Chapter 5 Notes

Chapter 5

Internal Control, Cash, and

Receivables

Learning Objective 1Learn about fraud and internal control

2Copyright ©2014 Pearson Education.

Fraud

•Intentional misrepresentation of facts•Causes injury or damage to another party•Large problem that increases each year


Types of FraudMisappropriatio

n of assets

• Employees ____ assets from company• Cash• Inventory• False

expense reports

Fraudulent ____________

• Managers make false entries so company appears more profitable

• Deceives investors and creditors 4Copyright ©2014 Pearson Education.

Fraud Triangle

5

Motive

RationalizationOpportunity

Copyright ©2014 Pearson Education.

Internal Control

•Primary way fraud and errors are: ▫Prevented▫Detected or▫Corrected

• Management and Board of Directors implement a:▫Plan of organization ▫System of procedures

•We will not cover Internal Controls in detail in this class.


Learning Objective ThreePrepare and use a bank reconciliation


Bank Account as Control Device

Signature card

Bank statement

Deposit ticket

Bank reconciliati

onCheck


Bank Account Documents

•Signature card▫__________of your signature▫Protects against forgery

•Deposit ticket▫Proof of transaction

•Cheque▫Maker – _____ the cheque▫Payee – to whom the cheque is paid▫Bank – where funds are drawn


The Bank Statement•Reports:

▫Cash _______▫Cash _______

•Electronic Funds Transfer (EFT)▫Make payments by

electronic communication


Bank Reconciliation

•Two records of a business’s cash▫The bank statement (maintained by _______)▫The Cash account in the general ledger

(maintained by __________)•Amounts are usually different

▫_________in recording transactions•Bank reconciliation ________________


Bank Reconciliation ItemsBank Side Book Side• ADD• Deposits in transit• Certain bank errors

• SUBTRACT• Outstanding cheques• Certain bank errors

• ADD• Bank collections• EFT receipts• Interest revenue• Certain book errors

• SUBTRACT• EFT payments• Service charges• NSF cheques• Certain book errors


In the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets:In the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets:In the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets:

NSF means _________________

Electronic Fund Transfer

Summary of Reconciling Items

BANK BALANCE - ALWAYS BOOK BALANCE - ALWAYS

Add deposits in transit Add bank collections, interest revenue and EFT receipts

Subtract outstanding cheques Subtract services charges, NSF cheques, EFT payments

Add or subtract correction of bank errors

Add or subtract correction of book errors


Journalizing Bank Reconciliation Items•All items on the _________of the bank

reconciliation require journal entries•If the item is added to book side

▫Debit Cash•If the items is subtracted from the book

side▫Credit Cash


Copyright ©2014 Pearson Education. 15

JOURNAL

Date

Accounts and explanation Debit Credit

Cash

Dividend Revenue

Receipt of dividend revenue earned on investment. (_____________________)

Cash

Accounts receivable

Account receivable _______________

Cash

Interest Revenue

Interest earned on bank balance.

Cash

Accounts Payable

Correction of cheque


JOURNAL

Date


Bank service charges

Cash

Bank service charge.

Accounts Receivable

Cash

NSF cheque returned by bank.

Insurance Expense

Cash

Payment of monthly insurance.

Online Banking

•allows you to pay bills and view your account electronically

•can reconcile transactions at any time


Exercise 5-39B• Harry Smith operates a bowling alley. • He has just received the monthly bank statement at September

30 from City National Bank, and the statement shows an ending balance of €545. Listed on the statement are an EFT rent collection of €325, a service charge of €8, two NSF checks totaling €125, and a €10 charge for printed checks. During September, he recorded a $310 check for the salary of a part-time employee as €31.

• In reviewing his cash records, Smith identifies outstanding checks totaling $609 and a September 30 deposit in transit of €1,790. Smith’s Cash account shows a September 30 cash balance of €1,823. How much cash does Smith actually have at September 30?

• Preparing a bank reconciliation.


Exercise 5-39B

Bank: Books:

Balance, September 30

€545 Balance, September 30

€1,823

Add: Add:

Less:

Less:


Budgeting•Budget

▫Financial plan to coordinate activities•Cash budget

▫Planning _______ and _______•Steps:

▫Start with beginning cash balance▫Add budgeted receipts and subtract budget

payments▫Equals expected cash balance▫Compare cash available to budgeted cash

balance 20Copyright ©2014 Pearson Education.

