Chapter 7 Lecture Notes: Cash and Accounts Receivable

I. CASH
A. Cash Defined
1. Coin
2. Currency
3. Bank deposits
 Checking accounts
 Savings accounts
4. Negotiable instruments
 Cashier’s checks & Money orders
 Certified checks
 Bank drafts
 Personal checks

B. Cash related Items not reported as cash

1. Postdated checks
 Reported as receivables
2. NSF Checks from Customers
 Checks returned for non-sufficient funds would be receivables.
3. I.O.U.s
 Reported as receivables.
4. Travel advances to employees
 Reported as receivables or prepaid expenses.
5. Postage stamps on hand
 Reported as prepaid expenses or office supplies.

C. Restricted cash
1. Restricted for some special purpose
 Cash designated for some specific use, other than payment of currently maturing
obligations is segregated from the general cash account.
 May be classified as a current asset if will be disbursed within one year or the
operating cycle, whichever is longer. Otherwise should be a noncurrent asset.
 Example: cash set aside for the retirement of bonds.
2. Compensating balances
 Legally restricted cash deposits held by a bank against borrowing arrangements.
 The SEC recommends reporting separately in either the current asset section or
the noncurrent asset section, depending on whether the borrowing arrangement is
short-term or long-term
Page 1
 Chapter 7 Lecture Notes: Cash and Accounts Receivable
D. Bank overdrafts
 When the amount of a check written exceeds the amount in the cash account.
1. US GAAP

a) Current Liability
o Most of the time, overdrafts will be reported as current liabilities.
IFRS Note:
Under IFRS,
(1) Not Material
overdrafts are  Reported as part of accounts payable.
reported as a
negative offset to (2) Material
the cash balance
 Reported as a separate item on the face of the balance sheet or
disclosed in the notes if lumped in with other liabilities.

b) Part of Cash as an Offset (i.e., reduces cash)

o Only when there is another account with available cash at the same bank
where the overdraft occurred.

E. Cash Equivalents
 A category on the balance sheet below cash
 Includes items that are both:
1) Readily convertible to known amounts of cash AND
2) So near to maturity that they present insignificant risk of changes in
interest rates (generally 3 months or lessx)
 Examples include:
 Treasury bills
 Commercial paper (short-term notes issued by companies)
 Money market funds (invest in very liquid short-term debt securities such as
treasury bonds, commercial paper and certificates of deposit). Those with
checking accounts attached are usually treated as cash.
1. Cash and equivalents
 Instead of reporting cash equivalents separate from cash, many companies
combine the two into a category called cash and equivalents.

Page 2
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

Source: Kieso, Weygandt and Warfield, Intermediate Accounting 14e Illustration 7-2., Wiley

Class Exercise 7-1

Carbine Company is preparing its December 31 Bank A reconciliation (end of the annual accounting
period), and it must determine the proper balance sheet classification of the items listed below. You have been asked
to complete the table provided below.

Cash Classification if Not Cash

1. Coins and currency, $1,000. X
2. Checks on hand received from customers, $12,000. X

3. Six Month Certificates of deposit (CDs), $16,000. Short term investment

4. Petty cash fund, $800. X

5. Postage stamps, $120. Prepaid expense/ office suuplies
6. Bank A, checking account balance, $42,000. X
7. Postdated check, customer, $200. Accounts Receivable
8. Money order from customer, $300. X
9. Bank draft from customer, $800. X
10. Cash in savings account, $20,000. X
11. Cash advance received from a customer, $160. X Liability
12. Utility deposit to the gas company, refundable, $100. Other asset – refundable utility
deposit
13. Certified check from customer, $2,000. X
14. NSF check, R. Roe, $400. Accounts Receivable
15. Cash advance to company executive, collectible upon Special Receivable
demand, $40,000.
16. Bank B, checking account overdraft, $4,000. X (if we If not material => part of the account
have payable
another
acc in the If material, it will be reported separate
same bank

Page 3
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

-> reduce
cash
account)

17. IOUs from employees, $240. Special receivable

Source: Dyckman et al. , Intermediate Accounting 3/e, 1995

II. Receivables
F. General Definition
 Claims held against customers and others for money, goods, or services.
 Classified as either trade or nontrade.

