Outline - Chapter 7A-1

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Apr 3, 2024

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CHAPTER 7A CASH AND CASH EQUIVALENTS Cash  Amounts readily available to pay off debt or to use in operations  Examples : Currency and coins, balances in checking accounts Cash Equivalents  Short-term, highly liquid investments, readily convertible to cash with little risk of loss  Have a maturity date no longer than three months from the date of purchase  Examples: Money market funds, treasury bills, and commercial paper Disclosure of Cash Equivalents— Walgreen Boots Alliance, Inc. • Companies are permitted flexibility in designating cash equivalents Delta Automotive Corp had the following assets at Dec. 31: What is the balance of cash and cash equivalents? $ 39,340 Internal Control Internal control refers to a company’s plan  To encourage adherence to company policies and procedures,  To promote operational efficiency,  To minimize errors and theft, and  To enhance the reliability and accuracy of accounting data. Sarbanes-Oxley Act (Section 404) requires:  A company to document and assess its internal controls  Auditors to express an opinion on management’s assessment Committee of Sponsoring Organizations (COSO): • Defines internal control as a process designed to provide reasonable assurance regarding the achievement of objectives in the following categories: – Effectiveness and efficiency of operations – Reliability of financial reporting – Compliance with applicable laws and regulations Cash in bank – checking account U.S. Treasury bills (mature in 60 days) U.S. Treasury bills (mature in six months) Cash on hand (currency and coins) Undeposited customer check $22,500 5,000 10,000 1,350 1,840 1

Internal Control Procedures—Cash Receipts • Separation of duties in the cash receipts process: - Step 1: Employee A opens the mail each day and prepares a multicopy listing of all checks including the amount and payor’s name. - Step 2: Employee B takes the checks, along with one copy of the listing, to the person responsible for depositing the checks in the company’s bank account. - Step 3: A second copy of the check listing is sent to the accounting department where Employee C enters receipts into the accounting records. Internal Control Procedures—Cash Disbursements  Objective • To prevent unauthorized payments • To ensure that disbursements are recorded properly Import elements: All disbursement should be made by check All expenditures should be authorized Checks should be signed only by authorized individuals Some underlying principles of internal control for cash:  Individuals that have physical responsibility for assets should not also have access to accounting records (separation of duties).  Cash receipts should be recorded immediately.  Cash receipts should be deposited immediately.  All cash disbursements should be made by check or electronically. Checks should be signed by authorized individuals.  Expenditures should be authorized Concept Check: Internal Control Systems Which of the following is not an element of a good internal control system for cash receipts and disbursements? a. Maintaining a separation of duties b. Ensuring all checks are signed by authorized individuals c. Having the most senior employee handle cash disbursements and bank reconciliations d. Making disbursements with checks rather than cash Restricted Cash 2

 Cash that is restricted in some way and not available for current use  Can be restricted for a specific purpose or can be contractually imposed Compensating Balance • An amount that compensates the bank for granting the loan or extending the line of credit • Under this arrangement: – Borrower is asked to maintain a specified balance in a low interest or noninterest-bearing account at the bank – Required balance equals some percentage of the committed amount – Borrower pays effective interest rate higher than the stated rate on the debt A Compensating Balance Makes the Effective Interest Rate Higher Than the Stated Rate A company borrows $10,000,000 from a bank at an interest rate of 12%. The bank requires a compensating balance of $2,000,000 to be held in a noninterest-bearing checking account. Total borrowing from bank 10,000,000 Interest (10,000,000 * 12%) 1,200,000 Actual borrowing (10,000,000 – 2,000,000) 8,000,000 Effective rate of interest (1,200,000/8,000,000) 15% Concept Check: Effective Interest Rates Jenks borrowed $13,000,000 from a bank at a 10% rate of interest. The bank requires Jenks to maintain a $3,000,000 compensating balance. What is Jenks’ effective interest rate? a. 7.7% b. 10% c. 13% d. 23% ($13,000,000 * 10%) = $1,300,000 = annual interest paid $1,300,000/($13,000,000 - $3,000,000) = 13% = effective interest rate 3

