Chapter

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FINANCIAL ASSETS

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

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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?
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

Cash
payments

receivable
Excess
cash is
invested
temporarily.

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

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The
The Valuation
Valuation of
of Financial
Financial Assets
Assets
Basis for Valuation in
Type of Financial Asset
the Balance Sheet
Cash (and cash equivalents) Face amount
Short-term investments
Current market value
(marketable securities)
Receivables
Net realizable value

Estimated
Estimated collectible
collectible amount
amount

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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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Reporting
Reporting Cash
Cash in
in the
the Balance
Balance
Sheet
Sheet
Combined
with cash on
balance sheet
Liquid shortterm
investments

Cash
Equivalents

Matures
within 90 days
of acquisition

Stable
market
values
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Reporting
Reporting Cash
Cash in
in the
the Balance
Balance
Sheet
Sheet
Not available
for paying
current
liabilities

Not a current
asset
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Restricted
Cash

Listed as an
investment

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Reporting
Reporting Cash
Cash in
in the
the Balance
Balance
Sheet
Sheet
Bank agrees in
advance to lend
money.

Lines of
Credit
Liability is
incurred when line
of credit is used.
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Unused line of
credit is disclosed
in notes.

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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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Cash
Cash Management
Management

Accurately
Accurately account
account for
for cash.
cash.

Prevent
Prevent theft
theft and
and fraud.
fraud.

Assure
Assure the
the availability
availability of
of
adequate
adequate amounts
amounts of
of cash.
cash.

Avoid
Avoid unnecessarily
unnecessarily large
large
amounts
amounts of
of idle
idle cash.
cash.

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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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Internal
Internal Control
Control Over
Over Cash
Cash

Segregate
Segregate authorization,
authorization, custody
custody and
and recording
recording of
of
cash.
cash.

Prepare
Prepare aa cash
cash budget.
budget.

Prepare
Prepare aa control
control listing
listing of
of cash
cash receipts.
receipts.

Require
Require daily
daily deposits.
deposits.

Make
Make all
all payments
payments by
by check.
check.

Verify
Verify every
every expenditure
expenditure before
before payment.
payment.

Promptly
Promptly reconcile
reconcile bank
bank statements.
statements.
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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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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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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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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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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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Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Example
Example
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.
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Outstanding
Outstanding checks
checks totaled
totaled $2,417.
$2,417.

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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Reconciling
Reconciling
the
Bank
Statement
Reconcilingthe
theBank
BankStatement
Statement
Example
Example

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

The McGraw-Hill Companies, Inc.

Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Example
Example
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

The McGraw-Hill Companies, Inc.

Petty
Petty Cash
Cash Funds
Funds
Used for minor
expenditures.

Petty Cash
Funds
Has one
custodian.
McGraw-Hill/Irwin

Replenished
periodically.

The McGraw-Hill Companies, Inc.

Short-Term
Short-Term Investments
Investments
Bond
Investments

Readily
Marketable

Marketable
Securities
are . . .

Capital
Stock
Investments

Current Assets

Almost As
Liquid As
Cash
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Mark-to-Market:
Mark-to-Market: A
ANew
New Principle
Principle
of
of Asset
Asset Valuation
Valuation
Short-term investments in marketable securities
appear on the balance sheet at their current market
value as of the balance sheet date.

Treatment
Treatmentof
ofUnrealized
Unrealized
Classification
Classification Management's
Management'sIntent
Intent Holding
Holding Gains
Gainsand
and Losses
Losses
Available
Held
Available for
for
Held for
forshort-term
short-term Reported
Reported in
instockholders'
stockholders'
sale
sale securities
securities resale
resale (often
(often 66to
to 18
18 equity
equitysection
section of
ofthe
the
months)
balance
months)
balance sheet
sheet
Trading
Held
Trading
Held for
forimmediate
immediate Reported
Reported in
in"other"
"other"revenue
revenue
securities
resale
securities
resale (often
(often within
within (expense)
(expense)section
section of
ofthe
the
hours
income
hoursor
ordays)
days)
income statement
statement
Held
Reported
Held to
to maturity
maturity Debt
Debtsecurities
securities
Reported in
instockholders'
stockholders'
securities
intended
securities
intended to
to be
be held
held equity
equitysection
section of
ofthe
the
sheet
The McGraw-Hill Companies, Inc.
until
balance
McGraw-Hill/Irwin
until they
theymature
mature
balance
sheet

Lets turn our

attention to accounts
receivable.

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The McGraw-Hill Companies, Inc.

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

The McGraw-Hill Companies, Inc.

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

The McGraw-Hill Companies, Inc.

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.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Writing
Writing Off
Off an
an Uncollectible
Uncollectible
Account
Account Receivable
Receivable
When
When an
an account
account is
is 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.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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

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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Recovery
Recovery of
of an
an Account
Account Receivable
Receivable
Previously
Previously Written
Written Off
Off
Subsequent
Subsequentcollections
collectionsrequire
requirethat
thatthe
theoriginal
original write-off
write-off
entry
entrybe
be reversed
reversed before
before the
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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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.

