© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 7-1 FINANCIAL ASSETS Chapter 7.
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Transcript of © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 7-1 FINANCIAL ASSETS Chapter 7.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-2
How Much Cash Should a Business Have?
How Much Cash Should a Business Have?
Cash
Short-term Investments
Receivables
Financial Assets
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-3
The Valuation of Financial AssetsThe Valuation of Financial Assets
Type of Financial AssetBasis for Valuation in
the Balance SheetCash (and cash equivalents) Face amountShort-term investments (marketable securities)
Current market value
Receivables Net realizable value
Estimated collectible amountEstimated collectible amount
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-4
CashCashCoins and
paper money
Checks
Money orders
Travelers’ checks
Bank credit card sales
Cash is defined as
any deposit banks will
accept.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-5
Combined with cash on balance sheet
Reporting Cash in the Balance Sheet
Reporting Cash in the Balance Sheet
Liquid short-term
investments
Stable market values
Matures within 90 days of acquisition
Cash Equivalents
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-6
Not available for paying
current liabilities
Reporting Cash in the Balance Sheet
Reporting Cash in the Balance Sheet
Not a current asset
Listed as an investment
“Restricted” Cash
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-7
Bank agrees in advance to lend
money.
Reporting Cash in the Balance Sheet
Reporting Cash in the Balance Sheet
Liability is incurred when line of credit is used.
Unused line of credit is disclosed
in notes.
Lines of Credit
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-8
Cash ManagementCash Management
Accurately account for cash.
Prevent theft and fraud.
Assure the availability of adequate amounts of cash.
Avoid unnecessarily large amounts of idle cash.
Accurately account for cash.
Prevent theft and fraud.
Assure the availability of adequate amounts of cash.
Avoid unnecessarily large amounts of idle cash.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-9
Using Excess Cash Balances Efficiently
Using Excess Cash Balances Efficiently
Cash available for long-term investment
may be used to finance growth and expansion of the business, or to
repay debt.
Cash not needed for business purposes
should be distributed to the company’s
stockholders.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-10
Internal Control Over CashSegregate authorization, custody and recording of
cash.
Prepare a cash budget.
Prepare a control listing of cash receipts.
Require daily deposits.
Make all payments by check.
Verify every expenditure before payment.
Promptly reconcile bank statements.
Internal Control Over CashSegregate authorization, custody and recording of
cash.
Prepare a cash budget.
Prepare a control listing of cash receipts.
Require daily deposits.
Make all payments by check.
Verify every expenditure before payment.
Promptly reconcile bank statements.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-11
Cash Over and ShortCash Over and Short
Cash Over and Short is debited for shortages and credited for overages.
Cash Over and Short is debited for shortages and credited for overages.
On May 5, XBAR, Inc.’s cash drawer was counted and found to be $10 over.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-12
Used for minor expenditures.
Petty Cash FundsPetty Cash Funds
Has one custodian.
Replenished periodically.
Petty Cash Funds
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-13
Short-Term InvestmentsShort-Term Investments
Bond Investments
Capital Stock
Investments
Current Assets
Almost As Liquid As
Cash
Readily Marketable
Marketable Securities
are . . .
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-14
Mark-to-Market: A Principle of Asset Valuation
Mark-to-Market: A Principle of Asset Valuation
Short-term investments in marketable securities appear on the balance sheet at their current market
value as of the balance sheet date.
Classification Management's IntentTreatment of Unrealized
Holding Gains and LossesAvailable-for-sale securities
Held for short-term resale (often 6 to 18 months)
Reported in stockholders' equity section of the balance sheet
Trading securities
Held for immediate resale (often within hours or days)
Reported in "other" revenue (expense) section of the income statement
Held to maturity securities
Debt securities intended to be held until they mature
Reported in stockholders' equity section of the balance sheet
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-15
Let’s turn our attention to
accounts receivable.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-16
Uncollectible AccountsUncollectible Accounts
If a company makes credit sales to
customers, some accounts inevitably will
turn out to be uncollectible.
If a company makes credit sales to
customers, some accounts inevitably will
turn out to be uncollectible.
PAST DUE
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-17
Reflecting Uncollectible Accounts in the Financial Statements
Reflecting Uncollectible Accounts in the Financial Statements
At the end of each period, record an estimate of the uncollectible
accounts.
At the end of each period, record an estimate of the uncollectible
accounts.
Contra-asset accountContra-asset accountSelling expenseSelling expense
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-18
The Allowance for Doubtful Accounts
The Allowance for Doubtful Accounts
Accounts receivableLess: Allowance for doubtful accountsNet realizable value of accounts receivable
The net realizable value is the amount of accounts receivable that the business
expects to collect.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-19
Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
When an account is determined to be uncollectible, it no longer qualifies as an asset and should be
written off.
When an account is determined to be uncollectible, it no longer qualifies as an asset and should be
written off.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-20
Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he
owes.
K-Max would make the following entry.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-21
Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Doubtful Accounts balance
was $2,500.
Let’s see what effect the write-off had on these accounts.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-22
Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
Before Write-Off
After Write-Off
Accounts receivable 10,000$ 9,500$ Less: Allow. for doubtful accts. 2,500 2,000 Net realizable value 7,500$ 7,500$
Notice that the $500 write-off did not change the net realizable value nor did it affect any income
statement accounts.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-23
Recovery of an Account Receivable Previously Written Off
Recovery of an Account Receivable Previously Written Off
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Accounts Receivable (X Customer) $$$$
Allowance for Doubtful Accounts $$$$
Cash $$$$
Accounts Receivable (X Customer) $$$$
Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-24
Monthly Estimates of Credit LossesMonthly Estimates of Credit Losses
At the end of each month, management should estimate the probable amount of
uncollectible accounts and adjust the
Allowance for Doubtful Accounts to this new
estimate.
