CHAPTER 7
Cash and Receivables
LEARNING OBJECTIVES
1. Indicate how to report cash and related items.
2. Define receivables and explain accounting issues related to their recognition.
3. Explain accounting issues related to valuation of accounts receivable.
CHAPTER REVIEW
*Note: All asterisked (*) items relate to material contained in the Appendix to the chapter.
1. Chapter 7 presents a detailed discussion of two of the primary liquid assets of
a business enterprise, cash and receivables. Cash is the most liquid asset held by a business
Cash
2. (L.O. 1) Cash is a financial asset and a financial instrument. It consists of coin, currency,
bank deposits, and negotiable instruments such as money orders, checks, and bank
3. Cash equivalents are short-term, highly liquid investments that are both
(a) readily convertible to known amounts of cash and (b) so near their maturity that they
4. Material amounts of cash set aside for a specific purpose, like payroll or dividend funds
are segregated from Cash as restricted cash for reporting purposes.
5. It is common practice for an enterprise to have an agreement with a bank concerning
credit and borrowing arrangements. When such an agreement exists, the bank usually
6. Bank overdrafts occur when a company writes a check for more than the amount in the
Receivables
7. (L.O. 2) Receivables are financial assets and financial instruments. They are defined as
claims held against customers and others for money, goods, or services. Receivables may
generally be classified as trade or nontrade. Trade receivables (accounts receivable and
notes receivable) are the most significant receivables an enterprise possesses. Accounts
receivable are oral promises of the purchaser to pay for goods and services sold. Notes
8. In most receivable transactions, the amount to be recognized is the transaction price (the
amount that the company expects to receive in exchange for transferring goods or services)
9. Two types of variable consideration that must be considered in determining the value of
receivables are trade discounts and cash discounts. Trade discounts represent
reductions from the list or catalog prices of merchandise. They are often used to avoid
frequent changes in catalogs or to quote different prices for different quantities
10. (L.O. 3) It is highly unlikely that a company that extends credit to its customers will be
successful in collecting all of its receivables. Thus, some method must be adopted to
account for receivables that ultimately prove to be uncollectible. The two methods currently
11. Use of the allowance method requires a year-end estimate of expected uncollectible
accounts based upon credit sales or outstanding receivables. The estimate is recorded by
12. Advocates of the allowance method contend that its use provides for a proper matching of
revenues and expenses as well as reflecting a proper carrying value for accounts receivable
at the end of the period. When the allowance method is used, the estimated amount of
13. The method used to determine the amount of bad debt expense each year affects the
amount of expense recorded. Under the percentage-of-sales method, the amount recorded
as bad debt expense is the amount determined by multiplying the estimated percentage times
14. When an account proves to be uncollectible, it is written off with the following entry: Debit
Allowance for Doubtful Accounts and Credit Accounts Receivable. If an account written
15. The IASB provides detailed guidelines to be used in determining whether a receivable
should be considered uncollectible or impaired. Assessing for impairment is done
annually. Possible loss events include: (1) significant financial problems of a customer,
16. A receivable is considered impaired when a loss event indicates a negative impact on the
a. Receivables that are individually significant should be considered for impairment
separately. If impaired, recognize it. Receivables that are not individually significant
may, but do not have to be, assessed individually.
Notes Receivable
17. (L.O. 4) The major differences between trade accounts receivables and trade notes
receivables are (a) notes represent a formal promise to pay and (b) notes bear an
18. Short-term notes are generally recorded at face value (less allowances) because the
interest implicit in the maturity value is immaterial. A general rule is that notes treated as
19. Long-term notes receivable should be recorded and reported at the present value of the
cash expected to be collected. When the interest stated on an interest-bearing note is
20. Whenever the face amount of a note does not reasonably represent the present value of
the consideration given or received in the exchange, the accountant must evaluate the
entire arrangement to record properly the exchange and the subsequent interest. Notes
receivable are sometimes issued with zero interest rate stated or at a stated rate that is
Valuation of Notes Receivable
21. The valuation of short-term notes receivable and the related recognition of bad debt
22. The valuation of long-term notes receivable involves impairment testing on an individual
note basis. The test involves comparing the carrying amount of the note to the present
23. Companies may choose to report their receivables using the fair value option. This
choice must be made when the receivable is originally recognized or some event triggers
24. When using the fair value option, any unrealized holding gains or losses are reported as
Issues Related to Derecognition Receivables
25. (L.O. 5) Derecognition of a receivable occurs when it can no longer be included as an
26. Receivables are often used as collateral in a borrowing transaction. A creditor often
requires that the debtor designate (assign) or pledge receivables as security for the loan.
