7-1

Topic 3: Cash, accounts

receivables and short-term
investments

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7-1

Learning resources
 Williams, Bettner, Carcello, Financial and
managerial accounting – The basis for
business decision (19th edition),
McGraw-Hill, 2021, Chapter 7
 End of chapter self-test questions, exercies,
discussion questions, problems...
 Other resources:
◦ Other accounting textbooks
◦ Online English dictionaries

7-2
 7-2

Learning Objectives

 Describe the objectives of cash management and internal

controls over cash.
 Prepare a bank reconciliation and explain its purpose.
 Describe how short-term investments are reported in the
balance sheet and account for transactions involving marketable
securities.
 Account for uncollectible receivables using the allowance and
direct write-off methods.
 Explain, compute, and account for notes receivable and interest
revenue.

7-3

How Much Cash Should a

Business Have?

7-4
 7-3

Cash
Coins and
paper Cash is Checks
money
defined as
any deposit
Bank credit banks will
Money orders
card sales accept.

Travelers’ checks

7-5

Reporting Cash in the Balance

Sheet
Cash
Equivalents

Restricted
Cash

Lines of
Credit

7-6
 7-4

Cash Equivalents
 To qualify as a cash equivalent, an investment
must:
◦ Be very safe.
◦ Have a very stable market value.
◦ Mature within 90 days of the date of
acquisition.
 Examples include:
◦ Money market funds.
◦ U.S. Treasury Bills.
◦ High grade commercial paper.
7-7

Restricted Cash
 Restricted cash refers to a bank balance that is
not available to meet the normal operating
needs of the company.
 Examples of restricted cash might include:
◦ Cash specifically earmarked for the repayment
of a noncurrent liability.
◦ Cash meant to serve as a compensating
balance.
KEY POINT
Restricted cash should be presented in the balance sheet as part of
the section entitled “Investments and Restricted Funds.”

7-8
 7-5

Lines of Credit
 A line of credit means that bank has agreed in
advance to lend the company any amount of
money up to a specified limit.
 The company can borrow this money at any
time simply by drawing checks on a special bank
account.
 A liability to the bank arises as soon as a
portion of the credit line is used.
KEY POINT
An unused line of credit increases a company’s liquidity. Therefore, it
is generally disclosed in the notes to the financial statements.

7-9

Cash Management
 Accurately account for cash.
 Prevent theft and fraud.
 Assure the availability of adequate
amounts of cash.
 Prevent unnecessarily large amounts of
idle cash.

7-10
 7-6

Internal Control Over Cash

• Segregate authorization, custody and
recording of cash.
• Prepare a cash budget (or forecast).
• Prepare a control listing of cash receipts.
• Require daily deposits.
• Make all payments by check.
• Require that every expenditure be
verified before payment.
• Promptly reconcile bank statements.
7-11

Cash Over and Short

Assume that on May 5, total cash sales
were $4,500. However, cash receipts in the
register drawer were counted
and total only $4,485.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

May 5 Cash Over and Short 15
Cash 15
To record a shortage in cash receipts for the day.

Cash Over and Short is debited for

shortages and credited for overages.
7-12
 7-7

Reconciling the Bank Statement

Explains the difference between cash

reported on bank statement and cash
balance in depositor’s accounting
records.

Provides information for

reconciling journal entries.

7-13

Differences between Bank and

Accounting Records
 Certain transactions recorded by the depositor may not
have been recorded by the bank. The most common
examples are:
◦ Outstanding checks. Checks issued and recorded by
the company but not yet presented to the bank for
payment.
◦ Deposits in transit. Cash receipts recorded by the
depositor that reached the bank too late to be
included in the bank statement for the current
month.

7-14
 7-8

Bank Statement Example

7-15

Other Reconciling Items

In addition, certain transactions appearing in the
bank statement may not have been recorded by
the depositor. For example:
◦ Service charges. Banks often charge a fee for
handling small accounts. The amount of this
charge usually depends on both the average
balance of the account and the number of
checks paid during the month.

7-16
 7-9

Other Reconciling Items (cont.)

