CASH AND CASH EQUIVALENTS(NOTES)

1. Cash connotes more than money.

2. Cash includes money and any other negotiable instrument that is payable in money and acceptable by the bank for deposit and immediate credit.
3. Postdated checks received cannot be considered as cash yet.
4. To be reported as “cash”, an item must be unrestricted in use.
5. Classification of Items:

Cash on Hand Cash in Bank Cash Fund Short-Term Investment Long-Term Investment
 Undeposited collections  Demand deposit  Petty cash fund  Cash held as compensating  Cash held as compensating
 Customers’ check  Checking account o Accommodation check balance – If loan is short-term balance – If loan is long-term
 Cashier’s or manager’s checks o Replenishment check  TB, TD, or MMI – if the term is  Cash for noncurrent operations:
 Traveler’s checks  Payroll fund more than three months but o Sinking fund
 Bank drafts  Dividend fund within one year o Preference share
 Money orders  Travel fund redemption fund
 Compensating balance not  Interest fund o Contingent fund
legally restricted  Tax fund o Insurance fund
o Fund for acquisition of
PPE
 TB, TD, or MMI – if the term
is more than one year
6. Cash equivalents are short-term highly liquid investments that are readily convertible into cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates.

Only highly liquid investments that are acquired three months before maturity can qualify as cash equivalents.
7. Examples of cash equivalents
 Three-month BSP treasury bill (TB)
 Three-year BSP treasury bill purchased three months before date of maturity
 Three-month time deposit (TD)
 Three-month money market instruments (MMI) or commercial paper
 Preference shares with specified redemption date acquired three months before redemption date

If the term of TB, TD, or MMI is more than three months but within one year such investments are classified as Short-Term Investment (presented separately as current asset) or if more than one year, such investments are
classified as Long Term Investment (non-current asset).

8. Equity securities cannot qualify as cash equivalents because shares do not have a maturity date. (Exception: Preference shares with redemption date)
9. Measurement of cash: At face value
If foreign currency – At the current exchange rate
 Deposits in foreign currency which are not subject to any foreign exchange restriction are included in cash

IA1 NOTES BY RLR 1

  Deposits in foreign currency which are subject to any foreign exchange restriction, if material, are classified separately among noncurrent assets and the restriction clearly indicated
If the bank or financial institution holding the funds of an entity is in bankruptcy or financial difficulty – At estimated realizable value
10. Classification of cash fund as current or noncurrent should parallel the classification of the related liability (e.g., sinking fund that is set aside to pay a bond payable already due within one year after the end of reporting
period)
Exception: Cash fund set aside for the acquisition of a noncurrent asset should be classified as noncurrent regardless of the year of disbursement.
11. Bank overdraft – When the cash in bank account has a credit balance
Classification: Current liability and should not be offset against other bank accounts with debit balances
Exception: When an entity maintains two or more accounts in one bank and one account results in an overdraft, such overdraft can be offset against the other bank account with a debit balance in order to show cash, net of
bank overdraft or bank overdraft, net of other bank account.
12. Compensating balance generally take the form of minimum checking or demand deposit account balance that must be maintained in connection with a borrowing arrangement with a bank.
Classification:
 If not legally restricted as to withdrawal (informal compensating balance agreement) – Part of cash
 If legally restricted because of formal compensating balance agreement:
o Short-term investment – If the loan is short-term
o Long-term investment - If the loan is long-term
13. Undelivered or unreleased check is one that is merely drawn and recorded but not given to the payee before the end of reporting period.
Treatment: Added back to cash if payor
14. Postdated check delivered is a check drawn, recorded and already given to the payee but it bears a date subsequent to the end of reporting period.
Treatment: Added back to cash if payor
15. Stale check or check long outstanding is a check not encashed by the payee within a relatively long period of time.
Treatment: Added back to cash if payor
16. “Cash short or over” account is a temporary or suspense account to recorded the cash shortage or overage.
17. Imprest system is a system of control of cash which requires that all cash receipts should be deposited intact and all cash disbursements should be made by means of check.
18. Petty cash fund is money set aside to pay small expenses which cannot be paid conveniently by means of check.
19. Method of handling Petty Cash:
a. Imprest fund system
b. Fluctuating fund system
20. Accounting procedures