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Monthly
Monthly Estimates
Estimates of
of Credit
Credit Losses
Losses
Example
Example
At
At December
December 31,
31, 2003,
2003, MusicLands
MusicLands accounting
accounting
records
records indicate
indicate the
the following:
following:
Accounts
Accounts Receivable
Receivable == $50,000
$50,000
Allowance
Allowance for
for Doubtful
Doubtful Accounts
Accounts == $200
$200 (credit)
(credit)
Past
Past experience
experience suggests
suggests that
that 5%
5%of
of receivables
receivables
are
are uncollectible.
uncollectible.
What
What is
is MusicLands
MusicLands Uncollectible
Uncollectible Accounts
Accounts
Expense
Expense for
for 2003?
2003?
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Monthly
Monthly Estimates
Estimates of
of Credit
Credit Losses
Losses
Example
Example
Desired balance in Allowance
for Doubtful Accounts.

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The McGraw-Hill Companies, Inc.

Lets
Lets look
look at
at
another
another way
way
to
to estimate
estimate
the
the
uncollectible
uncollectible
accounts!
accounts!
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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

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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The McGraw-Hill Companies, Inc.

Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach
At December 31, 2003, 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
At December 31, 2003, the receivables for
EastCo, Inc. were categorized as follows:

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Estimating
Estimating Credit
Credit Losses
Losses
The
The
Balance
Balance Sheet
Sheet Approach
Approach
At December 31, 2003, the receivables for
EastCo, Inc. were categorized as follows:

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

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

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Guess
Guess What!
What!
There
There is
is
another
another
alternative
alternative to
to
estimate
estimate the
the
uncollectible
uncollectible
accounts!
accounts!
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

An
An Alternative
Alternative Approach
Approach to
to
Estimating
Estimating Credit
Credit Losses
Losses
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.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

An
An Alternative
Alternative Approach
Approach to
to
Estimating
Estimating Credit
Credit Losses
Losses
Net
Net Credit
Credit Sales
Sales
%
% Estimated
Estimated Uncollectible
Uncollectible
Amount
Amount of
of Journal
Journal Entry
Entry

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

An
An Alternative
Alternative Approach
Approach to
to
Estimating
Estimating Credit
Credit Losses
Losses
In 2003, EastCo had credit sales of $60,000.
Historically, 1% of EastCos accounts have been
uncollectible.
For 2003, the estimate of uncollectible accounts
expense is $600.
($60,000 .01 = $600)

Now, prepare the adjusting entry for December

31, 2003.
The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin

An
An Alternative
Alternative Approach
Approach to
to
Estimating
Estimating Credit
Credit Losses
Losses

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Uncollectible
Uncollectible Accounts
Accounts
Summary
Summary
%
%of
of Receivables
Receivables

Aging
Aging of
of
Receivables
Receivables

%
%of
ofSales
Sales

Emphasis
Emphasison
on
Realizable
RealizableValue
Value

Emphasis
Emphasis on
on
Realizable
RealizableValue
Value

Emphasis
Emphasison
on
Matching
Matching

Accts.
Rec.

Accts.
Rec.

All. for
Doubtful
Accts.

Balance
BalanceSheet
Sheet
Focus
Focus
McGraw-Hill/Irwin

All. for
Doubtful
Accts.

Balance
BalanceSheet
Sheet
Focus
Focus

Sales

Uncoll.
Accts.
Exp.

Income
Income
Statement
Statement
Focus
Focus

The McGraw-Hill Companies, Inc.

Direct
Direct Write-Off
Write-Off Method
Method
This method makes no attempt to
match revenue with the expense of
uncollectible accounts.

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Income
Income Tax
Tax Regulations
Regulations and
and
Financial
Financial Reporting
Reporting
Direct write-off method
required to calculate
taxable income.

GAAP

GAAP

GAAP

GAAP

Taxable Income

Allowance methods
better match expenses
with revenues.

Financial
Statement Income
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Internal
Internal Controls
Controls for
for Receivable
Receivable
Separate the following duties:

Maintenance
Maintenance of
of the
the accounts
accounts receivable
receivable
subsidiary
subsidiary ledger.
ledger.

Custody
Custody of
of cash
cash receipts.
receipts.
Authorization
Authorization of
of accounts
accounts receivable
receivable writewriteoffs.
offs.

McGraw-Hill/Irwin

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Management
Management of
of Accounts
Accounts
Receivable
Receivable
Credit Terms

Extending credit encourages

customers to buy from us . . .

. . . but it ties up resources

in accounts receivable.

McGraw-Hill/Irwin

Minimize
Accounts
Receivable

The McGraw-Hill Companies, Inc.

Ways
Ways to
to Minimize
Minimize Amounts
Amounts in
in
Accounts
Accounts Receivable
Receivable
Selling
Accounts
Receivable

McGraw-Hill/Irwin

Credit
Card
Sales

The McGraw-Hill Companies, Inc.

Evaluating
Evaluating the
the Quality
Quality of
of Accounts
Accounts
Receivable
Receivable
Accounts
Accounts Receivable
Receivable Turnover
Turnover Ratio
Ratio
This
This ratio
ratio provides
provides useful
useful information
information for
for
evaluating
evaluating how
how efficient
efficient management
management has
has
been
been in
in granting
granting credit
credit to
to produce
produce revenue.
revenue.
Net Sales
Average Accounts Receivable

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Evaluating
Evaluating the
the Quality
Quality of
of Accounts
Accounts
Receivable
Receivable
Avg.
Avg. Number
Number of
of Days
Days to
to Collect
Collect A/R
A/R
This
This ratio
ratio helps
helps judge
judge the
the liquidity
liquidity of
of aa
companys
companys accounts
accounts receivable.
receivable.
Days in Year
Accounts Receivable Turnover Ratio

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

End
End of
of Chapter
Chapter 77

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.