Accounting Cycle week 8

5 Oct No Comments

Cash and cash equivalents

The following items may or may not be classified as cash, or cash equivalents.

Required:

For each of the following items, determine whether each would be classified as cash, a cash equivalent, or neither.

Principles of effective cash management

For the following two situations, select the statement that would be most helpful in managing cash in each situation which is consistent with effective cash management techniques.

Situation 1: Too many of our customers’ accounts had to be written off recently.

Situation 2: Sales of our products generated extra cash that is not needed until later in the year.

Situation 1: Too many of our customers’ accounts had to be written off recently.

An unusual number of customer account write-offs is an indication that credit was extended to unworthy customers who would later default on their payments. To reduce the credit risk, a business usually extends credit to customers who can provide solid references from their banks and suppliers. After the references have been checked and the credit application approved, a customer may obtain limited credit at the beginning until they prove to be creditworthy.

If references do not check out or if a customer seems risky, he/she may be asked to pay cash up front, pay cash upon delivery of the merchandise (C.O.D.), or furnish a letter of credit through his/her bank, guaranteeing payment.

Situation 2: Sales of our products generated extra cash that is not needed until later in the year.

Placing the extra cash in short-term investments will generate income. Good planning is required in order to have cash on hand when cash is needed and to have it invested during periods when it is not needed.

Short-term investments include government securities, money-market accounts, and commercial papers. In short-term investments, the investor is interested in liquidity and return on investment.

Situation 1: Sale of property raised our bank account balance so much that we do not know what to do with the excess funds.

Situation 2: A few of our suppliers are unhappy because some checks we issued have been returned marked NSF. We feel that we have enough money in the bank account.

Situation 1: At Rex Co., accounts receivable are collected six times a year as compared to the industry average of ten times a year, resulting in a cash shortage. Management is not prepared to offer a sales discount or to factor its receivable.

Situation 2: The accounts receivable turnover ratio is 7.9 compared to the industry average of 9.5. We offer our credit customers sales terms net 45.

Situation 1: At Rex Co., accounts receivable are collected six times a year as compared to the industry average of ten times a year, resulting in a cash shortage. Management is not prepared to offer a sales discount or to factor its receivable.

Collecting receivables only six times a year means that we currently offer our customers 60 days (360 days / 6 = 60) to pay their bills. By negotiating and offering shorter credit terms, such as 45 or 30 days, collection of receivables will be faster. Furthermore, it will be in line with the industry average of ten times a year.

Shorter credit terms mean faster cash collection from customers. This method is normally adopted if past credit terms have been more generous than those of the competition. If a company offers shorter credit terms than the competion, it may lose some of its customers.

Situation 2: The accounts receivable turnover ratio is 7.9 compared to the industry average of 9.5. We offer our credit customers sales terms net 45.

Collecting receivables only eight times a year means that we currently offer our customers 45 days (360 days / 8 = 45) to pay their bills. By negotiating and offering shorter credit terms, such as 30 days, collection of receivables will be faster. Furthermore, it will be in line with the industry average of ten times a year or every 36 days.

Shorter credit terms mean faster cash collection from customers. This method is normally adopted if past credit terms have been more generous than those of the competition. If a company offers shorter credit terms than the competion, it may lose some of its customers.

Thus, the answer is:

Situation 1: Sales of our products generated extra cash that is not needed until later in the year.

Situation 2: Major repairs to the office building are needed, and cash inflow from sales revenue is at its lowest level for the business cycle.

Situation 1: Sales of our products generated extra cash that is not needed until later in the year.

Placing the extra cash in short-term investments will generate income. Good planning is required in order to have cash on hand when cash is needed and to have it invested during periods when it is not needed.

Short-term investments include government securities, money-market accounts, and commercial papers. In short-term investments, the investor is interested in liquidity and return on investment.

Situation 2: Major repairs to the office building are needed, and cash inflow from sales revenue is at its lowest level for the business cycle.

It is best to time major expenditures so they follow a major sale and cash receipt season. In this case we should try to postpone repairing the office building until later in the fall when cash receipts are higher.