Transactions Imprest Fund System Fluctuating Fund System

1. Establishment of fund Petty cash fund xx Petty cash fund xx
Cash in bank xx Cash in bank xx
2. Payment of expenses No formal journal entries are made Expenses xx
Petty cash fund xx
3. Replenishment of petty cash payments Expenses xx Petty cash fund xx
Cash in bank xx Cash in bank xx
4. Adjustment for unreplenished expenses at the end Expenses xx No adjusting is necessary.
of the accounting period Petty cash fund xx
(To be reversed at the beginning of the next accounting period)

IA1 NOTES BY RLR 2

5. Increase in fund Petty cash fund xx Petty cash fund xx
Cash in bank xx Cash in bank xx
6. Decrease in fund Cash in bank xx Cash in bank xx
Petty cash fund xx Petty cash fund xx

IA1 NOTES BY RLR 3

 BANK RECONCILIATION(NOTES)
1. Three kinds of bank deposits:
a. Demand Deposit – is the current account or checking account or commercial deposit where deposits are covered by deposit slips and where funds are withdrawable on demand by drawing check against the bank. It
is noninterest bearing.
b. Saving Deposit – the depositor is given a passbook upon the initial deposit. The passbook is required when making deposits or withdrawals. It is interest bearing.
c. Time Deposit - is evidenced by a formal agreement embodied in an instrument called certificate of deposit. It is interest bearing.
2. Bank reconciliation is a statement which brings into agreement the cash balance per book and cash balance per bank.
3. Canceled checks are the checks issued by the depositor and paid by the bank during the month.
4. Reconciling items:
 Book reconciling items:
o Credit memos (CM) – refer to items not representing deposits credited by the bank to the account of the depositor but not yet recorded by the depositor as cash receipts.
 Example: Notes receivable collected by bank in favor of the depositor, proceeds of bank loan, and matured time deposits
o Debit memos (DM) – refer to items not representing checks paid by the bank which are charged or debited by the bank to the account of the deposit but not yet recorded by the depositor as cash
disbursement
 Example: NSF or no sufficient fund checks, DAIF, technically defective checks, bank service charges, and reduction of loan
o Errors – refer to errors committed by the depositor in its books
 Bank reconciling items:
o Deposits in transit (DIT) – are collections already recorded by the depositor as cash receipts but not yet reflected on the bank statement
 Example: Collection already forwarded to the bank for deposit but too late to appear in the bank statement and undeposited collections or those still in the hands of the depositor
o Outstanding checks (OC) – are checks already recorded by the depositor as cash disbursement but not yet reflected on the bank statement
 Example: Checks drawn and already given to payee but not yet present for payment, certified checks (one where the bank has stamped on its face the word accepted or certified indicating
sufficiency of fund)
o Errors – refer to errors committed by the bank
5. Forms of bank reconciliation
Adjusted Balance Method Book to bank method Bank to book method
Unadjusted Book balance xx Unadjusted Book balance xx Unadjusted Bank balance xx
Add: Credit memos xx Add: Credit memos xx Add: Debit memos xx
Total xx Add: Outstanding checks xx Add: Deposit in transit xx
Less: Debit memos xx Total xx Total xx
Adjusted book balance xx Less: Deposit in transit xx Less: Outstanding checks xx
Less: Debit memos xx Less: Credit memos xx
Unadjusted Bank balance xx Unadjusted Bank balance xx Unadjusted Book balance xx
Add: Deposit in transit xx
Total xx
Less: Outstanding checks xx
Adjusted book balance xx

