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Chapter 07—Financial Assets
Financial and Managerial Accounting, 18e 7-1
7 FINANCIAL ASSETS
Chapter Summary
This is the first in a series of chapters analyzing major balance sheet items. Topical
coverage includes cash, short-term investments in marketable securities, and receivables.
Accounting practices concerning these assets are often highly procedural.
Discussion of cash is organized around a series of critical internal control issues. Topics
include: specific internal control recommendations, accounting for cash over and short, and,
preparation of the bank reconciliation. Discussion of each topic emphasizes how the firm can
achieve the objectives of efficient cash management.
Fair value accounting of short-term investments in marketable securities is another major
topic discussed.
The remainder of the chapter concentrates on accounting for uncollectible accounts
receivable. The allowance method is discussed in detail. Coverage is provided for both the
balance sheet and income statement methods, and a brief discussion of the direct write-off
method is included. Discussion of the accounts receivable turnover ratio continues the financial
statement analysis begun in an earlier chapter.
Learning Objectives
1. Define financial assets and explain their valuation in the balance sheet.
2. Describe the objectives of cash management and internal controls over cash.
3. Prepare a bank reconciliation and explain its purpose.
4. Describe how short-term investments are reported in the balance sheet and account for transactions
involving marketable securities.
5. Describe internal controls over accounts receivable.
6. Account for uncollectible receivables using the allowance and direct write-off methods.
7. Explain, compute, and account for notes receivable and interest revenue.
8. Evaluate the liquidity of a company’s accounts receivable.
Chapter 07—Financial Assets
7-2 Instructor’s Resource Manual
Brief Topical Outline
A. How much cash should a business have?
B. The valuation of financial assets
C. Cash
1. Reporting cash in the balance sheet
a. Cash equivalents
b. Restricted cash
c. Lines of credit
2. Cash management
3. Internal control over cash
a. Cash over and short
4. Bank statements
5. Reconciling the bank statement
a. Normal differences between bank records and accounting records
b. Steps in preparing a bank reconciliation
c. Illustration of a bank reconciliation
d. Updating the accounting records
D. Short-term investments—see Case in Point (page 301)
E. Accounting for marketable securities
1. Purchase of marketable securities
2. Recognition of investment revenue
3. Sale of investments
a. Investments sold at a gain
b. Investments sold at a loss
4. Adjusting marketable securities to market value—see International Case in
Point (page 304)
F. Accounts receivable—see Pathways Connection (page 315)
1. Internal control over receivables
2. Uncollectible accounts
a. Reflecting uncollectible accounts in the financial statements
3. The allowance for doubtful accounts
a. Monthly adjustments of the allowance account
4. Writing off an uncollectible account receivable
a. Write-offs seldom agree with previous estimates
5. Monthly estimates of credit losses
a. Estimating credit losses—the balance sheet approach
b. Estimating credit losses—the income statement approach
6. Recovery of an account receivable previously written off
7. Direct write-off method
8. Factoring accounts receivable—see Your Turn (page 312)
9. Credit card sales
a. Bank credit cards
b. Other credit cards
G. Notes receivable and interest revenue
Chapter 07—Financial Assets
Financial and Managerial Accounting, 18e 7-3
1. Nature of interest
a. Computing interest
2. Accounting for notes receivable—see Your Turn (page 316) and Ethics, Fraud,
& Corporate Governance (page 317)
a. Illustrative entries
b. If the maker of a note defaults
H. Concluding remarks
Topical Coverage and Suggested Assignments
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions*
Brief
Exercises*
Exercises*
Problems*
Critical
Thinking
Cases*
1
A
3, 4, 5
1, 3, 5, 6
1, 2
1, 4
2
B
7, 8, 9
8
3
C – D
12, 13,
9, 12, 14
3, 4
‡4
‡E – H
15
‡15
‡5, 6
*Homework assignment (to be completed prior to class)
‡Optional assignment, time permitting.
Comments and Observations
Teaching Objectives for Chapter 7
Our specific teaching objectives in this chapter are to:
1. Explain the flow of financial resources among financial assets, and the valuation of those
assets in the balance sheet.
