CHAPTER 5

ACCOUNTING FOR CASH AND RECEIVABLE

ACCOUNTING FOR CAH
Key Terms and Concepts to Know
Cash: includes coins, currency (paper money), checks, and money orders. Money on deposit with a
bank or other financial institution that is available for withdrawal is also considered cash. Normally,
you can think of cash as anything that a bank would accept for deposit in your account. For example, a
check made payable to you could normally be deposited in a bank and, thus, is considered cash.
Purpose of Internal Controls:
Internal controls are a system of policies and procedures used by companies to safeguard assets and
ensure that transactions are recorded properly and in a timely manner.

Principles of Internal Control:

 Establish responsibilities
 Maintain adequate records
 Separation of recordkeeping from custody of assets
 Divide responsibility for related transactions
 Apply technological control
 Perform regular and independent review
Cash is the asset most likely to be stolen or used improperly in a business. For this reason, businesses
must carefully control cash and cash transactions.
Control of Cash Receipts
To protect cash from theft and misuse, a business must control cash from the time it is received until it
is deposited in a bank.
Control of Cash Payments
The control of cash payments should provide reasonable assurance that:
1. Payments are made for only authorized transactions.
2. Cash is used effectively and efficiently. For example, controls should ensure that all available
purchase discounts are taken.
Bank Accounts
A major reason that companies use bank accounts is for internal control. Some of the control
advantages of using bank accounts are as follows:
1. Bank accounts reduce the amount of cash on hand.
2. Bank accounts provide an independent recording of cash transactions. Reconciling the balance
of the cash account in the company’s records with the cash balance according to the bank is an
important control.
3. Use of bank accounts facilitates the transfer of funds using EFT systems.
Bank Statement
Banks usually maintain a record of all checking account transactions. A summary of all transactions,
called a bank statement, is mailed to the depositor or made available online, usually each month. The
bank statement shows the beginning balance, additions, deductions, and the ending balance.

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 Bank Reconciliation:
Identifies and explains the differences or reconciling items between the cash balance in the
depositor’s general ledger and the cash balance according to the bank’s records.
Reconciling items are transactions which have been recorded by either the depositor or the
bank, but not both, AND transactions which were not properly recorded by the depositor
and/or the bank.
Adjusting entries are recorded by the depositor for all reconciling items on the depositor’s side
of the bank reconciliation. If the adjusting entries are not recorded, these items will continue to
appear on the reconciliation if subsequent months until the adjusting entries have been made.

Bank Reconciliation
The balance according to the bank statement and the balance according to the depositor’s records
must be adjusted on the reconciliation properly determine the cash balance that should be in the
general ledger. Both the bank balance and the ledger balance are adjusted for items not
previously recorded as follows:

Bank Balance Ledger Balance

Add: Deposits in Transit Notes collected by the bank
Errors Errors

Deduct: Outstanding Checks Service Charges

Errors NSF checks
Errors

** All adjustments to the ledger balance MUST be journalized in order for the cash account
in the ledger to agree with the adjusted cash balance. **
Example #1
The cash account for Ace Co. on August 31, 2004, indicated a balance of $9,420. The bank
statement indicated a balance of $12,785 on August 31, 2004. The following reconciling items
were discovered.
a) Checks outstanding totaled $6,240.
b) A deposit of $5,375, representing cash receipts of August 31, had been made too late
to appear on the bank statement.
c) A check for $240 had been incorrectly charged by the bank as $420.
d) A check for $658 returned with the statement had been recorded by Ace as $568.
The check was for the payment of an obligation to Cahill Co. on account.
e) The bank had collected for Ace $2,800 on a note left for collection. The face of the
note was $2,000.
f) Bank service charges for August amounted to $30.
Required: Prepare the bank reconciliation and journalize the necessary entries.

