Chapter 5

Internal Control, Cash, and

Receivables

Fall 2019
Prof. Sumi Jung
Prepare and use a bank reconciliation

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Bank Account as Control Device

Signature Bank
Deposit ticket
card statement

Bank
Check
reconciliation

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Bank Account Documents
• Signature card
▫ Banks require each person authorized to sign on
an account to provide a signature card
▫ Protects against forgery
• Deposit ticket
▫ Customer fills out deposit ticket and receives a
receipt as proof of the transaction
• Cheque
▫ Maker – signs the cheque
▫ Payee – to whom the cheque is paid
▫ Bank – where funds are drawn

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The Bank Statement

• Reports:
▫ Cash receipts
▫ Cash payments

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Bank Reconciliation
• Two records of a business’s cash
▫ BANK: The bank statement (maintained by the
bank)
▫ BOOK: The Cash account in the general ledger
(maintained by the company)
• Amounts are usually different
▫ Time lags in recording transactions
• Bank reconciliation explains the differences

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 Bank Reconciliation Items
Bank Side (start with Book Side (start with
bank statement) cash ledger)
• ADD • ADD
• Deposits in transit • Bank collections
• Certain bank errors • EFT receipts Electronic Fund
Transfer
• Interest revenue
• SUBTRACT • Certain book errors
• Outstanding cheques
• Certain bank errors • SUBTRACT
• EFT payments
• Service charges
NSF means Non-Sufficient Funds
• NSF cheques
• Certain book errors

Calculate the “Adjusted Bank Balance” and the “Adjusted Book Balance” 7
Summary of Reconciling Items

BANK BALANCE - ALWAYS BOOK BALANCE - ALWAYS

Add deposits in transit Add bank collections, interest
revenue and EFT receipts
Subtract outstanding cheques Subtract services charges, NSF
cheques, EFT payments
Add or subtract correction of bank Add or subtract correction of book
errors errors

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Journalizing Bank Reconciliation Items

• All items on the book side of the bank

reconciliation require journal entries
• If the item is added to book side
▫ Debit Cash
• If the items is subtracted from the book side
▫ Credit Cash

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Exhibit 5-12 Bank Reconciliation
Bank side:
1. Deposit in transit, $ 1,600.
2. Bank error: the bank deducted $ 100 for a check written
by another company. Add $ 100 to the bank balance.
3. Outstanding check-total of $ 1,340
Exhibit 5-12 Bank Reconciliation
Book side:
4. EFT receipt of your dividend revenue earned on an
investment, $900
5. Bank collection of your account receivable, $2,100.
6. interest revenue earned on your bank balance, $30.
7. Book error: you recorded check no. 333 for $510. the
amount you actually paid on account was $150. add
$360 to your book balance.
8. Bank service charge, $20.
9. NSF check from a customer, $50. subtract $50 from
your book balance.
10.EFT payment of insurance expense, $400.
Exhibit 5-12 Bank Reconciliation
Journalizing Transactions from the Bank Reconciliation
JOURNAL
Date Accounts and explanation Debit Credit
Cash 900
Dividend Revenue 900
Receipt of dividend revenue earned on
investment. (Paid directly into bank account)
Cash 2,100
Accounts Receivable 2,100
Account receivable collected by bank
Cash 30
Interest Revenue 30
Interest earned on bank balance.
Cash 360
Accounts Payable 360
Correction of cheque (overstated cheque)
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 JOURNAL
Date Accounts and explanation Debit Credit
Miscellaneous Expense 20
Cash 20
Bank service charge.
Accounts Receivable 50
Cash 50
NSF cheque returned by bank.
Insurance Expense 400
Cash 400
Payment of monthly insurance.

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Report Cash on the Balance Sheet

• All cash accounts combined into a single total

called “Cash and Cash Equivalent”
▫ Include liquid assets such as time deposits,
certificates of deposit, and high-grade government
yield
▫ Interest-bearing accounts with no withdrawal
penalty
• Reports liquid assets available for day-to-day use

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Account for receivables and its potential
impairment

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Receivables
• Monetary claims against others

Accounts receivable are Notes receivable are

the amounts collectible written promises from
from customers from the another party to pay with
sale of goods and services. specified terms.