G. Trade receivables
 Amounts owed by customers for goods sold and services rendered as a part of normal
business operations.
1. Accounts Receivable
 Oral promises of the purchaser to pay for goods and services sold.
2. Notes Receivable
 Written promises to pay a certain sum of money on a specified future date.

H. Nontrade receivables
 Arise from a variety of transactions not part of normal business operations.
 See the text for examples.

II. Accounts Receivable

A. Recognition of Accounts Receivable
1. Returns & Allowances
 Receivables and revenue should be recognized net of returns and allowances.

Class Exercise 7-2

The Bloomfield Corporation shipped merchandise to the Madison Company and

sent an invoice on March15 for $3,000. Madison returned $500 of the
merchandise on March 23.

Required:
1) Record the initial sale on Bloomfield’s books, ignoring the inventory and
cost of goods sold accounts.
2) Record the entry for the return of the merchandise.

Page 4
 Chapter 7 Lecture Notes: Cash and Accounts Receivable
Requirement (1):
Accounts Receivable 3000
Sales Revenue 3000

Requirement (2):
Sales Return and Allowance 500
Accounts Receivable 500

Sales Return and Allowance is a contra revenue account (NOT

AN EXPENSE ACCOUNT)

2. Trade & Quantity Discounts

 Reductions from the list price for customers in certain trades or for the purchase
of large quantities.
 Customers are billed net of trade discounts and the discounts are not recognized
in the accounting records since customers are billed for the discounted amount.
3. Cash Discounts (Sales Discounts)
 Discounts for prompt payment.
Why do companies
offer these discounts?  Terminology Examples:
 Quicker collection
speeds up operating
 2/10, net 30 = 2% discount if paid within 10 days, otherwise the full
cycle, increases amount is due in 30 days.
liquidity, and enables
purchase of more
 2/10, E.O.M., net 30, E.O.M. = 2% if paid any time before the tenth day of the
inventory to generate following month with full payment due by the 30th of the following month.
more sales
a) Gross Method
Does it make sense for
customers to take
o Sales and receivables are recorded at the gross amount.
advantage of them? o Sales discounts taken by customers are debited to the Sales Discounts
 Generally yes, if the
customer has cash
account which is reported in the income statement as a reduction of sales.
available o Easiest and most common method.
 Effective rate for
terms 2/10 = 2% * b) Net Method
( 12/365) = 36.5%
o Sales and receivables are recorded at the net amount.
o Sales discounts not taken by customers are credited to the Sales Discounts
Forfeited account, which is reported in the other revenue section of the
income statement.
o Theoretically the better method because the receivable is initially stated closer
to the realizable value and the net sale figure better measures revenue earned.
o It is used less because it requires adjusting entries to record sales discounts
forfeited on receivables that have passed the discount period.

Page 5
 Chapter 7 Lecture Notes: Cash and Accounts Receivable
4. Non-recognition of Interest Element
 Theoretically, receivables should be measured at their present value, but this is not
done in practice for receivables due within one year.

Class Exercise 7-3

On December 29, 2014, Sabre Company sold merchandise for $5,000 less a 20%
trade discount with credit terms of 3/10, n/60. The accounting period ends
December 31.

Give the following entries under the net method and the gross method:
1. Record the 2014 sale.
2. Record collection of the account under the assumption the receivable is
collected on January 5, 2015.
3. Record collection of the account under the assumption the receivable is
collected on February 25, 2015.

