Cash and receivables
Cash and receivables are a business's most liquid assets. Controlling cash and estimating uncollectible accounts are key accounting tasks.
Cash and cash equivalents
Cash includes coins, currency, bank deposits, and cheques received. Cash equivalents are short-term, highly liquid investments, such as treasury bills with maturities of three months or less, that are easily converted to cash. They are reported together on the balance sheet.
Internal control over cash
Because cash is easy to steal, businesses use controls: segregating duties (the person handling cash should not record it), depositing receipts daily, paying by cheque or electronic transfer with approval, using locked cash registers, and reconciling bank statements regularly. A petty cash fund handles small expenses with receipts.
Bank reconciliations
A bank reconciliation compares the company's cash records with the bank statement and explains differences. Bank-side adjustments include deposits in transit (recorded by the company but not yet by the bank) and outstanding cheques. Book-side adjustments include bank fees, interest earned, NSF (bounced) cheques, and errors; these need journal entries.
Accounts receivable
Accounts receivable are amounts customers owe for goods or services sold on credit. Selling on credit increases sales but creates the risk that some customers never pay. Notes receivable are formal written promises to pay, usually with interest.
The allowance method
Under GAAP, businesses estimate uncollectible accounts in the same period as the related sales (matching). The estimate is recorded by debiting Bad Debt Expense and crediting Allowance for Doubtful Accounts, a contra-asset that reduces receivables to their net realisable value. When a specific account is written off, debit the Allowance and credit Accounts Receivable, with no effect on expense.
Estimating bad debts
The percentage-of-sales (income statement) approach estimates bad debt expense as a percentage of credit sales. The percentage-of-receivables (balance sheet) approach estimates the ending allowance balance, often using an ageing schedule that applies higher percentages to older, overdue accounts. The direct write-off method, expensing only when accounts are written off, is not GAAP-compliant for material amounts.
Receivables management
Businesses manage receivables by checking customer credit, setting clear payment terms, sending invoices promptly, and following up on overdue accounts. Accounts receivable turnover (net credit sales / average receivables) and days sales outstanding (365 / turnover) show how quickly customers pay.
Worked example
A company has receivables of 200,000 dollars. Its ageing schedule estimates 8,000 will be uncollectible. The allowance currently has a credit balance of 2,000, so the adjustment is 6,000: debit Bad Debt Expense 6,000, credit Allowance 6,000. Net realisable value of receivables is 200,000 - 8,000 = 192,000.
Key takeaways
Cash and cash equivalents are the most liquid assets and need strong controls, such as segregation of duties and daily deposits. Bank reconciliations explain differences; book-side items need entries. Accounts receivable carry collection risk. The allowance method estimates bad debts in the period of sale, using a contra-asset; write-offs do not affect expense. Estimates use percentage of sales or ageing of receivables. Turnover and days sales outstanding measure collection speed.
Flashcard
Liquid investments due within three months
Check your understanding
Under the allowance method, what is the effect of writing off a specific uncollectible account?