At the end of each month, management should estimate the probable amount of
uncollectible accounts and adjust the
Allowance for Doubtful Accounts to this new
estimate.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-25
At December 31, 2005, MusicLand’s accounting records indicate the following:
Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit)
Past experience suggests that 5% of receivables are uncollectible.
What is MusicLand’s Uncollectible Accounts Expense for 2005?
At December 31, 2005, MusicLand’s accounting records indicate the following:
Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit)
Past experience suggests that 5% of receivables are uncollectible.
What is MusicLand’s Uncollectible Accounts Expense for 2005?
Monthly Estimates of Credit Losses Example
Monthly Estimates of Credit Losses Example
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-26
Desired balance in Allowance for Doubtful Accounts.
Monthly Estimates of Credit Losses Example
Monthly Estimates of Credit Losses Example
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-27
Let’s look at another way to estimate
the uncollectible
accounts!
Let’s look at another way to estimate
the uncollectible
accounts!
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-28
Estimating Credit Losses — The “Balance Sheet” Approach
Estimating Credit Losses — The “Balance Sheet” Approach
Year-end Accounts Receivable is broken down into age
classifications.
Year-end Accounts Receivable is broken down into age
classifications.
Each age grouping has a different likelihood of being
uncollectible.
Each age grouping has a different likelihood of being
uncollectible.
Compute a separate allowance for each age grouping.
Compute a separate allowance for each age grouping.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-29
Estimating Credit Losses — The “Balance Sheet” Approach
Estimating Credit Losses — The “Balance Sheet” Approach
At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows:
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-30
EastCo’s unadjusted balance in the allowance account is
$500.
Per the previous computation, the desired balance is $1,350.
EastCo’s unadjusted balance in the allowance account is
$500.
Per the previous computation, the desired balance is $1,350.
Estimating Credit Losses — The “Balance Sheet” Approach
Estimating Credit Losses — The “Balance Sheet” Approach
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-31
Guess What! There is another
alternative to estimate the uncollectible
accounts!
Guess What! There is another
alternative to estimate the uncollectible
accounts!
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-32
An Alternative Approach to Estimating Credit Losses
An Alternative Approach to Estimating Credit Losses
Uncollectible accounts’ percentage is based on actual uncollectible accounts from
prior years’ credit sales.
Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-33
An Alternative Approach to Estimating Credit Losses
An Alternative Approach to Estimating Credit Losses
Net Credit Sales % Estimated Uncollectible
Amount of Journal Entry
Net Credit Sales % Estimated Uncollectible
Amount of Journal Entry
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-34
An Alternative Approach to Estimating Credit Losses
An Alternative Approach to Estimating Credit Losses
In 2005, EastCo had credit sales of $60,000.
Historically, 1% of EastCo’s accounts have been uncollectible.
For 2005, the estimate of uncollectible accounts expense is $600.
($60,000 × .01 = $600)
Now, prepare the adjusting entry for December 31, 2005.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-35
An Alternative Approach to Estimating Credit Losses
An Alternative Approach to Estimating Credit Losses
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-36
Direct Write-Off MethodDirect Write-Off Method
This method makes no attempt to match revenue with the expense of
uncollectible accounts.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-37
Internal Controls for ReceivableInternal Controls for Receivable
Separate the following duties:
Maintenance of the accounts receivable subsidiary ledger.
Custody of cash receipts.
Authorization of accounts receivable write-offs.
Maintenance of the accounts receivable subsidiary ledger.
Custody of cash receipts.
Authorization of accounts receivable write-offs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-38
Management of Accounts Receivable
Management of Accounts Receivable
Credit Terms
Minimize Accounts
Receivable
Extending credit encourages customers to buy from us . . .
. . . but it ties up resources in accounts receivable.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-39
Ways to Minimize Amounts in Accounts Receivable
Ways to Minimize Amounts in Accounts Receivable
Selling Accounts
Receivable
Credit Card
Sales
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-40
Financial AnalysisFinancial Analysis
Accounts Receivable Turnover Ratio
This ratio provides useful information for evaluating how efficient management has
been in granting credit to produce revenue.
Accounts Receivable Turnover Ratio
This ratio provides useful information for evaluating how efficient management has
been in granting credit to produce revenue.
Net Sales Average Accounts Receivable
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-41
Financial AnalysisFinancial Analysis
Avg. Number of Days to Collect A/R
This ratio helps judge the liquidity of a company’s accounts receivable.
Avg. Number of Days to Collect A/R
This ratio helps judge the liquidity of a company’s accounts receivable.
Days in Year Accounts Receivable Turnover Ratio
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide 7-42
Concentration of Credit RiskConcentration of Credit Risk
A concentration of credit risk exists when many of a business’s credit customers can be
affected in a similar manner by certain changes in economic conditions.
A concentration of credit risk exists when many of a business’s credit customers can be
affected in a similar manner by certain changes in economic conditions.
The FASB requires companies to disclose all significant concentrations of credit risk in the
notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from
changes in specific economic conditions.
The FASB requires companies to disclose all significant concentrations of credit risk in the
notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from
changes in specific economic conditions.