Chapter 7 Short term Liquid Assets

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Chapter 7Short term Liquid Assets

• Management issues. . .
• Cash Cash Equivalents, the EFT. . .
• Journal Entries
• Short Term Investments
• Accounts Receivable
• Allowance Method for Uncollectible Accounts
• Percentage of Sales
• Aging Method
• Writing off a Bad Debt (Uncollectible Account)

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Chapter 7 Short term Liquid Assets

• Describe methods to accelerate the receipt of
  cash from receivables.
• Journal Entries
• Notes Receivable
• Compute the maturity date of and interest on
  notes receivable.

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Receivables...

• Amounts due from individuals and companies-
  expected to be collected in cash.
• Frequently classified as
• Accounts receivable
• Notes receivable
• Other receivables

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Illustration 8-9
Notes Receivable...

• Represent claims for which formal instruments
  of credit are issued as evidence of debt.

2001
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Other Receivables

• Nontrade including
• interest receivable
• loans to company officers
• advances to employees
• income taxes refundable

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Management Issues

• How VALID is your AR?
• (How collectible is it?)
• Does your biz. have Seasonal Cycles?
• What is your credit policy?

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Managing Receivables

• Who gets credit?
• Policy Payment period.
• Monitor collections.
• Evaluate unpaid balance.
• Accelerate cash
• collections
• when necessary.

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Extending Credit

• Potential Customers?
• Continuing customers?
• Risky customers?

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Payment Period

• Required payment period policy communicate it
  to customers salesforce.
• Be competitive!

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Monitoring Collections

• Age accounts receivable monthly
• Follow up
• phone calls
• letters
• legal action if
  necessary.

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Evaluating the Receivables Balance

• Liquidity is measured by how quickly certain
  assets can be converted into cash.

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Receivables Turnover Ratio
Illustration 8-17

• Net Credit Sales
• Average Net Receivables

Is a measure of the liquidity of receivables.
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Average Collection Period
Illustration 8-17

• 365 days
• Receivables Turnover Ratio

Is the average amount of time that a receivable
is outstanding
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Cash Cash Equivalents

• Cash
• Compensating balance (will reduce liquidity)
• Cash equivalents (lt90 days)
• EFTs the future of debit cards, etc.

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Accounts Receivable...

• Amounts owed by customers on account.
• Result from the sale of goods/services.
• Expected to be collected within 30-60 days.
• Most significant type of claim held by company.
• Often called trade receivables.

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Accounts Receivable...

• Are recorded when service is provided or at
  point of sale of merchandise on account.
• Accounts Receivable 100
• Sales 100

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Bad Debts Expense...

• Is an expense to record estimated
  uncollectible receivables.

Keeps Expenses from Being Understated on the
Income Statement.
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2 Methods for Accounting for Uncollectible
Accounts

• The Direct Write-off Method
• The Allowance Method

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Direct Write-off Method

• Bad debt losses are not estimated.
• No allowance account is used.
• Accounts are written off when determined
  uncollectible as follows
• Uncollectible Accounts Expense 200
• Accounts Receivable--M. E. Doran 200

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Allowance Method

• Uncollectible accounts receivable are estimated
  and matched against sales in the same accounting
  period in which the sales occurred.
• Uncollectible accounts receivable may be
  estimated using
• Percentage of sales
• Aging of accounts receivable

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Percentage of sales

• Hampton Furniture has credit sales of
  1,200,000, of which 200,000 remains
  uncollected. The credit manager estimates 10 of
  sales will prove uncollectible.
• Uncoll. Accts. Expense 12,000
• Allowance for Uncoll.
• Accounts 12,000

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Recording Estimated Uncollectibles

• Uncoll. Accts Expense 12,000
• Allowance for Uncoll.
• Accounts 12,000

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Cash (Net) Realizable Value...

• Is the net amount expected to be collected in
  cash.
• Excludes amounts the company estimates it will
  not collect.

Keeps Receivables from Being Overstated on the
Balance Sheet.
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HAMPTON FURNITURE Balance Sheet (partial)
Illustration 8-4

• Current assets
• Cash 14,800
• Accounts receivable 200,000
• Less Allowance for uncoll. accounts 12,000
  188,000

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HAMPTON FURNITURE Balance Sheet (partial)
Illustration 8-4

• Current assets
• Cash 14,800
• Accounts receivable 200,000
• Less Allowance for uncoll. accounts 12,000
  188,000
• Merchandise Inventory 310,000
• Prepaid Expense 25,000
• Total current assets 537,800

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Write-off of an Uncollectible Account

• The vice president of finance authorizes a
  write-off of 500 owed by R.A.Ware.
• Allowance for Uncollectible
• Accounts 500
• Accounts Receivable-Ware 500

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Write-off of an Uncollectible Account
Illustration 8-5

• Allowance for Uncollectible
• Accounts 500
• Accounts Receivable-Ware 500

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Before Write-off

• Current assets
• Cash 14,800
• Accounts receivable 200,000
• Less Allowance for uncoll. accounts 12,000
  188,000

After Write-off
Current assets Cash 14,800 Accounts
receivable 199,500 Less Allowance for uncoll.
accounts 11,500 188,000
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Recovery of an Uncollectible Account

• Accounts Receivable-Ware 500
  Allowance
  for Uncollectible
• Accounts
  500
• Cash 500
• Accounts Receivable 500

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Percentage of Receivables...

• A percentage relationship
• the amount of receivables
• the expected losses from uncollectible accounts.

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Aging of Accounts Receivable

• Analysis of customer balances
• By length of time they have been unpaid.
• (The longer a debt
• is outstanding
• the less likely
• it is to be paid).

