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17/11/2020 10:15:06 AM

Cash and receivable in U.S accounting

1. Cash

1.1 What is Cash?

Cash, the most liquid of assets, is the standard medium of exchange and the basis for measuring and accounting for all other items. Companies generally classify cash as a current asset. Cash consists of coin, currency, and available funds on deposit at the bank. Negotiable instruments such as money orders, certified checks, cashier’s checks, personal checks, and bank drafts are also viewed as cash. What about savings accounts?

Banks do have the legal right to demand notice before withdrawal. But, because banks rarely demand prior notice, savings accounts nevertheless are considered cash. Certain items present classification problems: Companies treat postdated checks and I.O.U.s as receivables. They also treat travel advances as receivables if collected from employees or deducted from their salaries. Otherwise, companies classify the travel advance as a prepaid expense. Postage stamps on hand are classified as part of office supplies inventory or as a prepaid expense. Because petty cash funds and change funds are used to meet current operating expenses and liquidate current liabilities, companies include these funds in current assets as cash.

1.2 Reporting Cash

Although the reporting of cash is relatively straightforward, a number of issues merit special attention. These issues relate to the reporting of:

1.2.1 Cash Equivalents

A current classification that has become popular is “Cash and cash equivalents.” Cash equivalents are short-term, highly liquid investments that are both (a) readily convertible

A variety of “short-term paper” is available for investment. For example, certificates of deposit (CDs) represent formal evidence of indebtedness, issued by a bank, subject to withdrawal under the specific terms of the instrument. Issued in various denominations, they have maturities anywhere from 7 days to 10 years and generally pay interest at the short-term interest rate in effect at the date of issuance. In money-market funds, a variation of the mutual fund, the mix of Treasury bills and commercial paper making up the fund’s portfolio determines the yield.

Most money-market funds require an initial minimum investment of $1,000; many allow withdrawal by check or wire transfer.

Treasury bills are U.S. government obligations generally issued with 4-, 13-, and 26-week maturities; they are sold at weekly government auctions in denominations of $1,000 up to a maximum purchase of $5 million.

Commercial paper is a short-term note issued by corporations with good credit ratings. Often issued in $5,000 and $10,000 denominations, these notes generally yield a higher rate than Treasury bills.

It now appears likely that the FASB will eliminate the cash-equivalent classification from financial statement presentations altogether. Companies will now report only cash. If an asset is not cash and is short-term in nature, it should be reported as a temporary investment. An interesting moral to this story is that when times are good, some sloppy accounting may work. But in bad times, it quickly becomes apparent that sloppy accounting can lead to misleading and harmful effects for users of the financial statements.

1.2.3 Restricted Cash

Petty cash, payroll, and dividend funds are examples of cash set aside for a particular purpose. In most situations, these fund balances are not material. Therefore, companies do not segregate them from cash in the financial statements. When material in amount, companies segregate restricted cash from “regular” cash for reporting purposes.

Companies classify restricted cash either in the current assets or in the long-term assets section, depending on the date of availability or disbursement. Classification in the current section is appropriate if using the cash for payment of existing or maturing obligations (within a year or the operating cycle, whichever is longer). On the other hand, companies show the restricted cash in the long-term section of the balance sheet if holding the cash for a longer period of time.

Cash classified in the long-term section is frequently set aside for plant expansion, retirement of long-term debt

1.2.4. Bank Overdrafts

Bank overdrafts occur when a company writes a check for more than the amount in

its cash account. Companies should report bank overdrafts in the current liabilities section, adding them to the amount reported as accounts payable. If material, companies should disclose these items separately, either on the face of the balance sheet.

Bank overdrafts are generally not offset against the cash account. A major exception is when available cash is present in another account in the same bank on which the overdraft occurred. Offsetting in this case is required.

1.3. Summary of Cash- Related Items.

Cash and cash equivalents include the medium of exchange and most negotiable instruments. If the item cannot be quickly converted to coin or currency, a company separately classifies it as an investment, receivable, or prepaid expense. Companies segregate and classify cash that is unavailable for payment of currently maturing liabilities in the longterm assets section.

