1-1 REVENUE CYCLE: CASH AND RECEIVABLES Cash Cash includes coins and currency, as well as checking accounts, certified or cashier’s checks, traveler’s checks, bank drafts, and money orders. Amounts in savings and money market accounts also are usually considered to be cash. Cash equivalents are short-term investments that can be readily converted to cash. Only investments (such as treasury bills, commercial paper, and certificates of deposit), which have a maturity of 90 days or less (at the time of acquisition), are included as cash equivalents. Postdated checks and IOUs are not included as cash. They are properly classified as receivables. Cash that is restricted for some specific purposes is reported separately from unrestricted cash. A cash overdraft can arise when checks have been written for an amount more than the checking account balance. If a company has two or more accounts in a particular bank, then the overdraft amount can be offset against positive balances in other accounts. Otherwise, overdrafts should be reported as a current liability. COMPENSATING BALANCES are those amounts that a lending institution requires the borrower to maintain as support for borrowing arrangements. Compensating balances must be disclosed separately from other available cash. Bank Reconciliation The BANK RECONCILIATION identifies any differences between the cash balance on the company’s books and the cash balance reported on the bank statement. The two amounts may be different because of incomplete information. Once each amount is updated based on full information, the correct amount of the cash balance as of a particular date is obtained. That is, once the bank balance is adjusted based on information that the company alone knows, the correct cash balance is obtained. Similarly, once the book balance is adjusted based on information that the bank alone has
Transcript
1-1
REVENUE CYCLE: CASH AND RECEIVABLES
Cash
Cash includes coins and currency, as well as checking accounts, certified or cashier’s checks, traveler’s checks, bank drafts, and money orders. Amounts in savings and money market accounts also are usually considered to be cash.
Cash equivalents are short-term investments that can be readily converted to cash. Only investments (such as treasury bills, commercial paper, and certificates of deposit), which have a maturity of 90 days or less (at the time of acquisition), are included as cash equivalents.
Postdated checks and IOUs are not included as cash. They are properly classified as receivables. Cash that is restricted for some specific purposes is reported separately from unrestricted cash. A cash overdraft can arise when checks have been written for an amount more than the checking account balance. If a company has two or more accounts in a particular bank, then the overdraft amount can be offset against positive balances in other accounts. Otherwise, overdrafts should be reported as a current liability.
COMPENSATING BALANCES are those amounts that a lending institution requires the borrower to maintain as support for borrowing arrangements. Compensating balances must be disclosed separately from other available cash.
Bank Reconciliation
The BANK RECONCILIATION identifies any differences between the cash balance on the company’s books and the cash balance reported on the bank statement. The two amounts may be different because of incomplete information. Once each amount is updated based on full information, the correct amount of the cash balance as of a particular date is obtained. That is, once the bank balance is adjusted based on information that the company alone knows, the correct cash balance is obtained. Similarly, once the book balance is adjusted based on information that the bank alone has known so far (until the bank statement was received), the correct cash balance is obtained.
For example, the company may be aware of certain transactions but the bank may not have had information about them (or may not have considered such transactions in calculating the available cash balance). There are at least two types of such transactions that the company has information about but the bank’s information set does not have and needs to have:
DEPOSITS IN TRANSIT refer to deposits made by the company toward the end of a period that the bank has not yet recorded (or given credit).
OUTSTANDING CHECKS refer to checks written by the company that have not yet cleared the bank (thus, the company knows about such checks and has deducted the amounts, but the bank has not yet deducted them because the checks have not yet reached the bank).
1-2
Thus, in a bank reconciliation, the balance per the bank statement usually must be adjusted for two items: (add) deposits in transit and (subtract) outstanding checks. After these two adjustments, the correct cash balance is obtained. In addition, it is possible that the bank may have made errors (such as incorrectly posting the amount of a check or giving incorrect credits or charges). If so, the bank balance must be adjusted for such errors.
From a company’s perspective, the books must be adjusted for transactions about which the bank knows (and hence has accounted for) but the company does not yet know. For example, the bank may credit the account for interest income or deduct service charges. Sometimes the bank may collect directly from a receivable owed by a customer. Such direct collections need to be added to the book balance. Some customers’ checks may come back as not-sufficient-funds, NSF, (“bounced” checks). The bank has already subtracted the amount of the NSF check from the company’s account, but the company has not yet adjusted its books. Thus, the company’s information set needs to be updated by recording the impact of such transactions that the bank has already recorded.