2. Briefly describe the presentation of cash, cash equivalents, and restricted cash in the balance
sheet.
3. Explain the objectives of cash management.
4. Discuss the basic internal control concepts relating to cash receipts and cash payments.
5. Explain the importance of reconciling bank accounts; illustrate the preparation of a bank
reconciliation and the related entries to update the accounting records.
6. Explain the nature of investments in marketable securities, and their role in efficient cash
management.
7. Illustrate journal entries to record transactions arising out of investments in marketable
securities.
Chapter 07—Financial Assets
7-4 Instructor’s Resource Manual
8. Discuss the accounting principles applicable to the valuation of accounts receivable stressing
the matching principle.
9. Demonstrate the recognition of credit losses using allowance methods, with emphasis on the
aging schedule (balance sheet) approach.
10. Illustrate write-offs and recoveries of accounts receivable when an allowance is in use.
11. Contrast the direct write-off method with the “allowance” method.
12. Briefly discuss various types of credit card sales, emphasizing that “bank card” sales actually
are cash sales.
13. Explain why accounts receivable may be viewed as “nonproductive” assets, and identify
several ways of converting receivables quickly into cash.
14. Explain and illustrate accounting for notes receivable.
General Comments
In Chapter 7, we emphasize the importance of strong internal control over cash
transactions. Internal control is of special importance with respect to cash for two reasons. First,
cash is the asset most susceptible to theft or embezzlement. Second, however, is that cash
transactions affect every category of financial statement account. Thus, cash transactions
absolutely must be recorded properly if the accounting records are to be reliable. If a company
does not have adequate internal control to assure that cash receipts and cash payments are
recorded properly, errors may exist virtually anywhere in the accounting records and financial
statements.
The importance of properly recording cash transactions also explains our emphasis upon
bank reconciliations in this chapter. A bank reconciliation brings to light the most errors in
recording the dollar amounts of cash receipts or cash disbursements during the period and also
introduces students to the timing differences that often arise in the recording of transactions by
the company and the bank.
A continuing goal in this edition is to focus upon the use of financial accounting
information not only by outsiders but also by management. Therefore, we have supplemented
our coverage of cash management with an introduction that describes the flow of funds from one
form of financial asset to another over the course of the operating cycle. We highly recommend
an in-class review of Exercise 10, which makes a good point and is based on data from an actual
company.
We discuss Exercise 7 or 13 in class to review fair value accounting. Both exercises
stress the importance fair value accounting from the perspective of the user of the financial
statements.
In large and small businesses alike, the accounting practices used in accounting for
uncollectible accounts receivable are changing. For example, the income statement approach is
now seldom used. As all accounts receivable software automatically produces an aging schedule,
the income statement approach no longer provides a significant time advantage. As a result, most
Chapter 07—Financial Assets
Financial and Managerial Accounting, 18e 7-5
businesses now use the balance sheet approach in their monthly financial statements as well as in
their audited annual statements.
The direct write-off method of computing uncollectible accounts expense is now the only
approach allowable for income tax purposes. As a result, many small businesses, and also larger
businesses in which the allowance for doubtful accounts is not material, are switching to this
method for financial reporting purposes.
We want to recommend several specific Problems and Cases for use in the second and
third class meetings on this chapter. Problem 4 provides efficient yet comprehensive coverage of
the “balance sheet” method of accounting for receivables. Case 3 provides a good review of the
accounting theory underlying this chapter, and Case 4 is an excellent “decision oriented” case
relating cash flows and credit policies.
Supplemental Exercises
Group Exercise
Convenience stores carry out a large volume of small cash transactions. Make a listing of
what you feel are the critical internal control concerns at such a store. When your list is
complete, visit a store and through observation and interviews prepare a report in which you
explain how the internal control concerns are being addressed. Explain why you feel the controls
in place either are or are not adequate.
Internet Exercise
balance sheet and the notes to the financial statements. What kind of transactions give rise to
most of ADP’s receivables? Explain how ADP discloses the magnitude of its allowance for
uncollectible accounts. Why do you suppose that the allowance for uncollectible accounts
appears in the balance sheet itself?
