Chapter 4: Cash and Receivables – Financial Accounting Study Notes

Cash and Receivables

Introduction

This chapter covers the accounting treatment and reporting of cash and receivables, including bank reconciliation, accounts receivable, notes receivable, and methods for evaluating collectability. These topics are essential for understanding liquidity and the management of monetary claims in financial accounting.

Accounting for Cash

Cash and Cash Equivalents

Cash is the most liquid asset and is reported as a single total on the balance sheet, including all cash accounts and cash equivalents.

• Cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash and subject to insignificant risk of changes in value.

• Examples include treasury bills, commercial paper, and money-market funds.

Example: A company may hold $10,000 in cash and $5,000 in treasury bills, both reported as cash and cash equivalents.

Bank Reconciliation

Purpose and Process

Bank reconciliation ensures that the cash balance reported in the company's general ledger matches the balance reported by the bank, accounting for timing differences and errors.

• Two records: the Cash account (books) and the bank statement.

• Differences arise due to time lags and errors.

• Bank reconciliation explains and adjusts for these differences.

Bank Account Documents

• Signature card: Protects against forgery.

• Deposit slip: Proof of transaction.

• Cheque: Maker (signs), Payee (receives funds), Bank (draws funds).

• Bank statement: Reports account activity.

• Bank reconciliation: Matches book and bank balances.

Reconciling Items

• Bank Side: Deposits in transit, outstanding cheques, bank errors.

• Book Side: Bank collections, EFTs, service charges, interest income, NSF cheques, cost of printed cheques, book errors.

Bank Reconciliation Example

Cheque No.	Date	Amount
337	Jan. 27	$286.00
338	28	$319.47
339	28	$83.00
340	29	$203.14
341	30	$458.53
Total		$1,350.14

Bank Reconciliation (Bank Side)	Amount
Balance per bank, January 31	$5,931.51
Add deposit in transit	1,591.63
Cheque erroneously charged	100.00
Less outstanding cheques	-1,350.14
Adjusted bank balance	$6,273.00

Bank Reconciliation (Book Side)	Amount
Balance per books, January 31	$3,294.21
Add: EFT receipt of rent revenue	904.03
Add: Collection of note receivable	2,114.00
Add: Interest revenue earned	28.01
Add: Correction of book error	360.00
Less: Service charge	14.25
Less: NSF cheque	52.00
Less: Payment of insurance expense	361.00
Adjusted book balance	$6,273.00

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 service 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 book side require journal entries.

• If added to book side: Debit Cash

• If subtracted from book side: Credit Cash

Journal Entry Example

Item	Accounts and Explanation	Debit	Credit
4	Cash / Interest Revenue	904.03	904.03
5	Cash / Note Receivable / Interest Revenue	2,114.00	1,900.00 / 214.00
6	Cash / Interest Revenue	28.01	28.01
7	Accounts Payable	360.00	360.00
8	Bank Charge Expense	14.25
	Cash		14.25
9	Accounts Receivable – L. Ross	52.00
	Cash		52.00
10	Insurance Expense	361.00
	Cash		361.00

Accounts Receivable

Definition and Ledger Structure

Accounts receivable are amounts collectible from customers, representing monetary claims for goods or services sold on credit.

• Control account: Summarizes total amount due from all customers in the general ledger.

• Subsidiary ledger: Separate account for each customer.

Example: If Customer A owes $5,000, Customer B $1,000, and Customer C $3,000, the control account shows $9,000 total.

Notes Receivable

Notes receivable are more formal than accounts receivable and represent a written promise to pay a sum at a future date, usually with interest.

• Also called promissory notes.

• Include terms such as creditor, debtor, interest, maturity date, principal, and term.

Term	Definition
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
Principal	Amount borrowed by debtor
Term	Length of time the debtor has to repay the note

Risks of Selling on Credit

Benefits and Costs

Decision	Guidelines
Benefits and costs of extending credit	Benefit: increase in sales; Cost: risk of not collecting
Extend credit to only creditworthy customers	Run a credit check on prospective customers
Pursue collection from customers	Keep a close eye on customer paying habits

Uncollectible Receivables

Allowance Method

Some customers may not pay their debts, resulting in uncollectible accounts. The allowance method estimates and records these losses based on experience.

• Bad Debt Expense is estimated and recorded.

• Allowance for Uncollectible Accounts is a contra-account to Accounts Receivable, showing the amount expected not to be collected.

Net Realizable Value

Accounts receivable are reported at net realizable value, which is the amount expected to be collected.

Current assets	Amount
Accounts receivable	$100,000
Less: Allowance for uncollectible accounts	(5,000)
Accounts receivable, net	$95,000

Estimating Uncollectibles: Aging-of-Receivables Method

This method uses a balance-sheet approach, analyzing individual customer balances based on time outstanding to estimate uncollectible accounts.