Thus, in a bank reconciliation, the balance per the books must be adjusted as follows: add interest income credited by the bank, add direct collections of a receivable by the bank, deduct any service charge, and deduct any NSF check. In addition, the company must correct for any errors in posting (which it becomes aware of only after receiving the bank statement). For example, if a check was written for $20 but was wrongly posted as $200, the book balance understates the correct cash balance so the difference of $180 must be added back to the existing book balance. Conversely, if a $540 check was wrongly posted as $450, the book balance overstates the correct cash balance so the difference of $90 must be subtracted from the book balance.
Accounts Receivable
Accounts receivable Arise when companies sell on credit Are usually unsecured (that is, do not have claims on other assets as a guarantee of
payment) Are current assets
Companies usually perform credit checks of customers to ensure that the receivable will be paid. However, there is always some risk of nonpayment.
Companies also offer incentives to their customers to pay promptly. For example, the credit term 2/10, n/30 means the customer will be given a 2 percent discount if payment is made within 10 days. This is known as the CASH DISCOUNT or SALES DISCOUNT. If the discount is not taken, the full amount is due within 30 days. Companies may charge interest if the buyer does not pay the amount within 30 days.
Note that the cash (or sales) discount is different from a trade discount, which is a
1-3
reduction from the “list” price of an item. TRADE DISCOUNTS may be given by companies depending on many factors, such as the volume of business, size of the order, or period of the year or month.
Accounts receivable are usually unsecured and are associated with credit sales to customers. In contrast, NOTES RECEIVABLE involve a written promise to pay a certain sum of money by a specified date. NONTRADE RECEIVABLES involve receivables resulting from transactions such as (a) advances to employees and officers, (b) certain types of deposits, (c) claims for damages, losses, rebates, and refunds, and (d) dividend and interest receivable.
Recording Accounts Receivable
The two acceptable methods of recording transactions involving credit sales and accounts receivable are the gross method and the net method.
Under the GROSS METHOD, the sale is recorded at the invoice price. Thus, the assumption is that the buyer will not take the sales discount (remember that the journal entry for sales is made before the cash is collected so the seller does not know whether the buyer will take the discount for prompt payment). If the buyer: pays within the discount period, the amount of discount given to the buyer is recorded
in a sales discount account. does not pay within the discount period (and thus pays the full invoice price), then at
the time the cash is collected Cash is debited and Accounts Receivable is credited.
The NET METHOD, the sale is recorded at the invoice price less the discount for prompt cash payment. Thus, the assumption is that the buyer will take the sales discount. Thus, at the time of sale, the debit to Accounts Receivable and the credit to sales is the invoice price less the amount of discount that the buyer could take. If the buyer: takes the discount, then upon payment, Cash is debited and Accounts Receivable is
credited for the amount (which is, invoice price less the discount). does not pay within the discount period (and thus is required to pay the full invoice
price), the amount of discount forfeited is recorded in a separate account.
The following table gives the journal entries for the gross method and the net method, assuming $1,000 sales on account with terms of 2/10, n/30.Transaction Debit / Credit Gross Method Net MethodSale Debit Accounts Receivable
Sometimes buyers may return purchased items for a variety of reasons (they are not satisfied with the product, the goods were damaged in transit, the wrong item was shipped). In such instances, the returns are recorded as follows:
Debit Sales Returns and AllowancesCredit Accounts Receivable
Accounting for Bad Debts
Accounts receivable are reported on the balance sheet at their net realizable value, which is the amount of cash expected to be collected. This requires that any amounts deemed to be uncollectible be subtracted from the total balance in the Accounts Receivable account.
Accounts that are deemed to be uncollectible may be handled in two ways. The simplest is the direct write-off method, in which the journal entry is as follows:
Debit Bad Debt ExpenseCredit Accounts Receivable.
This journal entry is recorded only in the period when it is determined that the accounts are not collectible. However, this approach violates the principle of matching and hence is a departure from GAAP.