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Solution #1
Cash balance according to bank statement $12,785
Add: Deposit of August 30 not recorded by bank $5,375
Bank error 180 5,555
$18,340
Deduct: Outstanding checks 6,240
Adjusted balance $12,100
Cash balance according to depositor’s records $9,420
Add: Proceeds of note and interest collected by bank 2,800
12,220
Deduct: Error in recording check $90
Bank service charges 30 120
Adjusted balance $12,100

Journal entries

Cash………………2800
Notes Receivable……………… 2,000
Interest Revenue……………...... 800
A/P-Cahill Co………….. 90
Misc. Adm. Expense……30
Cash…………………..……120

Practice Problem #1
The cash account for Kahn Inc. on November 30, 2003, indicated a balance of $5,699. The
bank statement indicated a balance of $13,167 on November 30, 2003. The following
reconciling items were discovered.

a) Checks outstanding totaled $5,175.

b) A deposit of $3,842, representing cash receipts of November 30, had
been made too late to appear on the bank statement.
c) The bank had collected for Kahn $4,800 on a note left for collection.
The face of the note was $4,200.
d) Kahn had recorded a check for $2,040 returned with the statement as
$2,400. The check was for the payment of a 3-year insurance policy.
e) A check for $1,176 had been incorrectly charged by the bank as $176.
f) Bank service charges for November amounted to $25.

Required: Prepare the bank reconciliation and journalize the necessary entries.

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 Petty Cash Account:
A Petty Cash fund is used to provide small amounts of cash for common expenditures for which
the company does not write a check or purchase on account. The petty cash account always has
an entry to establish the fund and perhaps a subsequent entry to increase or decrease the fund’s
balance. Replenishment entries are not recorded using the petty cash account. Any differences
between the total of the receipts for funds expended and the amount necessary to replenish the
fund balance are debited or credited to the Cash Short and over account.
The replenishment entry can be prepared in three steps:
 Debit each expense account for the amount spent from the receipt
 Credit Cash for the difference between the imprest balance and actual cash Remaining in
the fund
 If the entry does not balance debit or credit the difference to Cash Over and Short as
appropriate
Example #2: In June, the Filbert Company established a petty cash account with a $200 balance.
During June, the following expenditures were made from petty cash: supplies $95, FEDEX bills
$42, and miscellaneous other receipts $38. When counted, there was $25 of cash remaining in
the petty cash fund. Journalize the entries for June.

Solution #2:
Petty Cash………200
Cash…………..200 To establish the fund

Supplies 95 to replenish the fund and record all the expenses paid for in cash.
Delivery Expense 42
Misc. Adm. Expense 38
Cash 175

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 Voucher System:
A set of control procedures designed to ensure the cash disbursements have been properly
approved and are supported by the appropriate documents.

If the above example was in the case of voucher system

Petty cash …………..200
Account payable……………200 for petty cash establishment
Account payable………200
Petty cash…………………...200
Supplies………………95
Delivery Expense…….42
Misc. Adm. Expense…38
A/P…………175
A/P………………….175
Cash at bank………..175

The Cash Over and Short account has two purposes:

 It will be debited or credited for the difference between the total of the receipts and the
cash required to replenish the petty cash account. If there are missing receipts, the
account is debited and if there is too much cash in the account, the account is credited.
 It is used to record shortages or overages in the cash register. The cash in the drawer
represents a debit to cash. The cash register tape represents the credit to sales. If there is a
shortage, it is debited Cash Short and Over. If there is an overage, it is credited Cash
Short and Over.

Example #3:
In July, the Filbert Company made the following expenditures from petty cash: repairs
$85, FEDEX bills $60 and postage $13. When counted, there was $40 of cash remaining in the
petty cash fund. Journalize the entries for July.
Solution #3:
Supplies …………….. 85
Delivery Expense…….60 from receipts
Misc. Adm. Expense…13
Cash Over and Short….2 160 – 85 – 60 – 13 = 2
Cash…………….160

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 ACCOUNTING FOR RECEIVABLE
Receivables are all claims against individuals, organization or other debtors. They are
acquired by business enterprises in various types of transactions common being.
 Result from sales on account (credit sales), not cash sales.
 May also result from credit card sales if there is a delay between when sale is made and
when the cash is received from the credit card company.
Classifications of Receivables

 Receivables are frequently classified as:

 Accounts receivable:
 Are amounts owed by customers on account
 Are based on oral agreements are known as open accounts.
 Are expected to be collected within 30 to 60 days.
 Is usually the most significant type of claim held by a company
 Notes receivable:
 Represent claims for which formal instruments of credit are issued as evidence of
debt.
 are based on formal (written) instruments are called promissory notes
 Are credit instruments that normally require payment of interest and extend for time
periods of 60-90 days or longer.
 Other receivables:
 Nontrade receivables including interest receivable, loans to company officers,
advances to employees, and income taxes refundable.
 Generally classified and reported as separate items in the balance sheet.
 Note that: Accounts and notes receivables originating from sales transactions are called
Trade Receivables.