◦ Charges for depositing NSF checks. NSF stands for Not
Sufficient Funds. When checks from customers are
deposited, the bank generally gives the depositor
immediate credit. On occasion, one of these checks
may prove to be uncollectible, because the customer
who wrote the check did not have sufficient funds in
his or her account. In such cases, the bank will reduce
the depositor’s account by the amount of this
uncollectible item and return the check to the
depositor marked NSF. The depositor should view an
NSF check as an account receivable from the
customer, not as cash.

7-17

Other Reconciling Items (concluded)

◦ Credits for interest earned. Checking accounts may earn
interest. At month-end, this interest is credited to the
depositor’s account and reported in the bank
statement.
◦ Miscellaneous bank charges and credits. Banks charge
for services—such as printing checks, handling
collections of notes receivable, and processing NSF
checks. The bank deducts these charges from the
depositor’s account and notifies the depositor by
including a debit memorandum in the monthly bank
statement. If the bank collects a note receivable on
behalf of the depositor, it credits the depositor’s
account and issues a credit memorandum.

7-18
 7-10

Steps in Preparing a Bank Reconciliation

The specific steps in preparing a bank reconciliation are as
follows.
1. Compare deposits listed in the bank statement with
the deposits shown in the accounting records. Any
deposits not yet recorded by the bank are deposits
in transit and should be added to the balance shown
in the bank statement.
2. Compare checks paid by the bank with the
corresponding entries in the accounting records.
Any checks issued but not yet paid by the bank
should be listed as outstanding checks to be
deducted from the balance reported in the bank
statement.
7-19

Steps in Preparing a Bank Reconciliation (cont.)

3. Add to the balance per the depositor’s accounting
records any credit memoranda issued by the bank that
have not been recorded by the depositor.
4. Deduct from the balance per the depositor’s records
any debit memoranda issued by the bank that have not
been recorded by the depositor.
5. Make appropriate adjustments to correct any errors in
either the bank statement or the depositor’s
accounting records.
6. Determine that the adjusted balance of the bank
statement is equal to the adjusted balance in the
depositor’s records.
7. Prepare journal entries to record any items in the bank
reconciliation listed as adjustments to the balance per
the depositor’s records.
7-20
 7-11

Reconciling the Bank Statement

Balance per Bank Balance per Depositor

+ Deposits by Bank
+ Deposits in Transit
(credit memos)

- Service Charge
- Outstanding Checks
- NSF Checks

± Bank Adjustments ± Book Adjustments

= Adjusted Balance = Adjusted Balance

7-21

Reconciling the Bank Statement

• The July 31 bank statement for Parkview Company indicated
a cash balance of $5,000.17.
• The cash ledger account on that date shows a balance of
$4,262.83.
• Four outstanding checks totaled $717.75.
• A $410.90 deposit made after banking hours on July 31 does
not appear in the bank statement.
• On July 30, the bank returned J.B. Ball’s NSF check for
$50.25, received as payment of an account receivable.
• The bank statement showed $24.74 interest earned on the
bank balance for the month of July. The bank collected a
non-interest bearing note on July 22 for $500 and charged a
$5 collection fee.
• Check 893 for telephone expenses cleared the bank for $85
but was erroneously recorded in our books as $58.
• The bank charged a July service charge of $12.00.
7-22
 7-12

Reconciling the Bank Statement

7-23

Reconciling the Bank Statement

7-24
 7-13

Short-Term Investments
Capital
Bond
Stock
Investments
Investments
Marketable
Securities
Readily are . . . Current Assets
Marketable

Almost As
Liquid As
Cash
7-25

Accounting for Marketable Securities

(1) The purchase of investments

(2) The receipt of dividends
(3) The sale of investments
(4) End-of-period adjustments.

7-26
 7-14

Purchase of Marketable
Securities
Foster Corporation purchases as a short-term
investment 4,000 shares of The Coca-Cola
Company on December 1. Foster paid $48.98
per share, plus a brokerage commission of $80.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec 1 Marketable Securities 196,000
Cash 196,000
Total Cost: (4,000 × $48.98) + $80 = $196,000
Cost per Share: $196,000 ÷ 4,000 = $49.00
7-27

Recognition of Investment
Revenue
On December 15, Foster Corporation
receives a $0.30 per share dividend on its
4,000 shares of Coca-Cola.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec 15 Cash 1,200
Dividend Revenue 1,200

4,000 × $0.30 = $1,200

7-28
 7-15

Sales of Investments at a Gain

On December 18, Foster Corporation sells 500
shares of its Coca-Cola stock for $50.04 per
share, less a $20 brokerage commission.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec 18 Cash 25,000
Marketable Securities 24,500
Gain on Sale of Investment 500
Sales Proceeds: (500 × $50.04) - $20 = $25,000
Cost Basis: 500 × $49 = $24,500
Gain on Sale: $25,000 - $24,500 = $500
7-29

Sales of Investments at a Loss

On December 27, Foster Corporation sells an
additional 2,500 shares of its Coca-Cola stock
for $48.01 per share, less a $25 brokerage fees.