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IFRS – Cash and Cash Equivalents U.S. GAAP IFRS Overdrafts should be treated as liability Allows overdrafts to be offset Requires assets and liabilities to be stated separately on balance sheet Liabilities can be offset against other cash accounts and stated at their net value on the balance sheet Example LaDonia Company has two cash accounts with the following balances as of December 31, 2024: National Bank $300,000 Central Bank (15,000) Under U.S. GAAP, LaDonia’s 12/31/24 balance sheet would report a cash asset of $300,000 and an overdraft current liability of $15,000. Under IFRS, LaDonia would report a cash asset of $285,000. Bank Reconciliations (Appendix A) One of the most important tools used in the control of cash is the bank reconciliation . • Since all cash receipts are deposited into the bank account and cash disbursements are made by check, the bank account provides a separate record of cash. It’s desirable to periodically compare the bank balance with the balance in the company’s own records and reconcile any differences. • Differences between the cash book and bank balance occur due to differences in – Timing of recognition of certain transactions – Errors • STEP 1: Adjust the bank balance to the corrected cash balance – Bank reconciliations include adjustments to the balance per bank for timing differences involving transactions already reflected in the company’s accounting records that have not yet been processed by the bank. • STEP 2: Adjust the book balance to the corrected cash balance – The balance per books is similarly adjusted for timing differences involving transactions already reflected by the bank of which the company is unaware until the bank statement is received. Step 1: Adjustments to Bank Balance 4

• Add deposits outstanding • Deduct checks outstanding • Add or deduct bank errors Step 2: Adjustments to Book Balance • Add collections by bank • Add cancelled checks/stop payments • Add other credit memos • Add or deduct company errors • Deduct service charges • Deduct NSF (nonsufficient funds) checks • Deduct other debit memos Reconciling entries for adjustments to book balance only. 5

Example: The Hawthorne Manufacturing Company maintains a general checking account at the First Pacific Bank. First Pacific provides a bank statement and cancelled checks once a month. The cut-off date is the last day of the month. The bank statement for the month of May is summarized as follows: Balance, May 1, 2024 Deposits Checks processed Service charges NSF checks Note payment collected by bank (includes $120 interest) Balance, May 31, 2024 The company’s general ledger cash account has a balance of $35,276 at the end of May. A review of the company records and the bank statement reveals the following: 1. Cash receipts not yet deposited totalled $2,965. 2. A deposit of $1,020 was made on May 31 that was not credited to the company’s account until June. 3. All checks written in April have been processed by the bank. Checks written in May that had not been processed by the bank total $5,536. 4. A check written for $1,790 was incorrectly recorded by the company as a $790 disbursement. The check was for payment to a supplier of raw materials. Step 1: Bank Balance to Corrected Balance Balance per bank statement $34,680 Add: Deposits outstanding $3,985 Deduct: Checks outstanding $(5,536) Corrected cash balance $33,129 Step 2: Book Balance to Corrected Balance Balance per book $35,276 Add: Note collected by bank 1,120 Deduct: Service charges (80) NSF check (2,187) Error – check (1,000) Corrected cash balance $33,129 $32,120 82,140 (78,433) (80) (2,187) 1,120 $34,680 6

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Prepare the journal entries necessary to adjust the cash account to the corrected balance: GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 5/31 5/31 To record the receipt of principal and interest on note collected directly by the bank Cash Note receivable Interest revenue To record credits to cash revealed by the bank reconciliation Miscellaneous expense (bank service charges) Accounts receivable (NSF checks) Accounts payable (error in check to supplier) Cash 1,120 80 2,187 1,000 1,000 120 3,267 7

Example: Jamal’s August 31 bank reconciliation includes the following information: • 8/31/24 Balance in the general ledger for cash: $10,000 • Outstanding checks of $2,500. • Deposits in transit of $1,000. • Bank service charge of $50. • A check by Jamal for $250 had been incorrectly recorded by Jamal as a disbursement of $150. (100) Jamal’s corrected August 31 cash balance is: a. $9,350. b. $9,850. c. $10,050. d. $10,850. 10000 book balance -50 service fee -100 Petty Cash • Most companies keep a small amount of cash on hand to pay for low-cost items such as postage, office supplies, delivery charges, and entertainment expenses. • It would be inconvenient, time-consuming, and costly to process a check each time these small payments are made. • A petty cash fund provides a more efficient way to handle these payments. • A petty cash fund is established by writing a check to the custodian for an amount that should approximate expenditures for a short period of time (such as a week or a month). Example: On May 1, 2024, the Hawthorne Manufacturing Company established a $200 petty cash fund. John Ringo is designated as the petty cash custodian. The fund will be replenished at the end of each month. On May 1, 2024, a check is written for $200 made out to John Ringo, petty cash custodian. During the month of May, John paid bills totalling $160 summarized as follows: Postage $40 Office supplies 35 Delivery charges 55 Entertainment 30 Total $ 160 In journal entry form, the transaction to establish the fund would be recorded as follows: Journal Entry Petty Cash 200 Cash 200 8

In journal entry form, replenishing the fund would be recorded as follows: Journal Entry Postage expense 40 Office supplies expense 35 Delivery expense 55 Entertainment expense 30 Cash 160 The fund was replenished on May 31. Once petty cash is established, entry to petty cash only to increase or decrease, not to replenish. 9

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