CHAPTER FIVE

CASH AND RECEIVABLES

5.1 Introduction
Cash is a medium of exchange that a bank will accept for deposit and immediate credit to the
depositors account. To achieve efficient use of all resources, management of business
enterprises frequently turns unproductive cash balances in to productive resources through the
acquisition of short-term investments.
Cash refers to coin, currency and other items that are;
- A standard medium of exchange or acceptable by knowledgeable parties in
exchange for goods or services
- The basis for measuring and accounting all other items
- Acceptable for deposit at face value by banks
Criteria: - An item to be reported as cash it must be
- Serve as a medium of exchange
- Readily available for the payment of current obligations
- It must be free from any contractual restriction that limits its use in satisfying
debts.
Based on the criteria listed above we can classify negotiable instruments and other highly
liquid items as cash and non-cash (cash equivalents).
Cash equivalents are short term, highly liquid investments that are both
i. Readily convertible to known amounts of cash and
ii. So near their maturity that they present insignificant risk of changes in interest
rates.
If the item cannot be converted to coin or currency on short notice, it is separately classified
as an investment, as a receivable, or as prepaid expenses. Cash that is not available for
payment of currently maturing liabilities is segregated and classified in the long term assets
section.

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 The following table summarizes the classification of cash related terms.
Item Classification Comment
cash Cash If unrestricted, report as cash. If restricted,
identify as current and noncurrent assets
Petty cash and change Cash Report as cash
funds
short term paper Cash equivalents Investments with maturity of less than 3
months
Short term paper Temporary investments Investments with maturity of 3 to 12
months
post dated checks and Receivables Assumed to be collectible
IOUs
Travel advance Receivables Assume to be collected from employees or
deducted from their salaries
Postage on hand (as stamps Prepaid Expenses May also be classified as office supplies
or in postage meters) inventory
Bank Overdrafts Current liability if right of offset exists, reduce cash.
Compensating balances
1. Legally restricted Cash separately classified Classify as current or non current in the
as a deposit maintained as balance sheet
compensating balance
2. Arrangement without Cash with note disclosure Disclose separately in notes details of the
legal restriction arrangement.

Based on the above criteria and table 1 items termed as cash like
 Coin and currency
 Negotiable instruments such as money orders, certified checks, personal checks, bank
drafts, saving accounts, (if prior notice is rarely demanded by banks) are classified as
cash because these items are readily available for the payment of current obligations
and free from any contractual restrictions.
In addition petty cash funds, change funds and other funds, even though these funds are
intended to be used for specific purposes they are used to meet current operating expenses
and to liquidate current liabilities so that they are included in current assets as cash accounts.
However cash balances deposited and maintained in checking or saving accounts as a
minimum requirements or compensating balances for borrowing are reported as follows.
Legally restricted deposits held as compensating balances against:

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 - Short term borrowing arrangements to be stated separately among the cash and cash
equivalent items in current assets
- Long term borrowing arrangements should be classified as noncurrent assets in the
investment or other Assets sections. As "cash on Deposit maintained as compensating
balance."
- In cases where compensating balance arrangements exist without legal restrictions, the
arrangements and the amounts involved should be described in the notes.
Money market funds, money market savings certificates, certificates of deposit, short term
papers that give an opportunity to earn high rates of interest are more appropriately classified
as temporary investments (cash equivalents) than as cash. The reason is that these securities
usually contain restrictions or penalties on their conversion to cash.
5.2 Cash Management and Control
5.2.1 Cash management
In any business enterprise management of cash is very important because cash is a means of
acquiring goods and services and cash can be easily misappropriated or lost. The management
of cash is centered on fore casting and internal controls.
The main objectives and responsibilities of management with respect to cash are
 To maintain liquidity (solvency) that is; to assure that there is sufficient cash to settle
maturing obligations, pay for operating expenses and also to finance unexpected
circumstances
 To invest any idle cash so as to maximize returns
 To prevent loss of cash due to theft, misuse or wastage
5.2.2 Control of cash
In organizations internal control methods, procedures, rules and policies are adopted;
The main purpose of having internal control systems in organizations is
- To assure that assets that belong to business enterprise are received when
tendered
- Protected while in the custody of the enterprise and
- Used only for authorized business purposes
-
Cash controlling consists of administrative control and accounting control
Administrative controls