If repairing the office building is necessary to get ready for the busy season, a business may have to take a short-term loan or use a line of credit to finance its expenditures.

Thus, the answer is:



Situation 1: Major repairs to the office building are needed, and cash inflow from sales revenue is at its lowest level for the business cycle.

Situation 2: Due to a recession, products are not selling as quickly as before, and the cash balance is too low to pay current liabilities. Inventory levels are adequate.

Situation 1: Major repairs to the office building are needed, and cash inflow from sales revenue is at its lowest level for the business cycle.

It is best to time major expenditures so they follow a major sale and cash receipt season. In this case we should try to postpone repairing the office building until later in the fall when cash receipts are higher.

If repairing the office building is necessary to get ready for the busy season, a business may have to take a short-term loan or use a line of credit to finance its expenditures.

Situation 2: Due to a recession, products are not selling as quickly as before, and the cash balance is too low to pay current liabilities. Inventory levels are adequate.

Obtaining longer credit terms is not difficult during a recession, because sales are usually slow and sellers are eager to please customers in order to keep them for repeat business. These conditions usually create what is called a “buyers’ market” in which various suppliers compete to offer better terms to potential customers.

Thus, the answer is:

Situation 1: The accounts receivable turnover ratio is 7.9 compared to the industry average of 9.5. We offer our credit customers sales terms net 45.

Situation 2: We are encountering a cash flow problem, and credit terms cannot be tightened any more. Management did not approve of selling receivables to a factor.

Situation 1: The accounts receivable turnover ratio is 7.9 compared to the industry average of 9.5. We offer our credit customers sales terms net 45.

Collecting receivables only eight times a year means that we currently offer our customers 45 days (360 days / 8 = 45) to pay their bills. By negotiating and offering shorter credit terms, such as 30 days, collection of receivables will be faster. Furthermore, it will be in line with the industry average of ten times a year or every 36 days.

Shorter credit terms mean faster cash collection from customers. This method is normally adopted if past credit terms have been more generous than those of the competition. If a company offers shorter credit terms than the competion, it may lose some of its customers.

Situation 2: We are encountering a cash flow problem, and credit terms cannot be tightened any more. Management did not approve of selling receivables to a factor.

A sales (cash) discount of 2/10, net 30 is very generous and is equal to 36% per year. Certainly, any customer would find this a great incentive and might even borrow funds, at lower interest rates, so as to take advantage of this discount. Even 1/10, net 30 translates into 18% per year, which is still generous.

A sales discount is a cash discount offered by the seller to the buyers as an incentive for early payment of their accounts receivable. From the buyers’ perspective, this discount is called a purchase discount.

Thus, the answer is:

Situation 1: Sales are increasing, but cash inflow is slow, and we need to buy inventory.

Situation 2: A new customer doubled our monthly sales three months ago, but we cannot get him/her to pay.

Situation 1: Sales are increasing, but cash inflow is slow, and we need to buy inventory.

A sales discount is a cash discount offered by the seller to the buyers as an incentive for early payment of their accounts receivable. Offering a sales discount is very likely to increase the speed of collections, thus increasing the cash inflow.

A sales (cash) discount of 2/10, net 30 is very generous and is equal to 36% per year. Certainly, any customer would find this a great incentive and might even borrow funds, at lower interest rates, so as to take advantage of this discount. Even 1/10, net 30 translates into 18% per year, which is still generous. From the buyers’ perspective, this discount is called a purchase discount.

Situation 2: A new customer doubled our monthly sales three months ago, but we cannot get him/her to pay.

To reduce the credit risk, a business usually extends credit to customers who can provide solid references from their banks and suppliers. After the references have been checked and the credit application approved, a customer may obtain limited credit at the beginning until they prove to be creditworthy.

If references do not check out or if a customer seems risky, he/she may be asked to pay cash up front, pay cash upon delivery of the merchandise (C.O.D.), or furnish a letter of credit through his/her bank, guaranteeing payment.

Thus, the answer is:

Situation 1: Expensive equipment needs to be purchased, but most cash sales come in the fall.

