7-1

Chapter

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FINANCIAL ASSETS

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How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?

McGraw-Hill/Irwin

7-2

Every
business
needs
enough
cash to pay
its bills!

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How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?

7-3

Financial
Assets

Cash

Receivables
Short-term
Investments

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How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?
Collections
from
customers

Cash (and cash

equivalents)

Accounts

7-4

Cash
payments

receivable
Excess
cash is
invested
temporarily

Investments
are sold as
cash is
needed
Marketable
securities
(short-term
investments)

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7-5

The
The Valuation
Valuation of
of Financial
Financial Assets
Assets

Estimated
Estimated collectible
collectible amount
amount

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7-6

Cash
Cash
Coins and
paper money

Bank credit
card sales

Cash is
defined as
any deposit
banks will
accept.

Checks

Money orders

Travelers checks
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7-7

The
The Statement
Statement of
of Cash
Cash Flows
Flows

Statement of Cash Flows

Summarizes cash
transactions for an
accounting period.
Includes cash and cash
equivalents.

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7-8

Using
Using Excess
Excess Cash
Cash Balances
Balances Efficiently
Efficiently
Cash available for
long-term investment
may be used to finance
growth and expansion
of the business, or to
repay debt.

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Cash not needed for

business purposes
should be distributed
to the companys
stockholders.

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7-9

Cash
Cash Over
Over and
and Short
Short
On May 5, XBAR, Inc.s cash drawer was
counted and found to be $10 over.

Cash
Cash Over
Over and
and Short
Short is
is debited
debited for
for shortages
shortages
and
and credited
credited for
for overages.
overages.
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7-10

Bank
Bank Statements
Statements
Shows the beginning bank balance,
deposits made, checks paid, other
debits and credits in the month, and
the ending bank balance.

Bank
Statement
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7-11

Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositors accounting
records.
Provides information for
reconciling journal entries.

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7-12

Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Balance per Bank

Balance per Depositor

+ Deposits in Transit

+ Deposits by Bank
(credit memos)

- Outstanding Checks

- Service Charge
- NSF Checks

Bank Errors

Book Errors

= Adjusted Balance

= Adjusted Balance

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7-13

Reconciling
Reconciling the
the Bank
Bank Statement
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 Errors
= Adjusted Balance

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7-14

Reconciling
Reconciling the
the Bank
Bank Statement
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 necessary for the
reconciliation is shown on the next page.
McGraw-Hill/Irwin

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Outstanding
Outstanding checks
checks totaled
totaled $2,417.
$2,417.

7-15

A
A$500
$500 check
check mailed
mailed to
to the
the bank
bank for
for deposit
deposit had
had

not
not reached
reached the
the bank
bank at
at the
the statement
statement date.
date.

The
The bank
bank returned
returned aa customers
customers NSF
NSF check
check for
for
$225
$225 received
received as
as payment
payment of
of an
an account
account
receivable.
receivable.

The
The bank
bank statement
statement showed
showed $30
$30 interest
interest earned
earned
on
on the
the bank
bank balance
balance for
for the
the month
month of
of July.
July.

Check
Check 781
781 for
for supplies
supplies cleared
cleared the
the bank
bank for
for $268
$268
but
but was
was erroneously
erroneously recorded
recorded in
in our
our books
books as
as
$240.
$240.

A
A$486
$486 deposit
deposit by
by Acme
Acme Company
Company was
was
erroneously
erroneously credited
credited to
to our
our account
account by
by the
the bank.
bank.
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7-16

Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Balance per bank statement, July 31
Additions:
Deposit in transit
Deductions:
Bank error
$
486
Outstanding checks
2,417
Adjusted cash balance

$ 9,610

Balance per depositor's records, July 31

Additions:
Interest
Deductions:
Recording error
$
28
NSF check
225
Adjusted cash balance

$ 7,430

McGraw-Hill/Irwin

500

2,903
$ 7,207

30

253
$ 7,207

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7-17

Reconciling
Reconciling the
the Bank
Bank Statement
Statement
GENERAL JOURNAL
Date

Account Titles and Explanation

Jul 31 Cash

P
R Debit

Credit
30

Interest Revenue
31 Supplies Inventory
Accounts Receivable
Cash

McGraw-Hill/Irwin

30
28
225
253

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7-18

Short-Term
Short-Term Investments
Investments
Bond
Investments

Readily
Marketable

Capital Stock
Investments

Marketable
Securities
are . . .