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 - Promote operational efficiency ( to ensure no authorized transactions are
entered into by officers or employees)
- Encourage adherence to prescribed managerial policies and achieving the
objectives of the organization
Accounting Controls
- Ensure the protection of assets for it is susceptible to improper diversion and
use
- Ensure the accuracy and reliability of accounting data
- To have access to assets only in accordance with management's authorization
- To maintain accountability for assets
5.2.2.1 Internal control procedures
A system of internal control is not designed primarily to detect errors but rather to reduce the
opportunity of errors or dishonesty to occur. Effective system of internal control procedures
should consider the following points:
i. Segregation of duties; like separating one that works on custody with record keeper,
purchaser or receiver of purchased item. Here the separation of duties enables to
protect assets against either fraud or error. In addition the work of one helps to cross
check the of the other
ii. Assignment of Responsibilities and Authorities; giving a specific authority to a
specific body helps a company to create responsibility and accountability in the
actions of each party, department or division. For example, to set an internal control
procedure for cash payments on enterprise could set a purchase procedure which gives
responsibility to order and acquire goods to purchase department maintain a record
and make payments for invoices to accounting and finance department and receive the
purchased stocks to receiving department.
iii. Using mechanical devices and pre-numbered documents; using cash registers,
check protector holes and pre-numbered business forms are very helpful to ensure the
accuracy and reliability of accounting data.
iv. Maintaining physical safeguarding tools; for example safe boxes, drawers with
lockers, having daily deposits etc.
v. Implementing periodical performance evaluation methods; evaluating helps to
take periodical corrections and to take sure that regulations are properly
implemented.

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vi. Hiring competent employee and having computer help, creates to have efficient
and accurate record keeping and report preparation function
vii. Planning (budgeting):- forecasting cash necessary for future operations such as
through preparing periodic cash budgets
5.2.2.2 Control over cash receipts
Control over cash is required to safeguard all cash inflows or assure that all cash receivables
by the enterprise is collected and recorded without loss.
It includes
 Immediate counting
 Daily recording
 Intact deposit
5.2.2.3 Control over cash payments
The main objective of control over cash payments is to ensure no authorized payments are
made. It includes;
 Verifying and approving payments for example by using voucher system.
 Making payments by checks
 Periodic preparation of Bank reconciliation
1. Elements of internal control over cash payments.
Cash is safeguarded by keeping it in a safe box, depositing it in banks and through use of
special (imp rest) cash funds.
i. Petty cash fund
A petty cash fund refers to a fund of fixed amount used for small expenditures that are most
conveniently paid in cash such as payments for taxi fare, postage stamps, minor amount of
supplies etc.
 Establishment
- Estimate the required amount of payment to meet minor expenditures for specified
period.
Journal Entry
Petty Cash fund xx
Cash xx
 Operation
As each cash payment is made from the petty cash fund, prepare a voucher or other
receipts

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 * No Journal entry
 Replenishment: petty cash fund is replenished
- When it reaches a minimum cash balance and
- At the end of the accounting period to recognize the periodic expenses paid from the
fund and to report the year end cash balance correctly.
- The vouchers or receipts will be reviewed and a check will be issued on the total
amount of the vouchers to restore the petty cash fund to its original amount.
Journal Entries at the time of replenishment will be
Various expenses xx
Cash xx
Illustration:
On January 1, 2006 ABC Company established a petty cash fund to make payments for minor
expenditures, for $ 500. During January the petty cash vouchers indicate payments are made
for the following transactions
Postage Expenses 189.60
Office Supplies 112.75
Minor repair Expenses 60.05
Miscellaneous expense 40.00
On January 28, the custodian requested replenishment for items paid to date and the cash
balance in the petty cash box is $ 95.20
Now let us see the record that ABC Company will have at the establishment of petty cash
fund and at the replenishment of the fund respectively.
Petty cash funds 500
Cash 500
Replenishment Entry
Postage Expenses 189.60
Office Supplies 112.75
Minor repair Expenses 60.05
Miscellaneous expense 40.00
Cash short and over 2.40
Cash ............................................... 404.80
The cash shortage and overage ledger account is classified as revenue when it has credit
balance and as expense when it has a debit balance.
ii. Cash Change Fund
A change fund is used to facilitate the collection of cash from customers