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Managing Risk of Not Collecting

Benefit of selling on credit Cost of selling on credit

• Customers that do not • Company cannot collect

have cash available can from some customers
buy on credit • This cost is called
• Sales increase Uncollectible account,
Doubtful-account, or
Bad debt expense

A Company Must Balance the Benefit And Cost of Credit Effectively

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Accounts Receivable
• The expected future cash receipts of a company for
sales made “on account”
• Current assets
• Sometimes called trade receivables

• Receivables are reported at their face value less an

allowance for accounts which are likely to be
uncollectible.

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Accounting for Bad Debts
Bad debts result from credit customers who will not pay the
business the amount they owe, regardless of collection efforts.

Bad Debt Expense

Matching Principle Record in same

accounting period.

Sales Revenue

Most businesses record an estimate of the bad debt expense

with an adjusting entry at the end of the accounting period.

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Accounting for Bad Debts
: Allowance Methods
• Step 1: Record estimated bad debts expense
▫ At the end of accounting period in which sales are
made (Matching principle)
▫ Net Income ↓, Assets (net A/R) ↓

• Step 2: Identify and write off actual bad debts

▫ Throughout the period as bad debts become known
▫ No effect on Net Income, Assets, and net A/R

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Step 1: Recording of Estimated Bad Debts
expense
• Journal Entry
Bad Debt Expense (+E, -SE) xxx
Allowance for Doubtful Accounts (+XA,-A) xxx
▫ Allowance Account: a contra-asset account on the B/S
▫ Bad Debt Expense: is the expense associated with
estimated uncollectible accounts receivable.
 Balance Sheet Disclosure Amount the business
Accounts Receivable (Gross) expects to collect.
500,000
Less: Allowance for doubtful accounts (25,000)
Accounts Receivable (Net) 475,000
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Step 2: Actual Write-off of
an Uncollectable Account
When it is clear that a specific customer’s account
receivable will be uncollectible, the amount should be
removed from the Accounts Receivable account and
charged to the Allowance for Doubtful Accounts.

• Journal Entry
Allowance for Doubtful Accounts(-XA,+A) xxx
Accounts Receivable(-A) xxx
▫ Uncollectable accounts are written off against the
allowance account
▫ No effects on Net Income and Assets
▫ Net book value of accounts receivable is not affected.
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Example: Deckers
 Deckers estimated bad debt expense for 2018 to be $2,000
Prepare the adjusting entry (at the end of December 2018)

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Bad Debt Expense (+E, -SE) 2,000
Allowance for Doubtful Accounts (+XA, -A) 2,000
 Deckers’ total write-offs for 2018 were $1,000. Prepare a
summary journal entry for these write-offs.
Date Description Debit Credit
Allowance for Doubtful Accounts (-XA, +A) 1,000
Accounts Receivable (-A) 1,000
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Example: Deckers
Assume that before the write-off, Deckers’ A/R balance was
$300,000 and the Allowance for Doubtful Accounts balance
was $10,000.
Let’s see what effect the bad debt expense of $2,000 had on
these accounts.

Before After
Accounts Receivable $ 300,000 $ 300,000
Less: Allow. for doubtful accts. 10,000 12,000
Accounts receivable (Net) $ 290,000 $ 288,000

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Example: Deckers

Let’s see what effect the total write-offs of $1,000 had on A/R
and Allowance for doubtful accounts.

Before Write- After Write-

Off Off
Accounts Receivable $ 300,000 $ 299,000
Less: Allow. for doubtful accts. 12,000 11,000
Accounts receivable (Net) $ 288,000 $ 288,000

Notice that the total write-offs of $1,000 did not change the Accounts Receivables (net) nor
did it affect any income statement accounts.
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Example: Deckers
Accounts Receivable (Gross) Allowance for Doubtful Accounts

Beg 300,000 10,000 Beg. Bal.

