay.
Payee—the person to whom payment is to be made.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-46
Notes Receivable and Interest Revenue
Porter Company is replacing an existing Accounts Receivable with this Note Receivable with Hall Company.
PROMISSORY NOTE
Location Date
after this date
promises to pay to the order of
the sum of with interest at the rate
of per annum. signed
title
Miami, Fl Nov. 1, 2007
Ninety days Porter Company
John Caldwell
Hall Company
$10,000.00
12.0%
CFO, Porter Company
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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On November 1, 2007, Hall Companywould make the following entry.
Notes Receivable and Interest Revenue
• Interest is a charge made for the use of money.
• The borrower incurs interest expense.• The lender earns interest revenue.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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On December 31, Hall Company would make the following entry
Notes Receivable and Interest Revenue
Interest = Principal × Interest Rate × Time
$10,00012% 60/360 = $200
Date Description Debit CreditDec. 31 Interest Receivable 200
Interest Revenue 200
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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What entry would Hall Companymake on the maturity date?
Notes Receivable and Interest Revenue
$10,00012% 90/360 = $300
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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If Porter Company defaulted on the note, Hall Company would make the following
entry on the maturity date.
Notes Receivable and Interest Revenue
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-51
Financial Analysis and Decision Making
Accounts Receivable Turnover RateThis 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., 2008McGraw-Hill/Irwin
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Financial Analysis and Decision Making
Avg. Number of Days to Collect A/RThis ratio helps judge the liquidity of a
company’s accounts receivable.
Days in Year Accounts Receivable Turnover Ratio