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Chapter 5
Internal Control, Cash, and
Receivables
Learning Objective 1Learn about fraud and internal control
2Copyright ©2014 Pearson Education.
Fraud
•Intentional misrepresentation of facts•Causes injury or damage to another party•Large problem that increases each year
3Copyright ©2014 Pearson Education.
Types of FraudMisappropriatio
n of assets
• Employees ____ assets from company• Cash• Inventory• False
expense reports
Fraudulent ____________
• Managers make false entries so company appears more profitable
• Deceives investors and creditors 4Copyright ©2014 Pearson Education.
Fraud Triangle
5
Motive
RationalizationOpportunity
Copyright ©2014 Pearson Education.
Internal Control
•Primary way fraud and errors are: ▫Prevented▫Detected or▫Corrected
• Management and Board of Directors implement a:▫Plan of organization ▫System of procedures
•We will not cover Internal Controls in detail in this class.
6Copyright ©2014 Pearson Education.
Learning Objective ThreePrepare and use a bank reconciliation
7Copyright ©2014 Pearson Education.
Bank Account as Control Device
Signature card
Bank statement
Deposit ticket
Bank reconciliati
onCheck
8Copyright ©2014 Pearson Education.
Bank Account Documents
•Signature card▫__________of your signature▫Protects against forgery
•Deposit ticket▫Proof of transaction
•Cheque▫Maker – _____ the cheque▫Payee – to whom the cheque is paid▫Bank – where funds are drawn
9Copyright ©2014 Pearson Education.
The Bank Statement•Reports:
▫Cash _______▫Cash _______
•Electronic Funds Transfer (EFT)▫Make payments by
electronic communication
10Copyright ©2014 Pearson Education.
Bank Reconciliation
•Two records of a business’s cash▫The bank statement (maintained by _______)▫The Cash account in the general ledger
(maintained by __________)•Amounts are usually different
▫_________in recording transactions•Bank reconciliation ________________
11Copyright ©2014 Pearson Education.
Bank Reconciliation ItemsBank Side Book Side• ADD• Deposits in transit• Certain bank errors
• SUBTRACT• Outstanding cheques• Certain bank errors
• ADD• Bank collections• EFT receipts• Interest revenue• Certain book errors
• SUBTRACT• EFT payments• Service charges• NSF cheques• Certain book errors
12Copyright ©2014 Pearson Education.
In the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets:In the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets:In the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets:
NSF means _________________
Electronic Fund Transfer
Summary of Reconciling Items
BANK BALANCE - ALWAYS BOOK BALANCE - ALWAYS
Add deposits in transit Add bank collections, interest revenue and EFT receipts
Subtract outstanding cheques Subtract services charges, NSF cheques, EFT payments
Add or subtract correction of bank errors
Add or subtract correction of book errors
13Copyright ©2014 Pearson Education.
Journalizing Bank Reconciliation Items•All items on the _________of the bank
reconciliation require journal entries•If the item is added to book side
▫Debit Cash•If the items is subtracted from the book
side▫Credit Cash
14Copyright ©2014 Pearson Education.
Copyright ©2014 Pearson Education. 15
JOURNAL
Date
Accounts and explanation Debit Credit
Cash
Dividend Revenue
Receipt of dividend revenue earned on investment. (_____________________)
Cash
Accounts receivable
Account receivable _______________
Cash
Interest Revenue
Interest earned on bank balance.
Cash
Accounts Payable
Correction of cheque
Copyright ©2014 Pearson Education. 16
JOURNAL
Date
Accounts and explanation Debit Credit
Bank service charges
Cash
Bank service charge.
Accounts Receivable
Cash
NSF cheque returned by bank.
Insurance Expense
Cash
Payment of monthly insurance.
Online Banking
•allows you to pay bills and view your account electronically
•can reconcile transactions at any time
17Copyright ©2014 Pearson Education.
Exercise 5-39B• Harry Smith operates a bowling alley. • He has just received the monthly bank statement at September
30 from City National Bank, and the statement shows an ending balance of €545. Listed on the statement are an EFT rent collection of €325, a service charge of €8, two NSF checks totaling €125, and a €10 charge for printed checks. During September, he recorded a $310 check for the salary of a part-time employee as €31.
