Chapter 5 Notes

Chapter 5
Internal Control,
Cash, and
Receivables
Learning Objective 1
Learn about fraud and internal control
Copyright 2014 Pearson Education.
Fraud
Intentional misrepresentation of facts
Causes injury or damage to another party
Large problem that increases each year
Types of Fraud
Misappropriation
of assets
Fraudulent
____________
Employees ____
assets from
company
Cash
Inventory
False expense
reports
Managers make
false entries so
company appears
more profitable
Deceives
investors and
creditors
Fraud Triangle
Motive
Rationalization
Opportunity
Internal Control
Primary way fraud and errors are:
Prevented
Detected or
Corrected
Management and Board of Directors implement a:
Plan of organization
System of procedures
We will not cover Internal Controls in detail in

this class.
Learning Objective Three

Prepare and use a bank reconciliation
Bank Account as Control Device

Signature
card
Bank
statement
Bank
reconciliation
Deposit ticket
Check
Bank Account Documents

Signature card
__________of your signature
Protects against forgery
Deposit ticket
Proof of transaction
Cheque
Maker _____ the cheque
Payee to whom the cheque is paid
Bank where funds are drawn
The Bank Statement

Reports:
Cash _______
Cash _______
Electronic Funds
Transfer (EFT)
Make payments by
electronic
communication
10
Bank Reconciliation
Two records of a businesss cash
The bank statement (maintained by _______)
The Cash account in the general ledger
(maintained by __________)
Amounts are usually different

_________in recording transactions
Bank reconciliation ________________
11
n the annual multivariate Tobit regressions, the dependent variable, REPURPCT, is the annual dollar value of repurchase divided by lagged total assets
Bank Reconciliation Items

Bank Side
Book Side
ADD
Deposits in transit
Certain bank errors
SUBTRACT
Outstanding cheques
Certain bank errors
NSF means _________________
Electronic Fund
ADD
Transfer
Bank collections
EFT receipts
Interest revenue
Certain book errors
SUBTRACT
EFT payments
Service charges
NSF cheques
Certain book errors
12
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 services charges, NSF

cheques, EFT payments
Add or subtract correction of bank Add or subtract correction of book

errors
errors
13
Journalizing Bank Reconciliation

Items
All items on the _________of the bank
reconciliation require journal entries
If the item is added to book side
Debit Cash
If the items is subtracted from the book side

Credit Cash
14
JOURNAL
Date Accounts and explanation
Debit
Credit
Cash
Dividend Revenue
Receipt of dividend revenue earned on
investment. (_____________________)
Cash
Accounts receivable
Account receivable _______________
Cash
Interest Revenue
Interest earned on bank balance.
Cash
Accounts Payable
Correction of cheque
15
JOURNAL
Debit
Credit
Bank service charges

Cash
Bank service charge.
Accounts Receivable
Cash
NSF cheque returned by bank.
Insurance Expense
Cash
Payment of monthly insurance.
16
Online Banking
allows you to pay bills and view your account
electronically
can reconcile transactions at any time
17
Exercise 5-39B
Harry Smith operates a bowling alley.
He has just received the monthly bank statement at
September 30 from City National Bank, and the statement
shows an ending balance of 545. Listed on the statement
are an EFT rent collection of 325, a service charge of 8,
two NSF checks totaling 125, and a 10 charge for
printed checks. During September, he recorded a $310
check for the salary of a part-time employee as 31.
In reviewing his cash records, Smith identifies outstanding
checks totaling $609 and a September 30 deposit in transit
of 1,790. Smiths Cash account shows a September 30
cash balance of 1,823. How much cash does Smith
actually have at September 30?
Preparing a bank reconciliation.
18
Exercise 5-39B
Bank:
Books:
Balance, September 30
Add:
545 Balance, September 30
1,823
Add:
Less:
Less:
19
Budgeting
Budget
Financial plan to coordinate activities
Cash budget
Planning _______ and _______
Steps:
Start with beginning cash balance
Add budgeted receipts and subtract budget
payments
Equals expected cash balance
Compare cash available to budgeted cash balance
20
Expected Cash Balance