Chapter 07—Financial Assets
7-6 Instructor’s Resource Manual
CHAPTER 7 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
Use the following data for questions 1 and 2.
At the end of the month, the unadjusted trial balance of Four Star Company included the following
accounts:
Debit Credit
Sales (75% represent credit sales) ....................................... $1,280,000
Accounts Receivable .......................................................... $875,000
Allowance for Doubtful Accounts ...................................... $10,750
1 Refer to the above data. If the income statement method of estimating uncollectible accounts
expense is followed, and uncollectible accounts expense is estimated to be 2% of net credit sales,
the net realizable value of Four Star accounts receivable at the end of the month is:
a $855,800. b $845,050. c $19,200 d $1,250,050
2 Refer to the above data. If Four Star uses the balance sheet approach in estimating uncollectible
accounts, and aging the accounts receivable indicates the estimated uncollectible portion to be
$24,000, the uncollectible accounts expense for the month is:
a $24,000. b $13,250. c $34,750. d $10,750.
3 Which of the following items is reported in neither the income statement nor the statement of cash
flows?
a Sale of marketable securities at a loss.
b Sale of marketable securities at a gain.
c Balance in the allowance for doubtful accounts.
d Investment of excess cash in marketable securities.
4 Fair value is the balance sheet valuation standard for:
a Investments in all financial assets.
b Investments in marketable securities.
c Investments in capital stock of any corporation.
d Stockholders’ equity of any publicly traded corporation.
5 Cash equivalents:
a Include amounts of cash available through an unused line of credit.
b Are investments in the publicly traded stocks and bonds of large corporations.
c Are usually included in the term “cash” in the balance sheet and the statement of cash flows.
d Is another term for financial assets.
Chapter 07—Financial Assets
Financial and Managerial Accounting, 18e 7-7
CHAPTER 7 NAME #
10-MINUTE QUIZ B SECTION
Shown below is a partially completed bank reconciliation for Hubbard Transport at August 31, as well as
additional data necessary to answer the questions that follow.
HUBBARD TRANSPORT
Bank Reconciliation
August 31, 20__
Balance per bank statement .................................................................................. $ 17,955
Add: (1)
Deduct: ___(2)
Adjusted cash balance ........................................................................................... $
Balance per depositor’s records ............................................................................ $14,249
Add: (3)
Deduct: ___(4)
Adjusted cash balance ........................................................................................... $________
Additional information
a Outstanding checks: no. 729, $1,253; no. 747, $245; no. 752, $781.
b Check no. 742 (for repairs) was written for $398 but erroneously recorded in Hubbard’s
records as $839.
c Deposits in transit, $2,254.
d Note collected by the bank and credited to Hubbard’s account, $4,800.
e NSF check of C. Craig, one of Hubbard’s customers, $1,525.
f Bank service charge for August, $35.
1 In Hubbard’s completed bank reconciliation at August 31, what dollar amount should be deducted
from the balance per bank statement (indicated by 2 above)?
a $2,254. b $2,279. c $1,525. d $4,800.
2 In Hubbard’s completed bank reconciliation at August 31, what dollar amount should be added to the
balance per depositor’s records (indicated by 3 above)?
a $4,800. b $2,254. c $5,241. d $6,766.
3 In Hubbard’s completed bank reconciliation at August 31, what dollar amount should be deducted
from the balance per depositor’s records (indicated by 4 above)?
a $2,254. b $2,001. c $1,525. d $1,560.
4 Hubbard Transport keeps $500 cash on hand in addition to this checking account and has no other
bank accounts or cash equivalents. What amount should appear as Cash in Emerald’s August 31
balance sheet?
a $18,430.
b $17,955.
c $14,249.
d Some other amount.
5 The necessary adjustment to Hubbard Transport’s accounting records as of August 31 includes a net:
a Increase to Cash of $5,241.
b Increase to Cash of $3,240.
c Increase to Cash of $3,681.
d Decrease to Cash of $35.