Internal control over Receivables

The management of a business enterprise installs the means of internal control over their
receivables. Thus, controls include

 Separation of the business operations and the accounting for receivables.

 Separation of duties helps to reduce possibility of errors and embezzlement.
 Adequate control over account receivable
 Effective collection procedures should also be established.

NOTES RECEIVABLE
 A promissory note is a written promise to pay a specified amount of money on demand or at
a definite time.
 In a promissory note, the party making the promise to pay is called the maker.

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  The party to whom payment is to be made is called the payee. The payee may be
specifically identified by name or may be designated simply as the bearer of the note.
 Notes receivable
 Give the holder a stronger legal claim to assets than accounts receivable.
 Are frequently accepted from customers who need to extend the payment of an
outstanding account receivable, and they are often required from high-risk
customers.
 Notes receivable, like accounts receivable, can be readily sold to another party.
Types of Notes
 There are two types of notes.
 Non-interest bearing note: a note that does not provide for the payment of interest.
 Interest bearing note: a note that provides for the payment of interest for the period
between the issuance date and the due date.

 The formula for computing interest is:

Interest =prt
Where; P=Face Value of Note (principal)
r = Annual Interest Rate
t = Time (in terms of one year)

 Due date: the date a note is to be paid is called the due date or maturity date.
 Maturity Value: the amount that is due on a note on date of maturity or due date is maturity
value. The maturity value of non-interest bearing note is the same with the face amount or
principal of the note.
Maturity value = principal + interest

 The interest rate specified on the note is an annual rate of interest. The time factor in the
computation expresses the fraction of a year that the note is outstanding.
 When the maturity date is stated in days, the time factor is frequently the number of days
divided by 360. For example, the maturity date of a 60-day note dated July 17 is determined
as follows:
Term of note…………………………………….. 60 days
Days in July …………………………… 31
Date of note…………………………… 17
Note’s days in July…………………….. 14

Days in August………………………… 31
Plus note’s days in July……………….. 14
Notes days to the end of August………. 45 45
Maturity date, September……………… 15

 When the due date is stated in terms of months, the time factor is the number of months
divided by 12.

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  Notes may be held to their maturity date, at which time the face value plus accrued
interest is due.
 In some situations, the maker of the note defaults, and appropriate adjustment must be
made.
 A note is honored when it is paid in full at maturity.
 A dishonored note is a note that is not paid in full at maturity.
 If the lender expects that it will eventually be able to collect, the Notes Receivable
account is transferred to an Account Receivable for both the face value of the note and
the interest due.
 If there is no hope of collection, the face value of the note should be written off.
 The note receivable is recorded at its face value, the value shown on the face of the note.

Example: 1

 On July 17, 2001, received a $12,000, 90-day, 10% notes from Adams Co. Assume that the
note was written to settle an open account.
Determine:
A) Due date for the note
B) Interest earned during the term of the note
C) Maturity value of the note
Prepare journal entries whether:
D) The note is honored on the maturity date
E) The note is dishonored on the maturity date
Solution:
A) Due Date:
Term of the note = 90
Days remaining in July 31 – 17 = 14
Remaining term of the note 76
Days in August 31
Remaining term of the note 45
Days in September 30
Remaining term of the note 15
Since the remaining 15 days are less than the 31 days in October, the note is due on October 15

B) Interest:
Calculated as Principal X Rate X Time
$12,000 x .10 x 90 days/360 days = $300
Time is calculated as the term of the note divided by 360 days for the year.
Time is always based on a 360-day year.
C) Maturity Value:
Calculated as Principal + Interest
$12,000 + $300 = $12,300