Source: Dyckman et al., Intermediate Accounting 3/e, Richard D. Irwin, Inc., 1995 - modified

5000* 0.8 = 4,000

NET APPROACH GROSS APPROACH
4,000* 0.97 = 3,380
Requirement 1
Accounts Receivable 3,880 Accounts Receivable 4,000
Sales Revenue 3,880 Sales Revenue 4,000

Requirement 2
Cash 3,880 Cash 3,880
Accounts Receivable 3,880 Sales Discount 120
Accounts Receivable 4000

Requirement 3
Cash 4,000 Cash 4,000
Sales Discount Forfeited 120 Accounts Receivable 4,000
Accounts Receivable 3,880

B. Valuation of Accounts Receivable & Uncollectible Accounts

 Receivables are valued at net realizable value (i.e., the amount expected to be
received in cash)
 Methods to Account for Uncollectible Accounts are as follows:
1. Direct write-off method
 Bad Debt Expense is debited and Accounts Receivable is credited at the time
when a specific account is determined to be uncollectible. This event may not
occur in the same period as the sale.
 While actual bad debt expenses are recorded, the method is theoretically
undesirable because it:

Page 6
 Chapter 7 Lecture Notes: Cash and Accounts Receivable
a) Makes no attempt to match revenues and expenses (i.e., it violates the
matching principle).
b) Does not result in receivables being stated at net realizable value in the
balance sheet (generally overstates receivables).
c) Allows manipulation of income.

Class Exercise 7-4

At the end of 20x1, the Spring Company’s trial balance before adjustments indicates
the company had $400,000 in gross sales (all on credit), $30,000 in sales returns
and allowances, and a $200,000 balance in accounts receivable. During 20x2 (the
following year) the company determines that $4,000 of the receivables are
uncollectible because of the length of time they have been outstanding and the poor
financial health of the customers that purchased the related merchandise.
Required:
(1) Prepare the journal entries required in each year to recognize bad debt
expense assuming the direct write-off method is used.
(2) Show the impact of the sales and bad debt on the income statement and
balance sheet each year.

Requirement (1):
Bad Debt Expense 4,000
Accounts Receivable 4,000

Requirement (2):
20x1 20x2
Income Balance Income Balance
Statement Sheet Statement Sheet
+400,000 Sales +200,000 A/R - 4,000 Bad -4,000 A/R
- 30,000 R&A Debt Expense
= 370,000 net

2. Allowance method
 At the end of each accounting period expected losses from uncollectible
accounts are estimated.
 The amount of the estimate is debited to Bad Debt Expense and credited to
Allowance for Doubtful Accounts.
 The allowance account is a contra-asset account that is subtracted from trade
receivables on the balance sheet.
 The method is justified because a company experiences a loss the moment
customers receive goods or services that will not be paid for.

a) Percentage-of-Sales (Income Statement Approach)

o Matches costs with revenues in a period.

Page 7
 Chapter 7 Lecture Notes: Cash and Accounts Receivable
o Bad debt expense is estimated as a percentage of net credit sales (i.e., after
returns and discounts).
o Since the estimate is based on sales in the period, it is unaffected by any
existing balance in the allowance account.

Class Exercise 7-5

At the end of 20x1, the Spring Company’s trial balance before adjustments
indicates the company had $400,000 in gross sales (all on credit), $30,000 in sales
returns and allowances, a $200,000 balance in accounts receivable. During 20x2
(the following year), the company determines that $4,000 of the receivables are
uncollectible because of the length of time they have been outstanding and the
poor financial health of the customers that purchased the related merchandise.
Required:
1) Prepare journal entry to record bad debt expense under the allowance
meth od assuming bad debts are estimated to be 2% of net sales in 20x1.
2) Prepare the journal entry to record the write off of the uncollectible
accounts in 20x2.
3) Show the impact of the sales and bad debt on the income statement and
balance sheet each year.
Requirement (1):
Net sales = 400,000- 30,000 return and allowance = 370,000
Bad Debt Expense (370,000*0.02 ) 7,400
Allowance for Doubtful Account 7,400
Requirement (2):
Allowance for Doubtful Account 4,000
Accounts Receivable 4,000
Requirement (3):
20x1 20x2
Income Balance Income Balance
Statement Sheet Statement Sheet
+400,000 sales +200,000 A/R -4,000 A/R
- 30,000 R&A +4,000
Allowance
= 370,000 net
- 7,400 Bad +7,400
debt expense allowance for
doubtful
account

