Lec5 - Cash & Receivables.pdf

AYB106 Week 5 Cash and Recievables  Learning objectives Define Demonstrate Define and explain Use Account Report Define internal control Demonstrate the use of Define and explain...

AYB106 Week 5 Cash and Recievables  Learning objectives Define Demonstrate Define and explain Use Account Report Define internal control Demonstrate the use of Define and explain Use the allowance Account for bills Report receivables on List and describe the a bank account as a common types of method to account for receivable the balance sheet, and components of internal control device receivable, and bad debts evaluate a business control and control Prepare a bank journalise sales on using the acid-test ratio, procedures reconciliation and the credit, credit card sales days’ sales in Describe control procedures related journal entries and debit card sales receivables and the unique to e-commerce Apply internal controls to accounts receivable cash receipts turnover ratio Apply internal controls to cash payments  Internal control Internal control is the organisational plan Internal controls thus include general Management is responsible for setting up and all the related measures designed to controls as well as accounting controls and maintaining the internal control system accomplish the following: Safeguard assets Encourage employees to follow organisational policy Promote operational efficiency Ensure accurate, reliable accounting records  The A business can achieve its internal control objectives by applying five components: components Control procedures of internal Risk assessment Information system control Monitoring of controls Environment Note: this can be remembered by using the acronym CRIME  Characteristics Employees should be competent, reliable and ethical of an effective Each employee is assigned certain responsibilities All duties should be clearly defined and assigned to internal control individuals who bear responsibility for carrying them out system No important duty is overlooked An organisation generally has a written set of rules that outline approved procedures, and any deviation from standard policy requires proper authorisation  Separation of duties—dividing the responsibilities for Characteristics transactions between two or more people or departments—limits the chances for fraud and promotes of an effective the accuracy of the accounting records internal This may divided into four parts: Separation of operations from accounting control system Separation of the custody of assets from accounting Separation of the authorisation of transactions from the custody of related assets Separation of duties within the accounting function  An audit (both internal and external) is an examination of the business’s financial statements and the accounting systems, controls and records that produced them Characteristics Business documents and records vary considerably, from of an effective source documents such as invoices and purchase orders to special journals and subsidiary ledgers. internal control Documents should be prenumbered to discourage theft system There is increasing reliance on electronic devices and documents Electronic security devices reduce theft Controls around e-commerce are discussed later  Other controls include: Characteristics Cash and important business documents kept in fireproof vaults and burglar alarms used to protect of an effective buildings and other property Point-of-sale terminals both serve as a cash register internal control and record the transactions Fidelity insurance on cashiers reimburses the business system for any losses due to theft Mandatory holidays and job rotation require employees to be trained for a variety of jobs which they are then moved between, both giving them variety in employment and keeping them honest Internal controls for e-commerce E-commerce creates its own unique types of risk Hackers may gain access to confidential information or introduce computer viruses, trojans or phishing expeditions Protective techniques include: Encryption—rearranging plain-text messages by a mathematical process Firewalls to limit access to a local network ‘Logical security’ measures to control access One-factor authentication: user-IDs and passwords Two-factor authentication: confirmation via a second device Other control measures to protect against fraud The limitations of internal control Collusion, where two or more employees work together to defraud the company The business must take additional steps to prevent this, which can be difficult and costly The stricter the internal control, the more expensive and time-consuming it becomes An internal control system that is too complex can negatively affect both efficiency and control Investments in internal control must be judged in light of the associated costs and benefits The bank account as a control device Cash is easy to conceal and relatively easy to steal, so most businesses keep their cash in a bank account, which has established practices for safeguarding the business’s money The most common bank account controls are: Signature card for comparison purposes Deposit slip as proof of the transaction Cheque, usually serially numbered and preprinted Bank statement to report transactions to the business Electronic funds transfer, also reported on the bank statement Bank reconciliation, to compare and explain differences between the business’s books and the bank’s records The bank reconciliation There are two records of a business’s cash: its Cash account in its own general ledger the bank statement, which tells the actual amount of cash the business has in the bank The balance in the business’s Cash account rarely equals the balance shown on the bank statement at any particular date, though both may be correct Differences arise because of a time lag in recording transactions, called timing differences The bank reconciliation To ensure accuracy of the financial records, the business’s accountant must explain all differences between the business’s cash records and the bank statement figures on a certain date The result of this process is a document called the bank reconciliation It is prepared by the business, not the bank The person who prepares the bank reconciliation should have no other cash duties— this shouldn’t be a person who has access to cash or who also records cash journal transactions A bank reconciliation is considered to be a control device Bank side of the reconciliation Items that appear on a bank reconciliation that cause differences between the bank balance and the book (Cash T-account) balance are: Items recorded by the business but not yet by the bank Deposits in transit (outstanding deposits)—deposits made by the business that haven’t yet cleared the