GAAP requires the use of the ALLOWANCE METHOD. Under this approach, the amount of accounts receivable estimated to be uncollectible in the future is recorded in an allowance account as follows:
Debit Bad Debt ExpenseCredit Allowance for Doubtful Accounts
Other names used for the allowance account are Allowance for Bad Debts or Allowance for Uncollectible Accounts.
It is important to note that under the allowance method, the entry for bad debt expense is recorded in the period in which the corresponding sales are recorded. Later, when the account receivable from a specific customer is deemed to be uncollectible, the journal entry is
Debit Allowance for Doubtful AccountsCredit Accounts Receivable.
Note that under the allowance method, when a customer actually defaults, bad debt expense is not debited (to prevent double counting). Instead, the allowance account is reduced with a corresponding reduction to accounts receivable.
Percentage of Sales Method
There are two ways to estimate bad debts expense for any period: the percentage of sales method and the percentage of accounts receivable method.
The percentage of sales approach also may be called the income statement approach because the amount of bad debt expense to be recorded in any period is based solely on
1-5
an income statement item (net sales or credit sales for a period). In this approach, based on historical patterns, the company determines a certain percentage of sales to be uncollectible.
For example, if the historical average indicates that 2 percent of sales in a given period will not be collected in the future and if the sales this year is $100,000, the bad debt expense is 2 percent of $100,000, or $2,000. Thus the adjusting entry for bad debt expense at the end of the period is:
Debit Bad Debt Expense $2,000Credit Allowance for Doubtful Accounts $2,000
An important point to note is that the income statement approach ignores any balance in the Allowance for Doubtful Accounts before the adjusting entry. That is, since the Allowance for Doubtful Accounts is a contra-asset account, it belongs in the balance sheet. As such, it is not closed at the end of a year but “rolls” along from year to year.
Assume that at the beginning of a year (say January 1, 2002), the balance in the allowance account was $500 (since it is a contra asset, the balance will be a credit). Assume that during the year, $350 of customer accounts receivable were written off. Thus, before any adjusting entry at the end of the year, there already is a balance of $150 in the allowance account. If the bad debt expense, based on the percentage of sales for the current year, is calculated to be $700, then after the adjusting entry for bad debt expense (which means the allowance account will be credited by $700), the total balance in the allowance account is $850. In other words, the fact that the allowance account already had a credit balance of $150 was not directly relevant.
Percentage of Receivables Method
The percentage of receivables approach also may be called the balance sheet approach because under this method, the amount of bad debt expense to be recorded in any period is based on a balance sheet item (accounts receivable at the end of a period). In this approach, based on historical patterns, the company determines a certain percentage of accounts receivable to be uncollectible.
For example, if the historical average indicates that 3 percent of accounts receivable is usually not collected and if the accounts receivable balance at the end of the year is $50,000, then the balance in the allowance account must equal $1,500 (3 percent of $50,000).
Under the percentage of receivables approach, the existing balance in the allowance account cannot be ignored. In the preceding example, assume that the allowance account already had a credit balance of $300 before the year-end adjusting entry for bad debt expense. Then, since the required balance is a credit of $1,500 and there already is a credit balance of $300, the additional amount required is only $1,200. Thus, the adjusting entry at the end of the year will be as follows:
Debit Bad Debt Expense $1,200
1-6
Credit Allowance for Doubtful Accounts $1,200
Companies usually use the aging method for aging collectible accounts. This method assumes that the likelihood of collecting on a receivable decreases with time. That is, an amount that has not yet been paid for 120 days is less likely to be paid in the future than is an amount that has not yet been paid for only 30 days.
Under the aging method, individual accounts are classified based on the length of time they have been due. Accounts are classified as current (if within the specified credit policy) or past due. Past due accounts are further classified in groups such as 31-60 days, 61-90 days, 91-150 days etc. For each group, the percentage expected to be uncollectible is estimated and applied to the overall group. The total of such amounts gives the total balance required in the allowance account.
Assignment and Factoring of Accounts Receivable
Collecting receivables usually takes some time, but sometimes a company may need cash immediately. In such instances, a company may decide to assign or factor accounts receivable.
