Chapter Five

Cash and Receivables

5. INTRODUCTION
Since cash is the asset most likely to be used improperly by employees, exposed for embezzlement and many business
transactions either directly or indirectly affect it, it is therefore necessary to have effective control of cash.
5.1. MEANINGS OF CASH
Cash includes money on deposit in banks and other items that a bank will accept for immediate deposit. Money on
deposit in banks includes checking and saving accounts. Other items such as ordinary checks received from customers,
money orders, coins and currency and petty cash also are included as cash. Banks do not accept postage stamps, travel
advances to employees, notes receivable or post-dated checks as cash.
CHARACTERISTICS OF CASH
The following are some of the characteristics of cash:
 Cash is used as medium of exchange
 Cash is the most liquid asset
 Cash is mostly affected by business transactions
 Cash is used to measure the value of other assets
 Cash is mostly exposed to embezzlements
MANAGEMENT OF CASH
Cash management refers to planning, controlling and accounting for cash transactions and cash balances. Efficient
management of cash is essential to the survival and success of every business organization. Managing cash requires
planning wisely so that there will not be excess cash held on hand at any point in time; or there is no shortage of cash
at any point in time to meet the business’s needs.
INTERNAL CONTROL OF CASH
The need to safeguard cash is crucial in most businesses because cash is mostly exposed to embezzlement. Firms
address this problem through the internal control system. An internal control system is a set of policies and procedures
designed to protect assets, provide accurate accounting records and evaluate performances.
A sound internal control system for cash increases the likely hood that the reported values for cash are accurate.
Internal control for cash should include the following procedures:
The individuals who receive cash should not also disburse (pay) cash
The individuals who handle cash should not access accounting records
Cash receipts are immediately recorded and deposited and are not used directly to make payments.

1
 Disbursements are made by serially numbered checks, only upon proper authorization by someone other than
the person writing the check
Bank accounts are reconciled monthly.
Control of cash receipts
Cash inflows have many sources, and cash control procedures vary across companies. These minimum procedures apply
in most situations:
1. Separate the responsibilities for handling cash, for recording cash transactions, and for reconciling cash balances.
This separation reduces the possibility of theft and concealment through false recording.
2. Assign cash handling and cash recording responsibilities to different persons to ensure an interrupted flow of
cash from receipts to deposit. This control requires immediate counting, immediate recording, and timely
deposit of all cash received.
3. Maintain close supervision of all cash-handling and cash-recording functions. This control includes both routine
and surprise cash counts, internal audits, and daily reports of cash receipts, payments, and balances.
Control of cash disbursements
Most firms disburse cash to large number of different payees. Although cash disbursement control systems are tailored
to each firm’s specific needs, certain fundamentals apply:
1. Separate the responsibilities for cash disbursement, documentation, check writing, check signing, check mailing,
and record keeping.
2. Except for internal cash funds (petty cash), make all cash disbursements by check.
3. If petty cash funds are employed, develop tight controls and authorization procedures for their use.
4. Prepare and sign checks only when supported by adequate documentation and verification.
5. Supervise all cash disbursements and record-keeping functions.
The voucher system is used for the purpose of coordinating these related activities and to link them with the final
issuance of checks to creditors
The following are the most common elements of cash control and managements: bank account system, petty cash fund,
voucher system, change fund, and cash short and over. Voucher System Controls
Most medium and large companies use vouchers as part of their internal control over cash disbursements. A voucher
system is a network of approvals by authorized individuals, acting independently, to ensure that all disbursements by
check are proper.
The system begins with the authorization to incur a cost or expense. It ends with the issuance of a check for the liability
incurred. Companies require vouchers for all types of cash disbursements except those from petty cash.
Voucher means any document that serves as proof of authority to pay cash, such as an invoice approved for payment or
as evidence that cash has been paid, such as a canceled check. A voucher is a special form on which recorded relevant

