Chapter 6

Cash and Accounts

Receivable

Slide 6.1
 Chapter 6 Learning
Objectives
Define the key information needs of decision makers
regarding cash and accounts receivable.
Account for the major types of transactions involving
cash and accounts receivable.
Discuss control activities for cash and accounts
receivable.
Compute and interpret key financial ratios involving
cash and accounts receivable.
Use the aging method to estimate uncollectible
accounts expense.
(Appendix) Prepare a bank reconciliation.

Slide 6.2
 “Cash and cash equivalents” is the most
common balance sheet caption for a company’s
cash resources.

Cash equivalents:
investments in
short-term
securities that have
90 days or less to
maturity when
purchased.

Slide 6.3
 Recognize that accrual-based profits do not
necessarily translate into an equal amount of cash
flows.

Recent Profits and Cash Flows from Operating (Profit-

Oriented) Activities Reported by Control Data:

In thousands

$16,000
$14,000
$12,000 Net Income
$10,000
$8,000
Cash Flows
$6,000
from Profit-
$4,000 Oriented
Activities
$2,000
$0
1995 1996
Note: Control Data develops and markets computer software
and hardware products and services.
Slide 6.4
Cash: Information Needs of
Decision Makers

Cash balances . . . any restrictions

on a firm’s cash resources
should be disclosed
Cash-flow information
Cash flow forecasts . . . would be
nice!

Slide 6.5
Accounting for Cash . . .

Cash sales of merchandise

Cash Over and Short account
Petty Cash Fund account

Slide 6.6
Key Control Activities
for Cash . . .

Physical security
measures
Cash processing
controls
Periodic counts and
reconciliations

Slide 6.7
 Analyzing Cash and
Liquidity: the Quick Ratio

Liquidity refers to an entity’s

ability to finance its day-
to-day operations and to
pay its liabilities as they
mature.
The quick ratio is a common
measure of liquidity.
Quick ratio: quick assets /
current liabilities
Quick assets: cash and cash
equivalents, short-term
investments, and net
current receivables

Slide 6.8
Common Benchmarks Used in
Evaluating a Company’s Quick
Ratio . . .

The “1.0” rule of thumb

Historical norms for the
company
Industry norm

Slide 6.9
 Introducing Accounts
Receivable . . .
Accounts Receivable: amounts owed
to businesses by their customers
Alternative balance sheet captions:
“Trade Accounts Receivable” or
simply “Receivables”
Collections of receivables are the
largest source of cash flows for
many (most?) companies

Slide 6.10
Accounts Receivable: Information
Needs of Decision Makers

Collectibility: receivables should

be reported at their net realizable
value
Unusual characteristics: any
“related party” receivables?
Have receivables been used for
financing purposes?

Slide 6.11
Accounting for Accounts
Receivable . . .
Recording credit sales transactions
Accounting for bad debts
Write-offs and recoveries of
doubtful accounts
Etc.

Slide 6.12
 “Booking” Credit Sales
Transactions
Credit sales of merchandise are the most common source of accounts
receivable
Credit terms: express the agreement between the buyer and seller
regarding timing of payment and any discount for early payment
2/10,n/30 are among the most common credit terms
Sales discounts are recorded in a contra revenue account
Sales returns and allowances is another contra revenue account
Examples of journal entries for receivables . . .
Accounts Receivable 800
Sales 800

Cash 784
Sales Discounts 16
Accounts Receivable 800

Sales Returns and Allowances 40

Accounts Receivable 40

Slide 6.13
 Allowance Method of
Accounting for Bad Debts . . .

Unlike the direct write-off method,

the allowance method satisfies
the matching principle
Future bad debts (uncollectible
accounts) must be estimated under
the allowance method
$ amount of estimated bad debts is
credited to the Allowance for
Doubtful Accounts

Slide 6.14
 Uncollectible Receivables as a
Percentage of Total Receivables Vary
Significantly Across Companies

40%

35%

30%

25%

20%

15%

10%

5%

0%
Caesar's Inland J.C.
World Steel Penney

Slide 6.15
 Aging (Allowance)
Method
Based on realization that collectibility is
largely a function of age
First step: Prepare an aging schedule
Next: Estimate uncollectible receivables in
each age group
Then: Prepare adjusting journal entry

Estimated uncollectible accounts $ xxx

Plus or minus pre-adjustment balance of
allowance account xx
Equals debit to Uncollectible Accounts Expense $xxx

Slide 6.16
 Key Control Activities for
Accounts Receivable . . .

Many businesses use “special journals” and “subsidiary

ledgers”
These accounting records enhance the degree of control over
key financial statement items
And, provide for more efficient processing of financial data
for these items
A Sales Journal and Accounts Receivable Ledger enhance a
company’s control over its credit sales and accounts
receivable
A sales journal provides for uniform processing of credit sales
transactions
An accounts receivable ledger contains records (accounts) of
the amounts owed to a business by each of its customers
An accounts receivable ledger provides the data needed to
prepare monthly billing statements

Slide 6.17
Analyzing Accounts
Receivable
The “quality” of receivables is
largely a function of their
collectibility
In turn, the collectibility of
receivables is largely a function
of their age
Accounts receivable turnover
ratio: Net credit sales / average
accounts receivable
Age of receivables: 360 days /
accounts receivable turnover
ratio

Slide 6.18
 The bank
reconciliation . . .
A critical control activity for
cash.

Slide 6.19
 Standard Format for a Bank
Reconciliation

Balance per bank statement $XX Balance per general ledger $XX
Add: Deposits in tranit Add: Notes receivable
and . . . XX collections and . . . XX

Less: Outstanding checks Less: Bank service charges

and . . . XX and . . . XX

Adjusted balance $XX Adjusted balance $XX

Note: Upon completion of a bank reconciliation, journal entries must be

prepared for those items necessary to reconcile the general ledger balance to
the adjusted balance.

Slide 6.20