ASSIGNMENT OF ACCOUNTS RECEIVABLE involves borrowing money by pledging the accounts receivable as security (or collateral). When specific receivables are assigned to a lender, the borrower must transfer the related accounts receivable to a special ledger account identifying them as assigned accounts receivable. However, when there is a general assignment of accounts receivable (without assigning specific receivables), the balance in the Accounts Receivable account is not reduced.
When accounts receivable are assigned, the finance company or bank typically provides an amount less than the face value of the accounts receivable. The amount financed is recorded by the borrower as a note payable. In addition, the finance company or bank charge an up-front finance charge (which the borrower will record as an expense at the time of financing) and interest for the duration of the financing. Subsequently, cash is collected on the receivables and the note is paid off.
A typical journal entry at the time of assignment is as follows:Debit Cash (for amount received–usually plug number)Debit Finance Charge
Credit Notes Payable (amount financed–usually less than receivables assigned)Debit Accounts Receivable Assigned
Credit Accounts Receivable
FACTORING ACCOUNTS RECEIVABLE involves selling accounts receivable to a third party, such as a bank or a financial institution, and receiving cash in return. This is called TRANSFER WITHOUT RECOURSE because the purchaser of accounts receivable assumes the risk of collecting on the receivable. Since the accounts receivable have been
1-7
sold, the company’s Accounts Receivable balance is reduced by the amount sold to the factor (the buyer of the receivables).
When accounts receivable are factored (that is, sold to a factor), any related allowance for doubtful accounts must be reduced (once the receivables are removed from the books, the related allowance amount also must be removed). In addition, the factor withholds a certain amount as protection against sales returns. This amount is recorded by the borrower as a receivable from the factor. (If there are no returns or allowances, the factor pays this amount back as the final settlement.) Furthermore, the factor typically pays less than the remaining balance of accounts receivable. This is recorded by the borrower as a loss from the factoring transaction.
A typical journal entry at the time of assignment will is follows:Debit Cash (for amount received from sale of accounts receivable)Debit Receivable from Factor (factor’s withholding for protection against sales returns)Debit Allowance for Doubtful Accounts (allowance related to the accounts sold)Debit Loss from Factoring (usually plug number)
Credit Accounts Receivable
TRANSFER WITH RECOURSE is a hybrid form of financing, and the company selling the receivable to a bank or financial institution guarantees collection on the receivable. Transfer with recourse is recorded either as a sale (with recognition of a loss from the transaction) or as a collateralized borrowing (with recognition of a liability), depending on the specific conditions of the transaction.
Long-Term Notes Receivable
A promissory note represents a written promise to pay a certain amount of money at a specified date. Long-term notes receivable should be recorded at their discounted present value. Short-term notes are not discounted but are recorded at face value.
Accounting for long-term notes receivable requires understanding the time value of money. Please refer to the module on the time value of money for the discussion related to long-term notes receivable.
There are two types of notes receivable. An INTEREST-BEARING NOTE specifies the principal to be paid and the rate of interest that will be charged on the note. The note includes a promise to pay the principal amount by a certain date and specifies the interest rate. A NON-INTEREST-BEARING NOTE does not specify the rate of interest; it includes only a promise to pay the total amount by a specific date. This total amount includes both the principal and the interest amount.
Assume that Smith Company sold $1,000 worth of goods to Jane Company on January 1, 2002. Jane Company promised to pay the required amount on December 31, 2003. If the interest rate is 10 percent, the interest for the first year is $100 ($1,000 0.10). The
1-8
amount owed at the beginning of the second year is thus $1,100 ($1,000 plus the interest for the first year of $100). Since interest is always calculated based on the amount owed at the beginning of the period, the interest amount for the second year is $110 ($1,100 0.10). Thus, the total amount owed at the end of the second year is $1,210.
If the note is an interest-bearing note, it specifies that Jane Company will pay Smith Company the principal of $1,000 plus interest on the note for two years at 10 percent. If the note is a non-interest-bearing note, it specifies that Jane Company will pay Smith Company $1,210 at the end of two years. The journal entry for various transactions related to the two types of notes are as follows:
Allowance method records the amount of accounts receivable estimated to be uncollectible in the future in an allowance account in the period of sale.
Assignment of accounts receivable is a form of borrowing money by pledging accounts receivable as security (or collateral).