Situation 2: At Rex Co., accounts receivable are collected six times a year as compared to the industry average of ten times a year, resulting in a cash shortage. Management is not prepared to offer a sales discount or to factor its receivable.

Situation 1: Too many of our customers’ accounts had to be written off recently.

Situation 2: Sale of property raised our bank account balance so much that we do not know what to do with the excess funds.

Situation 1: Too much money is tied up in receivables, and we need cash to buy new items of inventory. Our credit terms are already tight, and management is not willing to offer a discount.

Situation 2: Major repairs to the office building are needed, and cash inflow from sales revenue is at its lowest level for the business cycle.

Bank reconciliation items: Problem type 1

How would each of the following items be used in a bank reconciliation for Sanders Company?

A bank reconciliation is prepared by an entity to account for transactions that were not accounted for on either the bank statement or the entity’s books at the time of the reconciliation. The purpose of the bank reconciliation is to compare what the bank has recorded with what the entity has recorded to insure that the records match.

There are two basic rules to be followed:

Ask the question, “Which party, the bank or the entity, did not know about the item and therefore has not recorded it?” The item must now be included on the bank reconciliation on the side (bank or entity) that did not record it.

In the case of errors, errors are corrected on the bank reconciliation on the side (bank or entity) that made the error.

In this problem, we have the following:

(a) This is an item that does not appear on the bank reconciliation. Last month, this was an outstanding check. This month, however, the item has cleared the bank, and it no longer belongs on the bank reconciliation.
Not Used

(b) Sanders Company wrote a check for $490 but incorrectly recorded it for $940. This is a transposition error of $450 ($940 – $490). Since this is Sanders’s error, this item should go under the balance per books on the bank reconciliation. We subtracted $450 more than we should have. To correct this error, $450 should be added as an increase to balance per books and would require a journal entry by Sanders Company.

Thus, the answer is:

Bank reconciliation items: Problem type 2

For each of the four items that appear on the bank reconciliation of Gator Company, determine whether a journal entry is required by Gator to update its accounting records.

Bank reconciliations: Problem type 1

On December 31, Wood Company’s Cash account had a balance of $31,480, and the balance per bank statement was $34,020. Analysis of the bank statement and comparison of the statement and records indicated the following:

In reviewing the records, Wood Company also discovered the following error: A Koala Company check of $1,410 was charged to Wood Company’s account.

Required:

Compute the adjusted balance of Cash per books.

It is necessary to compute the adjusted balance of Cash per books as part of preparing a bank reconciliation statement. To compute the adjusted balance of Cash, we start with the final Cash balance as it appears in the general ledger at the end of an accounting period. To that Cash account balance we add all the items that were added by the bank on the bank statement that have not yet been recorded in the Cash account. Also we subtract from that Cash account balance all the items that the bank subtracted from the account balance on the bank statement that have not yet been recorded in the Cash account.

A bank reconciliation is complete once all the reconciling items have been accounted for and the adjusted balance per books (Cash account) is equal to the adjusted balance per bank statement.

Bank service charge, $10.

This item appears on the bank statement as a deduction from the account balance. Therefore, it is ignored in the computation of the balance per bank statement. This information is used by the entity to record the item in its books as a deduction from the Cash balance. Therefore, deduct $10 from the Cash balance per books.

Customer’s returned check, NSF, $1,250.

This is a check that was initially received from a customer and deposited in the bank account. Now the bank returns the check to the depositor marked NSF, indicating that the check failed to clear due to not sufficient funds in the customer’s (issuer’s) account. Since the item already appears on the bank statement, it is ignored in the computation of the balance per bank statement. Since the item appears as a deduction on the bank statement, and since it has not been recorded as NSF in the books of the depositor, it must also be deducted from the Cash balance. Therefore, deduct $1,250 from the Cash balance per books.

Bank collection of a note on our behalf, $6,250.

Bank collections are funds received by a bank on behalf of its customers. These items appear first on the bank statement as an addition to the account balance. Since the item already appears on the bank statement, it is ignored in the computation of the balance per bank statement. Since collections have not yet been recorded by the entity, now they should be recorded as an addition to the Cash balance. Therefore, add $6,250 to the Cash balance per books.