Expected Cash Balance


If expected cash is greater than

minimum needed

Invest excess

If expected cash is less than

minimum needed

Consider

borrowing

Very closely related to Corporate Finance


Cash Budget

Beginning cash balance

Budgeted cash receipts:

Collections from customers

Dividends from investments

Sale of store fixtures

Budgeted cash payments:

Purchases of inventory

Operating expenses

Expansion of store

Payment of long-term debt

Payment of dividends

Cash available (needed)

Budgeted cash balance, end of period

Cash available for investing or (new financing needed)

22

Reporting Cash on the Balance Sheet•All cash accounts combined into a single

total called “Cash and Cash Equivalent”▫Include liquid assets such as time deposits,

certificates of deposit, and high-grade government yield

▫Interest-bearing accounts with no withdrawal penalty

•Reports liquid assets available for day-to-day use


Exercise 5-25A• Cole Communications, Inc., is preparing its cash budget for 20X7.

Cole ended 20X6 with cash of $86 million, and managers need to keep a cash balance of at least $82 million for operations.

• Collections from customers are expected to total $11,305 million during 20X7, and payments for the cost of services and products should reach $6,167 million. Operating expense payments are budgeted at $2,544 million. During 20X7, Cole expects to invest $1,826 million in new equipment and sell older assets for $118 million. Debt payments scheduled for 20X7 will total $603 million. The company forecasts net income of $885 million for 20X7 and plans to pay dividends of $347 million.

• Prepare Cole Communications’ cash budget for 20X7. Will the budgeted level of cash receipts leave Cole with the desired ending cash balance of $82 million, or will the company need additional financing? If so, how much?



Cole CommunicationsCash Budget

Cash, December 31, 20X7 $86

Budgeted Cash Receipts:

Collections from customers $11,305

Sale of assets 118 $11,509

Budgeted Cash Payments:

Costs and services 6,167

Operating expenses 2,544

Purchase of equipment 1,826

Payment of long-term debt 603

Payment of dividends 347 $11,487

Cash available $22

Budgeted cash available $82

New financing needed $60

Exercise 5-25A

Where is the Net Income of $885?

Why is it not here?

Learning Objective FourAccount for receivables and uncollectible receivables


Receivables

•Monetary claims against others•Acquired mainly by:

▫selling goods and services▫lending money

•Two major types:▫________ receivables▫_______ receivables


Accounts Receivable

•Amounts collectible from customers•Balance in _________ ledger

▫Control account: summarizes total amount due from all customers

•___________ ledger▫Separate account for each customer



Accounts receivable

$9,000

Customer A

Customer B

$5,000

$1,800

Customer C

$3,000

General Ledger Accounts Receivable Subsidiary Ledger

Total

$9,000

Internal Control: Collections on Account•Separate cash-handling and cash

accounting duties▫Bookkeeper should not handle cash

Should record amounts from remittance advices

▫Separate employee should open incoming mail and make deposit

•Another option:▫Lockbox system

Payments are sent _____________which then notifies the company of the amount received 30Copyright ©2014 Pearson Education.

Managing Risk of Not CollectingBenefit of selling on credit Cost of selling on credit

• Customers that do not have cash available can buy on credit

• Sales and profits increase

• Company _________ from some customers

• This cost is called ________________, _______________, or ____________expense


A Company Must Balance the Benefit And Cost of Credit Effectively

Risks of Selling on CreditIssues Plan of action

What are the benefits and costs of extending credit to customers?

Benefit – increase in salesCost – risk of not collecting

Extend credit to only creditworthy customers

Run a credit check on prospective customers

Separate cash-handling and accounting duties to keep employees from stealing cash from customers

Design internal control system to separate duties

Pursue collection from customers to maximize cash flow

Keep a close eye on customers. Send additional statements to slow-paying customers 32Copyright ©2014 Pearson Education.

Accounting for Uncollectible Receivables

Balance SheetDecember 31, 20X6

Equipment $XXX

Less: allowance for doubtful receivables

(XXX)

Net trade and other receivables

XXX


The Allowance Method•Records collection losses based on

company’s _____________________•Estimates Bad Debt Expense

▫Dr Bad Debt Expense (as accounts receivables are recorded)

•Also sets up Allowance for Uncollectible Accounts (XA)▫Cr Allowance for Uncollectibles

Contra-account to Accounts Receivable Shows amount of receivables expected not to be

collected (_________).