Bank reconciliation is the process of identifying differences between the cash balance as per the company’s books and the cash balance reported on the bank statement.
Cash discount (sales discount) is the discount on invoice price given by seller to encourage the buyer to pay quickly.
Compensating balances are amounts that a lending institution requires the borrower to maintain as support for borrowing arrangements.
Deposits in transit are deposits made by the company toward the end of a period that the bank has not yet recorded (or given credit) and therefore are not shown on the bank statement.
1-9
Factoring accounts receivable refers to the sale of accounts receivable to a third party such as a bank or a financial institution.
Gross method is a method of recording receivables, in which the sale is recorded at the invoice price. Thus, the assumption is that the buyer will not take the sales discount.
Interest-bearing note is a type of note that specifies the principal to be paid and the rate of interest that will be charged on the note.
Net method is a method of recording receivables, in which the sale is recorded at the invoice price less the discount for prompt cash payment. Thus, the assumption is that the buyer will take the sales discount.
Non-interest-bearing note is a type of note that does not specify the rate of interest but includes only a promise to pay the total amount by a specific date. This total amount includes both the principal and the interest amount.
Notes receivable are notes for receivables that involve a written promise to pay a certain sum of money by a specified date.
Nontrade receivables are transactions such as advances to employees and officers; certain types of deposits; claims for damages, losses, rebates, and refunds; and dividend and interest receivable.
Outstanding checks are checks written by the company but have not cleared with the bank as of the statement date (thus, the company knows about such checks and has deducted their amounts, but the bank has not yet deducted them because the checks have not yet reached the bank).
Sales discount (cash discount) is a discount on an invoice price given by seller to encourage the buyer to pay quickly.
Trade discounts are discounts given by companies to clients depending on factors such as the volume of business or size of the order.
Transfer with recourse is a hybrid form of financing, in which the company selling the receivable to a bank or financial institution guarantees collection of the receivable.
1-10
Demonstration Problem 1Nixon Company
The following information is available for Nixon Company as of March 31, 2002. Compute the correct cash balance as of March 31, 2002.Balance per books $4,000Deposits in transit 320Interest credited by bank 80Outstanding checks 450Bank service charges 30Customer’s NSF check returned by bank 70Note collected by bank 500Check #374 written for $650 but incorrectly recorded in books for $560
1-11
Solution to Demonstration Problem 1, Nixon Company
Balance per books $4,000Add: Note collected by bank $500 Interest revenue 80
580Subtract NSF check $70 Bank service charges 30 Error in posting 90
(190)Correct cash balance $4,390
1-12
Demonstration Problem 2Wallace Company
The following information is available for Wallace Company as of December 31, 2002. Sales for the year $400,000Sales returns 10,000Sales discounts 15,000Accounts receivable, 1/1/2002 30,000Accounts receivable, 12/31/2002 40,000Allowance for doubtful accounts, 1/1/2002 1,200Accounts written-off during 2002 1,450Prepare the adjusting entry for bad debt expense for the year ended December 31, 2002 under each of the following assumptions:(a) 1 percent of net sales is uncollectible.(b) 5 percent of accounts receivable is uncollectible.
1-13
Solution to Demonstration Problem 2, Wallace Company
(a) Percentage of sales method:
Under this method, the existing balance in the allowance account is not directly relevant in calculating the bad debt expense.Bad debt expense for the year = 1 percent of net sales.Net sales for the year = $400,000 – $10,000 – $15,000 = $375,000.Hence bad debt expense = 0.01 $375,000 = $3,750.
Journal entry:Debit Bad Debt Expense $3,750
Credit Allowance for Doubtful Accounts $3,750
(b) Percentage of accounts receivable method:
Under this method, first calculate the balance in the account before the bad debt adjusting entry. The beginning balance in the allowance account was $1,200, but during the year, $1,450 was written off. Hence, before the bad debt adjustment, there is a debit balance of $250 in the allowance account.
After the bad debt adjustment, the required amount in the allowance account is 5 percent of accounts receivable, or $2,000 (0.05 $40,000). Thus, a credit balance of $2,000 is desired for the allowance account.
To go from $250 debit balance to a $2,000 credit balance requires a credit entry of $2,250. Thus, the bad debt expense for the year is $2,250.