1,000 W/O W/O 1,000 2,000 Bad Debt Expense

End. 299,000 11,000 End

Accounts Receivable (Net) Bad Debt Expense

Beg 290,000 2,000

2,000 Bad Debt Expense

End. 288,000 End. 2,000

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Adjusting Ending Allowance for
Doubtful Receivables

Relationship between uncollectible-account expense (bad debt expense),

write-offs of receivables and allowance for doubtful receivables account

Beginning – Receivables Bad Debt Ending

+ =
Allowance Write-offs Expense Allowance

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Methods for Estimating Bad Debts

Aging of accounts receivable method

????

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Aging of Accounts Receivable Method
• Estimates the percentage of accounts receivable
that will prove uncollectable.
▫ as accounts receivable become older and more overdue, it
is more likely that they will be uncollectible.
▫ Accounts receivable are divided into age categories, and a
different loss rate is applied to each category.
• Adjust net account receivable up or down to this
number
• The difference goes to bad debt expense
Focus is on determining the desired (ending)
balance in the Allowance for Doubtful Accounts
on the Balance Sheet.
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Example: Aging-of-Receivables
Age of Account
Not 1-30 31-60 Over 60 Total
yet days days days Balance
Customer due
Customer A $400 $400
Customer B 100 100 200
Customer C 300 200 600 100 1,200

All others … … … …
Totals 11,060 1,363 370 1,093 13,886
Est. percent uncollectible 1.0% 5.0% 12.5% 20.9%
Allowance balance should be: 111 68 46 219 444

Based on past experience, the business estimates the

percentage of uncollectible accounts in each time category.
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 Aging-of-Receivables

JOURNAL
Date Accounts and explanation Debit Credit
Uncollectible accounts expense 151
Allowance for uncollectible accounts 151
Recorded uncollectible accounts expense

Allowance for Uncollectible Accounts

Balance before adjustment $293
$____Adjustment needed
$444
Ending balance equals aging schedule

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Aging-of-Receivables

Accounts Receivables Allowance for Uncollectible Accounts

$13,886 $293
$151
$444

Net accounts receivables, $13,442

Uncollectible Account Expense

Notice that the balance after
$151 adjustment is equal to the
estimate of $444 based on
the aging analysis performed
$151
earlier.
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Direct Write-Off Method
• Waits until a specific account is uncollectible to
record the expense
• Inferior to Allowance method
▫ Receivables reported at full amount
 Assets overstated on Balance Sheet
▫ Fails to recognize uncollectible accounts in the same
period in which the related revenue is earned
 Normally not permitted under GAAP
JOURNAL
Date Accounts and explanation Debit Credit
Uncollectible-account Expense xxx
Accounts Receivable xxx
Write off customer account
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 Computing Cash Collections from
Customers
Accounts Receivable

Beginning balance $200 $100 Write-offs of

uncollectibles
Sales on credit $1,800 $1,500 ? Collections from
customers

Ending balance $400

If you know all other items except for collections, you can
compute collections by solving for X.
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Exercise
• CUHK Company uses the aging approach to estimate bad
debt expense.
• The balance of each account receivable is aged on the basis
of three time periods and the average loss rate (based on
experience) on the amount of the receivables at year- end
due to uncollectability as follows:
▫ (1) not yet due $ 250,000 3.5%
▫ (2) up to 120 days past due $ 50,000 10.0%
▫ (3) more than 120 days past due $ 30,000 30.0%
• On December 31, 2018, the Allowance for Doubtful
Accounts balance was $ 400 (credit) before the end-of-
period adjusting entry is made.
• Req.:
▫ 1) Prepare the appropriate bad debt expense adjusting entry for the
year 2018.
▫ 2) Show how the various accounts related to accounts receivable
should be shown on the December 31, 2018 balance sheet.
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 Exercise
• Req.1: December 31, 2018 adjusting entry
Account Title Debit Credit
Bad debt expense (+E, –SE) 22,350
Allowance for doubtful accounts (+XA, –A) 22,350