Accrued interest on note, $140.

This item represents interest (revenue) on a note receivable that was collected by the bank together with, and at the same time as the note. This item appears first on the bank statement as an addition to the account balance. Since the item already appears on the bank statement, it is ignored in the computation of the balance per bank statement. Since interest revenue has not yet been recorded by the entity, now it should be recorded as an addition to the Cash balance. Therefore, add $140 to the Cash balance per books.

Note: The bank incorrectly reduced our account by a Koala Company check. This error is a bank error and will appear on the bank side of the reconciliation. Since the Koala Company check erroneously reduced our balance, to correct the error the amount should be added back to the bank side of the reconciliation.

Thus, the adjusted (reconciled) balance of Cash per books is $36,610.

On December 31, Harris Company’s Cash account had a balance of $31,990, and the balance per bank statement was $33,170. Analysis of the bank statement and comparison of the statement and records indicated the following:

It is necessary to compute the adjusted balance of Cash per books as part of preparing a bank reconciliation statement. To compute the adjusted balance of Cash, we start with the final Cash balance as it appears in the general ledger at the end of an accounting period. To that Cash account balance we add all the items that were added by the bank on the bank statement that have not yet been recorded in the Cash account. Also we subtract from that Cash account balance all the items that the bank subtracted from the account balance on the bank statement that have not yet been recorded in the Cash account.

A bank reconciliation is complete once all the reconciling items have been accounted for and the adjusted balance per books (Cash account) is equal to the adjusted balance per bank statement.

Bank service charge, $15.

This item appears on the bank statement as a deduction from the account balance. Therefore, it is ignored in the computation of the balance per bank statement. This information is used by the entity to record the item in its books as a deduction from the Cash balance. Therefore, deduct $15 from the Cash balance per books.

Customer’s returned check, NSF, $870.

This is a check that was initially received from a customer and deposited in the bank account. Now the bank returns the check to the depositor marked NSF, indicating that the check failed to clear due to not sufficient funds in the customer’s (issuer’s) account. Since the item already appears on the bank statement, it is ignored in the computation of the balance per bank statement. Since the item appears as a deduction on the bank statement, and since it has not been recorded as NSF in the books of the depositor, it must also be deducted from the Cash balance. Therefore, deduct $870 from the Cash balance per books.

Bank collection of a note on our behalf, $7,580.

Bank collections are funds received by a bank on behalf of its customers. These items appear first on the bank statement as an addition to the account balance. Since the item already appears on the bank statement, it is ignored in the computation of the balance per bank statement. Since collections have not yet been recorded by the entity, now they should be recorded as an addition to the Cash balance. Therefore, add $7,580 to the Cash balance per books.

Accrued interest on note, $160.

This item represents interest (revenue) on a note receivable that was collected by the bank together with, and at the same time as the note. This item appears first on the bank statement as an addition to the account balance. Since the item already appears on the bank statement, it is ignored in the computation of the balance per bank statement. Since interest revenue has not yet been recorded by the entity, now it should be recorded as an addition to the Cash balance. Therefore, add $160 to the Cash balance per books.

Note: We wrote a check for $840 but incorrectly recorded it for $480. This is an example of a transposition error of $360 ($840 – $480). Since this is our error, this item will go under the books side of the reconciliation. We subtracted $360 less than we should have. To correct this error, $360 should be subtracted from the balance per books on the bank reconciliation.

Thus, the adjusted (reconciled) balance of Cash per books is $38,485.

On December 31, Hernandez Company’s Cash account had a balance of $34,740, and the balance per bank statement was $35,000. Analysis of the bank statement and comparison of the statement and records indicated the following:


In reviewing the records, Hernandez Company also discovered the following error: A Kansas Company deposit of $1,660 was incorrectly deposited into Hernandez Company’s account.

Note: The bank incorrectly increased our account by a Kansas Company deposit. This error is a bank error and will appear on the bank side of the reconciliation. Since the Kansas Company deposit erroneously increased our balance, to correct the error the amount should be deducted from the balance per bank statement on the bank reconciliation. Thus, the adjusted (reconciled) balance of Cash per books is $40,295.