2
data about a liability and the details of its payment. The basic idea of this system is that every transaction that will
result in cash disbursement must be verified, approved in writing, and recorded before a check is issued. The following
steps are invoiced under the voucher system
1. Preparation of a voucher
2. Approval of the voucher
3. Recording the voucher
4. Filing the unpaid voucher
5. Paying the voucher
Preparing the voucher: A voucher form is used for all expenditures, except those from petty cash. A voucher is normally
prepared in the accounting department by an accounting payable clerk and is based on invoice or other supporting
documents. The following comparisons and verifications should be made on the invoice:
1. Comparison of the invoice with a copy of the purchase order to verify quantities, prices, and terms.
2. Comparison of the invoice with the receiving report to verify receipt of the items billed.
3. Verification of the arithmetical accuracy of the invoice.
Approval of the voucher: After the voucher has been prepared, the invoice or other supporting evidence is attached to
the voucher. The voucher is then given to the proper official for approval.
Recording of the voucher: After a voucher has been approved, it is recorded as credit to account payable and a debit to
the appropriate account or accounts in a voucher register.
Filing the unpaid voucher: After the voucher is recorded, it is filed by date of payment in an unpaid voucher file
(sometime called a ticker file). This method of filling facilitates the payment of bills within due date.
Paying the voucher: On the due date, the voucher is removed from the ticker file and forwarded to cash disbursements
section. The employee prepares (but does not sign) the check, insert relevant data in the payment summary of the
voucher and transfers the unsigned check and voucher to the finance department for signature. After signing the check
signor then:
1. Mails the check to the payee
2. Stamps (or marks) the voucher and supporting documents “paid” to prevent them from being submitted again
for payment.
3. Sends the “Paid” voucher and a copy of the check to accounting division
Note: A voucher system not only provides effective controls over cash payments but also aids management in fulfilling
its responsibilities.
Petty Cash Fund Control
Better internal control over cash disbursements is possible when companies make payments by check. However, using
checks to pay small amounts is both impractical and a nuisance. For instance, a company would not want to write

3
checks to pay for postage due, working lunches, or taxi fares. A common way of handling such payments, while
maintaining satisfactory control, is to use a petty cash fund to pay relatively small amounts.
The operation of a petty cash fund, often called an imprest system, involves three steps:
establishing the fund making payments from the fund replenishing the fund.
Establishing petty cash Fund: A petty cash fund is established by first estimating the amount of cash needed for
payments from the fund during a period, such as a week or a month. After necessary approvals, a check is written and
cashed for this amount. The money obtained from cashing the check is then given to an employee, called the petty cash
custodian, who is authorized to disburse monies from the fund.
Making Payments from petty cash Fund: Each time monies are paid from petty cash, the custodian records the details
of the payment on a petty cash receipt form. For control purposes, the company may place restrictions on the maximum
amount and the types of payments that can be made from the fund. The company does not make an accounting entry to
record a payment when it is made from petty cash. Instead, the company recognizes the accounting effects of each
payment when it replenishes the fund.
Replenishing petty cash Fund: When the money in the petty cash fund reaches a minimum level, the company
replenishes the fund.
To illustrate normal petty cash fund entries, assume that ABC Co. a petty cash fund of $100 is established on August 1.
The entry to record this transaction is as follows:
August 1. Petty cash ................. $100
Cash in bank ........................ $100
(To establish a petty cash fund)
At the end of August, the petty cash receipts indicate expenditures for the following items: office supplies, $50; store
supplies, $35; and daily newspapers (miscellaneous administrative expense), $3. The entry to replenish the petty cash fund
on August 31 is as follows:
Aug. 31: Office Supplies . . . . . . . . . . . . . . . . . . . . . . . . 50
Store Supplies . . . . . . . . . . . . . . . . . . . . . . . . . 35
Miscellaneous Administrative Expense . . . . . . 3
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
(To replenish petty cash fund)
Replenishing the petty cash fund restores it to its original amount of $100. You should note that there is no entry in Petty
Cash when the fund is replenished. Petty Cash is debited only when the fund is initially set up or when the amount of the
fund is increased at a later time. Petty Cash is credited if it is being decreased.
Cash change Fund
Retail stores of other business that receive cash directly from customers must keep some currency & coins on hand in
order to make change. This cash is recorded in a cash change fund account.
Accounting procedures in relation to change fund:

4
 A. Check is drawn for the required amount
B. Journal entry is made to record the change fund
Cash on hand . . . . . . . . . . . . . xxx
Cash in Bank . . . . . . . . . . . . . . . . . xxx
Note that no additional changes or credits to the cash on hand account are necessary unless the amount of fund is
increased or decreased. The total amount of cash received during the day is deposited, and the original amount of the
change fund is retained.
Cash Short and Over
At the beginning of a work shift, each cash register clerk is given a cash drawer that contains a predetermined amount of cash for
making change for customers. At the end of the work shift, each clerk and the supervisor count the cash in the clerk’s cash drawer.
The amount of cash in each drawer should equal the beginning amount of cash plus the cash sales for the day. However, errors in
recording cash sales or errors in making change cause the amount of actual cash on hand to differ from this amount. Such
differences are recorded in cash short and over account.
To illustrate, assume that the cash register tape indicated sales for the day amount to $6,956.20 but the cash receipts in the cash
register drawer (actual cash count) total amounts of only $6,946.10. The company makes the following journal entry:
Cash ------------------------------ $6,946.10
Cash short & over------------------ 10.10
Sales ---------------------------------- 6,956.20
To record a Br. 10.10 (Br. 6,956.20 – 6,946.10) Shortage in cash receipts for the day
The account entitled Cash Over and Short is debited with shortages and credited with overages. If the account has a debit balance,
it appears in the income statements as a miscellaneous expense; if it has a credit balance; it is shown as miscellaneous revenue
or other income.
Control of Cash Through Bank Accounts
One of the major devices for maintaining control over cash is the bank account. Keeping cash in a bank account helps
because banks have established practices for safeguarding customers’ money. Banks also provide customers with
detailed records of their transactions. To take full advantage, businesses should deposit all cash receipts in the bank and
make all cash payments through the bank. When such a system is strictly followed, there is a double record of cash, one
by the business and the other by the bank.
The documents used to control a bank account include signature card, deposit ticket, check, bank Statement, and bank
reconciliation.
Signature Card: When you open a checking account, you sign a signature card. This card is used by the bank to verify
the signature on checks that are submitted for payment. Also, when you open an account, the bank assigns an
identifying number to the account.
Deposit Ticket: The details of a deposit are listed by the depositor on a printed deposit ticket supplied by the bank.
These forms are often prepared in duplicate. The bank teller stamps or initials a copy of the deposit ticket and gives it to

5
the depositor as a receipt.
Check - A check is a written document signed by the depositor, ordering the bank to pay a sum of money to an
individual or entity. There are three parties to a check:
 The maker, who signs the check
 The payee, to whom the check is paid
 The bank, on which the check is drawn
Record of Checks Drawn: A memorandum record of the basic details of a check should be prepared at the time the
check is written. The record may be a stamp form which the check is detached or it may be a small booklet designed to
be kept with the check forms.

Bank Statement: Banks send monthly statements to customers. A bank statement is the document on which the bank
reports what it did with the customer’s cash. Like any account with a customer or a creditor, the bank statement shows
the beginning balance, additions, deductions, and the balance at the end of the period. Included with the statement are
the maker’s canceled checks (or photocopies of the paid checks).

The depositor’s checks received by the bank during the period may accompany the bank statement, arranged in the
order of payment. The paid checks are stamped “Paid,” together with the date of payment. Other entries that the bank
has made in the depositor’s account may be described in debit or credit memorandums enclosed with the statement.

You should note that a depositor’s checking account balance in the bank’s records is a liability with a credit balance.
Debit memorandums issued by the bank on a depositor’s account therefore decrease the depositor’s balance. Likewise,
credit memorandums increase the depositor’s balance.

A bank issues a debit memorandum to charge (decrease) a depositor’s account for service charges or for deposited
checks returned because of insufficient funds. Likewise, a bank issues a credit memorandum when it increases the
depositor’s account for collecting a note receivable for the depositor, making a loan to the depositor, or receiving a wire
deposit.

A business can use a bank statement to compare the cash transactions recorded in its accounting records to those
recorded by the bank. The cash balance shown by a bank statement is usually different from the cash balance shown in
the accounting records of the business.

This difference may be the result of a delay by either party in recording transactions. For example, there is a time lag
of one day or more between the date a check is written and the date that it is presented to the bank for payment. If the
depositor mails deposits to the bank or uses the night depository, a time lag between the date of the deposit and the
date that it is recorded by the bank is also probable. The bank may also debit or credit the depositor’s account for
transactions about which the depositor will not be informed until later. The difference may be the result of errors made

6
by either the business or the bank in recording transactions.

