5.
Chapter 5: Cash and Receivables
Lecture Notes
Cash:
Definition: Most liquid asset; includes coin, currency, available funds on deposit
at the bank, money orders, certified checks, cashier’s checks, personal checks,
and bank drafts.
Reporting: Reported as a Current Asset unless it is restricted.
Cash Equivalents: Short-term, highly liquid investments that are (1) readily
convertible to known amounts of cash and (2) are so near their maturity that
they present insignificant risk of changes in value from changes in interest rates
(Maturity date of three months or less from the date of purchase). (e.g., Treasury
Bills, Commercial Paper, Money Market Funds).
Bank Reconciliation:
Purpose: A schedule explaining any differences between the bank's record of
cash (bank statement) and the company's record of cash (general ledger).
Reconciling Items (Bank Side):
Deposits in Transit (DIT): ↑ Bank Balance
Outstanding Checks (O/S): ↓ Bank Balance
Bank Errors: ± Bank Balance
Reconciling Items (Book/Company Side):
Unrecorded Bank Charges/Deductions: (e.g., Service Charges, NSF Checks) ↓
Book Balance.
Unrecorded Bank Collections/Additions: (e.g., Interest Revenue, Note Collection)
↑ Book Balance.
Company Errors: ± Book Balance.
Note: Adjusting entries must be made only for the items reconciling the Book
Balance.
Receivables (Claims held against customers and others for money, goods, or
services):
Classification:
Trade Receivables: Arise from the sale of goods or services (e.g., Accounts
Receivable and Notes Receivable).
Nontrade Receivables: All other receivables (e.g., advances to employees,
dividends/interest receivable).
Accounts Receivable (A/R):
Definition: Oral promises of the purchaser to pay for goods/services sold;
generally due in 30-60 days.
Valuation: Reported at their Net Realizable Value (NRV)—the net amount
expected to be collected.
Uncollectible Accounts (Bad Debts):
Direct Write-Off Method (Not GAAP/IFRS): Records bad debt expense only
when an account is deemed uncollectible. Violates the matching principle.
Allowance Method (Required by GAAP/IFRS): Estimates uncollectible accounts
and matches the estimated loss with the revenue in the same period.
Initial Entry (Estimation): Bad Debt Expense DR,Allowance for Doubtful
Accounts (AFDA) CR.
Write-Off (Actual Uncollectible): AFDA DR,Accounts Receivable CR (No change
to Net Realizable Value or Expense).
Recovery of Written-Off Account: (1) Reverse the write-off: A/RDR,AFDACR. (2)
Record cash collection: Cash DR,A/R CR.
Methods for Estimating AFDA (Used under Allowance Method):
Percentage-of-Sales (Income Statement Approach): Focuses on matching. Bad
Debt Expense is calculated as a percentage of credit sales. The result is the
amount to be recorded as the expense.
Percentage-of-Receivables or Aging (Balance Sheet Approach): Focuses on NRV.
Calculates the required ending balance of the AFDA. The Bad Debt Expense is
the amount needed to adjust the unadjusted AFDA to the calculated ending
balance.
Notes Receivable (N/R):
Definition: Written promises to pay a certain sum of money on a specified future
date, often involving interest.
Valuation: Measured at the present value of the cash expected to be collected.
Short-term N/R are typically reported at face value.
Impairment: Long-term notes are periodically reviewed for impairment. If the
present value of the expected cash flows is less than the carrying amount, an
impairment loss is recorded.
Transfer of Receivables (Selling/Factoring):
Receivables may be transferred to a third party (a factor or finance company)
for immediate cash.
Treated as a Sale if the seller surrenders control. Loss on Sale is recorded.
Treated as a Secured Borrowing (a collateralized loan) if the seller retains
control. A Recourse Liability is created.
Summary (Chapter 5)
Chapter 5 focuses on the highly liquid assets, Cash and Receivables. Cash includes immediately
available funds and Cash Equivalents (short-term, high-liquidity investments with maturities ≤3
months). The Bank Reconciliation is a control tool used to adjust the book balance of cash for
unrecorded items. Receivables are claims for future cash, categorized as Trade (A/R and N/R
from customers) or Nontrade. Accounts Receivable are valued at Net Realizable Value (NRV).
GAAP/IFRS requires the Allowance Method for uncollectible accounts, which estimates losses
using either the Percentage-of-Sales (to estimate Bad Debt Expense) or the
Percentage-of-Receivables/Aging (to estimate the required AFDA ending balance). Notes
Receivable are formal debt instruments, usually reported at face value if short-term. Finally,
companies may accelerate cash flow by transferring receivables, which may be accounted for as
a sale or a secured borrowing depending on whether the company surrenders control.