Current Assets

Almost As
Liquid As Cash
McGraw-Hill/Irwin

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7-19

Lets turn our

attention to accounts
receivable.

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7-20

Uncollectible
Uncollectible Accounts
Accounts

IfIf aa company
company makes
makes credit
credit
sales
sales to
to customers,
customers, some
some
accounts
accounts inevitably
inevitably will
will
turn
turn out
out to
to be
be
uncollectible.
uncollectible.

McGraw-Hill/Irwin

PAST DUE

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Reflecting
Reflecting Uncollectible
Uncollectible Accounts
Accounts in
in
the
the Financial
Financial Statements
Statements

7-21

At
At the
the end
end of
of each
each period,
period, record
record
an
an estimate
estimate of
of the
the uncollectible
uncollectible
accounts.
accounts.

Selling
Sellingexpense
expense
McGraw-Hill/Irwin

Contra-asset
Contra-assetaccount
account

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7-22

The
The Allowance
Allowance for
for Doubtful
Doubtful Accounts
Accounts
Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable
The net realizable value is the amount of
accounts receivable that the business expects
to collect.
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Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable

7-23

When
When an
an account
account isis determined
determined to
to be
be uncollectible,
uncollectible, itit no
no
longer
longer qualifies
qualifies as
as an
an asset
asset and
and should
should be
be written
written off.
off.

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Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable

7-24

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.

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Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable

7-25

Assume that before this entry, the Accounts

Receivable balance was $10,000 and the
Allowance for Doubtful Accounts balance was
$2,500.
Lets see what effect the write-off had on these
accounts.

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Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable
Before
Write-Off
Accounts receivable
$ 10,000
Less: Allow. for doubtful accts.
2,500
Net realizable value
$ 7,500

7-26

After
Write-Off
$ 9,500
2,000
$ 7,500

Notice that the $500 write-off did not change the net
realizable value nor did it affect any income
statement accounts.
McGraw-Hill/Irwin

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7-27

Monthly
Monthly Estimates
Estimates of
of Credit
Credit Losses
Losses
At
At the
the end
end of
of each
each month,
month,
management
management should
should
estimate
estimate the
the probable
probable
amount
amount of
of uncollectible
uncollectible
accounts
accounts and
and adjust
adjust the
the
Allowance
Allowance for
for Doubtful
Doubtful
Accounts
Accounts to
to this
this new
new
estimate.
estimate.

McGraw-Hill/Irwin

Two Approaches to Estimating

Credit Losses:

1.
2.

Balance Sheet Approach

Income Statement Approach

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach

7-28

Year-end
Year-endAccounts
AccountsReceivable
Receivableis
is
broken
brokendown
downinto
intoage
age
classifications.
classifications.

Each
Eachage
agegrouping
grouping has
hasaa
different
differentlikelihood
likelihoodof
ofbeing
being
uncollectible.
uncollectible.

Compute
Computeaaseparate
separate allowance
allowance for
for
each
eachage
agegrouping.
grouping.

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach

7-29

At December 31, 2005, the receivables for

EastCo, Inc. were categorized as follows:

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach

7-30

At December 31, 2005, the receivables for

EastCo, Inc. were categorized as follows:

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach

7-31

At December 31, 2005, the receivables for

EastCo, Inc. were categorized as follows:

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach

7-32

EastCos
EastCosunadjusted
unadjustedbalance
balance
in
inthe
theallowance
allowanceaccount
accountis
is
$500.
$500.
Per
Perthe
theprevious
previouscomputation,
computation,
the
thedesired
desiredbalance
balanceis
is$1,350.
$1,350.

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7-33

Lets
Lets look
look at
at
another
another way
way
to
to estimate
estimate
credit
credit losses!
losses!
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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Income
Income Statement
Statement Approach
Approach

7-34

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.

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Income
Income Statement
Statement Approach
Approach

7-35

Net
Net Credit
Credit Sales
Sales
%
% Estimated
Estimated Uncollectible
Uncollectible
Amount
Amount of
of Journal
Journal Entry
Entry

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Income
Income Statement
Statement Approach
Approach

7-36

In 2005, EastCo had credit sales of $60,000.

Historically, 1% of EastCos credit sales has
been uncollectible.
For 2005, the estimate of uncollectible
accounts expense is $600.
($60,000 .01 = $600)
Now, prepare the adjusting entry for
December 31, 2005.

