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. F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 1Cash and Receivables STEP #1 RECONCILIATION PER BANKBalance 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 BOOKBalance per book (general ledger), April 30, 2000 39,073 Add: Principle portion of note collection 1,000 Interest portion of note collection 200 1,20040,273 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 CREDITCash 1,200 Note receivable 1,000 Interest earned 200To record the collection of a note by the bankBank service charges 75Utilities expense 198 Cash 273To 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 F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 2Cash 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 BANKBalance per bank statement, September 30, 2000 Add: Deposits in transit Correction of error made by the bank Less: Outstanding checksCorrect balance at September 30, 2000 Solution: RECONCILIATION PER BANKBalance per bank statement, September 30, 2000 16,987 Add: Deposits in transit 19,625 Correction of error made by the bank 500 20,12537,112 Less: Outstanding checks (16,750)Correct balance at September 30, 2000 20,362 Prepare the reconciliation per book: RECONCILIATION PER BOOKBalance 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 2002Correct balance at September 30, 2000 Solution: F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 3Cash and Receivables RECONCILIATION PER BOOKBalance 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 15,30020,427 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 CREDITCash Note receivable Intrest earned Prepaid insuranceTo 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 CashTo the bank service charges for the month of September 2002 Solution: ACCOUNT DEBIT CREDITCash 15,300 Note receivable 10,000 Intrest earned 800 Prepaid insurance 4,500To 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 65To the bank service charges for the month of September 2002 F:\Teaching\3321\web\module3\c7\tnotes\C7a.doc 2/16/2007 4Cash 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 can’t be