cash, short-term investments and accounts receivable

Chapter 4 1

Cash, Short-term Investments

and Accounts Receivable

Chapter 4

Chapter 4 2

Cash, Short-term Investments

and Accounts Receivable

Chapter 4

Chapter 4 3Chapter 4 3

Chapter 4Learning Objectives

• Account for the major types of transactions involving cash, short-term investments, and accounts receivable.

• Prepare a bank reconciliation and related entries.

• Estimate and record bad debts for accounts receivable.

• Use ratios and other analysis techniques to make decisions about cash, short-term investments, and accounts receivable.

Chapter 4 4

To qualify as a cash equivalent, an item must be readily convertible into a specific amount of cash and have very little risk of a change in value from the time it is acquired to the time it is changed back into cash.

Cash and Cash Equivalents

Chapter 4 5

Petty Cash

Most organizations keep a limited amount of petty cash on hand (in a petty cash box, for example) to pay for small items.

What issues are of concern when a petty cash fund is in use?

Chapter 4 6

Entry to Establish Petty Cash

Chapter 4 7

Entry to Replenish Petty Cash

Chapter 4 8Chapter 4 8

The entry to establish petty cash includes a:

a. debit to the Cash account.

b. credit to the Petty Cash account.

c. debit to the Petty Cash account.

d. debit to the Petty Cash Expense account.

Chapter 4 9Chapter 4 9

The entry to establish petty cash includes a:

a. debit to the Cash account.

b. credit to the Petty Cash account.

c. debit to the Petty Cash account.

d. debit to the Petty Cash Expense account.

Chapter 4 10Chapter 4 10

Prepare the entry on January 1 to establish a petty cash fund for $100.

Prepare the entry on January 31 to replenish petty cash assuming $19 was spent on postage, $55 on office supplies, and $20 on coffee and doughnuts.

Chapter 4 11

Jan. 1 Petty Cash 100

Cash 100

31 Postage Expense 19

Office Supplies Expense 55

Miscellaneous Expense 20

Cash 94

Chapter 4 12

Bank Reconciliations• Deposits in Transit• Outstanding Checks• Deposits Unknown to Firm• Bank Fees• NSF Checks• Errors (on the part of the Bank or Firm)

Chapter 4 13

Categorizing items for the bank reconciliation 

    Found on Bank Stmt(Adjust Cash Ledger) Found on Cash Ledger

(Adjust Bank Balance)

IncreaseInterest EarnedDirect DepositsCompany errors

Deposits in TransitBank Errors

DecreaseService Charges

NSF ChargesDrafts

Company errors

Outstanding Checks

Bank Errors

Chapter 4 14

Bank Reconciliation Illustrated

Chapter 4 15

Bank Reconciliation Journal Entries

Chapter 4 16Chapter 4 16

A NSF check received from a customer is shown on bank reconciliation statement as a(n):

a. addition to the book balance.

b. deduction from the bank balance.

c. deduction from the book balance.

d. addition to the bank balance.

Chapter 4 17Chapter 4 17

A NSF check received from a customer is shown on bank reconciliation statement as a(n):

a. addition to the book balance.

b. deduction from the bank balance.

c. deduction from the book balance.

d. addition to the bank balance.

Chapter 4 18Chapter 4 18

Outstanding checks are shown on bank reconciliation statement as a(n):

a. addition to the book balance.

b. deduction from the bank balance.

c. deduction from the book balance.

d. addition to the bank balance.

Chapter 4 19Chapter 4 19

Outstanding checks are shown on bank reconciliation statement as a(n):

a. addition to the book balance.

b. deduction from the bank balance.

c. deduction from the book balance.

d. addition to the bank balance.

Chapter 4 20Chapter 4 20

The journal entry to record bank charges for printing checks includes a:

a. debit to Cash.

b. credit to Accounts Payable.

c. debit to Miscellaneous Expense.

d. credit to Miscellaneous Expense.