Bank reconciliations: Problem type 2

On December 31, Garcia Company’s bank statement had a balance of $32,000. Analysis of the bank statement and comparison of the statement and records indicated the following:

In reviewing the records, Garcia Company also discovered the following error: A Kansas Company deposit of $1,420 was incorrectly deposited into Garcia Company’s account.

Required:

Compute the adjusted balance of Cash per bank statement.

It is necessary to compute the adjusted balance per bank statement as part of preparing a bank reconciliation statement. To compute the adjusted balance per bank statement, we start with the ending balance of Cash as it appears on the bank statement. To the balance per bank statement we add all the items that were added by the entity to the Cash account in its books that have not yet been recorded on the bank statement. Also we subtract from the balance per bank statement all the items that the entity subtracted from the Cash account in its books that have not yet been recorded on the bank statement.

A bank reconciliation is complete once all the reconciling items have been accounted for and the adjusted balance per books (Cash account) is equal to the adjusted balance per bank statement.

Deposits in transit for December, $8,085.

These deposits have been made by the entity during December and recorded in its books. They are already part of the balance per books. Therefore, they are ignored in the computation of the adjusted balance of Cash per books. However, they had not been received and processed by the bank in time so as to appear on the bank statement. Therefore, deposits in transit, $8,085, are added to the balance per bank statement, to arrive at the adjusted balance per bank statement.

Outstanding checks for December, $4,790.

These checks have been issued by the entity during December and recorded in its books. They are already part of the balance per books. Therefore, they are ignored in the computation of the adjusted balance of Cash per books. However, they had not been received and processed by the bank in time to appear on the bank statement. Therefore, outstanding checks for December, $4,790, are subtracted from the balance per bank statement, to arrive at the adjusted balance per bank statement.

Note: The bank incorrectly increased our account by a Kansas Company deposit. This error is a bank error and will appear on the bank side of the reconciliation. Since the Kansas Company deposit erroneously increased our balance, to correct the error the amount should be deducted on the bank side of the reconciliation.

The adjusted (reconciled) balance of Cash per bank statement is $33,875.

Bank reconciliations: Deposits in transit and outstanding checks

Russell Company’s April 30 bank reconciliation shows deposits in transit of $1,480. The Cash account in the general ledger shows April cash receipts of $38,900. The April bank statement shows deposits of $41,900.

Required:

What amount of deposits in transit appeared in the March 31 bank reconciliation?

Note: Assume that all deposits in transit from the previous month have cleared the bank by the end of the current month.

The April 30 bank reconciliation shows deposits in transit of $1,480. Since Russell Company had cash receipts of $38,900, only $37,420 ($38,900 – $1,480) of April cash receipts was received by the bank. The bank reconciliation shows deposits received by the bank of $41,900. Therefore, the difference, $4,480 ($41,900 – $37,420), was the amount in transit on March 31.

The amount of deposits in transit was $4,480.

King Company’s August 31 bank reconciliation shows deposits in transit of $610. The Cash account in the general ledger shows September cash receipts of $40,500. The September bank statement shows deposits of $30,600.

Required:

What amount of deposits in transit would appear in the September 30 bank reconciliation?

Note: Assume that all deposits in transit from the previous month have cleared the bank by the end of the current month.

On August 31, there were $610 of deposits in transit. The September bank statement indicates deposits of $30,600, which includes the deposits in transit from August 31. Therefore, of the total deposits that the bank shows that it received in September ($30,600), only $29,990 ($30,600 – $610) was deposited by King in September. King Company’s records indicate that they received cash of $40,500 during September. The difference, $10,510 ($40,500 – $29,990), is the amount of deposits in transit at the end of September.

The amount of deposits in transit is $10,510.

Phillips Company’s May 31 bank reconciliation shows outstanding checks of $1,990. The Cash account in the general ledger shows total checks issued of $30,100 during June. The June bank statement shows that checks totalling $23,700 have cleared the bank.