20x1 20x2
Total Accounts Receivable 200,000 196,000
Less: Allowance for doubtful accounts (7,400) (3,400)
Net Realizable Value of A/R 192,600 192,6000

Page 8
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

b) Percentage-of-Receivables (Balance Sheet Approach)

o The allowance for uncollectible accounts is estimated as a percentage of
total accounts receivable.
o An entry is made to bring the allowance account to the correct level.
(different from percentage of sales)
o Provides a reasonably accurate estimate of net realizable value of
receivables, but does not necessarily provide the best matching of revenues
and expenses.
Class Exercise 7-6
At the end of 20x1, the Spring Company’s trial balance before adjustments indicates the
company had $400,000 in gross sales (all on credit), $30,000 in sales returns and
allowances, a $200,000 balance in accounts receivable, and a $6,500 credit balance in
the allowance for uncollectible accounts, before any adjustment for the current year.
During 20x2 (the following year) the company determines that $4,000 of the receivables
are uncollectible because of the length of time they have been outstanding and the poor
financial health of the customers that purchased the related merchandise.
Required:
1) Prepare journal entry to record bad debt expense under the allowance method
assuming bad debts are estimated to be 6% of gross accounts receivable in 20x1.
2) Prepare the journal entry to record the write off of the uncollectible accounts in 20x2.
3) Show the net realizable balance of accounts receivable as it would appear on the
balance sheet before and after the write-off of the $4,000.
Requirement (1):
Allowance for
Doubtful
Account

Required Allowance = 200,000*6% 12,000 6,500 BB

Allowance already on books (6,500) 5,500 A/E
Adjusted required 5,500
12,000 AEB

Bad Debt Expense 5,500

Allowance for Doubtful Account 5,500

Requirement (2):
Allowance for Doubtful Account 4,000
Accounts Receivable 4,000

Page 9
 Chapter 7 Lecture Notes: Cash and Accounts Receivable
Requirement (3):
Net realizable value on Balance Sheet Before Write-Off
Total Accounts Receivable 200,000
Less: Allowance for doubtful accounts (12,000)
Net Realizable Value of A/R 188,000

Net realizable value on Balance Sheet After Write-Off

Total Accounts Receivable 196,000
Less: Allowance for doubtful accounts (8,000)
Net Realizable Value of A/R 188,000

c) Collection of Receivables previously written off

o The receivable and allowance are first reinstated in the amount collected.
Then, the cash is recorded and the receivables are reduced by the same
amount.

Class Exercise 7-7

Refer back to Exercise 7-6. Now assume that in 20x2 $1,000 of the $4,000 written off is
unexpectedly collected.
Required:
Prepare the journal entry to record the collection of the receivable.

Accounts Receivable 1,000

Allowance for Doubtful Account 1,000

Cash 1,000
Accounts Receivable 1,000

d) Debit balance in allowance account at time of adjustment entry

Class Exercise 7-8

At the beginning of 20x2, the Spring Company had a $200,000 debit balance in gross
accounts receivable less a $12,000 credit balance in the allowance for doubtful accounts.
During 20x2, the company had net credit sales of $750,000 and collections of $650,000.
The company also wrote off $19,000 in accounts receivable, of which, $3,000 was
subsequently recovered.
Required:
1) Record the entry for the write off of the receivables during the year.
2) Record the entry for the subsequent recovery of receivables during the year.
3) Prepare journal entry at the end of the year to record bad debt expense under the
allowance method assuming bad debts are estimated to be 6% of gross accounts
receivable.
*Note: This is the continuation of the Spring Co.Exercise (7-6) except for the
4,000 written off there. Now we are looking at the next year.