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D) Note is honored:
7/17 Notes receivable…………..12,000
Accounts receivable……………………….12,000
10/15 Cash……………………….12,300
Notes receivable……………………….12,000
Interest receivable……………………….300
E) Note is dishonored:
7/17 Notes receivable……………………….12,000
Accounts receivable………………………….12,000
10/15 Accounts receivable……………………….12,300
Notes receivable………………………………..12,000
Interest receivable………………………………..300
The difference between the two entries for 10/15 is the account to be debited.
Example: 2
A 30 day, 12% note dated Dec.21, 2008, is accepted in settlement of the account of ABC
Company which has a balance of $4000. The entry to record the transaction on:
A. December 21 settlement of the account
B. Adjusting entry for accrued ones, Dec.31,2008
C. The necessary entry on the maturity date
Dec 21 Note receivable----------4000
Account receivable----------4000
Dec 31 Interest receivable-------13.33 (4000 x 10/360 x 12% = 13.33)
Interest Income----------------13.33

Jan 20 Cash---------------------------4040
Note Receivable---------------4000
Interest income-----------------26.7 (4000 x 20/360 x 12% = 40)
Interest receivable---------------13.3

Discounting Note receivable

To get cash quickly, company’s (payees) sometimes sell their note receivable to another party
before the note matures. The payee endorses the note and hands it over to the note purchaser,
usually bank, which collects the maturity value of the note at maturity date. Selling a note
receivable by endorsing before maturity value is called discounting a Note receivable because
the payee of the note receivable lasses than its maturity value.

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Important terms related to discounting of a Note

Proceeds: is the amount of the cash obtained from the bank by discounting a note.

Discount: is the difference between the amount of the holder of the note received from the bank
and the maturity value of the note (maturity value plus proceed). It is computed on the maturity
value of the note for the period of time the bank must hold the note i.e. the due date of transfer
and due date. The difference between the amount of the proceeds and the face values (carrying)
of the note is recorded by the payee as interest income or interest expense.

If proceeds exceeds principal = interest income

If principal exceeds proceeds = interest expense

Discount period: is the period (number of days) from the date of discounting the note to the date
of maturity.

Steps in computing the proceeds

1) Determine the maturity value (maturity value= face value plus interest)
2) Determine discount period
3) Determine the discount amount(discount = MV x discount rate x discount period)
4) Determine the proceeds (proceeds = maturity value - discount)

Example:

Assume that a note a 90 day, 12% note receivable for $1800 dated November 8, is discounted at
the payee’s bank on December 3, at the rate of 14%.

Calculate

1) Maturity value of the note (MV)

2) Discount period
3) Discount
4) Proceeds

Solution

1. Maturity value of the note (MV)

Face value of the note Nov 8……………………. $1800
Interest on note 90 days at 12% …………………….54
Maturity value of the note due Feb 6……………… $1,854
2. Discount period
Discount period December 3 to Feb 6……………65 days

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 3. Discount
Discount on maturity value = $1854 x 14% x 65/360 =$46.87
4. Proceeds = maturity value – discount = $1854- 46.87 = $1807.13

The excess of the proceeds from discounting the note $7.13($1807.13-1800) over its face value
$1800 is recorded as interest income. Therefore, the entry on December 3 is

December 3: cash………………….1807.13
Note receivable………………….1800
Interest income…………………..7.13
 Assume also that if the discount rate is 20% instead of 14%

Discount = $1854 x 20% x 65/360 =$66.95

Proceed = $1854 – 66.95 = $1787.05

 December 3: cash………………..1787.05
Interest expense……….…….12.95
Note receivable……..……….1800

Accounting for Uncollectible Accounts:

 Not all sales on account result in cash being collected from the customer.
 Account receivable that are not collected result in a bad debt expense.
 The matching principle requires that this expense be recorded in the period of sale, not
the period when the account is determined to be uncollectible.
Two methods are used in accounting for uncollectible accounts:

1. Direct Write-off Method

2. Allowance Method

 Direct write-off method

 When a specific account is determined to be uncollectible, the loss is charged to Bad

Debt Expense.
 For example, assume that Moza Co. writes off Sheba’s $200 balance as uncollectible on
December 12. The entry is:
Dec. 12: Bad Debts Expense……………….200
Accounts Receivable --Sheba…………..200

(To record write-off of M. E. Duran account)

 An account receivable that has been written off may be collected later. In such cases, the
account is reinstated by an entry that reverses the write-off entry. The cash received in
payment is then recorded as a receipt on account.

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  Journalize the following transactions using the direct write-off method of accounting for
uncollectible receivables:

July 9. Received $1,200 from Jay Burke and wrote off the remainder owed of $3,900 as
uncollectible.