If the loan is not paid when due, the creditor has the right to convert the collateral to cash,
that is, to collect the receivables.
27. Selling receivables may be without guarantee (without recourse) or with guarantee
on Sales of Receivables. Sales with guarantee do not transfer all of the risks and rewards
of ownership of the receivables to the factor. As a result, the transfer is considered
28. (L.O. 6) The presentation of receivables in the statement of financial position includes the
following considerations: (a) segregate the carrying amounts of the different categories of
receivables; (b) indicate the receivables classified as current and non-current in the
statement of financial position; (c) appropriately offset the valuation accounts for
29. The ratio used to assess the liquidity of receivables is the receivables turnover ratio, which
measures the number of times, on average, receivables are collected during the period.
*Cash Controls—Appendix 7A
*30. (L.O. 7) Control over the handling of cash and cash transactions is an important con–
*31. In an imprest petty cash system, a petty cash custodian is given a small amount of
currency from which to make small payments (minor office supplies, taxi, postage, etc.).
*32. A basic cash control is preparation of a monthly bank reconciliation. The bank recon–
ciliation, when properly prepared, proves that the cash balance per bank and the cash
balance per book are in agreement. The items that cause the bank and book balances to
differ, and thus require preparation of a bank reconciliation, are the following:
a. Deposits in Transit. Deposits recorded in the cash account in one period but not
received by the bank until the next period.
*33. Two forms of bank reconciliation may be prepared. One form reconciles from the bank
statement balance to the book balance or vice versa. The other form is described as the
reconciliation of bank and book balances to corrected cash balance. This form is
composed of two separate sections that begin with the bank balance and book balance,
respectively. Reconciling items that apply to the bank balance are added and subtracted
LECTURE OUTLINE
Chapter 7, the first of six asset chapters, covers cash, accounts receivable, and notes receivable.
This chapter can be covered in two class sessions. With the exception of transfers of receivables
The following lecture outline is appropriate for this chapter.
A. (L.O. 1) Cash and receivables represent two of the most liquid of assets. Liquidity is an
indication of an enterprise’s ability to meet its obligations as they come due.
1. Includes coin, currency, bank deposits including checking and savings accounts, and
negotiable instruments such as money orders, cashiers’ checks, personal checks, and
bank drafts.
B. Reporting cash and related items.
1. Cash equivalents.
a. This category includes items that are both (1) readily convertible to known amounts
of cash, and (2) so near their maturity that they present insignificant risk of changes
2. Restricted cash.
a. Cash restricted for some special purpose (such as the retirement of bonds) is
reported separately in either the current asset section or the noncurrent asset
3. Bank overdrafts should be reported as current liabilities. They are not offset against
the cash account unless there is available cash in another account at the same bank.
C. (L.O. 2) Receivables: Claims held against customers and others for money, goods, or
services. Classified as either trade or non-trade.
1. Accounts receivable are oral promises of the purchaser to pay for goods and
services sold.
D. Accounts Receivable—Recognition Issues. These involve the concepts of timing and
measurement. Measurement is complicated by:
1. Trade Discounts. These reductions from the list price are not recognized in the
accounting records; customers are billed net of trade discounts.
2. Cash Discounts (Sales Discounts). These are inducements for prompt payment.
Discuss the gross and net methods of recording receivables.
a. Gross Method (more practical than the net method). Sales and receivables are
3. Interest Element. Theoretically, receivables should be measured at their present value
E. (L.O. 3) Accounts Receivable—Valuation Issues. Companies value and report receivables
at cash realizable value (the net amount they expect to receive in cash).