If expected cash is
greater than
minimum needed
Invest
excess
Consider
borrowing
If expected cash is
less than minimum
needed
Very closely related to Corporate Finance

21
Cash Budget
Beginning cash balance
Budgeted cash receipts:
Collections from customers
Dividends from investments
Sale of store fixtures
Budgeted cash payments:
Purchases of inventory
Operating expenses
Expansion of store
Payment of long-term debt
Payment of dividends
Cash available (needed)
Budgeted cash balance, end of period
Cash available for investing or (new
financing needed)
22
Reporting Cash on the Balance

Sheet
All cash accounts combined into a single total
called Cash and Cash Equivalent
Include liquid assets such as time deposits,
certificates of deposit, and high-grade government
yield
Interest-bearing accounts with no withdrawal
penalty
Reports liquid assets available for day-to-day use

23
Exercise 5-25A
Cole Communications, Inc., is preparing its cash budget for
20X7. Cole ended 20X6 with cash of $86 million, and
managers need to keep a cash balance of at least $82 million
for operations.
Collections from customers are expected to total $11,305
million during 20X7, and payments for the cost of services and
products should reach $6,167 million. Operating expense
payments are budgeted at $2,544 million. During 20X7, Cole
expects to invest $1,826 million in new equipment and sell
older assets for $118 million. Debt payments scheduled for
20X7 will total $603 million. The company forecasts net
income of $885 million for 20X7 and plans to pay dividends of
$347 million.
Prepare Cole Communications cash budget for 20X7. Will the
budgeted level of cash receipts leave Cole with the desired
ending cash balance of $82 million, or will the company need
additional financing? If so, how much?
24
Exercise 5-25A
Cole Communications
Cash Budget
Cash, December 31, 20X7
$86
Budgeted Cash Receipts:

Collections from customers
$11,305
Sale of assets
118
$11,509
Where is the Net
Income of $885?
Budgeted Cash Payments:

Costs and services
6,167
Operating expenses
2,544
Purchase of equipment
1,826
Payment of long-term debt
603
Payment of dividends
347
Why is it not here?
$11,487
Cash available
$22
Budgeted cash available
$82
New financing needed
$60
25
Learning Objective Four

Account for receivables and uncollectible
receivables
26
Receivables
Monetary claims against others
Acquired mainly by:
selling goods and services
lending money
Two major types:

________ receivables
_______ receivables
27
Accounts Receivable
Amounts collectible from customers
Balance in _________ ledger
Control account: summarizes total amount due
from all customers
___________ ledger
Separate account for each customer
28
Accounts Receivable Subsidiary Ledger
General Ledger
Customer A
$5,000
Accounts receivable
$9,000
Total
$9,000
Customer
B
$1,800
Customer C
$3,000
29
Internal Control: Collections on

Account
Separate cash-handling and cash accounting
duties
Bookkeeper should not handle cash
Should record amounts from remittance advices
Separate employee should open incoming mail

and make deposit
Another option:
Lockbox system
Payments are sent _____________which then
notifies the company of the amount received
30
Managing Risk of Not Collecting

Benefit of selling on credit
Cost of selling on credit
Customers that do not

have cash available can
buy on credit
Sales and profits increase
Company _________
from some customers
This cost is called
A Company Must Balance the Benefit And
Cost of Credit Effectively
________________,
_______________, or
____________expense
31
Risks of Selling on Credit

Issues
Plan of action
What are the benefits and costs of

extending credit to customers?
Benefit increase in sales

Cost risk of not collecting
Extend credit to only creditworthy

customers
Run a credit check on prospective

customers
Separate cash-handling and

Design internal control system to
accounting duties to keep
separate duties
employees from stealing cash from
customers
Pursue collection from customers
to maximize cash flow
Keep a close eye on customers.