IA1 NOTES BY RLR 4

6. Book reconciling items require adjusting entries on the book of depositor.
7. Errors will have to be analyzed for proper treatment. They are reconciling items of the party which committed them.
8. Cash balance per ledger/book = Unadjusted balance per book
9. Cash balancer per bank statement = Unadjusted balance per bank

IA1 NOTES BY RLR 5


1. Relevant formulas in two-date bank reconciliation
Computation of book balance
Balance per book – beg. of month xx
Add: Book debits during the month xx
Total
Less: Book credits during the month xx
Balance per book – end of month xx
PROOF OF CASH(NOTES)
Computation of bank balance Computation of DIT Computation of OC
Balance per bank – beg. of month xx Deposit in Transit – beg. of month xx Outstanding checks – beg. of month xx
Add: Bank credits during the month xx Add: Cash receipts deposited Add: Checks drawn by depositor
xx Total xx during the month (Note 3) xx during the month (Note 5) xx
Less: Bank debits during the month xx Total deposits to be acknowledged Total checks to be paid by bank xx
Balance per bank – end of month xx by bank xx Less: Checks paid by bank
Less: Deposits acknowledged by during month (Note 6) xx
bank during month (Note 4) xx Outstanding checks – end of monthxx
Deposit in Transit – end of month xx

2. Definitions:
a. Book debits refer to cash receipts or all items debited to the cash in bank account
b. Book credits refer to cash disbursement or all items credited to the cash in bank account
c. Bank credits refer to all items credited to the account of the depositor which include deposits acknowledged by bank and credit memos
d. Bank debits refer to all items debited to the account of the depositor which include checks paid by bank and debit memos
3. All items debited to the cash in bank account which do not represents deposits should be deducted from the book debits total to arrive at the cash receipts deposited. (e. g., prior month credit memo)
4. All items credited to the depositor’s account which do not represent deposits should be deducted from the bank credits to determine the deposits acknowledged by bank. (e. g., current month credit memo)
5. All items not representing checks credited to the cash in bank account should be deducted from the book credits total to arrive at the checks drawn by the depositor. (e. g., prior month debit memo)
6. All items debited to the account of the depositor not representing checks paid should be deducted from the bank debits total to arrive at the checks paid by bank. (e. g., current month debit memo)
7. Proof of cash is an expanded reconciliation in that it includes proof of receipts and disbursements.
8. Three forms of proof of cash:
a. Adjusted balance method
b. Book to bank method – The same as bank reconciliation. Start with unadjusted balance per book to unadjusted balance per bank.
c. Bank to book method – The same as bank reconciliation. Start with unadjusted balance per bank to unadjusted balance per book.
9. For detailed notes on proof of cash you may refer to the comments on pages 78 to 80.

ACCOUNTS RECEIVABLE(NOTES)
1. Receivables are financial assets that represent a contractual right to receive cash or another financial asset from another entity.
a. Trade receivables refer to claims arising from sale of merchandise or services in the ordinary course of business.

IA1 NOTES BY RLR 6

 i. Accounts receivable/Customers’ accounts/Trade debtors/Trade accounts receivable are open accounts arising from the sale of goods and services in the ordinary course of business and not supported by
promissory notes.
ii. Notes receivable are those supported by formal promises to pay in the form of notes.
b. Nontrade receivables represent claims arising from sources other than the sale of merchandise or services in the ordinary course of business.
2. Classification of Receivables