Date Account Titles and Explanation Debit Credit

Dec 27 Cash 120,000
Loss on Sale of Investment 2,500
Marketable Securities 122,500

Sales Proceeds: (2,500 × $48.01) - $25 = $120,000

Cost Basis: 2,500 × $49 = $122,500
Loss on Sale: $120,000 - $122,500 = $2,500
7-30
 7-16

Adjusting Marketable Securities

to Market Value
On December 31, Foster Corporation’s remaining shares
of Coca-Cola capital stock have a current market value
of $47,000. Prior to any adjustment, the company’s
Marketable Securities account has a balance of $49,000
(1,000 × $49 per share).

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec 31 Unrealized Holding Loss on Investments 2,000
Marketable Securities 2,000

Unrealized Loss: $47,000 - $49,000 = ($2,000)

7-31

Presentation of Marketable Securities

in the Balance Sheet

7-32
 7-17

Accounts Receivable
 One of the key factors underlying the growth of
the American economy is the trend toward
selling goods and services on credit.
 Accounts receivable comprise the largest
financial asset of many merchandising
companies.
 Accounts receivable are relatively liquid assets,
usually converting into cash within a period of
30 to 60 days.

7-33

Matching Uncollectible Accounts

Expense to the Period in which the
Credit Sale is Made

7-34
 7-18

Reflecting Uncollectible Accounts in

the Financial Statements
To illustrate the matching process, assume that World Famous Toy
Co. begins business on January 1, 2021, and makes most of its sales
on account. At January 31, accounts receivable amount to $250,000.
On this date, the credit manager reviews the accounts receivable and
estimates that approximately $10,000 of these accounts will prove to
be uncollectible. The following adjusting entry should be made at
January 31.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Jan 31 Uncollectible Accounts Expense 10,000
Allowance for Doubtful Accounts 10,000

Selling expense Contra-asset account

7-35

Reporting Accounts Receivable at

Estimated Net Realizable Value

7-36
 7-19

The Allowance for Doubtful

Accounts
The net realizable value is the amount of
accounts receivable that the business
expects to collect.

Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable

7-37

Writing Off an Uncollectible Account Receivable

When an account is determined to be
uncollectible, it no longer qualifies as an asset
and should be written off.
To illustrate, assume that, early in February, World Famous Toy
Co. learns that Discount Stores has gone out of business and
that the $4,000 account receivable from this customer is now
worthless. The entry to write off this uncollectible account
receivable is as follows.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Jan. 5 Allowance for Doubtful Accounts 4,000
Accounts Receivable (Discount Stores) 4,000

7-38
 7-20

Writing Off an Uncollectible

Account Receivable

Before After Write-

Write-Off Off
Accounts receivable $ 250,000 $ 246,000
Less: Allow. for doubtful accts. 10,000 6,000
Net realizable value $ 240,000 $ 240,000

Notice that the $4,000 write-off did not

change the net realizable value nor did it
affect any income statement accounts.

7-39

Monthly Estimates of Credit

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

Two Approaches to Estimating Credit Losses

1. Balance Sheet Approach
2. Income Statement Approach
7-40
 7-21

Estimating Credit Losses — The

Balance Sheet Approach
 Year-end Accounts Receivable is
broken down into age
classifications.

 Each age grouping has a

different likelihood of being
uncollectible.

 Compute a separate allowance

for each age grouping.