Journal entry:Debit Bad Debt Expense $2,250
Credit Allowance for Doubtful Accounts $2,250
1-14
Demonstration Problem 3Anderson Company
Anderson Company obtained a 12 percent, $100,000 loan from Bay Finance Company by assigning specific customer accounts receivable totaling $120,000 on July 1, 2002. Bay Finance Company charged a fee (finance charge) of $2,500. By the end of the month, Anderson Company had collected on $40,000 of the assigned receivables. Sales discounts of $600 were allowed on the collections. Anderson Company paid back the amount collected to Bay Finance Company on July 31. Prepare the necessary journal entries for these transactions.
1-15
Solution to Demonstration Problem 3, Anderson Company
Interest expense for the month = $100,000 0.12 (1/12) = $1,000.
Cash paid to lender at month end = Cash collected on receivables = $39,400.Of this amount, $1,000 is for interest for the period and the rest goes to reduce notes payable.Reduction of notes payable = $39,400 – $1,000 = $38,400.
At the time of assignment (July 1, 2002):Debit Cash $ 97,500Debit Finance Charge 2,500 Credit Notes Payable 100,000Debit Accounts Receivable Assigned 120,000 Credit Accounts Receivable 120,000
At the time of collection on receivables:Debit Cash (plug number) $ 39,400Debit Sales Discounts 600 Credit Accounts Receivable Assigned 40,000
At the time of payment to Bay Finance Company:Debit Notes Payable (plug number) $ 38,400Debit Interest Expense 1,000 Credit Cash 39,400
1-16
Practice Problem 1Ford Company
The following information is available for Ford Company as of March 31, 2002. What was the book balance before a bank reconciliation statement was prepared?Balance per bank $15,400Deposits in transit 480Interest credited by bank 120Outstanding checks 790Bank service charges 40Customer’s NSF check returned by bank 150Note collected by bank 900Check #582 written for $470 but incorrectly recorded in books for $740
1-17
Solution to Practice Problem 1, Ford Company
The first step is to calculate the correct cash balance. This amount can be used to calculate what would have been the book balance prior to a bank reconciliation.
Step 1: Calculate correct cash balance from bank statement:Balance per bank $15,400Add: deposits in transit 480Less: outstanding checks (790)Correct cash balance $15,090
Step 2: Adjust book balance (note that we know that the ending amount, that is, the correct cash balance, should be $15,090):Balance per books ?Add: Note collected by bank $900 Interest revenue 120 Error in posting 270
1,290Subtract NSF check $150 Bank service charges 40
(190)Correct cash balance $15,090
So if X is the balance per books, then X + $1,290 – $190 = $15,090, or$X = $15,090 – $1,100 = $13,990.
1-18
Practice Problem 2Chavez Company
Chavez Company uses the aging method for estimating uncollectible accounts. The following are some data about Chavez Company’s customers, as of December 31, 2002. The Allowance for Uncollectible Accounts had a debit balance of $500 prior to the adjusting entry for uncollectible accounts expense. The aging schedule follows:
On January 25, 2003, Chavez Company wrote off the account of Adela Company (balance $250). Calculate uncollectible accounts expense for the year ended December 31, 2002 and prepare the necessary journal entries for December 31, 2002 and January 25, 2003.
1-19
Solution to Practice Problem 2, Chavez Company:
The required credit balance in the Allowance for Uncollectible Accounts on December 31, 2002 = (0.01 $100,000) + (0.02 $60,000) +(0.05 $30,000) + (0.25 $5,000)
= $1,000 + $1,200 + $1,500 + $1,250 = $4,950
The Allowance for Uncollectible Accounts is a contra-asset account, and its normal balance is a credit balance.Since the Allowance for Uncollectible Accounts already has a debit balance of $500, to bring the balance in the account to a credit balance of $4,950, we need a credit entry of $5,450. Thus the uncollectible accounts expense must be $5,450.