Page 10
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

Requirement (1):
Allowance for Doubtful Account 19,000
Accounts Receivable 19,000

Requirement (2):
Account Receivable 3,000
Allowance for Doubtful Account 3,000

Cash 3,000
Account Receivable 3,000

Requirement (3):
Accounts Allowance for
Receivable Doubtful Accounts
BB 200,000 12,000 BB
Sales 750,000 Write-off 19,000
650,000 Collected 3,000 Recovered
19,000 Write-off
Recovered 3,000 Balance 4,000
3,000 Collected 20,860 A/E
AEB 281,000 16,860 EB required

Required Allowance =281,000*0.06 16,860

Bad Debt Expense 20,860

Allowance for Doubtful Account 20,860

e) Comparison of Income Statement and Balance Sheet Methods

 The Balance Sheet method focuses on recording a reasonable estimate of
collectible net accounts receivable (i.e., gross accounts receivable less the
allowance for doubtful accounts). Thus, the amount required in the
allowance for doubtful accounts is estimated and an adjusting entry is made
to bring the allowance to the required amount, taking into consideration the
beginning balance in the account.
 The Income Statement method focuses on recording bad debt expense as a
percentage of net credit sales. Thus, it ignores any existing balance in the
allowance account.

Page 11
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

Class Exercise 7-9

During the year, the Killingly Corporation has net credit sales of $500,000. At the end of
the year, Killingly has a $150,000 balance in accounts receivable and a $10,000 credit
balance in the allowance for doubtful accounts.

Instructions:
a) Create the year end adjusting entry assuming bad debts are estimated to be 10%
of gross accounts receivable.
b) Create the year end adjusting entry assuming bad debts are estimated to be 1.5%
of net credit sales.

Don’t care about credit

balance, only about bad
debt EXPENSE
a) Balance Sheet Method b) Income Stmt. Method
Required Adjustment : (150,000)* 10% – 10,000 500,000* 1.5%
= 5,000 = 7,5000

Bad Debt Expense 5,000 7,500

Allowance for Doubtful Account 5,000 7,500

f) Aging schedule – Balance Sheet Method Variation

o Variation on the percentage of receivables/balance-sheet approach.
o A schedule is created listing accounts receivable by their age with the
probability of collection of each aging group is estimated.
o The probability of collection decreases as the age of receivables increases.

Class Exercise 7-10

The Bobcat Corporation operates in an industry that has a high rate of bad debts. Before any
year-end adjustments, the balance Bobcat’s Accounts Receivable account was $1,080,000
and the Allowance for Doubtful Accounts had a credit balance of $70,000 . The year-end
balance reported in the balance sheet for the Allowance for Doubtful Accounts will be
based on the aging schedule shown below.
Days Account Probability of
Outstanding Amount Collection
30 days or less $600,000 .96
31-60 days 200,000 .90
61-90 days 160,000 .83
91-120 days 80,000 .74
121-150 days 40,000 .30
Over 150 days *write off 30,000 .00
immediately bcz .00*

Page 12
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

Instructions:
a) What is the appropriate balance for the Allowance for Doubtful Accounts at year-end?
b) What adjusting journal entries should be made at year-end?
c) Show how accounts receivable would be presented on the balance sheet.

Requirement (a):
Expected
Days Account Percentage Estimated
Outstanding Amount Uncollectible Uncollectible
30 days or less $600,000 .04 24k
31-60 days 200,000 .10 20k
61-90 days 160,000 .17 27.2k
91-120 days 80,000 .26 20.8k
121-150 days 40,000 .70 28k
Balance for Allowance for Doubtful Account = 120,000

Requirement (b):
The $30,000 over 150 days are written off immediately – not considered in (a) above
Allowance for Doubtful Accounts 30,000
Account Receivable 30,000

Estimated amount required in the allowance for doubtful account 120,000

40,000
Balance in the account after write off uncollectible before the
adjustment (70,000 – 30,000)
Required adjusting entry for bad debt expense & allowance 80,000

Bad debt expense 80,000

Allowance for doubtful account 80,000

Requirement (c):
Account Receivable (1,080,000 – 30,000 written off) 1,050,000
Less: Allowance for Doubtful Accounts 120,000
Net Accounts Receivable 930,000

Is it better to estimate the allowance by calculating a percentage of total accounts

receivable or by using the aging method? Why?

