2-1 financial assets chapter 7. 7-2 how much cash should a business have?
TRANSCRIPT
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2-1
Financial Assets
Chapter
7
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7-2
How Much Cash Should a How Much Cash Should a Business Have?Business Have?
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The Valuation of Financial The Valuation of Financial AssetsAssets
Type of Financial AssetsBasis 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
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CashCash
Coins and paper money
Checks
Money orders
Travelers’ checks
Bank credit card sales
Cash is defined as
any deposit banks will
accept.
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Reporting Cash in the Reporting Cash in the Balance SheetBalance Sheet
Cash Equivalents
Restricted Cash
Lines of Credit
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Cash ManagementCash ManagementAccurately account for cash.
Prevent theft and fraud.
Assure the availability of adequate amounts of cash.
Prevent unnecessarily large amounts of idle cash.
Accurately account for cash.
Prevent theft and fraud.
Assure the availability of adequate amounts of cash.
Prevent unnecessarily large amounts of idle cash.
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Internal Control Over CashInternal Control Over Cash
•Segregate authorization, custody and recording of cash.
•Prepare a cash budget (or forecast).
•Prepare a control listing of cash receipts.
•Require daily deposits.
•Make all payments by check.
•Require that every expenditure be verified before payment.
•Promptly reconcile bank statements.
•Segregate authorization, custody and recording of cash.
•Prepare a cash budget (or forecast).
•Prepare a control listing of cash receipts.
•Require daily deposits.
•Make all payments by check.
•Require that every expenditure be verified before payment.
•Promptly reconcile bank statements.
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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 drawerwas counted and found to be $15 short.
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Reconciling the Bank Reconciling the Bank StatementStatement
Explains the difference between cash reported on bank statement and cash
balance in depositor’s accounting records.
Provides information for reconciling journal entries.
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Reconciling the Bank Reconciling the Bank StatementStatement
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
± Bank Adjustments
= Adjusted Balance
Balance per Depositor
+ Deposits by Bank (credit memos)
- Service Charge - NSF Checks
± Book Adjustments
= Adjusted Balance
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Reconciling the Bank Reconciling the Bank StatementStatement• The July 31 bank statement for Simmons Company
indicated a cash balance of $9,610
• The cash ledger account on that date shows a balance of $7,430.
• Outstanding checks totaled $2,417.
• A $500 check mailed to the bank for deposit had not reached the bank at the statement date.
• The bank returned a customer’s NSF check for $225 received as payment of an account receivable.
• The bank statement showed $30 interest earned on the bank balance for the month of July.
• Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.
• A $486 deposit by Acme Company was erroneously credited to our account by the bank.
• The July 31 bank statement for Simmons Company indicated a cash balance of $9,610
• The cash ledger account on that date shows a balance of $7,430.
• Outstanding checks totaled $2,417.
• A $500 check mailed to the bank for deposit had not reached the bank at the statement date.
• The bank returned a customer’s NSF check for $225 received as payment of an account receivable.
• The bank statement showed $30 interest earned on the bank balance for the month of July.
• Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.
• A $486 deposit by Acme Company was erroneously credited to our account by the bank.
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Reconciling the Bank Reconciling the Bank StatementStatement
Balance per bank statement, July 31 9,610$
Additions:
Deposit in transit 500
Deductions:
Bank error 486$
Outstanding checks 2,417 2,903
Adjusted cash balance 7,207$
Balance per depositor's records, July 31 7,430$
Additions:
Interest 30
Deductions:
Recording error 28$
NSF check 225 253
Adjusted cash balance 7,207$
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Reconciling the Bank Reconciling the Bank StatementStatement
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Jul 31 Cash 30
Interest Revenue 30
31 Supplies Inventory 28
Accounts Receivable 225
Cash 253
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Short-Term InvestmentsShort-Term Investments
Bond Investments
Capital Stock
Investments
Current Assets
Almost As Liquid As
Cash
Readily Marketable
Marketable Securities
are . . .
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Purchase of Marketable Purchase of Marketable SecuritiesSecurities
Foster Corporation purchases as a short-term investment 4,000 shares of The Coca-Cola Company on December 1. Foster paid
$48.98 per share, plus a brokerage commission of $80.
Foster Corporation purchases as a short-term investment 4,000 shares of The Coca-Cola Company on December 1. Foster paid
$48.98 per share, plus a brokerage commission of $80.
Total Cost: (4,000 × $48.98) + $80 = $196,000Cost per Share: $196,000 ÷ 4,000 = $49.00
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Recognition of Investment Recognition of Investment RevenueRevenueOn December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000 shares of Coca-Cola.
On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000 shares of Coca-Cola.
4,000 × $0.30 = $1,200
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Sales of Investments at a Sales of Investments at a GainGainOn December 18, Foster Corporation sells 500
shares of its Coca-Cola stock for $50.04 per share, less a $20 brokerage commission.
On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $50.04 per share, less a $20 brokerage commission.
Sales Proceeds: (500 × $50.04) - $20 = $25,000Cost Basis: 500 × $49 = $24,500Gain on Sale: $25,000 - $24,500 = $500
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Sales of Investments at a Sales of Investments at a LossLossOn December 27, Foster Corporation sells an additional 2,500 shares of its Coca-Cola stock
for $48.01 per share, less a $25 brokerage fees.
On December 27, Foster Corporation sells an additional 2,500 shares of its Coca-Cola stock
for $48.01 per share, less a $25 brokerage fees.