The Bank Reconciliation

Bank reconciliation is a listing of the items and amounts that causes the cash balance reported in the bank statement
to differ from the balance of the cash account in the ledger. Bank reconciliation, which is prepared by the company (not
by the bank), properly done, it explains all differences between the company’s cash records and the bank statement
figures. It ensures that all cash transactions have been accounted for. It also establishes that bank and book (your own)
records of cash are correct. Monthly reconciling of the bank balance with the depositor’s cash accounts balance is
essential cash control procedure. To reconcile a bank statement means to verify that the bank balance and the
accounting records of the depositor are consistent. The balance shown in a monthly bank statement seldom equals the
balance appearing in the depositor’s accounting records. Certain transactions recorded by the depositor may not have
been recorded by the bank and vice versa.
Here are the items that appear on a bank reconciliation. They all cause differences between the bank balance and the
book balance.
Bank Side of the Reconciliation
The bank side contains items not yet recorded by the bank, but recorded by the company or errors made by the bank.
These items include the following:
1. Deposits in transit (outstanding deposits). These deposits have been recorded and have already been added to the
company’s book balance, but the bank has not yet recorded them. Deposits in transit are deposits the company made
that haven’t yet cleared the bank. These are shown as “Add deposits in transit” on the bank side because when the bank
does record these deposits, it will increase the bank balance.
2. Outstanding checks. These checks have been recorded and have already been deducted from the company’s book
balance, but the bank has not yet paid (deducted) them. Outstanding checks are checks the company wrote that haven’t
yet cleared the bank. They are shown as “Less outstanding checks” on the bank side because when the bank does record
the checks, it will decrease the bank balance.
3. Bank errors. Bank errors are posting errors made by the bank that either incorrectly increase or decrease the bank
balance. All bank errors are corrected on the Bank side of the reconciliation by reversing the effect of the errors.
Book Side of the Reconciliation
The book side contains items not yet recorded by the company on its books but that are recorded by the bank, or errors
made by the company. Items to show on the Book side include the following:
1. Bank collections. Bank collections are cash receipts the bank has received and recorded for a company’s account but
that the company has not recorded yet on its books. An example of a bank collection would be if a business has its
customers pay directly to its bank. This is called a lock-box system. This system helps to reduce theft. Another example
is a bank’s collecting of a note receivable for a business. A bank collection (which increases the bank balance) that
7
 appears on the bank statement will show as “Add bank collections” on the book side of the reconciliation because it
represents cash receipts not yet recorded by the company.
2. Service charge. This cash payment is the bank’s fee for processing a company’s transactions. This will show as “Less
service charges” on the book side of the reconciliation because it represents a cash payment not yet subtracted from
the company’s cash balance.
3. Interest revenue on a checking account. A business will earn interest if it keeps enough cash in its account. The bank
statement tells the company of this cash receipt. This will show as “Add interest revenue” on the book side of the
reconciliation because it represents cash receipts not yet added in the company’s cash balance.
4. Nonsufficient funds (NSF) checks. These are earlier cash receipts that have turned out to be worthless. NSF checks
(sometimes called hot checks or bad checks) are treated as subtractions on a company’s bank reconciliation. NSF checks
are customer checks the company has received and deposited for which the customer doesn’t have enough money in his
or her bank account to cover. NSF checks will show as “Less NSF checks” on the book side of the reconciliation.
5. Book errors. Book errors are errors made on the books of the company that either incorrectly increase or decrease
the cash balance in the company’s general ledger. All book errors are corrected on the book side of the reconciliation by
reversing the effect of the errors.
Steps in Preparing Bank Reconciliation
A bank reconciliation is a schedule prepared by the depositor to bring the balance shown in the bank statement and the
balance shown in the depositor’s accounting into agreement.
The steps to prepare a bank reconciliation are:
a. The deposits listed on the bank statement are compared with the deposits shown in the accounting records. Any
deposits not yet recorded by the bank are deposits in transit and should be added to the balance shown in the bank
statements.
b. The paid and received checks from the bank are compared with the check stubs. Any checks issued but not yet paid
by the bank are outstanding checks and should be deducted from the balance reported in the bank statements.
c. Any credit memorandums issued by the bank that have not been recorded by the depositor, are added to the
balance per depositor’s record.
d. Any debit memorandums issued by the bank that have not been recorded by the depositor are deducted from the
balance per depositor’s record.
e. Any errors in the bank statement or depositor’s accounting records are adjusted.
f. The equality of adjusted balance of statement and adjusted balance of the depositor’s record is compared.
g. Journal entries are prepared to record any items delayed by the depositor.
The format of the bank reconciliation is shown below.
Cash balance according to bank statement. . . . . . . . . . . . . . . . . . . .. . . . . . $XXX

8
Add: Additions by depositor not on bank statement . . .............. . $XXX
Bank errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX . ... XXX
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ........ . . .. $XXX
Deduct: Deductions by depositor not on bank statement . . . . .. . $XXX
Bank errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX .... (XXX)
Adjusted balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$XXX
Cash balance according to depositor’s records. . . . . . . . . . . . . . . .... . . . . . $XXX
Add: Additions by bank not recorded by deposit . . . . . . .. . . $XXX
Depositor errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX Must
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. . $XXX be equal
Deduct: Deductions by bank not recorded by depositor . . . . . . $XX
Depositor errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .XXX ...... (XXX)Adjusted balance . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .. $XXX

