3. 1. Cash and Cash Equivalents
1.1 Definition
1.2 Petty cash
1.3 Bank Reconciliation
1.4 Restricted cash and compensating balances
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4. 1.1 Definition
Cash
- Cash on hand: Currency and Coins
- Cash in bank: Balances in checking accounts, and
items acceptable for deposit in these accounts (e.g.
checks, money orders received from customers)
These forms of cash represent amounts readily available
to pay off debt or to use in operations without any
legal or contractual restriction.
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5. 1.1 Definition (cont)
Cash equivalents
- Treasury bills
- Commercial paper
These investments must have a maturity date no
longer than three months from the date of
purchase.
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6. 1.2 Petty cash
Small amount on cash on hand to pay for low-
cost items such as postage, office supplies,
delivery charges, and entertainment expenses.
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7. Illustration
On May 1, 2003, the Hawthorne Manufacturing
Company established a $200 petty cash fund.
John Ringo is designated as the petty cash fund
custodian. The fund will be replenished at the
end of each month. On May 1, 2003, a check is
written for $200 made out to John Ringo, petty
cash custodian. During the month of May, John
paid bills totaling $160 summarized as follows:
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8. Postage $40
Office supplies 35
Delivery charges 55
Entertainment 30
Total $160
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9. Journal entries
May 1, 2003
A petty cash fund is established by writing a
check to the custodian.
May 31, 2003
The appropriate expense accounts are debited
when the petty cash fund is reimbursed.
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10. 1.3 Bank Reconciliation
Differences between the cash book and bank
balance occur due to differences in the timing
of recognition of certain transactions and errors.
Step 1: Adjust the bank balance to the corrected
cash balance
Step 2: Adjust the book balance to the corrected
cash balance
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11. Step 1: Adjustments to Bank Balance
Bank balance Book balance
+ Deposits outstanding + Collections by bank
- Check outstanding - Service charges
- NSF checks
+/- Errors +/- Errors
----------------------- -----------------------
Corrected balance Corrected balance
The two corrected balances must equal.
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12. 1.4 Restricted cash and
compensating balances
Restricted cash
Cash that is restricted in some way and not available for
current use usually is reported as investments and
funds or other assets.
Compensating balances
The borrower us asked to maintain a specified balance in
a low-interest or noninterest-bearing account at the
bank to compensate the bank for granting the loan or
extending the line of credit.
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13. 2. Accounts Receivable
2.1 Classification
2.2 Initial valuation of accounts receivable
2.3 Subsequent valuation of accounts receivable
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14. 2.1 Classification
Accounts receivable are current assets because,
by definition, they will be converted to cash
within the normal operating cycle.
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15. 2.2 Initial valuation of accounts
receivable
The typical accounts receivable is valued at the
amount expected to be received, not the present
value of that amount.
Trade Discount
Cash Discount (sales discount)
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16. Trade Discount
Usually a percentage reduction from the list
price to change prices or to give quantity
discount to large customers
The discount is recognized indirectly by
recording the sale at the net of discount price,
not at the list price.
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17. Cash Discount (sales discount)
Reduce the amount to be paid if remittance is
made within a specified short period of time.
Represent reduction not in the selling price of
good or service but in the amount to be paid
within a specified period of time to provide
incentive for quick payment
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18. Cash discount: journal entries
The Hawthorne Manufacturing Company offers credit
customers a 2% cash discount if the sales price is paid
within 10 days. Any amounts not paid within 10 days
are due in 30 days. These repayment terms are stated
as 2/10, n/30. On October 5, 2003, Hawthorne sold
merchandise at a price of $20,000. The customer paid
$13,720 ($14,000 less the 2% cash discount) on
October 14 and the remaining balance of $6,000 on
November 4.
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19. Cash discount: journal entries
By either method, net sales is reduced by
discount taken
Discounts not taken are included in sales
revenue using the gross method and interest
revenue using the net method
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20. 2.3 Subsequent Valuation
Two situations possibly could cause the cash
collected to be less than the initial valuation of
the receivable:
1. Sales returns: The customer could return the
product.
2. Uncollectible Accounts Receivable: The
customer could default and not pay the agreed
on sales price.
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21. Sales returns
Recognizing sales returns when they occur
could result in an overstatement of income in
the period of the related sale.
To avoid misstating the financial statements,
when amounts are material, when amount are
material, returns should be anticipated by
subtracting an allowance for estimated returns.
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22. Illustration
During 2003, its first year of operations, the Hawthorne
Manufacturing Company sold merchandise on account
for $2,000,000. This merchandise cost $1,200,000
(60% of the selling price). Industry experience
indicates that 10% of all sales will be returned.
Customers returned $130,000 in sales during 2003,
prior to making payment. The entries to record sales
and merchandise returned during the year, assuming
that a perpetual inventory system is used, are as
follows:
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23. If sales returns are material, they should be
estimated and recorded in the same period in
the same as the related sales
The allowance for sales returns is a contra
account to accounts receivable. When returns
actually occur in the following reporting period,
the allowance for sales returns is debited. In this
way, income is not reduced in the return period
but in the period of the sales revenue.
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24. Uncollectible Accounts Receivable
Income statement approach
Estimate bad debt expense as a percentage of each
period’s net sales. The balance sheet amount is an
indirect outcome of estimating bad dent expense.
Balance sheet approach
Determine bad debt expense by estimating the net
realizable value of accounts receivable to be reported
in the balance sheet.
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25. Illustration
The Hawthorne Manufacturing Company sells its
products offering 30 days’ credit to its customers.
During 2003, its first year of operations, the following
events occurred:
Sales on credit $1,2000,000
Cash collections from credit customers (895,000)
Accounts receivable, end of year $305,000
There were no specific accounts determined to be
uncollectible in 2003. The company anticipates that
2% of all credit sales will ultimately become
uncollectible. 25