 Aging method is more accurate and thus generally a better method, especially
when we have large amount of A/R. However, its more costly to maintain and in
some cases the benefit may not be worth the cost.

 Using just one percentage is simpler and requires fewer resources. It may be
more appropriate for smaller A/R balances and in cases where the aging
method does not result in a significantly different estimate.

Page 13
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

III. Notes Receivable

A. Recognition of Long-Term Notes Receivable
 The present value of the future cash flows is the proper amount to record for long-
term notes receivable.
 You will learn more about recognizing and measuring notes from the perspective of
the lender/issuer in Intermediate II (AC 306). Treatment from the borrower’s side is
similar.

IV. Fair Value Option

 US GAAP now allows companies to carry receivables at their fair market value, instead
of historical cost.
 Also allowed under IFRS.
 It is primarily used for notes receivable.
 The fair value option must be chosen when the receivable is initially recognized or
when an event triggers a new basis of accounting (e.g., a business acquisition).
 At each financial statement date, the asset is revalued with an adjustment made to the
receivable along with an offsetting unrealized holding gain (loss) recognized in net
income equal to the increase (decrease) in value

V. Disposition of Accounts and Notes Receivable

 In order to accelerate the receipt of cash from receivables, they may be transferred to a
third party for cash.
 Why might a company need to accelerate the receipt of cash?
 Cash may be tight and the company may hav difficulty getting credit loans to meet
short-term cash needs (eg. During a recession, banking crisis, etc.)
 Borrowing to meet short-term cash needs may violate current credit agreements
 Managing A/R collections can be costly and time consuming

A. National Credit Cards & Cards Managed by a Third-Party Bank

 One way to speed up the collection of cash is through the acceptance of national
credit cards such as MasterCard and Visa, or to issue credit cards with the company’s
name on it that is managed by a third party bank.
 With these credit cards, the company is essentially farming out or selling its
receivables to the bank that manages the credit card.
 The collection of cash is so quick, that receivables are never recorded. Instead the
sale is recorded as cash sale less with fees paid to the credit card company recorded
as expenses.
 Note that credit cards issued and managed by the company itself are recorded as
receivables.

Page 14
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

B. Secured Borrowing (Assigning or Pledging).

 The owner of the accounts receivable borrows cash by writing a promissory note
designating the accounts receivable as collateral.
 Risk of ownership and title remain with the borrower.
 The borrower and lender agree as to the specific accounts that serve as security. The
assignor (borrower) typically makes collections on the assigned accounts and remits
the collections plus a finance charge (interest cost) to the lender.
 The borrower also recognizes all discounts, returns and allowances, and bad debts.

C. Sale (Factoring)
 These transfers of accounts and notes receivable may be without recourse or with
recourse.
1. Sale Without Recourse
 The purchaser assumes the risk of collectibility and absorbs any credit losses.
 This is an outright sale of receivables both in form and substance.
 A loss on the sale is recognized for the excess of the face amount of the
receivables over the cash proceeds.
2. Sale With Recourse
 The seller guarantees payment to the purchaser for those receivables which
become uncollectible.
 Accounted for as a sale if three conditions are met as outlined in the text book.
 If treated as a sale, then any gain or loss on the sale should be recognized.

VI. Presentation of Receivables/General Rules

 Segregate the different types of receivables, if material.
 Offset appropriate valuation accounts against the proper receivable accounts.
 Determine that receivables classified as current assets will be converted into cash within
the year or the operating cycle, whichever is longer.
 Disclose any loss contingencies that exist on the receivables.
 Disclose any receivables designated or pledged as collateral.
 Disclose the nature of credit risk inherent in the receivables, and the changes in the
allowance for credit losses.
 See textbook Illustration reproduced on the following page.

Page 15
 Chapter 7 Lecture Notes: Cash and Accounts Receivable

Source: Kieso, Weygandt and Warfield (Wiley), Intermediate Accounting 15e Illustration 7-23.

Page 16