• In reviewing his cash records, Smith identifies outstanding checks totaling $609 and a September 30 deposit in transit of €1,790. Smith’s Cash account shows a September 30 cash balance of €1,823. How much cash does Smith actually have at September 30?
• Preparing a bank reconciliation.
18Copyright ©2014 Pearson Education.
Exercise 5-39B
Bank: Books:
Balance, September 30
€545 Balance, September 30
€1,823
Add: Add:
Less:
Less:
19Copyright ©2014 Pearson Education.
Budgeting•Budget
▫Financial plan to coordinate activities•Cash budget
▫Planning _______ and _______•Steps:
▫Start with beginning cash balance▫Add budgeted receipts and subtract budget
payments▫Equals expected cash balance▫Compare cash available to budgeted cash
balance 20Copyright ©2014 Pearson Education.
Expected Cash Balance
Copyright ©2014 Pearson Education. 21
If expected cash is greater than
minimum needed
Invest excess
If expected cash is less than
minimum needed
Consider
borrowing
Very closely related to Corporate Finance
Copyright ©2014 Pearson Education.
Cash Budget
Beginning cash balance
Budgeted cash receipts:
Collections from customers
Dividends from investments
Sale of store fixtures
Budgeted cash payments:
Purchases of inventory
Operating expenses
Expansion of store
Payment of long-term debt
Payment of dividends
Cash available (needed)
Budgeted cash balance, end of period
Cash available for investing or (new financing needed)
22
Reporting Cash on the Balance Sheet•All cash accounts combined into a single
total called “Cash and Cash Equivalent”▫Include liquid assets such as time deposits,
certificates of deposit, and high-grade government yield
▫Interest-bearing accounts with no withdrawal penalty
•Reports liquid assets available for day-to-day use
23Copyright ©2014 Pearson Education.
Exercise 5-25A• Cole Communications, Inc., is preparing its cash budget for 20X7.
Cole ended 20X6 with cash of $86 million, and managers need to keep a cash balance of at least $82 million for operations.
• Collections from customers are expected to total $11,305 million during 20X7, and payments for the cost of services and products should reach $6,167 million. Operating expense payments are budgeted at $2,544 million. During 20X7, Cole expects to invest $1,826 million in new equipment and sell older assets for $118 million. Debt payments scheduled for 20X7 will total $603 million. The company forecasts net income of $885 million for 20X7 and plans to pay dividends of $347 million.
• Prepare Cole Communications’ cash budget for 20X7. Will the budgeted level of cash receipts leave Cole with the desired ending cash balance of $82 million, or will the company need additional financing? If so, how much?
24Copyright ©2014 Pearson Education.
Copyright ©2014 Pearson Education. 25
Cole CommunicationsCash Budget
Cash, December 31, 20X7 $86
Budgeted Cash Receipts:
Collections from customers $11,305
Sale of assets 118 $11,509
Budgeted Cash Payments:
Costs and services 6,167
Operating expenses 2,544
Purchase of equipment 1,826
Payment of long-term debt 603
Payment of dividends 347 $11,487
Cash available $22
Budgeted cash available $82
New financing needed $60
Exercise 5-25A
Where is the Net Income of $885?
Why is it not here?
Learning Objective FourAccount for receivables and uncollectible receivables
26Copyright ©2014 Pearson Education.
Receivables
•Monetary claims against others•Acquired mainly by:
▫selling goods and services▫lending money
•Two major types:▫________ receivables▫_______ receivables
27Copyright ©2014 Pearson Education.
Accounts Receivable
•Amounts collectible from customers•Balance in _________ ledger
▫Control account: summarizes total amount due from all customers
•___________ ledger▫Separate account for each customer
28Copyright ©2014 Pearson Education.
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Accounts receivable
$9,000
Customer A
Customer B
$5,000
$1,800
Customer C
$3,000
General Ledger Accounts Receivable Subsidiary Ledger
Total
$9,000
Internal Control: Collections on Account•Separate cash-handling and cash
accounting duties▫Bookkeeper should not handle cash
Should record amounts from remittance advices
▫Separate employee should open incoming mail and make deposit
•Another option:▫Lockbox system
Payments are sent _____________which then notifies the company of the amount received 30Copyright ©2014 Pearson Education.