Chapter 07—Financial Assets
7-8 Instructor’s Resource Manual
CHAPTER 7 NAME #
10-MINUTE QUIZ C SECTION
1 You are to complete the June 30 bank reconciliation for Huang, Inc. using the following
information:
a Outstanding checks: c Deposit in transit ................... $3,300
No. 181 ............................. $350 d Note collected by bank as
No. 184 ............................. $300 Huang’s agent (no
No. 185 ............................. $225 interest) .................................. $2,000
b Check no. 142 (for Repair ... e NSF check of I.M. Broke ...... $250
Expense) was written for $320 f Bank service charge .............. $30
but erroneously recorded in
Huang’s records as $230.
Difference ............................ $90
HUANG, INC.
Bank Reconciliation
June 30, 2017
Balance per bank statement, June 30 ................................................................. $13,265
Add: ________
$
Less:
________
Adjusted balance ................................................................................................ $_______
Balance per depositor’s records, June 30 .......................................................... $14,060
Add:
________
$
Less:
________
Adjusted balance (as above) .............................................................................. $_______
2 Prepare the journal entry to correct Huang’s records as of June 30. (Explanations may be omitted;
one compound journal entry is acceptable.)
2017
General Journal
Debit
Credit
June 30
Chapter 07—Financial Assets
Financial and Managerial Accounting, 18e 7-9
CHAPTER 7 NAME #
10-MINUTE QUIZ D SECTION
1 After aging its accounts receivable at December 31, Howland Company estimates that $68,000 of
the $835,000 outstanding accounts receivable will prove uncollectible. The Allowance for
Doubtful Accounts has a debit balance of $6,200 prior to adjustment. In the space provided,
prepare the adjusting entry required by Huey in this situation:
Dec. 31
2 At year-end, Atkins Company applies the income statement approach in estimating uncollectible
accounts expense and determines such expense to be 2% of net sales. At December 31 of the current
year, accounts receivable total $600,000, and Allowance for Doubtful Accounts has a credit balance
of $4,200 prior to adjustment. Net sales for the current year were $2,300,000. Compute the net
realizable value of accounts receivable to be reported in Dewey’s December 31 balance sheet.
3 During the year, Brown Corporation’s average accounts receivable were $316,000. The current-year
income statement reported net sales of $2,010,000, uncollectible accounts expense of $118,000, and
net income of $982,000. Using 365 days to a year, compute the average number of days Brown waits
to collect its accounts receivable. (Round answer to the nearest day, if necessary.)
Use the following for questions 4 and 5.
At September 30, the Cash account in the general ledger of Breen Construction shows a balance of
$13,221. However, the bank statement shows a balance of $16,720 at the same date. The only reconciling
items consist of a bank service charge of $42, outstanding checks totaling $4,744, a deposit in transit, and
an error in recording check no. 529. Check no. 529 was written in the amount of $772 but was recorded as
$727 in Gentle’s accounting records.
1. Refer to the above data. What is the adjusted cash balance in the September 30 bank
reconciliation?
2. Refer to the above data. What is the amount of the deposit in transit?
Chapter 07—Financial Assets
7-10 Instructor’s Resource Manual
SOLUTIONS TO CHAPTER 7 10-MINUTE QUIZZES
QUIZ A
1 B
QUIZ B
QUIZ C
1
HUANG, INC.
Bank Reconciliation
June 30, 2017
Balance per bank statement, June 30 ................................................................. $13,265
Chapter 07—Financial Assets
Financial and Managerial Accounting, 18e 7-11
2
2017
General Journal
Debit
Credit
June 30
Cash
$1,630
Learning Objective: 3
QUIZ D
1
Dec. 31
Uncollectible Accounts Expense
74,200
2
Chapter 07—Financial Assets
7-12 Instructor’s Resource Manual
Assignment Guide to Chapter 7
Brief
Exercises
Exercises
Problems
Cases
Net
Item Number
1 - 11
1 - 15
1
2
3
4
5
6
7
8
1
2
3
4
Time estimate (in minutes)
<10
<15
25
45
15
30
40
20
20
40
20
40
40
n/a
Difficulty rating
E
E
M
S
M
M
S
M
M
S
M
S
S
M
Learning Objectives:
1, 2, 6, 7, 8,
10, 11, 12,
1. Define financial assets and explain
their valuation in the balance sheet.