Net Realizable ValueBalance Sheet

Current assets:

Accounts receivable $10,000

Less: Allowance for uncollectible accounts

(900)

Accounts receivable, net $9,100


Balance Sheet

Current assets:

Accounts receivable, less allowance of $900

$9,100

Method to Estimate Uncollectibles

Aging-of-receivables

• Focuses on proper valuation of (______)accounts receivable on the ____________

• Individual customer balances analyzed based on _____________• Aging schedule (older accounts more

likely to go bad)• Allowance for Uncollectible Accounts

adjusted to equal amount from aging schedule



Age of Account

Customer

Not yet due

1-30 days

31-60 days

Over 60 days

Total Balance

Customer A $400 $400

Customer B 100 100 200

Customer C 300 200 600 100 1,200

All others … … … …

Totals 11,060

1,363 370 1,093 13,886

Est. percent uncollectible 1.0% 5.0% 12.5% 20.9%

Allowance balance should be:

111 68 46 219 444

Aging-of-Receivables


38

JOURNAL

Date


Uncollectible accounts expense 151

Allowance for uncollectible accounts 151

Recorded uncollectible accounts expense


Allowance for Uncollectible Accounts

$293Balance before adjustment

$444

$____Adjustment needed

Ending balance equals aging schedule



Allowance for Uncollectible Accounts

$293

$444

$151

Accounts Receivables

$13,886

Uncollectible Account Expense

$151

$151

Net accounts receivables, $13,442

Writing Off Uncollectible Accounts


JOURNAL

Date


Allowance for uncollectible accounts 12

Accounts Receivable 12

Write off customer accountAllowance for Uncollectible

AccountsAccounts Receivable

$100 $20Bal. Bal.$12$12

$88 $8

No impact on Income Statement!

40

Adjusting Ending Allowance for Doubtful Receivables

JOURNAL

Date


Uncollectible for Doubtful receivables 22

Allowance for Doubtful receivables ($30 - $8)

22

Recorded bad debt expense for the year

41

Beginning Allowance

Receivables Write-offs

Bad Debt Expense

Ending Allowance

– + =

Relationship between uncollectible-account expense, write-offs of receivables and allowance for doubtful receivables account


Direct Write-Off Method•Waits until a specific account is

uncollectible to record the expense•Inferior to Allowance method

▫Receivables reported at full amount Assets overstated on Balance Sheet Normally _____________under GAAP

JOURNAL

Date


Uncollectible-account Expense

Accounts Receivable

Write off customer account


Computing Cash Collections from Customers


Accounts Receivable

Ending balance

Sales on credit

Write-offs of uncollectibles

Collections from customers

Beginning balance $200

$1,800

$100

$400

?$_____

Notes Receivable

•More formal than accounts receivable•______________to pay a sum at the maturity

date▫Plus interest

•Also called promissory notes


Notes Receivable•Can be current or long-term assets•Terms:


Creditor Party to whom money is owed; Lender

Debtor Party that borrowed and owes money; Maker, borrower

Interest Cost of borrowing money; stated as annual percentage rate

Maturity date

Date when debtor must pay note

Maturity value

Sum of principal and interest

Principal Amount borrowed by debtor

Term Length of time from when note was signed to when payment must be made


Amount Date

For value received, I promise to pay to the order of

RaboBankAmsterdam, Netherlands

Dollars

On

plus interest at the annual rate of 9 percent

$1,000 August 31, 20X6

One thousand and no/100s--------------------------------

February 28, 20X7

Lauren Holland

PROMISSORY NOTE

Principal Date Interest Starts

Payee (Creditor)

PrincipalMaturity Date

Maker (Debtor)

Accounting for Notes Receivable


JOURNAL

Date Accounts and explanation Debit Credit

20X6

Aug 31

Notes receivable – L.Holland

Cash

Dec 31

Interest receivable ($1,000 x 0.09 x 4/12)

Accrued Interest revenue

2011

Feb 28 Cash

Notes receivable – L.Holland

Interest receivable

Interest revenue ($1,000 x 0.09 x 2/12)

Interest Computation

•Interest rates are always expressed as _______ _______, unless stated otherwise▫For example, a 6-month note with an

interest of 9% means the annual rate is 9%. The note will actually earn 4.5%.

•The time element (4/12) is the fraction of the year that the note has been in force during 2010.

•Often interest is computed based on days▫Denominator would be days/365


Speeding Up Cash Flow

Credit cards

• Customers pay with credit cards• Revenues increases, with a cost

• Credit card company takes 2-3% as a fee

Selling receivables (________)

• Companies sell receivables to another business, called a factor

• The factor pays a discounted price and then collects full amount from customer


Learning Objective FiveUse two key ratios to evaluate a business


Current Ratio


Total current assets

Total current liabilities

Short Exercise 5-15

Acid-test ratio

$294,900

$99,000

= 2.98


Days’ Sales in Receivables (Collection Period)


Receivables Turnover


Sales Sales

Average Receivabl

es

Average Receivabl

es

Days’ sales in

receivables


365

(Beginning net receivables + Ending net receivables)/2(Beginning net receivables + Ending net receivables)/2

Short Exercise 5-15

$802,000

$73,900

Days’ sales in receivables

10.85

$2,197.26

(Beginning net receivables + Ending net receivables)/2(Beginning net receivables + Ending net receivables)/2

= 34 days

Days’ sales in receivable