 Computation of bad debt expense for 2018

Estimated Estimated
Aged Accounts Receivables Percentage Amount
Uncollectable Uncollectable
Not Yet due $250,000 * 3.5 % = $8,750
Up to 120 days past due 50,000 * 10 % = 5,000
Over 120 days past due 30,000 * 30 % = 9,000
Estimated balance in Allowance for Doubtful Accounts $22,750
Current Balance in Allowance for Doubtful Accounts 400
Bad Debt Expense for the year $22,350

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Exercise
• Req.2: Balance Sheet
Accounts Receivable( $250,000+$50,000+$30,000) $330,000

Less allowance for doubtful accounts (22,750)

Accounts Receivable, net of allowance for

doubtful accounts $307,250

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Notes Receivable
• More formal than accounts receivable
• Written promise to pay a sum at the maturity
date
▫ Plus interest
• Also called promissory notes

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Notes Receivable
• Can be current or long-term assets
• Terms:
Creditor Party to whom money is owed; Lender
Debtor Party that borrowed and owes money; borrower
Interest Cost of borrowing money; stated as annual
percentage rate
Maturity date Date when debtor must pay note
Maturity value Sum of principal and interest on maturity
Principal Amount borrowed by debtor
Term Length of time from when note was signed to when
payment must be made

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 Principal Date Interest
Starts

PROMISSORY NOTE
$1,000 August 31, 20X6
Amount Date

For value received, I promise to pay to the order of

RaboBank Payee (Creditor)
Amsterdam, Netherlands
Principal One thousand and no/100s-------------------------------- Dollars
Maturity Date
On February 28, 20X7
plus interest at the annual rate of 9 percent
Lauren Holland Maker
(Debtor)

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 Accounting for Notes Receivable
JOURNAL
Date Accounts and explanation Debit Credit
20X6
Aug 31 Notes receivable – L.Holland 1,000
Cash 1,000
Dec 31 Interest receivable ($1,000 x 0.09 x 4/12) 30
Accrued Interest revenue 30

20X7
Feb 28 Cash 1,045
Notes receivable – L.Holland 1,000
Interest receivable 30
Interest revenue ($1,000 x 0.09 x 2/12) 15
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Interest Computation
• Interest rates are always expressed as an annual
percent, unless stated otherwise
▫ For example, a 6-month note with an interest of
9% means the annual rate is 9%. The note will
actually earn 4.5%.
• The time element (4/12) is the fraction of the
year that the note has been in force during 2018.
• Often interest is computed based on days
▫ Denominator would be days/365

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Speeding Up Cash Flow

Credit cards

• Customers pay with credit cards

• Revenues increases, with a cost
• Credit card company takes 2-3% as a fee

Selling (Factoring) receivables

• Companies sell receivables to another business, called a factor
• The factor pays a discounted price and then tries to collect from
the customer
• Immediate receipt of cash but quite expensive

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Example: Credit Card or Bankcard Sales

Fujitsu sells computers for $2,000, and the customer pays with
a VISA card. Fujitsu records the sale as follows (2% fee):

Date Description Debit Credit

Cash 1,960
Credit Card Processing Fee 40
Sales Revenue 2,000

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Example: Selling (Factoring) Receivables

A company wishes to speed up cash flow and therefore sells

$100,000 of accounts receivables, receiving cash of $95,000.
The record is as follows:

Date Description Debit Credit

Cash 95,000
Financing Expense 5,000
Account Receivable 100,000

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Evaluate a company’s ability to collect receivables

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Receivable Turnover and
Receivable Collection Period
 How effective is collection activities?

Receivable Sales
Turnover = Average Accounts Receivables

▫ Avg. A/R = (Beginning receivables + Ending receivables)/2

▫ A number of times average receivables are converted into
cash during the period

Receivable Collection 365

=
Period Receivables Turnover
▫ How long it takes to collect its average level of receivables
▫ Also called the days’ sales in receivables, or days sales
outstanding
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Take-aways of Chapter 5
• Bank Reconciliation
• Accounts Receivables & Notes Receivables
• Bad Debts and Uncollectible Accounts
▫ How to account for bad debt?
 Allowance method
1. Record estimated bad debts expense
2. write off actual bad debts
▫ How to estimate bad debt expense?
 Aging of accounts receivable method
• Receivable Turnover and Receivable Collection
Period
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