Chapter

7 FINANCIAL ASSETS

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?
Every
business
needs
enough

McGraw-Hill/Irwin
$ cash to pay
its bills!
© The McGraw-Hill Companies, Inc., 2002
 How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?

Financial
Assets

Cash Receivables

Short-term
Investments
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?
Collections
from Cash (and cash
customers equivalents) Cash
Accounts payments

receivable
“Excess” Investments
cash is are sold as
invested cash is
temporarily. needed.
Marketable
securities
(short-term
investments)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash
Coins and
paper
money
Cash is Checks

defined as
any deposit
Bank credit
card sales
banks will Money orders
accept.

Travelers’ checks

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Liquid short- Matures

Cash
term within 90 days
Equivalents
investments of acquisition

Stable
market
values

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

“Restricted”
Not a current Cash Listed as an
asset investment

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Lines of
Credit

Liability is Unused line of

incurred when line credit is disclosed
of credit is used. in notes.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Using
Using Excess
Excess Cash
Cash Balances
Balances
Efficiently
Efficiently
Cash available for
Cash not needed for
long-term investment
business purposes
may be used to finance
should be distributed
growth and expansion
to the company’s
of the business, or to
stockholders.
repay debt.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositor’s accounting
records.

Provides information for

reconciling journal entries.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Balance per Bank Balance per Depositor

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

- Service Charge
- Outstanding Checks
- NSF Checks

± Bank Errors ± Book Errors

= Adjusted Balance = Adjusted Balance

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
All reconciling Balance per Depositor

items on the + Deposits by Bank

book side (credit memos)

require an - Service Charge

adjusting - NSF Checks

entry to the ± Book Errors

cash account.
= Adjusted Balance

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
  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 customer’s
customer’s NSF NSF check
check for
for
$225
$225 received
received asas 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 thethe bank
bank for
for $268
$268
but
but was
was erroneously
erroneously recorded
recorded in in our
our books
books asas
$240.
$240.
 AA $486
$486 deposit
deposit byby Acme
Acme Company
Company was was
erroneously
erroneously credited
credited to
to our
our account
account byby the
the bank.
bank.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Reconciling
Reconcilingthe
Reconciling theBank
the BankStatement
Bank Statement
Statement
Example
Example
Balance per bank statement, July 31 $ 9,610
Additions:
Deposit in transit 500
Deductions:
Bank error $ 486
Outstanding checks 2,417 2,903
Adjusted cash balance $ 7,207

Balance per depositor's records, July 31 $ 7,430

Additions:
Interest 30
Deductions:
Recording error $ 28
NSF check 225 253
Adjusted cash balance $ 7,207
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Example
Example
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jul 31 Cash 30
Interest Revenue 30

31 Supplies Inventory 28
Accounts Receivable 225
Cash 253

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Petty
Petty Cash
Cash Funds
Funds
Used for minor
expenditures.

Petty Cash
Funds

Has one Replenished

custodian. periodically.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Almost As
Liquid As
Cash
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Mark-to-Market:
Mark-to-Market: AA New
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
Available for for Held
Held for
forshort-term
short-term Reported
Reported in in stockholders'
stockholders'
sale
sale securities
securities resale
resale (often
(often 66to
to 18
18 equity
equitysection
section of ofthethe
months)
months) balance
balance sheet
sheet
Trading
Trading Held
Held for
forimmediate
immediate Reported
Reported in in "other"
"other"revenue
revenue
securities
securities resale
resale (often
(often within
within (expense)
(expense)section
section of ofthe
the
hours
hoursor ordays)
days) income
income statement
statement
Held
Held to
tomaturity
maturity Debt
Debtsecurities
securities Reported
Reported in in stockholders'
stockholders'
securities
securities intended
intended to to be
be held
held equity
equitysection
section of ofthethe
McGraw-Hill/Irwin until
until they
theymature
mature balance
balance sheet
sheet
© The McGraw-Hill Companies, Inc., 2002
 Let’s turn our
attention to accounts
receivable.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Uncollectible
Uncollectible Accounts
Accounts

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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 ofof the
the uncollectible
uncollectible
accounts.
accounts.

Selling
Sellingexpense
expense Contra-asset
Contra-assetaccount
account
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 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., 2002

 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 bebe
written
written off.
off.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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., 2002

 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.