1. Methods of accounting for uncollectible accounts:
b. Allowance method—At the end of each accounting period an estimate is made
Methods of estimating bad debt expense under the allowance method.
(a) Percentage-of-Sales (Income Statement Approach). Bad debt expense
is estimated directly by multiplying a percentage times credit sales.
(b) Percentage-of-Receivables (Statement of Financial Position Approach):
(i) First the required ending balance in the Allowance for Doubtful Accounts
2. Discuss the IASB requirements for impairment assessment.
a. Receivables that are individually significant should be considered for impairment
individually. If impaired, recognize it. Receivables that are not individually
significant may also be assessed individually.
F. (L.O. 4) Notes Receivable—Recognition Issues. The present value of the future cash
flows is the proper amount to record for notes.
1. Review the terminology in accounting for notes:
b. Stated interest rate—The rate that is stated on the face of the note. This rate is
used to determine the amount of periodic interest payments. A note may be non–
interest-bearing (i.e. have a stated rate of zero).
e. Carrying amount of the note—This is the amount at which notes are reported on
the statement of financial position.
2. Notes Bearing Interest Equal to the Effective Rate—The interest element is ignored
3. Zero Interest or Unreasonable Interest-Bearing Notes—An appropriate rate of interest
must be determined in order to compute the present value of the note.
a. The present value of the note can be determined by measuring the fair market
G. Valuation of Notes Receivable.
1. Recording bad debt expense and the related allowance for short-term notes receivable
parallels that for trade accounts receivable.
a. Notes should be reported at net realizable value although allowance for doubtful
accounts can be difficult to estimate for long-term notes.
b. Companies have the option of using fair value as the basis of measurement in the
financial statements.
1. In order to accelerate the receipt of cash from receivables, accounts receivable and
notes receivable may be transferred to a third party for cash.
a. Secured Borrowing (Assigning or Pledging). The owner of the accounts
receivable borrows cash by writing a promissory note designating the accounts
receivable as collateral.
(1) The borrower and lender agree as to the specific accounts that serve as
b. Sale (Factoring). These transfers of accounts and notes receivable may be without
recourse or with recourse.
(1) Sale Without Guarantee—The purchaser assumes the risk of collectibility
and absorbs any credit losses. This is an outright sale of receivables in both
(2) Sale With Guarantee—The seller guarantees payment to the purchaser for
those receivables that become uncollectible.
(a) The transfer is considered a borrowing—or a failed sale.
I. (L.O. 6) Presentation and analysis of receivables.
1. General classification rules:
a. Segregate the carrying amounts of the different categories of receivables.
e. Disclose information to assess the credit risk inherent in the receivables by providing
information on:
(i) receivables that are neither past due nor impaired,
(ii) the carrying amount of receivables that would otherwise be past due or
2. Accounts receivable turnover ratio: measures the number of times, on average,
receivables are collected during the period.
a. A/R Turnover =
Net Sales
Average Trade Receivables (net)
b. Days to Collect =
J. (L.O. 7) Appendix 7-A: Cash Controls.
1. Imprest Petty Cash System.
a. Imprest bank accounts are used to make a specific amount of cash available for
a limited purpose.
b. Review the accounting procedures for a petty cash system:
(1) The Petty Cash account is debited or credited only when the fund is first
established or is changed in size.
2. Bank Reconciliations.
a. Two forms of bank reconciliations may be prepared:
(1) Reconciliation from the bank statement balance to the book balance or vice
versa.
(2) Reconciliation of bank and book balances to the corrected cash balance. This
(3) The latter form is illustrated in the text. It is useful because it facilitates com–
b. Describe the preparation of a two-section bank reconciliation.
(1) “Balance per bank statement” section.
(a) The “balance per bank statement” is the amount shown on the most
recent bank statement as of the bank’s closing date for the month.
(2) “Balance per books” section.
(a) The “balance per books” is the amount shown in the company’s Cash or
Cash in Checking Account general ledger account as of the desired
reconciliation date (i.e., as of the statement of financial position date,
(3) Both sections end with the correct cash balance, which is the amount that
should be reported on the statement of financial position.