Chapter 4 21Chapter 4 21

The journal entry to record bank charges for printing checks includes a:

a. debit to Cash.

b. credit to Accounts Payable.

c. debit to Miscellaneous Expense.

d. credit to Miscellaneous Expense.

Chapter 4 22

Short-Term Investments

• Companies need to hold an adequate amount of cash to meet current obligations, but do not generally want to hold significantly more cash than will be needed.

• Companies often make short-term investments of excess cash in the stocks and bonds of other companies.

• These investments are referred to as available-for-sale securities.

• Available-for-sale securities are shown on on the balance sheet at fair market value rather than cost.

• Such an adjustment requires an end-of-period adjusting entry to record a gain or loss relative to the investment cost.

Chapter 4 23

Adjusting Entries for Available-for-Sale Securities

Assume Caliope Co. purchased $2,500 of stock in Orleans Corp. in November 2009. By Dec. 31, 2009, the stock was worth $2,200. Caliope Co. would prepare the following adjusting entry:

Chapter 4 24

Contra Revenue Accounts

•Sales Discounts

•Sales Returns and Allowances

•What are contra revenue accounts?•How and why are they used?

Chapter 4 25

Sales Discounts Illustrated

Assume that Payne Company sells $400 of merchandise with credit terms of 2/10, n/30 to Brenda Joyner on March 1. Payne Company would record the following entry on March 1.

Chapter 4 26

Sales Discounts Illustrated continued

Assume that Brenda Joyner pays the amount due to PayneCompany on March 11. Payne Company would record the following entry:

Chapter 4 27

Sales Discounts Illustrated continued

Assume now that Brenda Joyner pays the amount due to PayneCompany on March 31 instead of March 11. Payne Company would record the following entry:

Chapter 4 28

Sales Returns and Allowances Illustrated

Assume now that on March 4 Brenda Joyner wants to return $100 of merchandise purchased from Payne Company on March 1. Payne Company records the following journal entry on March 4.

Mar. 4 Sales Returns and Allowances 400

Accounts Receivable-B. Joyner 400

Chapter 4 29

Income Statement Presentation of Contra Revenue Accounts

Sales Returns and Allowances and Sales Discounts are both subtracted from Sales to obtain Net Sales on the income statement.

Following is an example of an income statement with contra revenue accounts.

Chapter 4 30Chapter 4 30

The amount paid to the seller within the discount period on a $1,500 sale on account, with credit terms of 2/10, n/30, and a credit for a return of $300 is:

a. $1,200.

b. $1,176.

c. $1,224.

d. $1,470.

Chapter 4 31Chapter 4 31

The amount paid to the seller within the discount period on a $1,500 sale on account, with credit terms of 2/10, n/30, and a credit for a return of $300 is:

a. $1,200.

b. $1,176.

c. $1,224.

d. $1,470.

Chapter 4 32

Uncollectible AccountsUncollectible Accounts

• Two key activities are associated with a credit sale: making the sale and collecting the resulting receivable.

• Whenever a business decides to extend credit to customers, there is the potential for bad debts.

• When it becomes apparent that a receivable will not be collected, the business should eliminate, or write off, that receivable.

• The two ways to account for bad debt write-offs are the direct write-off method and the allowance method.

Chapter 4 33

Recording Bad Debts

Direct Write-OffEasyNot GAAPViolates MatchingAccurate

Allowance MethodNot so EasyGAAPMatches Expense/RevenueRequires Estimation

Chapter 4 34

Direct Write-Off

Sept. 18 Uncollectible Accounts Expense 300 Accounts Receivable - D. Duck 300To write off account receivable.

NOT GAAP

Chapter 4 35

Allowance Method2010

Aug.10 Accounts Receivable-Kent Pai 2,300Sales 2,300

To record a credit sale in 2010.

Dec 31 Uncollectible Accounts Expense 27,000 Allowance for Uncollectible Accounts 27,000

To record an estimate for bad debts related to 2010 credit sales.

