Cash and Receivables

CASH AND CASH EQUIVALENTS

Cash on hand, demand deposits and other bank accounts are considered cash. Cash equivalents
are short-term investments (90 days or less) that can be converted into cash without any
significant cost. There cannot be any contractual limitations or restrictions on the use of cash
(for example, cash restricted to pay debts is not considered cash).

INTERNAL CONTROL OF CASH

Cash is the asset most easily misappropriated by management and/or employees. It is extremely
important that proper internal control be established to protect this asset. Internal controls should
be established to prevent unauthorized cash transactions and to provide information necessary for
the proper management of cash. There are two types of internal controls that enhance the
reliability of the financial statements.
(1) Preventive Controls
Policies and procedures that are designed to prevent errors and fraud
(2) Detective Controls
Policies and procedures that provide an after the fact double-check to identify errors
and fraud.
A routine accounting activity that provides a detective control is the monthly reconciliation of
cash. There are three steps in the reconciliation of cash at the end of each month.
(1) Reconciliation per bank
Using the bank statement the accountant reconciles the amount per bank to the actual
amount that should be reflected in the accounting records at the end of the period.
(2) Reconciliation per book
Using the general ledger balance the accountant reconciles the amount per books to
the actual amount that should be reflected in the accounting records at the end of the
period.
(3) Preparation of adjusting journal entries
Using the information developed in the reconciliation per book the accountant
prepares the necessary month end adjusting journal entry to bring the cash per the
general ledger into balance with the actual balance per the bank and book
reconciliations.

Example: Spencer Company has the following information available as of April 30, 2002.

Balance per April 30, 2002 bank statement $48,000

Balance per general ledger on April 30, 2002 39,073
Deposits in transit 12,000
Checks in transit 19,500
Note receivable, collected by the bank:
Principle portion of note collection 1,000
Interest portion of note collection 200
Bank service charges for the month of April 75
Errors:
Bank deposited $500 in the account by mistake
Bookkeeper recorded a payment for utilities as $22 but the check was actually written
for $220.

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STEP #1
RECONCILIATION PER BANK
Balance per bank statement, April 30, 2000 48,000
Add: Deposits in transit 12,000
Total 60,000
Less: Outstanding checks (19,500)
Correction of error made by the bank (500) (20,000)
Correct balance at April 30, 2000 40,000

STEP #2
RECONCILIATION PER BOOK
Balance per book (general ledger), April 30, 2000 39,073
Add: Principle portion of note collection 1,000
Interest portion of note collection 200 1,200
40,273
Less: Correction of error made by company (198)
Bank service charges for April 2002 (75) (273)
Correct balance at April 30, 2000 40,000

STEP #3
ACCOUNT DEBIT CREDIT
Cash 1,200
Note receivable 1,000
Interest earned 200
To record the collection of a note by the bank

Bank service charges 75

Utilities expense 198
Cash 273
To record the correction of an error and bank service
charges for the month of April 2002

Exercise: Spencer Company has the following information available for the month ended
September 30, 2002.

Balance per September 30, 2002 bank statement $16,987

Balance per general ledger on September 30,2002 5,127
Deposits in transit 19,625
Checks in transit 16,750
Note receivable collected by the bank:
Principle portion of note collection 10,000
Interest portion of note collection 800

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Cash and Receivables

Bank service charges for the month of April 65

Errors:
Bank charged the account for $500 by mistake
Bookkeeper recorded a payment for prepaid insurance as $5,000 but the check was
actually written for $500.

Prepare the reconciliation per bank:

RECONCILIATION PER BANK

Balance per bank statement, September 30, 2000
Add: Deposits in transit
Correction of error made by the bank

Less: Outstanding checks

Correct balance at September 30, 2000

Solution:

RECONCILIATION PER BANK

Balance per bank statement, September 30, 2000 16,987
Add: Deposits in transit 19,625
Correction of error made by the bank 500 20,125
37,112
Less: Outstanding checks (16,750)
Correct balance at September 30, 2000 20,362

Prepare the reconciliation per book:

RECONCILIATION PER BOOK

Balance per book, September 30, 2000
Add: Principle portion of note collection
Interest portion of note collection
Correction of error made by company

Less: Bank service charges for September 2002

Correct balance at September 30, 2000

Solution:

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Cash and Receivables

RECONCILIATION PER BOOK

Balance per book, September 30, 2000 5,127
Add: Principle portion of note collection 10,000
Interest portion of note collection 800
Correction of error made by company 4,500 15,300
20,427
Less: Bank service charges for September 2002 (65)
Correct balance at September 30, 2000 20,362

Prepare the month-end adjusting journal entries:

ACCOUNT DEBIT CREDIT

Cash
Note receivable
Intrest earned
Prepaid insurance
To record the collection of a note by the bank and the
correction of an error made by the company in
recording prepaid insurnace.

Bank service charges

Cash
To the bank service charges for the month of
September 2002

Solution:

ACCOUNT DEBIT CREDIT

Cash 15,300
Note receivable 10,000
Intrest earned 800
Prepaid insurance 4,500
To record the collection of a note by the bank and the
correction of an error made by the company in
recording prepaid insurnace.

Bank service charges 65

Cash 65
To the bank service charges for the month of
September 2002

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Cash and Receivables

RESTRICTED CASH AND COMPENSATING BALANCES

a. Restricted Cash
Compensating balances: Many times a bank will require that an organization maintain a
certain minimum balance in its checking account in order to qualify for loans and other bank
services. This is essentially restricted cash that cant be used for current operations. As a
result it must be reported separately from other cash in the balance sheet. If the
compensating balances are related to long-term obligations then they should be reported on
the balance sheet as non-current assets.

Other types of restricted cash: Petty cash, payroll accounts and dividend funds are cash
accounts that are restricted for specific use. These should be reported as current or non-
current based on the date that the cash is expected to be disbursed.

b. Bank Overdrafts
Bank overdrafts occur when an organization writes checks against a checking accounting in
excess of the amount available. In this situation the negative checking account balance
should be reported on the balance sheet as a current liability. If the organization has multiple
accounts in the same bank and one of the accounts has an overdraft, the organization may
offset this amount against the positive balances in the other accounts as long as the overall
net balance of the aggregated accounts is positive. This right of offset is not available if the
accounts are in different banks.

c. Cash Equivalents
Cash equivalents are highly liquid short-term investments that can be converted to cash easily
and are not subject to significant interest rate risk. They have a maturity date of 90 days or
less.

Exercise:
In the space provided please indicate how each of the following should be classified in the
balance sheet.

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ITEM CLASSIFICATION
Cash on hand
Cash in savings
Cash refund due from IRS
Postdated checks
Travel advances
Certificates of deposit (180-day)
Postage meter balance
Bank overdraft
Legally restricted compensating balance
Short-term paper (30 days)
Petty cash fund
Solution:

ITEM CLASSIFICATION
Cash on hand Cash
Cash in savings Cash
Cash refund due from IRS Receivables
Postdated checks Receivables
Travel advances Receivables
Certificates of deposit (180-day) Temporary investments
Postage meter balance Prepaid expenses
Bank overdraft Current liability
Legally restricted compensating balance Cash, separately stated in the balance sheet
Short-term paper (30 days) Cash equivalent
Petty cash fund Cash

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