bank Outstanding cheques—issued by the business but not yet paid by the bank Bank errors—posting errors by the bank Book side of the reconciliation The book side contains items not yet recorded by the business on its book but are recorded by the bank, or are errors made by the business Bank collections—monies directly collected by the bank on behalf of the business (direct deposits by customers) Electronic funds transfers (EFTs) Service charges, i.e. bank fees Interest revenue on cheque or savings accounts Dishonoured cheques Cheques collected, deposited and returned to payee by the bank for other reasons than being dishonoured Cost of specially printed cheques Book errors—recording errors made by the business Preparing the bank reconciliation Step 1:Start with two figures: the balance shown on the bank statement (balance per bank) and the balance in the business’s Cash account (balance per books) Step 2:Add to, or subtract from, the bank balance those items that appear on the books but not on the bank statement (bank side of the reconciliation) Add deposits in transit Subtract outstanding cheques Calculate the adjusted bank balance Preparing the bank reconciliation Step 3:After checking their correctness, journalise those items that appear on the bank statement but not on the business’s books (Cash T-account) (book side of the reconciliation) Debit bank collections, EFT cash receipts, and interest revenue Credit EFT cash payments, service charges, cost of specially printed cheques, and other bank charges Step 4: Compare the adjusted bank balance and the adjusted book balance— they should be equal Step 5: Notify the bank of any errors it has made The bank reconciliation - Exhibit 8-7 XERO: Bank feed and reconciliation example Bank feeds: https://www.youtube.com/watch?v=MfRs_gJ4e6s Bank reconciliation: https://www.youtube.com/watch?v=fjMD90xN_00 Journalising transactions from the reconciliation The bank reconciliation is an accountant’s tool that is separate from the journal entries and ledgers It signals the business to record the transactions listed on the book side of the reconciliation because the business hasn’t yet recorded these items The journal entries are dated with the date of the reconciliation to bring the Cash account to the correct balance on that date Internet banking Internet banking allows you to pay bills, set up automatic payments, and view your account electronically rather than waiting to get a bank statement The transaction history is like a bank statement but kept up to date daily with running balances Banks promote a paperless/green approach with electronic notification of bank statements and/or transactions and secure online delivery of the same They also offer integration of accounts with spreadsheet and popular financial accounting software Receivables: an introduction A receivable arises when a business (or person) sells goods or services to another party on account (on credit) The receivable is the seller’s claim against the buyer for the amount of the transaction Receivables also occur when a loan is made The creditor sells goods or a service and obtains a receivable (an asset) The debtor takes on an obligation/payable (a liability), and will pay cash later Receivables: an introduction The three main types of receivable are: Accounts receivable, sometimes called trade receivables or trade debtors, are amounts to be collected from customers from sales made on credit, usually collected within a short period of time (therefore are current assets) Bills (and notes) receivable usually have longer terms than accounts receivable They are current assets if due within 1 year or less, and non-current assets otherwise; they may be collected in installments A promissory note is a special type of bill receivable, and is a written promise to pay principal plus interest by a certain date Other receivables—any other type of cash receivable in the future (e.g. dividends or interest receivable) Receivables: an introduction Internal control over collection of receivables must be applied similarly to that described for cash, e.g. separation of duties Most large companies also have a credit department to evaluate whether customers meet credit approval standards A business does not want to lose sales to good customers who need time to pay, but at the same time does not want to sell to customers who represent a poor credit risk  Recording Sales on Credit To record revenue at the time of sale: The separate customer accounts receivable are called subsidiary accounts, whose balances sum to the balance in the control account Accounts receivable (i.e. $15,000)  Recording Sales on Credit To record collection of cash Recording Credit and Debit card sales Aug Cash (A+) 2,940 15 Card fee expense ($3,000 × 60 0.02) (E+) Sales revenue (R+) 3,000 Recorded credit card sales, net of fee (2%).  Recording Credit and Debit card sales Gross—total sale deposited, with processing fees deducted later, usually at the end of each month Cash Accounting for bad debts (uncollectable accounts) Some customers do not pay, and that creates an expense called a bad debt expense, doubtful debt expense or uncollectable account expense These expenses must be written off from the books because the business does not expect to receive the cash in the future There are two methods of accounting for uncollectable receivables: allowance method direct write-off method The allowance method The allowance method allows companies to recognise impairment of receivables after initial recognition The offset to the expense is a contra account called Allowance for doubtful debts (or Allowance for bad debts) The Allowance account shows the amount of the receivables that the business expects not to collect, and reduces Accounts receivable to its net realisable value Allowance for doubtful debts decreases Accounts receivable on the balance sheet; bad debts expense is included in operating expenses on the income statement The allowance method The more accurate the estimate of bad debts, the more reliable the information in the financial statements Businesses use their past experience regarding bad debts as well as considering observable data about economic conditions and other indicators that defaults are probable There are two basic ways to estimate bad debts: percentage of sales method ageing of accounts receivable method  Percentage of sales method for estimating bad debts The percentage of sales method calculates bad debts expense as a percentage of net credit sales This is also called the income statement approach because it focuses on the amount of expense to be reported on the income statement Bad debts expense is recorded as an adjusting entry at the end of the period (GST is shown here as an example)  Ageing of accounts