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  Establishment
- Estimate the required types and amounts denominations.
Journal entry
Cash change fund xx
Cash xx
 Operation
Make the necessary changes and deduct the amount of the change fund from the total cash
money on hand at the close of each business day to determine the daily collections.
* No Journal entry will be required.
iii. Bank checking account (Reconciliation of bank balances)
Enterprises usually open checking account in a bank to have a daily deposits of all cash
collections and to make payments from the bank by issuing checks. Periodically banks
prepare bank statement, which is a summary of cash deposit and out lays made from each
checking account of the depositor. Similarly the depositor will have a ledger account to record
daily cash transactions in the bank account. Usually the cash balance in dictated in a bank
statement seldom agrees with cash balance indicated by the depositors ledger account for the
specific period.
Bank reconciliation: - is a schedule that analyzes and explains the difference between the
ending balance of cash in a bank and bank statement.
The possible reasons for the difference between two balances could be
 Delay in recording transactions
For example: Deposit in transit (deposits made after the bank closes it records for the
statement period), outstanding checks (checks issued but not presented for payment in the
bank), bank service charges, collections made bank.
 Errors or omissions in recording transactions
Note that, adjustment entries are required for transactions and events that are not included in
the depositor record and for the errors, which are made in recording by the depositor.
However for transactions that are not recorded by bank and for the differences that are self-
correcting such as, deposit in transit, outstanding checks, adjustment entries, will not be
required. But for the errors made by the bank it should be called for correction by writing a
memorandum to the bank.
The two commonly used forms of bank reconciliation are:

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 1. Reconcile both bank balance and depositors balance to correct cash balance (Direct
method).
2. Reconcile the bank balance to the balance in the depositor's record (Indirect method)
1. Reconcile both bank balance and depositors balance to correct cash balance.
Illustration:
On August 31, 2006 the cash ledger account in Awash international company shows a debit
balance of Birr 82, 461 while the bank statement provided by Abyssinia bank indicates a
balance of birr 110,632. A receipt of August 31, for 12,924 birr was not included in August
bank statement. In addition the checks, which were issued but not paid by, bank during this
month totals birr 11,458. Credit memorandums send by the bank indicated that notes
receivable left with the bank for birr 10,200 had been collected and credited for 10,240 birr
including interest revenue of birr 40. In addition the maturing value of Treasury bill birr
20,000 collected during this month. The bank acquired for Awash Company at a discount for
birr 18,800 and had been recorded at cost in the short term investment ledger account by
Awash Company. The bank statement included in debit memorandum includes birr 28 as a
service charge for the month of August. A check for 521 birr drown by ABC Company
(Creditor) returned and marked as NSF. Check number 1334 issued for 328 birr had been
recorded by bank as 382 birr.
Required:
i) Prepare bank recondition schedule for Awash Company for the month of
August.
ii) Make the necessary journal entries.
1. Reconciling the bank balance and depositor’s balance to correct cash balances (direct
Method).
Under this method reconciliation will be made to bring both unadjusted balance in a bank and
a depositor’s record to the adjusted or correct balances.

Awash International Company

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 Bank Reconciliation
August 31, 2006
Balance in depositor’s record Br 82,461
Add: Note and interest of Br.40 collected by bank 10,240
: Proceeds from Treasury bill that had been
Acquired for br.18, 800 and interest revenue.br 1,200 20,000 30, 240
Subtotal 112,701
Less: NSF checks drown by ABC company 521
: Bank service charges for August 28 549
Correct cash balance 112, 152
Balance in bank statement Br 110,632
Add: Deposit in transit 12,924
Error in recording check number 1334 54 12,978
Subtotal 123,610
Less: Outstanding checks 11,458
Correct cash balance 112,152
Preparing the above bank reconciliation will have the following three functions.
1. It helps to determine the correct cash balance to be reported in the balance sheet.
2. To disclose errors made in recording cash transactions, either by the bank or by the
depositor, and
3. To provide information necessary to bring the accounting records up to date.
After bank reconciliation statement is made, all items appearing in the reconciliation as
additions to or deductions from the “balance in the depositor’s record" must be included in the
journal entry. The journal entry on August 31, 2006 to adjust the accounting records of Awash
Company is shown below:
Cash 29,691
Account Receivable 521
Miscellaneous Expenses 28
Interest revenue ( Br 40 + 1,200) 1,240
Notes Receivable 10,200
Short term investments (Treasury bill) 18,800
The cash at bank account in the depositor's record before the above adjustment has a debit
balance for 82,461 Birr.
Cash
82,461

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 Adjustment 29,691
---------------
112, 152
And after the above journal entry is posted it will show the correct balance of 112,152 Birr.
2. Reconcile bank balance to the balance in the depositor’s record (indirect method)
Steps to use this method;
1st Reconcile the bank balance to the unadjusted cash account balance in the general ledger.
- Include all items that are not included in the bank statement
- Add the items that were deducted in the bank statement but not in the depositor’s
cash account record.
- Deduct the items that were added in the bank statement but not in the depositor’s
cash account record.
2nd Enter the required adjustments in the bank reconciliation to the cash account in the
depositor’s record.
Awash International Company
Bank reconciliation
August 31, 2006
Balance in Bank statement Br 110,632
Add: Deposit in transit 12,924
: Error in recording check no. 1334 54
: NSF check drown by ABC company 521
: Bank service charges for August 28 13,527
Subtotal 124,159
Less: outstanding checks 11,458
Note and interest of Br 40 collected 10,240
by bank
: Proceeds from treasury bill that 20,000
had been acquired for br, 18,800
and interest revenue br 1,200 ________ 41,698
Balance in depositor’s records; unadjusted 82,461
Add: Adjustment to cash ledger account (See the above journal entry) 29,691
Correct cash balance (adjusted) 112,152