Illustration of Bank Reconciliation

On December 31, 2012, ABC Company had a cash balance per books of $3,949.25. The bank statement indicated a balance
of $5,346.60. A comparison of the statement with the cash account revealed the following facts.
1) Checks outstanding: check No 453, $450; check No 457, $300; check No 460, $226.25
2) A deposit of $1,916.15, representing receipts of December 31, had been too late to appear in the bank statement
3) The bank had collected $3,580 on a note left for collection. The face value of the note was $3,500
4) A check for $685 returned with the statement had been recorded erroneously in the check register as $658. The
check was for the payment of an obligation to XYZ Company for the purchase of office equipment on account
5) A check drawn for $55 had been erroneously charged by the bank as $550
6) Bank service charges for December amounted to $40.75
7) On December 31, the bank statement showed an NSF charge of $680 for a check issued by Sandy Mack, a customer,
to ABC Company on account.
Required: A. Prepare bank reconciliation.
B. Record the necessary journal entry
Solution: A
ABC COMPANY
Bank Reconciliation
December 31, 2012
Cash balance per bank statement …………………………………………..…….. $5,346.60
Add: Deposits in transit ………………………………….……. $1,916.15
Bank error ……………………………………………..… 495 2,411.15
Subtotal …………………………………………….……………………………… 7,757.75
Less: Outstanding checks
No. 453 ……………………………………………… $450
No. 457 ……………………………………………… 300
No. 460 ……………………………………………… 226.25 976.25

9
Adjusted cash balance per bank ……………………………………………….. $6,781.50
Cash balance per depositors record ………………………………...…………….. $3,949.25
Add: Collection of note receivable, plus interest earned ……………………...….. $3,580
Subtotal ……………………………………………………………….........……… 7,529.25
Less: Bank service charge ………………………..……………. $40.75
NSF check returned ………………………………….…. 680
Error in recording check ……………………..………….. 27 747.75
Adjusted cash balance per depositor ……………..……………………………. $6,781.50

Solution B
Cash in Bank ………………………. 3,580
Notes Receivable ………………….… 3,500
Interest Revenue ………………..…… 80
(To record collection of notes and interest by the bank)
Accounts payable …………………..…. 27
Cash in bank …………………………... 27
(To record error in recording check)
Accounts Receivable- Sandy Mack …..... 680
Cash in bank …………………………………. 680
(To record NSF check)
Miscellaneous Expense …………….... 40.75
Cash in bank ……………..…………….. 40.75
(To record bank service charge)

10
 5.2. Accounting for Receivables
Receivables are amounts that are expected to be collected from different entities such as customers and organizations

5.2.1. Classification of Receivables

Based the source, receivables are classified as trade and non-trade receivables:
1) Trade Receivables – receivables that originate from the major operation of the business such as sale of goods
or services on account
2) Non-trade Receivables- receivables that originate from miscellaneous source rather than the major operation of
the business and includes lending money to:
 Outsiders
 Employees as advance
 Officers
Based on the nature, receivables are classified in to two as Accounts Receivable and Notes Receivables:
1) Accounts Receivable: are receivables based on non-written or oral promises to pay for goods and services on credit.
Accounts receivable:
 Are open accounts
 Are normally collectible within 60 days
 Are non-interest bearing
2) Notes Receivable: is receivables based written promises to pay certain sum of money on a specified future date to
the bearer of the note. Promissory Note (Notes Receivables):
 Note is a written promise to pay a sum of money on demand or at a definite time.
 Are usually used for credit periods of more than 60 days and for transaction of relatively large amounts.
 May also be used in settlement of an open account (Account receivables) and in borrowing or lending money,
since note is legal and formal instrument.
This classification is not mutual exclusive rather it is an overlapping classification because a receivable can be both trade
and accounts receivable or trade and notes receivables. All receivables that are expected to be realized in cash within a
year are presented in the current assets section of the balance sheet. Those receivables that is not currently collectible
such as long-term loans should be presented under the caption “Investments” below the current asset section.

11
5.2.2. Characteristics of Notes Receivables:
1. Notes receivable is more liquid than Accounts Receivables
2. Notes receivable can be made interest bearing or non-interest bearing. A note that provides for the payment of
interest for the period between the issuance date and the due date is called an interest bearing note. If the note
makes no provision for interest, it is said to be non-interest bearing note.
3. Promissory notes have a stronger legal status than open accounts.
4. There are two parties regarding notes: (1) Payee – the party to which the ordered note is payable, and (2) The
Maker – the party which is making the promise.
Example 8.1: On May 1, 2005 GG Co purchased merchandise for Br 5,000 from XYZ Co giving a written promise to pay
after 90 days. Determine the Payee and the maker of the note
Payee: XYZ Company
Maker: GG Company