2011Feb. 18 Allowance for Uncollectible Accounts 2,300

Accounts Receivable – Kent Pai 2,300

To write off an accounts receivable in 2011 from a 2010 credit sale.

Chapter 4 36

Reinstating Accounts Receivable

May 15 Accounts Receivable – Saffron Cheng 920Allowance for Uncollectible Accounts 920

To reinstate an account previously written off. May 15 Cash 920

Accounts Receivable – Saffron Cheng 920

To collect a reinstated account previously written off.

Chapter 4 37Chapter 4 37

The entry to write off an account using the allowance method involves a debit to:

a. Uncollectible Accounts Expense.

b. Accounts Receivable.

c. Allowance for Uncollectible Accounts.

d. Sales Discounts.

Chapter 4 38Chapter 4 38

The entry to write off an account using the allowance method involves a debit to:

a. Uncollectible Accounts Expense.

b. Accounts Receivable.

c. Allowance for Uncollectible Accounts.

d. Sales Discounts.

Chapter 4 39Chapter 4 39

The Allowance for Uncollectible Accounts is classified as a:

a. liability account.

b. contra asset account.

c. contra liability account.

d. stockholders’ equity account.

Chapter 4 40Chapter 4 40

The Allowance for Uncollectible Accounts is classified as a:

a. liability account.

b. contra asset account.

c. contra liability account.

d. stockholders’ equity account.

Chapter 4 41Chapter 4 41

1. Prepare the entry on December 15, 2009, to record a sale on account for $5,000 to June DeLucas.

2. Prepare the entry on March 31, 2010, to write off the account in full for June DeLucas using the allowance method.

Chapter 4 42

2009

Dec. 15 Accounts Receivable-J. DeLucas 5,000

Sales 5,000

2010

Mar. 31

Allowance for Uncollectible Accounts 5,000

Accounts. Receivable-J. DeLucas 5,000

Chapter 4 43

Credit Card Receivables Feb. 20 Credit Cards Receivable 6,000

Sales Revenue 6,000

To record Visa sales.

What are the costs and benefits of accepting credit cards?

Feb. 22 Cash 5,850 Credit Card Expense 150 Credit Cards Receivable 6,000

To record Visa deposit and related service charge.

Chapter 4 44

Financial RatiosFinancial ratios are measures that express the relationship or interrelationships between, or among, two or more financial statement items.

Liquidity refers to an entity's ability to finance its day-to-day operations and to pay its liabilities as they mature.

Quick assets generally include cash and cash equivalents, short-term investments, and the net amount of current notes and accounts receivable.

Chapter 4 45

Relevant Financial Ratios

Quick ratio = Quick Assets ÷ Current Liabilities

A/R turnover ratio = Net credit sales ÷ Average A/R

Age of receivables = 360 days ÷ A/R turnover ratio

Chapter 4 46

Alternative Method for A/R Turnover

One Day’s Sales = Sales ÷ 360 days

A/R turnover = Average A/R ÷ One Day’s Sales

Chapter 4 47

Turnover Example

Chapter 4 48Chapter 4 48

Compute the quick ratio for MamaMia Soup Company for Year 1 and Year 2 based on the following information.

Year 1 Year 2

Cash $ 94 $ 63

Short-term investments 2 7

Accounts receivable (net) 578 646

Inventory 786 904

Property, plant & equipment (net) 2,401 2,265

Current liabilities 1,465 1,851

Long-term liabilities 1,338 1,343

Chapter 4 49Chapter 4 49

Year 1Quick ratio = Quick Assets/Current Liabilities = ($94 + 42 + $578)/$1,465

= $674/$1,465 = .46

Year 2 Quick ratio = Quick Assets/Current Liabilities = ($63 + $7 + $646)/$1,851

= $716/$1,851 = .39

Chapter 4 50Chapter 4 50

THE END!