Oct. 11. Reinstated the account of Jay Burke and received $3,900 cash in full payment.

Solution

July 9: Cash . . . . . . . . . . . . .. . . . . . . . . 1,200

Bad Debt Expense ….....…. . . . 3,900
Accounts Receivable—Jay Burke. .... 5,100
Oct. 11: Accounts Receivable—Jay Burke . . .. . . . . . . . 3,900
Bad Debt Expense . . . . . .. . . . . . . . . . . . . . . . . . 3,900
11: Cash . . . . . . . . . . . . . . . .. . . .. . . . . . . . . . 3,900
Accounts Receivable—Jay Burke . . . . . . . . . .. 3,900

 Bad debts expense is often recorded in a period different from that in which the revenue
was recorded. No attempt is made to show accounts receivable in the balance sheet at the
amount actually expected to be received.
 Use of the direct write-off method can reduce the usefulness of both the income statement
and balance sheet.
 Unless bad debt losses are insignificant, the direct write-off method is not acceptable for
financial reporting purposes.
 In the period when a specific account is determined to be uncollectible. The Direct Write-
off Method violates the matching principle because it does not match revenues and
expenses in the same period, and may not be used unless the expense closely
approximates the expense under the Allowance Method
.
 Allowance method
 The allowance method of accounting for bad debts involves estimating uncollectible
accounts at the end of each period.
 It provides better matching of expenses and revenues on the income statement and
ensures that receivables are stated at their net realizable value on the balance sheet.
 Receivables are therefore reduced by estimated uncollectible amounts on the balance
sheet through use of the allowance method.
 The Allowance Method is GAAP that fulfills the matching principle, and required for
financial reporting purposes when bad debts are material.

 Three essential features of the allowance method are:

1. Uncollectible accounts receivable are estimated and matched against revenues in
the same accounting period in which the revenues occurred.

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 2. Estimated uncollectible are recorded as an increase to Bad Debts Expense and an
increase to Allowance for Doubtful Accounts (a contra asset account) through an
adjusting entry at the end of each period.
3. Actual uncollectible are debited to Allowance for Doubtful Accounts and credited to
Accounts Receivable at the time the specific account is written off as uncollectible.
Note that:
 Allowance for Doubtful Accounts is not closed at the end of the fiscal year.
 Bad Debts Expense is reported in the income statement as an operating expense (usually
a selling expense).
 Under the allowance method, every bad debt write-off is debited to the allowance account
and not to Bad Debt Expense.

Procedures in using allowance method:

 The Allowance Method debits bad debt expense in the period when the sale is recorded
and credits a contra-asset account, Allowance for Uncollectible Accounts.
Uncollectible Accounts Expense………..xxx
Allowance for Uncollectible Accounts………..xxx
 In the period in which a specific account is determined to be uncollectible, the Allowance is
debited and Accounts Receivable is credited.
Allowance for Uncollectible Accounts………..xxx
Accounts Receivable………..xxx
 Uncollectible Accounts Expense is reported on the Income Statement. The Allowance for
Uncollectible (Doubtful) Accounts is a contra asset account and is reported on the balance
Sheet as a deduction from Accounts Receivable. The result is called Net Realizable Value:

Current Assets:
Accounts Receivable 25,000
Less allowance for doubtful accounts 3,000
= Net Realizable Value 22,000
 Sometimes a customer will pay the accounts receivable after it was written off. Recording
the receipt of cash is always a two-step process:
 first, the account receivable is reinstated (added back into the general ledger)
 Second, the cash is recorded and accounts receivable is reduced for the payment.
To reinstate the accounts receivable:
Accounts Receivable………..xxx
Allowance for Uncollectible Accounts………..xxx
To apply the cash received:
Cash………..xxx
Accounts Receivable………..xxx

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Example #1: Journalize the following transactions.

Dec/31: estimated that $8,000 of accounts receivable would become uncollectible.