Bank overdrafts usually occur because of a simple oversight by the company writing the check. Banks often expect companies to have overdrafts from time to time and therefore negotiate a fee as payment for this possible occurrence.

Note: Compare between IFRS and Vietnam Accounting

2. Account Receivable

Receivables are claims held against customers and others for money, goods, or services. For financial statement purposes, companies classify receivables as either current (short-term) or noncurrent (long-term). Companies expect to collect current receivables within a year or during the current operating cycle, whichever is longer. They classify all other receivables as noncurrent. Receivables are further classified in the balance sheet as either trade or nontrade receivables. Customers often owe a company amounts for goods bought or services rendered.

A company may subclassify these trade receivables, usually the most significant item it possesses, into accounts receivable and notes receivable. Accounts receivable are oral promises of the purchaser to pay for goods and services sold. They represent “open accounts” resulting from short-term extensions of credit. A company normally collects them within 30 to 60 days. Notes receivable are written promises to pay a certain sum of money on a specified future date. They may arise from sales, financing, or other transactions. Notes may be short-term or long-term.

Nontrade receivables arise from a variety of transactions. Some examples of nontrade receivables are:

1. Advances to officers and employees.

2. Advances to subsidiaries.

3. Deposits paid to cover potential damages or losses.

4. Deposits paid as a guarantee of performance or payment.

5. Dividends and interest receivable.

6. Claims against:

(a) Insurance companies for casualties sustained.

(b) Defendants under suit.

(c) Governmental bodies for tax refunds.

(d) Common carriers for damaged or lost goods.

(e) Creditors for returned, damaged, or lost goods.

(f) Customers for returnable items (crates, containers, etc.).

2.1 Recognition of Account Receivable

In most receivables transactions, the amount to be recognized is the exchange price

between the two parties. The exchange price is the amount due from the debtor

(a customer or a borrower). Some type of business document, often an invoice,

serves as evidence of the exchange price. Two factors may complicate the measurement

of the exchange price: (1) the availability of discounts (trade and cash

discounts), and (2) the length of time between the sale and the due date of payments

(the interest element).

2.1.1 Trade Discounts

Prices may be subject to a trade or quantity discount. Companies use such trade discounts to avoid frequent changes in catalogs, to alter prices for different quantities purchased, or to hide the true invoice price from competitors.

Trade discounts are commonly quoted in percentages. For example, say your textbook has a list price of $90, and the publisher sells it to college bookstores for list less a 30 percent trade discount. The publisher then records the receivable at $63 per textbook. The publisher, per normal practice, simply deducts the trade discount from the list price and bills the customer net.

As another example, Maxwell House at one time sold a 10-ounce jar of its instant coffee listing at $5.85 to supermarkets for $5.05, a trade discount of approximately 14 percent. The supermarkets in turn sold the instant coffee for $5.20 per jar. Maxwell House records the receivable and related sales revenue at $5.05 per jar, not $5.85.

2.1.2 Cash Discounts (Sales Discounts)

Companies offer cash discounts (sales discounts) to induce prompt payment. Cash discounts generally presented in terms such as 2/10, n/30 (2 percent if paid within 10 days, gross amount due in 30 days), or 2/10, E.O.M., net 30, E.O.M. (2 percent if paid any time before the tenth day of the following month, with full payment received by the thirtieth of the following month).

Companies usually take sales discounts unless their cash is severely limited. Why? A company that receives a 1 percent reduction in the sales price for payment within 10 days, total payment due within 30 days, effectively earns 18.25 percent (.01 _[20/365]), or at least avoids that rate of interest cost.

Companies usually record sales and related sales discount transactions by entering the receivable and sale at the gross amount. Under this method, companies recognize sales discounts only when they receive payment within the discount period.