Let’s see what effect the write-off had on

these accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Before After
Write-Off Write-Off
Accounts receivable $ 10,000 $ 9,500
Less: Allow. for doubtful accts. 2,500 2,000
Net realizable value $ 7,500 $ 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 © The McGraw-Hill Companies, Inc., 2002

 Recovery
Recovery of
of an
an Account
Account Receivable
Receivable
Previously
Previously Written
Written Off
Off
Subsequent
Subsequent collections
collectionsrequire
requirethat
thatthe
theoriginal
originalwrite-off
write-off
entry
entrybe
bereversed
reversed before
beforethe
thecash
cashcollection
collectionis
isrecorded.
recorded.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Accounts Receivable (X Customer) $$$$
Allowance for Doubtful Accounts $$$$

Cash $$$$
Accounts Receivable (X Customer) $$$$

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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 thethe
probable
probable amount
amount of of
uncollectible
uncollectible accounts
accounts
and
and adjust
adjust the
the
Allowance
Allowance forfor Doubtful
Doubtful
Accounts
Accounts to to this
this new
new
estimate.
estimate.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Monthly
Monthly Estimates
Estimates of
of Credit
Credit Losses
Losses
Example
Example
At
At December
December 31,
31, 2003,
2003, MusicLand’s
MusicLand’s 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 MusicLand’s
MusicLand’s Uncollectible
Uncollectible Accounts
Accounts
Expense
Expense for
for 2003?
2003?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Monthly
Monthly Estimates
Estimates of
of Credit
Credit Losses
Losses
Example
Example
Desired balance in Allowance
for Doubtful Accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Let’s
Let’s 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., 2002
 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
“Balance
“Balance Sheet”
Sheet” Approach
Approach

Year-end
Year-end Accounts
AccountsReceivable
Receivableis
is
broken
brokendown
down into
intoage
age
classifications.
classifications.


Each
Eachage
agegrouping
groupinghas
hasaa
different
differentlikelihood
likelihoodof
ofbeing
being
uncollectible.
uncollectible.

Compute
Computeaaseparate
separateallowance
allowancefor
for
each
eachage
agegrouping.
grouping.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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., 2002

 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., 2002

 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., 2002

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
“Balance
“Balance Sheet”
Sheet” Approach
Approach
EastCo’s
EastCo’sunadjusted
unadjustedbalance
balance
in
in the
theallowance
allowance account
account is
is
$500.
$500.
Per
Per the
theprevious
previouscomputation,
computation,
the
thedesired
desired balance
balanceis
is$1,350.
$1,350.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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., 2002
 An
An Alternative
Alternative Approach
Approach toto
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., 2002

 An
An Alternative
Alternative Approach
Approach toto
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., 2002

 An
An Alternative
Alternative Approach
Approach toto
Estimating
Estimating Credit
Credit Losses
Losses
In 2003, EastCo had credit sales of $60,000.

Historically, 1% of EastCo’s 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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 An
An Alternative
Alternative Approach
Approach toto
Estimating
Estimating Credit
Credit Losses
Losses

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Uncollectible
Uncollectible Accounts
Accounts
Summary
Summary
Aging
Agingof
of
%
%of
ofReceivables
Receivables %
% of
of Sales
Sales
Receivables
Receivables
Emphasis
Emphasisonon Emphasis
Emphasisonon Emphasis
Emphasison
on
Realizable
RealizableValue
Value Realizable
RealizableValue
Value Matching
Matching
Accts. Accts. Sales
Rec. All. for Rec. All. for Uncoll.
Doubtful Doubtful Accts.
Accts. Accts. Exp.

Income
Income
Balance
BalanceSheet
Sheet Balance
BalanceSheet
Sheet Statement
Statement
Focus
Focus Focus
Focus Focus
Focus
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Direct
Direct Write-Off
Write-Off Method
Method
This method makes no attempt to
match revenue with the expense of
uncollectible accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Taxable Income

Allowance methods
GAAP
GAAP
GAAP

GAAP

better match expenses

with revenues.

Financial
Statement Income
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 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 write-
write-
offs.
offs.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Management
Management of
of Accounts
Accounts
Receivable
Receivable

Extending credit encourages

Credit Terms
customers to buy from us . . .

. . . but it ties up resources Minimize

in accounts receivable. Accounts
Receivable

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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

Selling Credit
Accounts Card
Receivable Sales

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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 howhow efficient
efficient management
management has has
been
been inin granting
granting credit
credit to
to produce
produce revenue.
revenue.

Net Sales
Average Accounts Receivable

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 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
company’s
company’s accounts
accounts receivable.
receivable.

Days in Year
Accounts Receivable Turnover Ratio

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 End
End of
of Chapter
Chapter 77

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002