Jan/05: Wrote-off the $600 balance owed by Jane Camp and the $400 balance owed by
Friends, Inc.
March/18: reinstated the account of Jane Camp that had been written off as Uncollectible
Solution #1
Dec/31: Uncollectible Accounts Expense………..8,000
Allowance for Uncollectible Accounts………..8,000

Jan/05: Allowance for Uncollectible Accounts………..1,000

Accounts Receivable-Camp………..600
Accounts Receivable-Friends………..400

March/18: Accounts Receivable-Camp………..600

Allowance for Uncollectible Accounts………..600
Cash………..……….. 600
Accounts Receivable-Camp………..600

Methods for Estimating the Uncollectible Amount

Most companies estimate their uncollectible accounts receivable using one of three approaches:

1. The percent of sales method

2. The percent of receivables method
3. The aging of receivables method

1. The percent of sales method.

 Uses credit sales for the period to estimate bad debt expense for the period. Sometimes
referred as the income statement method.
 Under this method, the amount of the adjustment is calculated by multiplying a
historical percent of bad debts by the current year’s net credit sales. Although
acceptable, this method is not as accurate as the either the percentage of receivables
method or the aging of receivables method.
Example #1: A company had net sales of $1,000,000. It is estimated that one percent of net
sales are uncollectible. The current balance in Allowance for Doubtful Accounts is $300
credit. Determine the following:
a) The uncollectible accounts expense for the year.
b) The adjusting entry to be made on December 31.
c) The balance in Allowance for Doubtful Accounts after adjustment.

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Solution #1
A. 1,000,000 * 0.01 = $10,000
B. Uncollectible Accounts Expense………..10,000
Allowance for Uncollectible Account………..10,000
C. $300 credit balance + 10,000 additional credit = $10,300 credit balance

2. Percent of Accounts Receivable Method

 Analyses the balance in Accounts Receivable to estimate the balance in the Allowance
for Uncollectible Accounts at the end of the period. Sometimes referred to as the balance
sheet method.
 Unlike the percentage of sales method, the percentage of receivables method does not
directly estimate bad debts expense. This method actually estimates the ending balance of
allowance for bad debts account. The estimated bad debts expense is then calculated as
shown below:

Ending Balance of Allowance for Bad Debts

− CR Balance in Allowance for Bad Debts; or
+ DR Balance in Allowance for Bad Debts
= Bad Debts Expense

Example #1: The balance of Allowance for Doubtful Accounts before adjustment at the end of
the period is $400 debit. Based on an analysis of Accounts Receivable, it was estimated that
$10,000 would become uncollectible.
Determine the following:
a) The uncollectible accounts expense (bad debts expenses) for the year.
b) The adjusting entry to be made of December 31.
c) The balance in Allowance for Doubtful Accounts after adjustment.
Solution #1
a) Uncollectible accounts expense = 400 + 10,000= 10,400

b) Uncollectible accounts expense………..10,400

Allowance for doubtful accounts………..10,400

c) 10,000

Example 2: The balance of Accounts Receivable is $100,000, and it is estimated that 5% of

accounts are uncollectible. The balance of the Allowance for Doubtful Accounts, before
adjustment, is $2,000 (credit). The desired balance of the Allowance for Doubtful Accounts
would be $5,000 ($100,000 * 5%). Since the balance of the Allowance for Doubtful Accounts is
now only $2,000, a $3,000 adjustment is required, as follows.

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Determine the following:
a) The uncollectible accounts expense (bad debts expenses) for the year.
b) The adjusting entry to be made of December 31.
c) The balance in Allowance for Doubtful Accounts after adjustment.

Solution #2

a) Uncollectible accounts expense = 5000 - 2,000= 3,000

b) Bad Debts Expense …………3,000
Allowance for Doubtful Accounts …………3,000
c) 5,000

3. The aging of receivables method. Most companies have an aging of customers’ accounts
receivable. In this aging report, each customer balance is classified by how long it is past
due. Based on this aging, experience is used to estimate the percent of each aging total. Older
past due receivables will be more likely uncollectible. Once the total uncollectible amount is
estimated, an adjusting entry is made to increase the Allowance for Doubtful Accounts so
that its balance equals the uncollectible estimate calculated by using the aging report.

Example: Based on its aging report, a company estimates its uncollectible accounts receivable to
be $6,000. The current balance in the Allowance for Doubtful Accounts is $1,000 (credit). An
adjusting entry of $5,000 ($6,000 desired less $1,000 balance before adjustment) would be
recorded as follows.

Bad Debts Expense …………5,000

Allowance for Doubtful Accounts …………5,000

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