5.5. ACCOUNTING FOR RECEIVABLES

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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 sub classify these trade receivables, usually the most significant item it possesses, into
accounts receivable and notes receivable.
The basic issues in accounting for accounts and notes receivable are the same: recognition,
valuation, and disposition.
Recognition of Accounts Receivable
Accounts receivable are recognized only when the criteria for recognition are fulfilled. They
are valued at the original exchange price between the firm and the outside party, less
adjustments for cash discounts, sales returns and allowances, trade discounts and uncollectible
accounts yielding an approximation to net realizable value, the amount of cash expected to be
collected.
Trade Discounts
Example: Assume an item priced Br. 50 is offered at a trade discount of 40 percent for order
over 1000 units. The unit price for an order of 1,100 units is therefore Br. 30 (Br. 50 x 0.6).
The percentage discount can be changed for different order quantities without changing the
basic Br. 50 price.
Gross and Net Methods
When cash discounts are offered, the receivable and sell is recorded either at the gross or net
amount (gross invoice less available cash discount). The key distinction between the two is
the treatment of sales discounts. The gross method record sells discounts only if the customer
pays within the discount period. The net amount records sales discounts only if the customer
fails to pay within the discount period.
To illustrate the two methods, assume that Cock Company sells merchandise to Ethio
Company at a gross sales price of Br. 1000. Credit terms are 2/10, n/30. Cock company’s
entries for selected events follow.
Entry to record credit sale:
Gross method Net method
Accounts receivable 1000 Accounts receivable 980
Sales 1000 Sales 980

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Cock Company’s offer of a cash discount supports the net valuation of sales and accounts
receivable. Cock Company is satisfied with Br. 980 if payment is made within 10 days of sale.
Therefore, the additional Br.20 is a finance charge for delaying payment.
Entry to record collection within the 10-day discount period:
Gross method Net method
Cash 9------------------------------80 Cash ---------------980
Sales discount --------------------20 Accounts receivable ----980
Accounts receivable -----------1000

Sales discount is a contra account to sales, reducing net sales by the amount of cash discount
taken. The gross method specifically identifies discounts taken by customers.
Entry to record collection after the 10-day discount period:
Gross method Net method
Cash -----------------------------1000 Cash --------------1000
Accounts receivable --------------------1000 Accounts receivable --------980
Sales discount forfeited ---- 20
Measurement of uncollectible accounts receivable
When credit is extended, some amount of uncollectible receivables is generally inevitable.
Firms attempt to develop a credit policy neither too conservative (leading to excessive lost
sales) nor too liberal (leading to excessive uncollectibles accounts). Past records of payment
and the financial condition and income of customers are key inputs to the credit-granting
decision.
Two general approaches to recognizing the cost of uncollectibles receivables are found in
practice.
Allowance method: If uncollectibles accounts receivable are both probable and estimatable,
an estimate of uncollectibles receivables is recognized and net accounts receivable is reduced.
Most large firms use this method.
Direct-write-off method: If uncollectible accounts are not probable or estimatable, no
adjustment to income or receivables is made until specific accounts are considered
uncollectible.

Use of Accounts Receivable as a Source Of Cash

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Business enterprises generally raise the cash needed for current operation through the
collection of accounts receivable. It is possible to accelerate this process by Selling
receivables (Factoring):
 Assigning receivables
 Pledging receivables as collateral for loans.
Factoring Accounts Receivable
Factoring refers to selling accounts receivable to another party. The enterprise selling the
accounts receivable is called the transferor and the company buying the receivables is called
transferee (factor).
Factoring transfers ownership of the receivables to the factor. Factoring is common in the
textile industry and in retailing. Suppliers to apparel retailers, department stores, and discount
retailers prefer not to risk shipping merchandise without assurance that a factor will purchase
the resulting receivables. The diagram below depicts the relationship among the parties.

Supplier Accounts Receivable Retailer

Accounts (5)
Cash Receivable Cash
(4) (3)
Factor
(Transferee)

The factor plays a key role in the continuance of the business relationship between supplier
and retailer. The factor charges a fee in return for accepting the risk of default by retailers. If
that risk increases, the factor will increases the fee, reduce the amount of receivables
purchased, or suspend credit to the supplier.

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