Managing Risk of Not CollectingBenefit of selling on credit Cost of selling on credit
• Customers that do not have cash available can buy on credit
• Sales and profits increase
• Company _________ from some customers
• This cost is called ________________, _______________, or ____________expense
31Copyright ©2014 Pearson Education.
A Company Must Balance the Benefit And Cost of Credit Effectively
Risks of Selling on CreditIssues Plan of action
What are the benefits and costs of extending credit to customers?
Benefit – increase in salesCost – risk of not collecting
Extend credit to only creditworthy customers
Run a credit check on prospective customers
Separate cash-handling and accounting duties to keep employees from stealing cash from customers
Design internal control system to separate duties
Pursue collection from customers to maximize cash flow
Keep a close eye on customers. Send additional statements to slow-paying customers 32Copyright ©2014 Pearson Education.
Accounting for Uncollectible Receivables
Balance SheetDecember 31, 20X6
Equipment $XXX
Less: allowance for doubtful receivables
(XXX)
Net trade and other receivables
XXX
Copyright ©2014 Pearson Education. 33
The Allowance Method•Records collection losses based on
company’s _____________________•Estimates Bad Debt Expense
▫Dr Bad Debt Expense (as accounts receivables are recorded)
•Also sets up Allowance for Uncollectible Accounts (XA)▫Cr Allowance for Uncollectibles
Contra-account to Accounts Receivable Shows amount of receivables expected not to be
collected (_________).
34Copyright ©2014 Pearson Education.
Net Realizable ValueBalance Sheet
Current assets:
Accounts receivable $10,000
Less: Allowance for uncollectible accounts
(900)
Accounts receivable, net $9,100
35Copyright ©2014 Pearson Education.
Balance Sheet
Current assets:
Accounts receivable, less allowance of $900
$9,100
Method to Estimate Uncollectibles
Aging-of-receivables
• Focuses on proper valuation of (______)accounts receivable on the ____________
• Individual customer balances analyzed based on _____________• Aging schedule (older accounts more
likely to go bad)• Allowance for Uncollectible Accounts
adjusted to equal amount from aging schedule
36Copyright ©2014 Pearson Education.
Copyright ©2014 Pearson Education. 37
Age of Account
Customer
Not yet due
1-30 days
31-60 days
Over 60 days
Total Balance
Customer A $400 $400
Customer B 100 100 200
Customer C 300 200 600 100 1,200
All others … … … …
Totals 11,060
1,363 370 1,093 13,886
Est. percent uncollectible 1.0% 5.0% 12.5% 20.9%
Allowance balance should be:
111 68 46 219 444
Aging-of-Receivables
Aging-of-Receivables
38
JOURNAL
Date
Accounts and explanation Debit Credit
Uncollectible accounts expense 151
Allowance for uncollectible accounts 151
Recorded uncollectible accounts expense
Copyright ©2014 Pearson Education.
Allowance for Uncollectible Accounts
$293Balance before adjustment
$444
$____Adjustment needed
Ending balance equals aging schedule
Aging-of-Receivables
39Copyright ©2014 Pearson Education.
Allowance for Uncollectible Accounts
$293
$444
$151
Accounts Receivables
$13,886
Uncollectible Account Expense
$151
$151
Net accounts receivables, $13,442
Writing Off Uncollectible Accounts
Copyright ©2014 Pearson Education.
JOURNAL
Date
Accounts and explanation Debit Credit
Allowance for uncollectible accounts 12
Accounts Receivable 12
Write off customer accountAllowance for Uncollectible
AccountsAccounts Receivable
$100 $20Bal. Bal.$12$12
$88 $8
No impact on Income Statement!
40
Adjusting Ending Allowance for Doubtful Receivables
JOURNAL
Date
Accounts and explanation Debit Credit
Uncollectible for Doubtful receivables 22
Allowance for Doubtful receivables ($30 - $8)
22
Recorded bad debt expense for the year
41
Beginning Allowance
Receivables Write-offs
Bad Debt Expense
Ending Allowance
– + =
Relationship between uncollectible-account expense, write-offs of receivables and allowance for doubtful receivables account
Copyright ©2014 Pearson Education.