Journal Entries
Date Account Debit Credit2002
12/31/2002
Uncollectible Accounts Expense Allowance for Uncollectible Accounts
5,4505,450
20031/25/2003 Allowance for Uncollectible Accounts
Accounts Receivable250
250
1-20
Practice Problem 3Buchanan Company
Buchanan Company obtained a 12 percent, $250,000 loan from Star Finance Company by assigning specific customer accounts receivable totaling $275,000 on July 1, 2002. Star Finance Company charged a fee of 2 percent on the loan amount as a finance charge. By the end of the month, Buchanan Company had collected on $90,000 of the assigned receivables. Sales discounts of $1,400 were allowed on the collections. Buchanan Company paid back the amount collected to Star Finance Company on July 31. Prepare the necessary journal entries for these transactions.
Interest expense for the month = $250,000 x 0.12 (1/12) = $2,500.
Cash paid to lender at month end = Cash collected on receivables = $88,600.Of this amount, $2,500 is for interest for the period and the rest goes to reduce notes payable.Reduction of notes payable = $88,600 – $2,500 = $86,100.
At the time of assignment (July 1, 2002):Debit Cash $ 245,000Debit Finance Charge 5,000 Credit Notes Payable 250,000Debit Accounts Receivable Assigned 275,000 Credit Accounts Receivable 275,000
At the time of collection on receivables:Debit Cash (plug number) $ 88,600Debit Sales Discounts 1,400 Credit Accounts Receivable Assigned 90,000
At the time of payment to Star Finance Company:Debit Notes Payable (plug number) $ 86,100Debit Interest Expense 2,500 Credit Cash 88,600
1-22
Practice Problem 4Multiple Choice
1. In a bank reconciliation, to get the correct cash balance from the bank balance,a. add deposits in transit.b. subtract deposits in transit.c. subtract bank service charges.d. add bank service charges.
2. Which of the following will not be classified as cash?a. Travelers’ checks.b. Bank drafts.c. Two-month certificate of deposit.d. Postdated checks.
3. When using the allowance method, the journal entry for recording bad debt expense is toa. debit Allowance for Doubtful Accounts and credit Bad Debt Expense.b. debit Bad Debt Expense and credit Allowance for Doubtful Accounts.c. debit Accounts Receivable and Credit Allowance for Doubtful Accounts.d. debit Allowance for Doubtful Accounts, and Credit Accounts Receivable.
4. Accounts receivable includea. advances to employees and officers.b. claims for damages, losses, rebates, and refunds.c. amounts due from credit sales to customers.d. a and c.
5. When accounts receivable are sold to someone, the receivables have beena. factored.b. transferred with recourse.c. pledged.d. assigned.
6. Markey Company estimates uncollectible accounts using the percentage of sales method. The credit sales for 2002 is $60,000. The company expects 2 percent of sales to be uncollectible. The Allowance for Uncollectible Accounts has a credit balance of $400 before the adjusting entry for bad debt expense. The uncollectible accounts expense for 2002 isa. $800.b. $1,600.c. $1,200.
1-23
d. $2,200.
7. Meehan Company estimates uncollectible accounts using the allowance method. On July 15, 2002, the business decided to write off the account of J. Smith. The balance in this account was $250. Just before the write off, the Accounts Receivable account had a debit balance of $6,000 and the Allowance for Uncollectible Accounts account had a credit balance of $1,200. The balance in the Allowance for Uncollectible Accounts after the write-off isa. $950.b. $1,200.c. $5,750.d. $5,050.
8. Daubach Company estimates uncollectible accounts using the aging method. On December 31, 2002, $7,000 of accounts receivable was outstanding for less than 30 days and $2,000 of accounts receivable was outstanding for more than 30 days and less than 60 days. The company expects that 1 percent and 5 percent, respectively, of these accounts receivable balances to be uncollectible. The Allowance for Uncollectible Accounts has a credit balance of $60 before the adjusting entry for bad debt expense. The uncollectible accounts expense for 2002 isa. $230.b. $170.c. $110.d. $310.