5.2.3. Determination of Interest, Due Date, and Maturity Value

1. Determination of Interest
Interest = Principal @ Rate @ Time
Example 8.2: Compute the interest on Br 10,000, 12%, 90 days promissory note.
 Interest = 10,000 @ 12% @ 90/ 360
 Interest = Birr 300
2. Determination of Due Date
Due Date (Maturity Date): is the date on which the note is to be paid. The term of the note may be stated in terms of
specified number of days or months. When the term of a note is stated in days, the due date is the specified number of
days after its issuance. When the term of a note is stated as a certain number of months after the issuance date, the
due date is determined by counting the number of months from the issuance date.
Example 8.3: X Company issued 90 days, 12%, Br 10,000 note, dated October 14 to Y Corporation in settlement of an open
account. Determine the due date of the note.
Solution:
Terms of the note 90 Days

Days remaining in October (31-14) 17 Days

Days in November 30 Days
Days in December 31 Days
Total 78 Days
Due Date, January 12
Example 8.4: W Company issued a 60-day, 12% Br1000, dated May 10, to L Corporation. Determine the due date of the
note?

Solution:
Terms of the note 60 Days

Days remaining in May (31-10) 21 Days

Days in June 30 Days
Total 51 Days
Due Date, July 9
Example 8.5: The Maturity Date of a 3 months note dated June 5 would be on September 5. On those cases in which

12
there is no date in the month of maturity that corresponds to the issuance date, the due date will be the last day of that
month.
3. Determination of Maturity Value
 The amount that is due at the maturity or due date is called the maturity value
 The maturity value of a non-interest bearing note is the face amount.
 The maturity value of interest-bearing note is the sum of the face amount and the interest.
Example 8.6: W Co. issued a 60 day, Birr 10,000, 12% interest bearing note , dated may 19 to L Corporation on account.
Determine the Maturity Value of the Note.
Solution:
 Face Value Br 10,000.00
 Add: Interest (10,000 @ 12% @ 60/360) 200.00
 Maturity Value Br 10,200.00

5.2.4. Accounting for Notes Receivable

If the accounts of a customer become delinquent, the creditor may insist that the account be converted into a note. If
the debtor is given more time and the creditor needs more funds, the note may be endorsed and transferred to a bank
or other financial agency.

Example 8.7:ABC Co purchased merchandise for Br30, 000 on Nov 11, 1995 with terms 2/10, n/30 from XYZ Corporation.
However, as ABC Company didn’t pay its account to its creditors on the agreed date (Dec.11, 1995) and XYZ Corporation
insisted the debtor to give a note in the place of the open account (A/R). Consequently, ABC Company signs a Br 30,000,
12%, 90 days interest bearing note dated December11, 1995. Required: Record the appropriate journal entry to be made by
XYZ Corporation (seller):
1. On December11, 1995 when the note was received
2. On December 31, 1995, end of the fiscal year
3. At maturity date of the note
A. Assuming reversing entry was made on Jan 1, 1996
B. Assuming reversing entry was not made on Jan 1,1996
Solution:
1. To convert an open account to a note
Dec. 11, 1995: Notes Receivable 10,000.00
Accounts Receivable 10,000.00
2. To record accrued interest for 20 days
 From Dec. 11 to Dec. 31 = 20 days
 Accrued Interest = 30,000 @ 12% @ (20 / 360) = Br 200
Dec. 31, 1995: Interest Receivable 200.00
Interest Income 200.00

3. On Maturity Date
A. Assuming Reversing Entry was made
Terms of the note 90 Days

Days Remaining December (31-11) 20 Days

Days in January 31 Days
Days in February 29 Days
Total 80 Days
Due Date: March 10

13
March 10, 1996:
Cash 30,900.00
Notes Receivable 30,000.00
Interest Income 900.00
B. Assuming Reversing Entry was not made
Cash 30,900.00
Notes Receivable 30,000.00
Interest Receivable 700.00
Interest Income 900.00

 Discounting of Notes Receivable

Discounting of notes receivable refers to the act of selling a note receivable by a company to financial institutions before
the maturity date of the note and get net cash proceeds in return. When a company is in need of cash, it may transfer
its notes receivable to a bank by endorsement.
 The discount charged by the bank is computed on the maturity value of the note for the period of time the
bank holds the note. I.e. the time that will pass between the date of the transfer and the due date
 The amount of the proceeds paid to the endorser is the excess of the maturity value over the discount
 There are three parties: (1) Maker: the one who makes a note, (2) Endorser: the one who takes the proceeds
and (3) Payee: the bank or other Financial Institution accepting the Note.
Example 8.8: XYZ Corporation discounted the 90 days, 12%, Birr 30,000 notes receivable dated December 11, 1995 on
December 21 at the rate of 14% at its local bank. Required: Determine the proceeds and record the journal entries at the
time of discounting the note.
Net Cash Proceeds = Maturity Value – Bank Discount Amount
Where Maturity Value = Principal + Interest
Bank Discount = Maturity Value @ Bank Discount Rate @ Time
Solution: The Discount Period: (Dec. 21 – Feb. 9) = 50 days
Face Value of Note Dated Dec. 11 10,000.00
Interest 60,000 @ 12% @ 60/360 200.00
Maturity Value 10,200.00
Bank Discount = 10,200 @14% @ 50/360 198.33
Net Cash Proceeds 10,001.67