Current asset Noncurrent asset

1. Trade receivables – expected to be realized in cash within the normal operating cycle or one year,  Nontrade receivables – if collectible beyond one year
whichever is longer o Advances to receivables from shareholders, directors, officers or employees, if collectible
in one year
o Advances to affiliates
o Special deposits on contract bids
2. Nontrade receivables – expected to be realized in cash within one year, the length of the operating
cycle notwithstanding
o Advances to receivables from shareholders, directors, officers or employees, if collectible
in one year
o Advances to supplier for the acquisition of merchandise
o Subscription receivable collectible within one year, otherwise deduction from Subscribed
Share Capital (equity)
o Creditors accounts
o Special deposits on contract bids, if collectible currently
o Accrued Income
 Dividend receivable
 Accrued rent receivable
 Accrued interest receivable on bond investment
 Accrued royalties receivable
o Claims receivable
 Claims against common carriers for losses or damages
 Claim for rebates and tax refunds
 Claim from insurance entity
3. Customers’ credit balances are credit balances in accounts receivable resulting from overpayments, returns and receivable from overpayments, returns and allowances, and advance payments from customers.
Classification: Current liabilities and are not offset against the debit balances in other customers’ accounts, except when the same is not material.

4. Initial measurement of AR: Fair value (transaction price/fair value of the consideration given) plus transaction costs that are directly attributable to the acquisition.
5. Subsequent measurement of AR: Amortized cost (long-term receivable) or Net realizable value (short-term receivable)
o Net realizable value (NRV) of accounts receivable is the amount of cash expected to be collected or the estimated recoverable amount.
6. In estimating the NRV of trade account receivable, the following deductions are made:
a. Allowance for freight charge – In case the term is FOB destination and freight collect

To record the sale Upon collection

Accounts receivable xx Cash xx
IA1 NOTES BY RLR 7
 Freight out xx Allowance for freight charge xx
Sales xx Accounts receivable xx
Allowance for freight charge xx
b. Allowance for sales return – To record probability that some customers will return goods that are unsatisfactory

To recognize probable return

Sales return xx
Allowance for sales return xx
c. Allowance for sales discount – In case the entity offers cash discounts to credit customers by reason of prompt payment (e. g., 5/10, n/30)
 Gross method – The accounts receivable and sales are recorded at gross amount of the invoice.
 Net method – The accounts receivable and sales are recorded at net amount of the invoice.

Transaction Gross method Net method

Sale of merchandise for P100,000 Accounts receivable 100,000 Accounts receivable 95,000
Terms: 5/10, n/30 Sales 100,000 Sales 95,000

Collection made within the discount period Cash 95,000 Cash 95,000
Sales discount 5,000 Accounts Receivable 95,000
Accounts Receivable 100,000
Assume collection is made beyond the discount period Cash 100,000 Cash 100,000
Accounts Receivable 100,000 Accounts Receivable 95,000
Sales discount forfeited ** 5,000
** Sales discount forfeited accounts is classified as other income.

To recognize expected sales discount

Sales discount xx
Allowance for sales discount xx
d. Allowances for doubtful accounts
 Allowance method – requires recognition of a bad debt loss if the accounts are doubtful of collection. It conforms with the matching principle.
 Direct write off method – requires recognition of a bad debt loss only when the account proved to be worthless or uncollectible

Transaction Allowance method Direct write off method

Accounts of P30,000 are considered doubtful of collection Doubtful accounts 30,000 No entry
Allowance for doubtful accounts 30,000
The accounts are subsequently discovered to be worthless or Allowance for doubtful accounts 30,000 Bad debts 30,000
uncollectible Accounts Receivable 30,000 Accounts Receivable 30,000
Recovery of accounts written off Accounts Receivable 30,000 Accounts Receivable 30,000
Allowance for doubtful accounts30,000 Bad debts *** 30,000