• An aging schedule is prepared.

• Allowance for Uncollectible Accounts is adjusted to match the estimated total from the schedule.

Customer	1-30 days	31-60 days	61-90 days	Over 90 days	Total Balance
Customer A	$1,500	$1,000	$0	$2,500	$5,000
Customer B	$66,070	$57,000	$10,300	$2,500	$133,370
Totals	$67,570	$58,000	$10,300	$5,000	$138,370

Age Category	% Uncollectible	Estimated Uncollectible
1-30 days	2%	$1,351
31-60 days	5%	$2,900
61-90 days	10%	$1,030
Over 90 days	35%	$875
Total Allowance		$6,156

Year-End Adjustment Example

• Allowance before adjustment: $346

• Adjustment needed: $5,810

• Ending balance: $6,156

Journal entry:

• Debit Bad Debt Expense $5,810

• Credit Allowance for Uncollectible Accounts $5,810

Writing Off Uncollectible Accounts

When a specific account is determined to be uncollectible, it is written off against the allowance account.

Date	Accounts and Explanation	Debit	Credit
	Allowance for Uncollectible Accounts	900
	Accounts Receivable		900

Impact of Write-Off

Partial Balance Sheet – Before Write Off
Accounts receivable: $138,370
Less: Allowance for uncollectible accounts: $6,156
Accounts receivable, net: $132,214

Partial Balance Sheet – After Write Off
Accounts receivable: $137,470
Less: Allowance for uncollectible accounts: $5,256
Accounts receivable, net: $132,214

Cash Collections from Customers

Accounts Receivable Analysis

	Beginning Balance	Sales on Credit	Write-offs	Collections	Ending Balance
Amount	200	1,800	100	1,500	400

Formula:

$\text{Collections from customers} = \text{Beginning balance} + \text{Sales on credit} - \text{Write-offs} - \text{Ending balance}$

Speeding Up Cash Flow from Sales

Strategies

• Offer sales discounts for early payment

• Charge interest on overdue accounts

• Credit card and debit card sales

Credit Card (and Debit Card) Sales

• Increase sales volume

• Retailer pays a fee (operating expense), often a percentage of the sale

Date	Accounts and Explanation	Debit	Credit
	Cash	485
	Credit Card (or Debit Card) Expense	15
	Sales Revenue		500

Example: For a $500 sale, the retailer receives $485 in cash and pays $15 in fees (3% of sale).

Notes Receivable and Interest Revenue

Accounting for Notes Receivable

• Notes receivable can be current or long-term assets.

• Interest is usually stated as an annual percentage rate.

• For periods less than a year, use a fraction (months/12 or days/365).

Formula for Interest:

$\text{Interest} = \text{Principal} \times \text{Rate} \times \frac{\text{Time}}{\text{Period}}$

Example: For a $10,000 note at 6% for 3 months: $10,000 \times 0.06 \times \frac{3}{12} = $150 interest.

Reporting on the Statement of Cash Flows

• Collections of accounts receivable: Operating activity

• Collections of notes receivable: Investing activity

Evaluating Liquidity Using Ratios

Current Ratio

Measures ability to pay current liabilities with current assets.

$\text{Current Ratio} = \frac{\text{Total Current Assets}}{\text{Total Current Liabilities}}$

Acid-Test (Quick) Ratio

Measures ability to pay current liabilities with quick assets (cash, short-term investments, net receivables).

$\text{Acid-Test Ratio} = \frac{\text{Cash} + \text{Short-term investments} + \text{Net current receivables}}{\text{Total current liabilities}}$

Example: If cash = $9,000, short-term investments = $12,000, net receivables = $55,000, current liabilities = $80,000:

$\text{Acid-Test Ratio} = \frac{9,000 + 12,000 + 55,000}{80,000} = 0.95$

Days’ Sales in Receivables

Indicates how long it takes to collect receivables.

$\text{Average daily sales} = \frac{\text{Net sales}}{365}$

$\text{Days' sales in receivables} = \frac{\text{Average receivables}}{\text{Average daily sales}}$

Example: If net sales = $803,000, average receivables = $52,200:

$\text{Average daily sales} = \frac{803,000}{365} = 2,200$

$\text{Days' sales in receivables} = \frac{52,200}{2,200} = 23.7 \text{ days}$

Analyzing Receivables Collectability Using Excel Pivot Table

Application

• Managers can use Excel pivot tables to summarize invoices by “Days past due” category.

• Estimated uncollectible percentages are applied to each category to estimate total uncollectible accounts.

End of Chapter 4