Send additional statements to
slow-paying customers
32
Accounting for Uncollectible

Receivables
Balance Sheet
December 31, 20X6
Equipment
$XXX
Less: allowance for doubtful

receivables
(XXX)
Net trade and other receivables
XXX
33
The Allowance Method

Records collection losses based on companys
_____________________
Estimates Bad Debt Expense
Dr Bad Debt Expense (as accounts receivables are
recorded)
Also sets up Allowance for Uncollectible Accounts

(XA)
Cr Allowance for Uncollectibles
Contra-account to Accounts Receivable
Shows amount of receivables expected not to be collected
(_________).
34
Net Realizable Value

Balance Sheet
Current assets:
Accounts receivable
$10,000
Less: Allowance for uncollectible accounts

Accounts receivable, net
(900)
$9,100
Balance Sheet
Current assets:
Accounts receivable, less allowance of $900
$9,100
35
Method to Estimate Uncollectibles

Aging-of-receivables
Focuses on proper valuation of (______)accounts
receivable on the ____________
Individual customer balances analyzed based on
_____________
Aging schedule (older accounts more likely to go
bad)
Allowance for Uncollectible Accounts adjusted to
equal amount from aging schedule
36
Aging-of-Receivables
Age of Account
Not
1-30
yet due days
Customer
31-60
days
Over 60
days
Total
Balance
Customer A
$400
Customer B
100
100
Customer C
300
200
600
100
1,200
11,060
1,363
370
1,093
13,886
1.0%
5.0%
12.5%
20.9%
111
68
46
219
All others
Totals
Est. percent uncollectible
Allowance balance should be:
$400
200
444
37
JOURNAL
Debit
Uncollectible accounts expense
Credit
151
Allowance for uncollectible accounts
151
Recorded uncollectible accounts expense
Allowance for Uncollectible Accounts

Balance before adjustment
$293
$____Adjustment needed
$444
Ending balance equals aging schedule
38
Accounts Receivables
Allowance for Uncollectible Accounts
$293
$13,886
$151
$444
Net accounts receivables, $13,442
Uncollectible Account Expense
$151
$151
39
Writing Off Uncollectible Accounts

JOURNAL
Debit
Allowance for uncollectible accounts
Credit
12
Accounts Receivable
12
Write off customer account
Allowance for Uncollectible

Accounts
Accounts Receivable
Bal.
$100
$12
$12
$20
Bal.
$8
$88
No impact on Income
Statement!
40
Adjusting Ending Allowance for

Doubtful Receivables
JOURNAL
Debit
Uncollectible for Doubtful receivables
Credit
22
Allowance for Doubtful receivables ($30 - $8)
22
Recorded bad debt expense for the year
Relationship between uncollectible-account expense, write-offs of receivables

and allowance for doubtful receivables account
Beginning
Allowance
Receivables
Write-offs
Bad Debt
Expense
Ending
Allowance
41
Direct Write-Off Method

Waits until a specific account is uncollectible to
record the expense
Inferior to Allowance method
Receivables reported at full amount
Assets overstated on Balance Sheet
Normally _____________under GAAP
JOURNAL
Debit
Credit
Uncollectible-account Expense
Accounts Receivable
Write off customer account
42
Computing Cash Collections from

Customers
Accounts Receivable
Beginning balance
$200
Sales on credit
$1,800
Ending balance
$400
$100
$_____?
Write-offs of
uncollectibles
Collections from
customers
43
Notes Receivable
More formal than accounts receivable
______________to pay a sum at the maturity
date
Plus interest
Also called promissory notes
44
Notes Receivable
Can be current or long-term assets
Terms:
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
Maturity value
Sum of principal and interest
Principal
Amount borrowed by debtor
Term
Length of time from when note was signed to when

payment must be made
45
Principal
Date Interest
Starts
PROMISSORY NOTE
August 31, 20X6
$1,000
Amount
Date
For value received, I promise to pay to the order of