7-41

Estimated Dollar Amount of

Uncollectible Accounts

7-42
 7-22

Estimating Credit Losses — The

Balance Sheet Approach
At December 31, the receivables for Valley
Ranch Supply were categorized as follows:

  

7-43

Estimating Credit Losses — The

Balance Sheet Approach
Valley Ranch’s unadjusted Allowance for
balance in the allowance Doubtful Accounts
account is $4,000. 4,000
Per the previous
1,680
computation, the desired
5,680
balance is $5,680.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec. 31 Uncollectible Accounts Expense 1,680
Allowance for Doubtful Accounts 1,680

7-44
 7-23

Estimating Credit Losses — The

Income Statement Approach
Uncollectible accounts’ percentage is based
on actual uncollectible accounts from prior
years’ credit sales.

Net Credit Sales

 % Estimated Uncollectible
Amount of Journal Entry

7-45

Estimating Credit Losses — The

Income Statement Approach
In September,Valley Ranch Supply had credit
sales of $150,000. Historically, 2% of Valley’s
credit sales has been uncollectible. For the
September, the estimate of uncollectible
accounts expense is $600.
($150,000 × .02 = $3,000)

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Sep 30 Uncollectible Accounts Expense 3,000
Allowance for Doubtful Accounts 3,000

7-46
 7-24

Recovery of an Account Receivable Previously Written Off

Subsequent collections require that the original
write-off entry be reversed before the cash
collection is recorded.
Let us assume, for example, that a company wrote
off a $500 account receivable from Brad Wilson on
February 16. The write-off of this account was
recorded as follows.
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Feb 27 Accounts Receivable (Brad Wilson) 500
Allowance for Doubtful Accounts 500

27 Cash 500
Accounts Receivable (Brad Wilson) 500

7-47

Direct Write-Off Method

This method makes no attempt to
match revenues with the expense of
uncollectible accounts.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Feb 16 Uncollectible Accounts Expense 250
Accounts Receivable (Bell Products) 250

7-48
 7-25

Management of Accounts
Receivable
Extending credit encourages customers to
buy from us but it ties up resources in
accounts receivable.

Factoring
Credit Card
Accounts
Sales
Receivable

7-49

Notes Receivable and Interest

Revenue
A promissory note is an unconditional
promise in writing to pay on demand or at
a future date a definite sum of money.

Maker—the person who

signs the note and
thereby promises to pay.
Payee—the person to
whom payment is to be
made.
7-50
 7-26

Simplified Example of Promissory Note

7-51

Notes Receivable and Interest

Revenue
The interest formula includes three
variables:

Interest = Principal × Interest Rate × Time

When computing interest for one year, “Time”

equals 1. When the computation period is less
than one year, then “Time” is a fraction.
For example, if we needed to compute interest for
3 months, “Time” would be 3/12.

7-52
 7-27

Notes Receivable and Interest

Revenue
On December 1, a three-month, 6 percent note
receivable is acquired from a customer, Marvin
White, in settlement of an existing account
receivable of $60,000. The entry for acquisition of
the note is as follows.

7-53

Notes Receivable and Interest

Revenue
On December 1, a three-month, 6 percent note
receivable is acquired from a customer, Marvin
White, in settlement of an existing account
receivable of $60,000. What adjusting entry needs
to be made on Dec. 31 to accrue the interest
earned to date on notes receivable?

Date Description Debit Credit

Dec. 31 Interest Receivable 300
Interest Revenue 300

$60,0006% 1/12 = $300

7-54
 7-28

Notes Receivable and Interest

Revenue
What entry would Valley Ranch Supply
make on March 1, the maturity date?

$60,0006% 2/12 = $600

Date Description Debit Credit
Mar. 1 Cash 60,900
Interest Receivable 300
Interest Revenue 600
Notes Receivable 60,000

7-55

Note Defaults
 A note receivable that cannot be collected at maturity is said to
have been defaulted by the maker.
 The holder of the note transfers the amount due from the Notes
Receivable account to an account receivable from the debtor.
 The amount transferred into Accounts Receivable includes the
principal amount of the defaulted note as well as any interest due.

7-56
 7-29

Financial Analysis and Decision

Making
Accounts Receivable Turnover Rate
This ratio provides useful information for
evaluating how efficient management has
been in granting credit to produce
revenue.

Net Sales
Average Accounts Receivable

7-57

Financial Analysis and Decision

Making

Avg. Number of Days to Collect A/R

This ratio helps judge the liquidity of a
company’s accounts receivable.

Days in Year
Accounts Receivable Turnover Ratio

7-58