Cash 30,000 Cash 30,000

Accounts Receivable 30,000 Accounts Receivable 30,000
*** If the recovery is subsequent to the year of writeoff, the recovery may simply be credited to other income.
IA1 NOTES BY RLR 8
7. Terms related to freight charge:
a. FOB destination – means that ownership of the goods purchased is vested in the buyer upon receipt thereof. The seller is responsible for the freight charge up to the point of destination
b. FOB shipping point – means that ownership of the goods purchased is vested in the buyer upon shipment thereof. It is incumbent upon the buyer to pay for the transportation charge from the point of shipment to the
point of destination
c. Freight collect – means that freight charge on goods shipped is not yet paid. The common carrier shall collect the same from the buyer.
d. Freight charge – means that freight charge on the goods shipped is already paid by the seller.
8. Treatment of Doubtful accounts in the income statement:
a. Distribution cost – if the granting of credit and collection of accounts are under the charge of the sales manager
b. Administrative cost – if the granting of credit and collection of accounts are under the charge of an officer other than sales manager

IA1 NOTES BY RLR 9

 ESTIMATION OF DOUBTFUL ACCOUNTS(NOTES)
1. Methods of estimating doubtful accounts:
a. Aging of AR or “Statement of Financial Position Approach”
 Involves an analysis where the accounts are classified into not due or past due
 Amount computed: Required allowance of doubtful accounts at the end of the period
 Pros:
 More accurate and scientific computation of allowance for doubtful accounts
 It has the advantage of presenting fairly the accounts receivable in the statement of financial position at NRV
 Cons:
 It violates the matching process
 Time consuming if a large number or accounts are involved
b. Percent of AR or also “Statement of Financial Position Approach”
 A certain rate of multiplied by the open accounts at the end of the period to get the required allowance balance
 Amount computed: Required allowance of doubtful accounts at the end of the period
 Pros:
 Presents the accounts receivable at NRV
 Simple apply
 Cons:
 It violates the principle of matching bad debt loss against the sales revenue
 Loss experience rate may be difficult to obtain and may not be reliable
c. Percent of sales or “Income Statement approach”
 The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts expense
 The rate to be used is computed by dividing the bad debt losses in prior years by the charge sales of prior years
 Amount computed: Doubtful expense for the period
 Pros:
 Eliminates the extra work of making a record of cash sales and credit sales
 Proper matching of cost against revenue is achieved
 Cons:
 May prove unsatisfactory when there is a considerable fluctuation in the proportion of cash and credit sales periodically
 The AR may not be shown at estimated NRV because the allowance for doubtful accounts may prove excessive or inadequate
2. Debit balance in allowance account – Occur when the entity has a policy of adjusting the allowance at the end of the period and record accounts written off during the year.

IA1 NOTES BY RLR 10

 NOTES RECEIVABLE(NOTES)
1. Notes receivables are claims supported by formal promises to pay usually in the form of notes. It represents only claims arising from sale of merchandise or service in the ordinary course of business.
2. Negotiable promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed determinable future time a sum certain in money to order or
to bearer.
a. Maker is the one who promises to pay another person
b. Payee is the one being paid
3. Dishonored notes are notes not paid upon maturity. These are removed from notes receivable and transferred to accounts receivable at face amount plus interest and other charges.
4. Initial measurement:
o Short-term notes receivable - At face value
o Interest-bearing long-term notes - At face value
o Noninterest-bearing long-term notes - At present value
 Present value is the sum of all future cash flows discounted using the prevailing market rate of interest for similar notes
 Equivalent to cash sales price if given
 If no cash sales price, use PV factor
 PV factor of ordinary annuity - if the payment is on equal installments
 PV of 1 – if payment is lump sum
 How to get PV factor of ordinary annuity using manual calculator:
 Example: PV factor of an ordinary annuity of 1 for three periods at 10%
o Type 1.10
o Press “” twice
o Then press “=” three times representing the number of periods
o Deduct one (1)
o Divide by the rate (.10)
o Then multiply by -1 or simple press “+/-” key
o Answer is 2.4869 (round to four decimal places)
o Now try PV factor of an ordinary annuity of 1 for nine periods at 8%. Answer should be 6.2469
 How to get PV factor of 1 using manual calculator:
 Example: PV factor of 1 for three years at 10%
o Type 1.10
o Press “” twice
o Then press “=” three times representing the number of years
o Answer is 0.7513 (round to four decimal places)
o Now try PV factor of 1 for nine years at 8%. Answer should be 0.5002
 Prevailing market rate of interest is actually the effective interest rate