Payee (Creditor)
RaboBank
Amsterdam, Netherlands
Principal
One thousand and no/100s--------------------------------
Dollars
Maturity Date
On February 28, 20X7

plus interest at the annual rate of 9 percent
Lauren Holland
Maker
(Debtor)
46
Accounting for Notes Receivable

JOURNAL
Date
Accounts and explanation
Debit
Credit
20X6
Aug 31
Notes receivable L.Holland

Cash
Dec 31
Interest receivable ($1,000 x 0.09 x 4/12)

Accrued Interest revenue
2011
Feb 28
Cash
Notes receivable L.Holland
Interest receivable
47
Interest Computation
Interest rates are always expressed as _______
_______, unless stated otherwise
For example, a 6-month note with an interest of
9% means the annual rate is 9%. The note will
actually earn 4.5%.
The time element (4/12) is the fraction of the

year that the note has been in force during 2010.
Often interest is computed based on days
Denominator would be days/365
48
Speeding Up Cash Flow

Credit cards
Customers pay with credit cards
Revenues increases, with a cost
Credit card company takes 2-3% as a fee
Selling receivables (________)

Companies sell receivables to another business, called a
factor
The factor pays a discounted price and then collects full
amount from customer
49
Learning Objective Five

Use two key ratios to evaluate a business
50
Current Ratio
Total current assets
Total current liabilities
51
Short Exercise 5-15

Acid-test ratio
$294,900
$99,000
= 2.98
52
Days Sales in Receivables (Collection

Period)
Sales
Receivables
Turnover
Average
Receivables
Days sales in
receivables
Receivables Turnover
365
(Beginning net receivables + Ending net receivables)/2

53
Short Exercise 5-15

Days sales in receivable
$802,000
Receivables
Turnover
Days sales in
receivables
$73,900
10.85
$2,197.26
= 34 days
(Beginning net receivables + Ending net receivables)/2

54

Chapter 5 Notes

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Chapter 5 Notes

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Chapter 5

Copyright 2014 Pearson Education.

Copyright 2014 Pearson Education.

Copyright 2014 Pearson Education.

Copyright 2014 Pearson Education.

We will not cover Internal Controls in detail in

Learning Objective Three

Copyright 2014 Pearson Education.

Bank Account as Control Device

Bank Account Documents

The Bank Statement

Copyright 2014 Pearson Education.

Amounts are usually different

Bank reconciliation ________________

Copyright 2014 Pearson Education.

Bank Reconciliation Items

NSF means _________________

Copyright 2014 Pearson Education.

Summary of Reconciling Items

BOOK BALANCE - ALWAYS

Add deposits in transit

Add bank collections, interest

Subtract outstanding cheques

Subtract services charges, NSF

Add or subtract correction of bank Add or subtract correction of book

Copyright 2014 Pearson Education.

Journalizing Bank Reconciliation

If the items is subtracted from the book side

Copyright 2014 Pearson Education.

Bank service charges

Copyright 2014 Pearson Education.

Copyright 2014 Pearson Education.

Copyright 2014 Pearson Education.

545 Balance, September 30

Copyright 2014 Pearson Education.

Expected Cash Balance

Very closely related to Corporate Finance

Reporting Cash on the Balance

Reports liquid assets available for day-to-day use

Budgeted Cash Receipts:

Budgeted Cash Payments:

Payment of long-term debt

Why is it not here?

Budgeted cash available

New financing needed

Copyright 2014 Pearson Education.

Learning Objective Four

Copyright 2014 Pearson Education.

Two major types:

Copyright 2014 Pearson Education.

Copyright 2014 Pearson Education.

Accounts Receivable Subsidiary Ledger

Copyright 2014 Pearson Education.

Internal Control: Collections on

Separate employee should open incoming mail

Managing Risk of Not Collecting

Cost of selling on credit

Customers that do not

Risks of Selling on Credit

What are the benefits and costs of

Benefit increase in sales

Extend credit to only creditworthy

Run a credit check on prospective

Separate cash-handling and