Journal Entry:
Dec. 21, 1991: Cash 10,001.67
Notes Receivable 10,000.00
Interest Income 1.67

Example 8.9: Assume the above note is discounted at 15% instead of 14%. Determine the net cash proceeds and record
the journal entry.
Solution:
Face Value of Note Dated Dec. 11 10,000.00
Interest 60,000 @ 12% @ 60/360 200.00
Maturity Value 10,200.00
Bank Discount=10,200 @14% @ 50/360 212.50
Net Cash Proceeds 9,987.50
Journal Entry:
Dec. 21, 1991: Cash 9,987.50
14
 Interest Expense 12.50
Notes Receivable 10,000.00
Note: If the Cash Proceeds > Face Value, Interest Income will be recognized. If Cash Proceeds < Face Value, Interest
Expense will be recognized.

 Dishonored Notes Receivable

If the maker of a note fails to pay the debt on the due date, the note is said to be dishonored. A dishonored note
receivable is no longer negotiable, and for that reason the holder usually transfers the claim, including any interest due
.At this time the bank will get the whole amount from endorser. Dishonored notes can be:
1. Before Discounting the Note
Example 8.10: If the XYZ Company received a 10,000, 60 days, 12% note and recorded on December 11, 1995 had been
dishonored at maturity, the entry to charge the note, including the interest back to the customer’s (ABC company)
account would have been as follows:
Feb. 9, 1995: Accounts Receivable – ABC Co. 10,200.00
Notes Receivable 10,000.00
Interest Income 200.00
2. After Discounting The Note:
Example 8.11: Br 10,000, 60 days, 12% notes discounted on December 21, had been dishonored by the maker on maturity
.The necessary journal entry in the book of endorser (XYZ Company) is:
Feb. 9, 1995: Accounts Receivable – ABC Co. 10,200.00
Cash 10,200.00
Assume the bank charges endorser a protest fee of 10 birr and the endorser, who in turn charges it to the maker of the
note in example 2, the journal entry in the book of endorser (XYZ Company) is:
Feb. 9, 1995: Accounts Receivable – ABC Co. 10,210.00
Cash 10,210.00

5.2.5. Accounting for Uncollectible Accounts

When merchandise or services are sold without the immediate receipt of cash, a part of the claims against customers is
proves to be uncollectible. The operating expense incurred because of the failure to collect receivable is called an
expense or a loss from uncollectible accounts, doubtful accounts, or bad debts. There are two methods: (1) The
Allowance Methods/Reserve Method and (2) Direct Write off Methods/Direct Charge off Method

1. Allowance Method:
This method makes a provision for possible future uncollectible amount in advance. This procedure requires you to make
an estimate about possible uncollectible amounts and recognize this in the record as an adjustment to account receivable
account at the end of every accounting period. The journal entry for the estimated amount is:
Uncollectible Account Expense. xxxxx
Allowance for Doubtful Accounts xxxxx
Note: Uncollectible accounts expense is generally reported on the income statement as an administrative expense.
Allowance for doubtful accounts is the amount to be deducted from A/R to determine net realizable value.
Partial Balance Sheet Presentation
Current Asset:
Cash xxxxx
Accounts Receivable xxxxx
Less: Allowance for Doubtful Accounts xxxxx xxxxx

15
Write-off to the Allowance Account
During the year, as more accounts or portions of accounts are determined to be uncollectible, it is written off against
allowance for doubtful accounts. When an account is believed to be uncollectible, it is written off against the allowances
account as follows
Allowance for Doubtful Accounts. xxxxx
Accounts Receivable xxxxx
 The total amount written off against the allowance account during the period will rarely be equal to the amount
in the account at the beginning of the period
 The allowance account will have a credit balance at the end of the period if the write offs during the period
amount to less than the beginning balance
 It will have a debit balance if the write the write offs exceed the beginning balance
 After the year-end adjusting entry is recorded the allowance account will have a credit balance
Reinstatement of Write-off Entry
An account receivable that has been written off against the allowance account may later be collected. In such cases, the
account should be reinstated as:
Accounts Receivable xxxxx
Allowance for Doubtful Accounts. xxxxx
Example 8.12: ABC Company’s account receivable has a balance of Br 25,000 at the end of the period. Based on study, it
is estimated that a total of Br 2,000 will be uncollectible. The Adjusting Entry on December 31
Uncollectible Account Expense. 2,000.00
Allowance for Doubtful Accounts 2,000.00
Account Receivable 25,000.00
Less: Allowance for doubtful account 2000.00
Net Realizable Value of account receivable 23,000.00
Assuming Br 500 of the receivables is believed to be uncollectible and is written off on January 10, the entry would as
follows:
Allowance for Doubtful Account. 500.00
Accounts Receivables 500.00
Account receivable 24,500.00
Less: Allowance for Doubtful Account 1,500.00
Net Realizable Value of Account Receivable 23,000.00
Note: there is no change in net realizable value of account receivable.