receivable method for estimating bad debts The ageing of accounts receivable method is also called the balance sheet approach as it focuses on the actual age of the accounts receivable and determines a target allowance balance from that age Exhibit 9-2 Ageing the accounts receivable of Greg’s Tunes  Comparing the percentage of sales and ageing methods In practice, businesses could use the two methods together: percentage of sales in the interim as indications of impairment appear, and the ageing method at the end of the accounting period Exhibit 9-3 Comparing the percentage of sales and ageing methods for estimating bad debts  Writing off a bad debt—allowance method Under the allowance method, when a specific customer account is identified as uncollectible, it is written off to the Allowance account  A bad debtor pays their account—allowance method Sometimes a customer will pay the amount owed after their account is written off To account for this recovery, the business must reverse the effect of the earlier write-off to the Allowance account and record the cash collection Date Account title Dr Cr Sep 4 Accounts receivable—Andrews (A+) 80 Allowance for doubtful debts (CA+) 80 Cash (A+) 80 Accounts receivable—Andrews (A–) 80 Bills receivable A promissory note is ‘an unconditional promise in writing, signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money, to or to the order of a specified person, or to bearer’ Bills of exchange are commonly used where foreign trade is concerned, with businesses selling goods or services in exchange for bills receivable A bill of exchange is ‘an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person or bearer’ Both specify an obligation to pay on demand or in the future Bills receivable The drawer (maker) of a bill is the person or business that draws up (creates) the bill requiring payment to them of the amount specified; the drawer is the creditor and payee of a bill The acceptor of a bill is the person or business required to make the specified payment (i.e. the debtor) The principal amount (or principal) is the amount owing to the drawer (creditor) and due to be paid by the acceptor (debtor) Interest is the revenue due to the payee for lending out the principal, and the expense for the debtor for borrowing the principal Bills receivable The interest period (also called the period or term of the bill) is the period of time during which interest is to be calculated, extending from the original date of the bill to the maturity date The interest rate is the percentage rate that is multiplied by the principal amount to calculate the interest on the bill The maturity date (also called due date) is the date on which final payment of the bill is due The maturity value is the sum of the principal and interest due at the maturity rate A bill of exchange - Exhibit 9-7  Maturity date and calculating interest The maturity date can be: a specific date, e.g. 18 January 2022 stated in terms of number of months, e.g. a 12-month bill (which falls due on the same day of the month as the date of issue) stated in terms of number of days, e.g. a 120-day bill The formula for calculating interest is Amount Interest Principal Time of rate interest  To record the bill of exchange Recording bills receivable shown in Exhibit 9-7: Date Account title Dr Cr 2021 Oct 20 Bill receivable—Dorman Builders (A+) 15,000 Sales revenue (R+) 15,000 To record sale. 2022 Jan 18 Cash (A+) 15,370 Bill receivable—Dorman Builders (A–) 15,000 Interest revenue 370 ($15 000 × 0.10 × 90/365) (R+) To record collection at maturity. Accruing interest revenue on a bill receivable Discounting a bill receivable If the payee of a bill receivable needs the cash before the maturity date, the payee may sell the bill This is called discounting a bill receivable and is common with non-current bills receivable that often have real estate as security The price that a financial intermediary pays for a bill receivable depends mainly on the interest rate it seeks to earn on its investment—the intermediary pays cash now, at a discounted price, to receive a larger amount at a later date  Using accounting information for decision making In making decisions, owners and managers use some ratios based on the relative liquidity of assets A measure of a business’s ability to pay current liabilities is the acid-test (or quick) ratio This ratio tells whether the entity could pay all its current liabilities if they came due immediately The higher the acid-test ratio, the better the business is able to pay its current liabilities Using accounting information for decision making After a business makes a credit sale, the next critical event in the business cycle is collection of the receivable ys’ s s v b s, also called the collection period, indicates how many days it takes to collect the average level of receivables The number of days in average accounts receivable should be close to the number of days customers have to pay The shorter the collection period, the more quickly the organisation can use cash for operations  Using accounting information for decision making ▪ Days’ sales in receivables can be calculated in two steps:  Using accounting information for decision making The accounts receivable turnover ratio measures the number of times the business sells and collects the average receivables balance in a year. The higher the ratio, the faster the cash collections  Summary Internal control is the organisational plan and all the related measures designed to safeguard assets, encourage employees to follow organisational policy, promote operational efficiency, and ensure accurate, reliable accounting records The bank reconciliation acts as a control device A receivable arises when a business (or person) sells goods or services to a second business (or person) on credit The two main types of receivable are accounts receivable and bills receivable There are two methods of accounting for uncollectable receivables—the allowance method and the direct write-off method  Summary Bills of exchange are commonly used where foreign trade is concerned, with businesses selling goods or services in exchange for bills receivable Receivables provide information to assist in the financial analysis of a business In making decisions, owners and managers use some ratios based on the relative liquidity of assets Common ratios are acid-test (or quick) ratio, days’ sales in receivables (collection period), and accounts receivable turnover ratio  Before the tutorial on this topic Complete the following exercises from Chapters 8 and 9 of the textbook E8-2, E8-4, E8-6, E8-8 and P8-4 S9-3, S9-6, S9-12, E9-4, P9-5 and P9-9 These exercises should take in total about 3 hours. Next lecture Introduction to Accounting Information Systems