Required:

What is the total amount of outstanding checks that would appear in the June 30 bank reconciliation?

Note: Assume that all outstanding checks from the previous month have cleared the bank by the end of the current month.

On May 31, there were $1,990 of outstanding checks. The June bank statement indicates cleared checks of $23,700, which includes the outstanding checks on May 31. Therefore, of the total checks that the bank cleared during June ($23,700), only $21,710 ($23,700 – $1,990) was paid by the bank for checks issued by Phillips in June. Phillips Company’s records indicate that they issued checks for $30,100 during June. The difference, $8,390 ($30,100 – $21,710), is the amount of outstanding checks at the end of June.

The amount of outstanding checks is $8,390.

Moore Company’s November 30 bank reconciliation shows outstanding checks of $2,650. The Cash account in the general ledger shows total cash outflows (credits) of $23,100 during November. The November bank statement shows that checks totalling $34,300 have cleared the bank.

Required:

What is the total amount of outstanding checks that appeared in the October 31 bank reconciliation?

Note: Assume that all outstanding checks from the previous month have cleared the bank by the end of the current month.

The November 30 bank reconciliation shows outstanding checks of $2,650.

Since Moore Company had cash payments of $23,100, only $20,450 ($23,100 – $2,650) of November cash payments was recorded by the bank.

Also, the bank reconciliation shows that checks cleared by the bank total $34,300.

Therefore, the difference, $13,850 ($34,300 – $20,450), was the amount of outstanding checks on October 31.

The amount of outstanding checks was $13,850.

Journal entries for bank reconciliations

On September 30, Watson Company’s Cash account had a balance of $31,300. On that date, the bank statement had a balance of $26,900. Analysis of the bank statement and comparison of the statement with the records indicated the following:

In reviewing the records, Watson Company also discovered the following error: A Henderson Company check of $1,480 was deducted from Watson Company’s account.

Required:

Prepare the journal entries necessary to update the Cash account so that its balance is equal to the adjusted balance per bank reconciliation. Make sure to enter the day for each separate transaction.

Note: It will be helpful if you prepare a bank reconciliation before you prepare the journal entries.

Cash is received for the note collected plus interest income.

Debit Cash:
Cash, an asset account, is debited (increased) for the total, $4,720.

Credit Notes Receivable:
Notes Receivable, an asset account, is credited (decreased) for the principal of the note, $4,580.

Credit Interest Revenue:
Interest Revenue, a revenue account, is credited (increased) for the interest earned, $140.

 Debit Miscellaneous Expense:
Miscellaneous Expense, an expense account, is debited (increased) for the amount of the service charge, $23

 Credit Cash:
Cash, an asset account, is credited (decreased) by the amount of the service charge, $23.

NSF stands for Non-Sufficient Funds. We deposited a customer’s check, but that customer did not have enough funds to cover the payment. The bank deducted $820 from our account, which will try to collect from our customer.

 Debit Accounts Receivable:
Accounts receivable, an asset account, is debited (increased) for $820.

 Credit Cash:
Cash, an asset account, is credited (decreased) for $820.

To assist you in understanding the solution, the bank reconciliation is presented below:

Note: The bank incorrectly deducted the Henderson Company’s check from the Watson Company’s account. This error is a bank error and will appear on the bank side of the reconcilliation. Since the Henderson Company check erroneously reduced our balance, to account for the error, the amount should be added back to the bank side of the reconciliation. Correction of the error will be done by the bank. No journal entry is required.

Thus, the answer is:

On October 31, Washington Company’s Cash account had a balance of $32,330. On that date, the bank statement had a balance of $31,670. Analysis of the bank statement and comparison of the statement with the records indicated the following:

In reviewing the records, Washington Company also discovered the following error: A Ward Company deposit of $1,470 was incorrectly credited to Washington Company’s account.

On October 31, Cox Company’s Cash account had a balance of $33,020. On that date, the bank statement had a balance of $33,760. Analysis of the bank statement and comparison of the statement with the records indicated the following:

In reviewing the records, Cox Company also discovered the following error: A check for $390 in legal expenses was incorrectly recorded on the books as $930.




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