Further assume that the Br 500 written-off in the preceding journal entry is later collected. The entry to reinstate the
account would be as follows:
Accounts Receivables 500.00
Allowance for Doubtful Account. 500.00

Estimating Uncollectible
The estimate of uncollectible at the end of the fiscal period is based on past experience and forecasts of future business
activity. The two methods to estimate uncollectible are:
1. Estimate Based on Credit Sales
2. Estimate Based on Analysis Age of Receivables

1. Estimate Based on Credit Sales

The probable amount of the accounts that will be uncollectible is estimated based on credit sales. The amount of this
estimate is added to whatever balance exists in allowance for doubtful accounts.
Example 8.13: Assume that the allowance account has a credit balance of Br 1,500 before adjustment. The credit sales for

16
the year is Br 100,000 and it is known from past experience 1% of the credit sales will be uncollectible. Therefore, the
adjusting amount will be = 1% @ 100,000= Br 1,000
Uncollectible Account Expense. 1,000.00
Allowance for Doubtful Accounts 1,000.00
After adjusting entry is posted, allowance for doubtful account has Br 2,500 credit balance.
If the balance of Allowance for Doubtful Account had been a debit balance of Br 300, the amount of the adjustment
would still have been Br 1,000 (that is 1% @ 100,000)
Uncollectible Account Expense. 1,000.00
Allowance for Doubtful Accounts 1,000.00
After the adjusting entry is posted, allowance for doubtful account has Br 700 debit balance.
Note: a newly established business enterprise, having no record of credit experience, may obtain data from trade
association journals and other publications.
2. Estimate Based on Analysis of Age of Receivables (Aging of Receivables)
There are some steps in aging of receivables methods:
1. Classify account receivable by age(days that receivables past due)
2. Provide percentage provision for uncollectibility
3. Apply the percentage

Example 8.14:
Amount of Est. Percentage Amount of
Age Interval Receivable of uncollectible Uncollectible
Not due 60,000 1% 600
1 – 30 days 15,000 2% 300
31 – 60 days 10,000 10% 1,000
61 – 90 days 8,000 25 % 2,000
The Estimate of Uncollectible 3,900
The estimate of uncollectible account is 3,900. This amount is the desired balance of the Allowance for Doubtful Account
after adjustment. Therefore, the adjustment will be determined taking into account the existing balance of the Allowance
for Doubtful Account. Assume, the Allowance for Doubtful Account has a credit balance of Br 1,500 before adjustment.
The adjusting entry will be by Br 2,400 (3,900 – 1,500)
Uncollectible Account Expense. 2,400
Allowance for Doubtful Accounts 2,400
After posting is made, the Allowance for Doubtful Account has a credit balance of Br 1,500 + 2,400 = Br 3,900. If there had
been a debit balance of Br 300 in the Allowance for Doubtful Account before the year end adjustment, the amount of the
adjustment would have been 4,200 (3,900 + 3,00=4,200)
Uncollectible Account Expense. 4,200
Allowance for Doubtful Accounts 4,200
After posting is made, the Allowance for Doubtful Account has a credit balance of Br 3,900.

2. Direct Write-off Methods

It is useful when:
1. A particular customer is known
17
 2. Bankruptcy notice is available
3. There is a continuous correspondence with customers
4. There is disappearance of a customer through death
 The entry to write off an account when it is believed to be uncollectible is as follows:
Uncollectible Account Expense. xxxxx
Accounts Receivables xxxxx
 If an account that has been written off is collected later, the account should be reinstated.
 If the recovery is in the same fiscal year as the write off, the entry to reinstate is
Accounts Receivables xxxxx
Uncollectible Account Expense. xxxxx
 If the recovery is made in the subsequent fiscal year, it may be reinstated by an entry illustrated below:
Accounts Receivables xxxxx
Recovery of Written-off Uncollectible Account. xxxxx

18