IA1 NOTES BY RLR 11

5. Subsequent measurement: Long-term notes receivable - At amortized cost
o Interest-bearing long-term notes
 Amortized cost is the amount at which the note receivable is measured initially:
 Minus principal repayment
 Plus/Minus cumulative amortization if any difference between the initial carrying amount and the principal maturity amount
 Minus reduction for impairment or uncollectibility
o Noninterest-bearing long-term notes
 Amortized cost is the present value plus amortization of the discount, or the face value minus the unamortized unearned interest income
6. When interest is “compounded”, it means that any accrued interest receivable also earns interest.
7. Unearned interest income (UII) = Discount on note receivable
 UII upon issuance of the note = Face of noninterest bearing note minus its present value
8. Do not include in the computation of present value any installment payment to be received on the date of the transaction. The present value of such installment payment should only be 1. (See Problem 6-8)
9. Effective interest method
a. Equal annual installments

Date Annual Collection (a) Interest Income (b) Principal (c) Present value (d)
b = d times EIR* c=a-b d1 = d0 - c
* Effective Interest Rate (EIR)
** d0 – Present value at the beginning
*** d1 – Present value / Carrying amount after one year
b. Lump sum payment

Date Interest Income (a) Unearned Interest Income (b) Present value (c)
a = c times EIR* b1 = b0 - a c1 = c0 + a
* Effective Interest Rate (EIR)
** c0 – Present value at the beginning
*** c1 – Present value / Carrying amount after one year
10. Interest income = Interest revenue
11. Proforma entry in amortizing UII
Unearned interest income xx
Interest income xx

IA1 NOTES BY RLR 12

 LOAN RECEIVABLE(NOTES)
1. Loan receivable is a financial asset arising from a loan granted by a bank or other financial institution to a borrower or client
2. Initial measurement: At fair value plus transaction costs that are directly attributable to the acquisition of the financial asset
 Transaction costs include direct origination costs (DOC)
 Indirect origination costs should be treated as outright expense
3. Subsequent measurement: At amortized cost using effective interest method
o Amortized cost is the amount at which the loan receivable is measured initially:
 Minus principal repayment
 Plus/Minus cumulative amortization if any difference between the initial carrying amount and the principal maturity amount
 If Initial carrying amount < principal amount – amortization of the difference is added to the carrying amount
 If Initial carrying amount > principal amount – amortization of the difference is deducted to the carrying amount
o You just need to remember that the goal is to arrive at the principal amount
 Minus reduction for impairment or uncollectibility
4. Origination fees (OF) – are fees charged by the bank against the borrower for the creation of the loan. These include:
a. Evaluating the borrower’s financial condition
b. Evaluating guarantees, collateral and other security
c. Negotiating the terms of the loan
d. Preparing and processing the documents related to the loan
e. Closing and approving the loan transaction
Treatment of OF: Recognized as UII and amortized over the term of the loan
5. Direct Origination Costs (DOC) – origination fees which are not chargeable against the borrower.
Treatment of DOC: Deferred and amortized over the term of the loan.
6. Preferably, DOC is offset against any unearned OF received.
 If OF > DOC - Difference is UII and amortization will increase interest income
 If OF < DOC - Difference is charged to “direct origination costs” and the amortization will decrease interest income
7. Effective interest method
a. Equal annual installments

Date Interest received(a) Interest Income (b) Amortization (c) Carrying Amount (d)
a = principal times nominal rate b = d times EIR* c=a-b d1 = d0 - c
* Effective Interest Rate (EIR)
** d0 – Present value at the beginning
*** d1 – Present value / Carrying amount after one year
8. The carrying amount is actually the amortized cost.
9. Impairment of loan

IA1 NOTES BY RLR 13