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Estimating
Estimating Credit
Credit Losses
Losses
The
The
Income
Income Statement
Statement Approach
Approach

McGraw-Hill/Irwin

7-37

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Uncollectible
Uncollectible Accounts
Accounts
Summary
Summary

7-38

Aging
Agingof
of
Receivables
Receivables

%
%of
ofCredit
Credit Sales
Sales

Emphasis
Emphasison
on
Realizable
RealizableValue
Value

Emphasis
Emphasison
on
Matching
Matching

Accts.
Rec.

All. for
Doubtful
Accts.

Balance
BalanceSheet
Sheet
Focus
Focus
McGraw-Hill/Irwin

Sales

Uncoll.
Accts.
Exp.

Income
Income
Statement
StatementFocus
Focus

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Recovery
Recovery of
of an
an Account
Account Receivable
Receivable
Previously
Previously Written
Written Off
Off

7-39

Subsequent
Subsequentcollections
collectionsrequire
requirethat
thatthe
theoriginal
originalwrite-off
write-offentry
entrybe
be
reversed
reversedbefore
beforethe
thecash
cashcollection
collectionis
isrecorded.
recorded.

GENERAL JOURNAL
Date

Account Titles and Explanation

Accounts Receivable (X Customer)

P
R Debit
$$$$

Allowance for Doubtful Accounts

Cash
Accounts Receivable (X Customer)

McGraw-Hill/Irwin

Credit
$$$$

$$$$
$$$$

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7-40

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
AApromissory
promissorynote
noteis
isan
an unconditional
unconditional promise
promisein
in
writing
writingto
topay
payon
ondemand
demandor
orat
at aafuture
futuredate
dateaadefinite
definite
sum
sum of
of money.
money.

Makerthe
Makerthe person
personwho
who
signs
signsthe
thenote
noteand
andthereby
thereby
promises
promises to
topay.
pay.
Payeethe
Payeetheperson
personto
towhom
whom
payment
payment isisto
tobe
bemade.
made.
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7-41

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
PROMISSORY NOTE
Miami, Fl
Location
Ninety days after this date
promises to pay to the order of
the sum of
of

12.0%

$10,000.00

Nov. 1, 2005
Date
Porter Company
Hall Company
with interest at the rate

per annum.
signed
title

John Caldwell
CFO, Porter Company

Porter Company is replacing an existing Accounts Receivable

with this Note Receivable with Hall The
Company.
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7-42

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
On November 1, 2005, Hall Company would
make the following entry.

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7-43

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue

Interest
Interest is
is aa charge
charge made
made for
for the
the
use
use of
of money.
money.

The
The borrower
borrower incurs
incurs interest
interest
expense.
expense.

The
The lender
lender earns
earns interest
interest
revenue.
revenue.

Interest
rates
down!

Lender
McGraw-Hill/Irwin

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7-44

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
The
The interest
interest formula
formula includes
includes three
three variables:
variables:

Interest = Principal Interest Rate Time

When
Whencomputing
computinginterest
interestfor
forone
oneyear,
year,Time
Time
equals
equals1.
1. When
Whenthe
thecomputation
computationperiod
periodis
isless
less
than
thanone
oneyear,
year,then
thenTime
Timeis
isaafraction.
fraction.
For
Forexample,
example,ififwe
weneeded
neededto
tocompute
computeinterest
interestfor
for
3
33months,
months,Time
Timewould
wouldbe
be 3/12
/12..

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7-45

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
What
What entry
entry would
would Hall
Hall Company
Company make
make on
on
December
December 31,
31, the
the fiscal
fiscal year-end?
year-end?

60
$10,00012%

= $200
$10,00012% 60//360
360 = $200
McGraw-Hill/Irwin

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7-46

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
What
What entry
entry would
would Hall
Hall Company
Company make
make on
on
the
the maturity
maturity date?
date?
90
$10,00012%

=
$300
$10,00012% 90//360
=
$300
360

Days remaining in November (30-1)

Days in December
Days needed in January
Note term in Days
McGraw-Hill/Irwin

29
31
30
90

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7-47

Notes
Notes Receivable
Receivable and
and Interest
Interest Revenue
Revenue
IfIf Porter
Porter Company
Company defaulted
defaulted on
on the
the note,
note,
Hall
Hall Company
Company would
would make
make the
the following
following
entry
entry on
on the
the maturity
maturity date.
date.

McGraw-Hill/Irwin

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7-48

End
End of
of Chapter
Chapter 77

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