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Aging Method

• Hampton Furniture has credit sales of
  1,200,000, of which 92,500 remains uncollected.
  
• What does the 92,500 represent?
• How old is it?

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Which method is better?

• Income Statement Approach vs.
• A more accurate income statement
• Balance Sheet Approach
• A more accurate balance sheet

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Accelerating Cash Receipts
Waiting for the normal collection process cost
money.
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Accelerating Cash Receipts
A bird in the hand is worth two in the bush.
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Companies Sell Receivables

• They get more sales if they provide financing to
  customers.
• General Motors Acceptance Corporation
• Ford Motor Credit Corporation
• They may be the only reasonable
  source of cash.
• Billing and collection are often
  time-consuming and
  costly.

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Factor...

• Is a finance company or bank that buys
  receivables from businesses for a fee and then
  collects payments
  directly
  from the
  customers.

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Credit Card

• A common type of credit card is a national
  credit card such as
• Visa
• Master Card
• American Express.

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Credit Card

• Three parties are involved when national credit
  cards are used in making retail sales
• the credit card issuer
• the retailer
• the customer

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Bank Credit Card

• Sales resulting from the use of VISA and
  MasterCard are considered cash sales by the
  retailer.
• A form of factoring without recourse (credit card
  issuer assumes ALL risk)

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Notes Receivable...

• Result from sale of goods and services.
• Often called trade receivable.
• Stronger legal claim to assets than accounts
  receivable.
• Are negotiable instruments and may be transferred
  to another party by endorsement.
• Earn interest ()

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Notes Receivable...

• Credit instrument normally requires
• payment of interest
• extends for time periods of 60-90 days or longer.

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Notes Receivable

• Life of a note may be expressed in months or
  days.
• When the life of a note is expressed in terms of
  months, the due date is found by counting the
  months from the date of issue.

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Notes Receivable

• When the due date is stated in terms of days,
  count the exact number of days to determine the
  maturity date.

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Maker
Is the party in a promissory note who is making
the promise to pay.
Payee
Payee
Is the party to whom payment of a promissory note
is to be made.
Is the party to whom payment of a promissory note
is to be made.
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Illustration 8-9
Notes Receivable...

• Represent claims for which formal instruments
  of credit are issued as evidence of debt.

2001
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Maturity Date
Illustration 8-10
The maturity date of a 60-day note dated July 17
is computed as follows

• Term of note 60 days
• July (31-17) 14
• August 31 45
• Maturity date, September 15

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Formula for Interest
Illustration 8-11
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Notes Receivable...

• Interest revenue is recorded when the note is
  paid.
• If interim financial statements are prepared,
  interest on notes receivable is accrued.

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Notes Receivable...

• Notes receivable are listed before accounts
  receivable because notes are more easily
  converted to cash.
• Uncoll. accts expense is reported as a selling
  expense in the income statement.
• Interest revenue is shown under Other Revenues
  and Gains in the nonoperating section of the
  income statement.

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Short term investments

• 3 major categories
• Dividend and interest income from these is
  recorded in
• Other income/expense section of Income statement

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Held-to-Maturity Securities...
Illustration 12-5

• Are debt securities that the investor has the
  intent and the ability to hold to maturity.
• Why?

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Trading Securities...

• Securities bought and held primarily for sale in
  the near term to generate income on short-term
  price differences.
• Are reported at fair value referred to as
  cost-adjusted-to-
• market accounting.
• Changes from cost are reported in net income.

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Available-for-Sale Securities...

• Are securities that may be sold in the future.
• Are reported at fair value.
• Changes from cost are reported in the
  stockholders equity section.

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Extending Credit

• Risky customers might be required to provide
  letters of credit or bank guarantees.
• Risky customers might be required to pay cash on
  delivery (COD).
• Ask potential customers for references from banks
  and suppliers and check the references.
• Periodically check financial health of continuing
  customers.

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Credit Risk Ratio...
Illustration 8-14

• Is a measure of the risk that a companys
  customers may not pay their accounts.

Credit Risk Ratio Allowance for Doubtful
Accounts Accounts Receivables
Changes in credit risk ratio over time
suggests that a companys overall credit risk is
increasing and decreasing.
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Concentration of Credit Risk

• Is a threat of nonpayment from a single
  customer or class of customers that could
  adversely affect the financial health of the
  company.

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Expense Associated with Selling Receivables

• If a company usually sells its receivables, the
  service charge expense is recorded as a selling
  expense.
• However, if receivables are sold infrequently the
  fee may be reported under Other Expenses and
  Losses in the income statement.

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Trade Receivables...

• Notes and accounts receivables that result
  from sales transactions.

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Notes Receivable...

• Are often accepted from customers who need to
  extend payment of an account receivable.
• Are often required
  from high-risk
  customers.

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Notes Receivable...

• Each type of receivables should be identified in
  the balance sheet or in the notes to the
  financial statements.
• Short-term receivables are reported in the
  current asset section of the balance sheet below
  short-term investments.
• The gross amount of receivables and the allowance
  for doubtful accounts should be reported.

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Notes Receivable...

• are recorded at face value.
• are reported at cash (net) realizable value.
• are honored when paid in full at maturity.
• are dishonored when not paid in full at
  maturity.

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Advantages of Credit Cards to the Retailer
Illustration 8-18
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Illustration 8-18
Advantages of Credit Cards to the Retailer
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Illustration 8-18
Advantages of Credit Cards to the Retailer
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Illustration 8-18
Advantages of Credit Cards to the Retailer