Direct Write-Off Method•Waits until a specific account is
uncollectible to record the expense•Inferior to Allowance method
▫Receivables reported at full amount Assets overstated on Balance Sheet Normally _____________under GAAP
JOURNAL
Date
Accounts and explanation Debit Credit
Uncollectible-account Expense
Accounts Receivable
Write off customer account
42Copyright ©2014 Pearson Education.
Computing Cash Collections from Customers
Copyright ©2014 Pearson Education. 43
Accounts Receivable
Ending balance
Sales on credit
Write-offs of uncollectibles
Collections from customers
Beginning balance $200
$1,800
$100
$400
?$_____
Notes Receivable
•More formal than accounts receivable•______________to pay a sum at the maturity
date▫Plus interest
•Also called promissory notes
44Copyright ©2014 Pearson Education.
Notes Receivable•Can be current or long-term assets•Terms:
45Copyright ©2014 Pearson Education.
Creditor Party to whom money is owed; Lender
Debtor Party that borrowed and owes money; Maker, borrower
Interest Cost of borrowing money; stated as annual percentage rate
Maturity date
Date when debtor must pay note
Maturity value
Sum of principal and interest
Principal Amount borrowed by debtor
Term Length of time from when note was signed to when payment must be made
Copyright ©2014 Pearson Education. 46
Amount Date
For value received, I promise to pay to the order of
RaboBankAmsterdam, Netherlands
Dollars
On
plus interest at the annual rate of 9 percent
$1,000 August 31, 20X6
One thousand and no/100s--------------------------------
February 28, 20X7
Lauren Holland
PROMISSORY NOTE
Principal Date Interest Starts
Payee (Creditor)
PrincipalMaturity Date
Maker (Debtor)
Accounting for Notes Receivable
Copyright ©2014 Pearson Education. 47
JOURNAL
Date Accounts and explanation Debit Credit
20X6
Aug 31
Notes receivable – L.Holland
Cash
Dec 31
Interest receivable ($1,000 x 0.09 x 4/12)
Accrued Interest revenue
2011
Feb 28 Cash
Notes receivable – L.Holland
Interest receivable
Interest revenue ($1,000 x 0.09 x 2/12)
Interest Computation
•Interest rates are always expressed as _______ _______, unless stated otherwise▫For example, a 6-month note with an
interest of 9% means the annual rate is 9%. The note will actually earn 4.5%.
•The time element (4/12) is the fraction of the year that the note has been in force during 2010.
•Often interest is computed based on days▫Denominator would be days/365
Copyright ©2014 Pearson Education. 48
Speeding Up Cash Flow
Credit cards
• Customers pay with credit cards• Revenues increases, with a cost
• Credit card company takes 2-3% as a fee
Selling receivables (________)
• Companies sell receivables to another business, called a factor
• The factor pays a discounted price and then collects full amount from customer
49Copyright ©2014 Pearson Education.
Learning Objective FiveUse two key ratios to evaluate a business
50Copyright ©2014 Pearson Education.
Current Ratio
Copyright ©2014 Pearson Education. 51
Total current assets
Total current liabilities
Short Exercise 5-15
Acid-test ratio
$294,900
$99,000
= 2.98
Copyright ©2014 Pearson Education. 52
Days’ Sales in Receivables (Collection Period)
Copyright ©2014 Pearson Education. 53
Receivables Turnover
Receivables Turnover
Sales Sales
Average Receivabl
es
Average Receivabl
es
Days’ sales in
receivables
Receivables Turnover
365
(Beginning net receivables + Ending net receivables)/2(Beginning net receivables + Ending net receivables)/2
Short Exercise 5-15
$802,000
$73,900
Days’ sales in receivables
10.85
$2,197.26
(Beginning net receivables + Ending net receivables)/2(Beginning net receivables + Ending net receivables)/2
= 34 days
Days’ sales in receivable
54Copyright ©2014 Pearson Education.
Receivables Turnover