Sales Proceeds: (2,500 × $48.01) - $25 = $120,000Cost Basis: 2,500 × $49 = $122,500Loss on Sale: $120,000 - $122,500 = $2,500
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Adjusting Marketable Adjusting Marketable Securities to Market ValueSecurities to Market ValueOn December 31, Foster Corporation’s remaining
shares of Coca-Cola capital stock have a current market value of $47,000. Prior to any adjustment, the company’s Marketable Securities account has a balance of $49,000 (1,000 × $49 per share).
On December 31, Foster Corporation’s remaining shares of Coca-Cola capital stock have a current
market value of $47,000. Prior to any adjustment, the company’s Marketable Securities account has a balance of $49,000 (1,000 × $49 per share).
Unrealized Loss: $47,000 - $49,000 = ($2,000)
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Presentation of Marketable Securities in the Balance Sheet
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Reflecting Uncollectible Reflecting Uncollectible Accounts in the Financial Accounts in the Financial StatementsStatements
At the end of each period, record an estimate of the uncollectible
accounts.
At the end of each period, record an estimate of the uncollectible
accounts.
Contra-asset accountContra-asset accountSelling expenseSelling expense
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The Allowance for The Allowance for Doubtful AccountsDoubtful Accounts
The net realizable value is the amount of accounts receivable that the business expects to
collect.Accounts receivableLess: Allowance for doubtful accountsNet realizable value of accounts receivable
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Writing Off an Writing Off an Uncollectible Account Uncollectible Account ReceivableReceivableWhen an account is determined to be
uncollectible, it no longer qualifies as an asset and should be written
off.
When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written
off.
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Before Write-Off
After Write-Off
Accounts receivable 10,000$ 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.
Writing Off an Writing Off an Uncollectible Account Uncollectible Account ReceivableReceivable
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Monthly Estimates of Monthly Estimates of Credit LossesCredit 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.
Two Approaches to Estimating Credit Losses1. Balance Sheet Approach2. Income Statement Approach
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Estimating Credit Losses Estimating Credit Losses — The Balance Sheet — The Balance Sheet ApproachApproach
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.
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Estimating Credit Losses Estimating Credit Losses — The Balance Sheet — The Balance Sheet ApproachApproach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
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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 Estimating Credit Losses — The Balance Sheet — The Balance Sheet ApproachApproach
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Net Credit Sales% Estimated Uncollectible
Amount of Journal Entry
Net Credit Sales% Estimated Uncollectible
Amount of Journal Entry
Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior
years’ credit sales.
Estimating Credit Losses Estimating Credit Losses — The Income Statement — The Income Statement ApproachApproach
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In the current year, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s credit sales has been uncollectible. For
the current year, the estimate of uncollectible accounts expense is $600.
($60,000 × .01 = $600)
In the current year, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s credit sales has been uncollectible. For
the current year, the estimate of uncollectible accounts expense is $600.
($60,000 × .01 = $600)
Estimating Credit Losses Estimating Credit Losses — The Income Statement — The Income Statement ApproachApproach
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Recovery of an Account Recovery of an Account Receivable Previously Receivable Previously Written OffWritten Off 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.
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Accounts Receivable (X Customer) $$$$
Allowance for Doubtful Accounts $$$$
Cash $$$$
Accounts Receivable (X Customer) $$$$
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ExampleExample
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Direct Write-Off MethodDirect Write-Off MethodThis method makes no attempt to
match revenues with the expense of uncollectible accounts.
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Management of Accounts Management of Accounts ReceivableReceivableExtending credit encourages customers to
buy from us but it ties up resources in accounts receivable.
Factoring Accounts
Receivable
Credit Card Sales
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Financial Statement AnalysisFinancial Statement Analysis
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A promissory note is an unconditional promise in writing to pay on demand or at
a future date a definite sum of money.
A promissory note is an unconditional promise in writing to pay on demand or at
a future date a definite sum of money.
Notes Receivable and Notes Receivable and Interest RevenueInterest Revenue
Maker—the person who signs the note and thereby promises to pay.Payee—the person to whom payment is to be made.
Maker—the person who signs the note and thereby promises to pay.Payee—the person to whom payment is to be made.
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Notes Receivable and Notes Receivable and Interest RevenueInterest Revenue The interest formula includes
three variables: The interest formula includes
three variables:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
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On November 1, Hall Company loans $10,000 to Porter Company on a 3 month note earning 12
percent interest. On December 31st, Hall Company needs an adjusting entry to record the interest
revenue on the Porter Company note.
On November 1, Hall Company loans $10,000 to Porter Company on a 3 month note earning 12
percent interest. On December 31st, Hall Company needs an adjusting entry to record the interest
revenue on the Porter Company note.
Notes Receivable and Notes Receivable and Interest RevenueInterest Revenue
$10,00012% 2/12 = $200$10,00012% 2/12 = $200
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What entry would Hall Companymake on February 1, the maturity
date?
What entry would Hall Companymake on February 1, the maturity
date?
Notes Receivable and Notes Receivable and Interest RevenueInterest Revenue
$10,00012% 3/12 = $300$10,00012% 3/12 = $300
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Financial Analysis and Financial Analysis and Decision MakingDecision Making
Accounts Receivable Turnover Rate
This ratio provides useful information for evaluating how efficient management has
been in granting credit to produce revenue.
Accounts Receivable Turnover Rate
This ratio provides useful information for evaluating how efficient management has
been in granting credit to produce revenue.
Net Sales Average Accounts Receivable
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Financial Analysis and Financial Analysis and Decision MakingDecision Making
Avg. Number of Days to Collect A/RThis ratio helps judge the liquidity of a
company’s accounts receivable.
Avg. Number of Days to Collect A/RThis ratio helps judge the liquidity of a
company’s accounts receivable.
Days in Year Accounts Receivable Turnover Ratio
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End of Chapter 7