1-24
Homework Problem 1Carter Company
The following information is available for Carter Company as of March 31, 2002. What is the correct cash balance?Balance per books $22,700Deposits in transit 1,050Interest credited by bank 210Outstanding checks 1,450Bank service charges 60Customer’s NSF check returned by bank 120Note collected by bank 1,200Check #2164 written for $340 but incorrectly recorded in books for $430
1-25
Solution to Homework Problem 1, Carter Company
Balance per books $22,700Add: Note collected by bank $1,20
0 Interest revenue 210 Check posting error 90
1,500Subtract NSF check $120 Bank service charges 60
(180)Correct cash balance $24,020
1-26
Homework Problem 2Daniels Company
Daniels Company uses the aging method for estimating uncollectible accounts. The following are some data about Daniels Company’s customers, as of December 31, 2002. The Allowance for Uncollectible Accounts had a credit balance of $1,200 prior to the adjusting entry for uncollectible accounts expense. On January 25, 2003, Daniels Company wrote off the account of Dutra Company (with a balance $700). Calculate uncollectible accounts expense and record the transactions in the general journal.
Aging Schedule:0-30 Days 31-60 Days 61-90 Days More than 90
DaysAmount $300,000 $120,000 $90,000 $10,000
Estimated percentage uncollectible
1% 2% 4% 20%
1-27
Solution to Homework Problem 2, Daniels Company
The required credit balance in the Allowance for Uncollectible Accounts on December 31, 2002
The Allowance for Uncollectible Accounts is a contra-asset account, and its normal balance is a credit balance.Since the Allowance for Uncollectible Accounts already has a credit balance of $1,200, to bring the balance in the account to a credit balance of $11,000, we need a credit entry of $9,800. Thus, the uncollectible accounts expense must be $9,800.
Journal Entries
Date Account Debit Credit2002
12/31/2002
Uncollectible Accounts Expense Allowance for Uncollectible Accounts
9,8009,800
20031/25/2003 Allowance for Uncollectible Accounts
Accounts Receivable700
700
1-28
Homework Problem 3
1. In a bank reconciliation, to get the correct cash balance from the book balance,a. add deposits in transit.b. subtract deposits in transit.c. subtract bank service charges.d. add bank service charges.
2. In a bank reconciliation, interest paid by the bank to the company’s account isa. added to the book balance.b. subtracted from the book balance.c. added to the bank balance.d. subtracted from the bank balance.
3. When using the allowance method, the journal entry for writing off a specific account is toa. debit Allowance for Doubtful Accounts and Credit Bad debt Expense.b. debit Bad Debt Expense and Credit Allowance for Doubtful Accounts.c. debit Accounts Receivable and Credit Allowance for Doubtful Accounts.d. debit Allowance for Doubtful Accounts and Credit Accounts Receivable.
4. Which of the following statements is false?a. Notes receivable involve a written promise to pay a certain sum of money by a specified date.b. Accounts receivable involve a written promise to pay a certain sum of money by a specified date.c. Nontrade Receivables include dividend and interest receivable. d. Direct write-off method of accounting for bad debt is a departure from GAAP.
5. The Accounts Receivable balance is reduced when there is a(n):a. factoring of receivables.b. assignment of specific receivables.c. a general assignment of receivables.d. a and b.
6. Edward Company estimates uncollectible accounts using the percentage of sales method. The credit sales for 2002 is $80,000. The company expects 2 percent of sales to be uncollectible. The Allowance for Uncollectible Accounts has a credit balance of $600 before the adjusting entry for bad debt expense. The balance in the Allowance for Uncollectible Accounts on December 31, 2002, isa. $1,000.
1-29
b. $2,200.c. $1,600.d. $2,000.
7. Martin Company estimates uncollectible accounts using the percentage of sales method. The credit sales for 2002 is $80,000. The accounts receivable balance on December 31, 2002, is $7,000. The company expects 2 percent of sales to be uncollectible. The Allowance for Uncollectible Accounts has a credit balance of $300 before the adjusting entry for bad debt expense. The net realizable value of accounts receivable on December 31, 2002, isa. $6,700.b. $5,400.c. $5,100.d. $7,300.
8. Veras Company estimates uncollectible accounts using the aging method. On December 31, 2002, $7,000 of accounts receivable was outstanding for less than 30 days and $2,000 of accounts receivable was outstanding for more than 30 days and less than 60 days. The company expects that 1 percent and 5 percent, respectively, of these accounts receivable balances to be uncollectible. The Allowance for Uncollectible Accounts has a credit balance of $60 before the adjusting entry for bad debt expense. The balance in the Allowance for Uncollectible Accounts on December 31, 2002, isa. $230.b. $170.c. $110.d. $310.