The income statement shows sales discounts as a deduction from sales to arrive at net sales. If using the gross method, a company reports sales discounts as a deduction from sales in the income statement. Proper expense recognition dictates that the company also reasonably estimates the expected discounts to be taken and charges that amountagainst sales. If using the net method, a company considers Sales Discounts Forfeited as an “Other revenue” item.

2.1.3 Nonrecognition of Interest Element

Ideally, a company should measure receivables in terms of their present value, that is, the discounted value of the cash to be received in the future. When expected cash receipts require a waiting period, the receivable face amount is not worth the amount that the company ultimately receives.

To illustrate, assume that Best Buy makes a sale on account for $1,000 with payment due in four months. The applicable annual rate of interest is 12 percent, and payment is made at the end of four months. The present value of that receivable is not $1,000 but $961.54 ($1,000 _.96154). In other words, the $1,000 Best Buy receives four months from now is not the same as the $1,000 received today.

2.2 Valuation of Account Receivable

Reporting of receivables involves (1) classification and (2) valuation on the balance sheet. Classification involves determining the length of time each receivable will be outstanding. Companies classify receivables intended to be collected within a year or the operating cycle, whichever is longer, as current. All other receivables are classified as long-term.

Companies value and report short-term receivables at net realizable value the net amount they expect to receive in cash. Determining net realizable value requires estimating both uncollectible receivables and any returns or allowances to be granted.

2.2.1 Uncollectible Accounts Receivable

The direct write-off method records the bad debt in the period in which a company determines that it cannot collect a specific receivable. In contrast, the allowance method enters the expense on an estimated basis in the accounting period in which the sales on account occur.

Supporters of the direct write-off method (which is used for tax purposes) contend that it records facts, not estimates. It assumes that a good account receivable resulted from each sale, and that later events revealed certain accounts to be uncollectible and worthless. From a practical standpoint this method is simple and convenient to apply.

But the direct write-off method is theoretically deficient: It usually fails to match costs with revenues of the period. Nor does it result in receivables being stated at estimated realizable value on the balance sheet. As a result, using the direct write-off method is not considered appropriate, except when the amount uncollectible is immaterial.

A receivable is a prospective cash inflow. The probability of its collection must be considered in valuing cash flows. These estimates normally are based either on (1) percentage of sales or (2) outstanding receivables.

Percentage-of-Sales (Income Statement) Approach

The percentage-of-sales approach matches costs with revenues because it relates the charge to the period in which a company records the sale.

To illustrate, assume that Chad Shumway Corp. estimates from past experience that about 2 percent of credit sales become uncollectible. If Chad Shumway has credit sales of $400,000 in 2010, it records bad debt expense using the percentage-of-sales method as follows.

DR Bad Debt Expense 8,000

CR Allowance for Doubtful Accounts 8,000

The Allowance for Doubtful Accounts is a valuation account (i.e., a contra asset), subtracted from trade receivables on the balance sheet

Percentage-of-Receivables (Balance Sheet) Approach

Using past experience, a company can estimate the percentage of its outstanding receivables that will become uncollectible, without identifying specific accounts. This procedure provides a reasonably accurate estimate of the receivables’ realizable value. But, it does not fit the concept of matching cost and revenues. Rather, it simply reports receivables in the balance sheet at net realizable value. Hence it is referred to as the percentage-of-receivables (or balance sheet) approach.

Companies may apply this method using one composite rate that reflects an estimate of the uncollectible receivables. Or, companies may set up an aging schedule of accounts receivable, which applies a different percentage based on past experience to the various age categories. An aging schedule also identifies which accounts require special attention by indicating the extent to which certain accounts are past due.

Wilson reports bad debt expense of $37,650 for this year, assuming that no balance existed in the allowance account. To change the illustration slightly, assume that the allowance account had a credit balance of $800 before adjustment. In this case, Wilson adds $36,850 ($37,650 – $800) to the allowance account, and makes the following entry.

DR Bad Debt Expense 36,850

CR Allowance for Doubtful Accounts 36,850