The group also includes accruals of earnings of every description, such as accrued interest on bonds, dividends receivable on stocks, accrued interest on notes and accounts receivable, etc. Separate accounts for each of these items will usually appear in the general ledger, although cash in hand and on deposits is frequently consolidated in the balance sheet.
Cash in hand is sometimes known as petty cash. Working funds are sometimes known as petty cash. There should never be any question as to whether or not an account for cash should appear in the ledger. It is to be presumed that a general ledger which has been posted up will permit of a trial balance being taken from it. This would not be possible if the ledger did not include a cash account and such exclusion would constitute a violation of the principles upon which a general ledger is run.
It is difficult to describe any fixed rule for the handling of cash and cash accounts. In some cases there will be but one account for cash in the general ledger. Under such circumstances all receipts and disbursements are put through one cash book and if there be petty cash accounts or other cash funds, books for such classes of items will be made subsidiary to the general cash book. This method of handling the cash is somewhat complicated. The debit side will show receipts of every description, whether deposited in the bank or not. The credit side will show disbursements of every kind, whether by check or in actual cash. The balance of the cash account in the general ledger will require for proof the adding together of the cash in bank and the cash in hand.
The scheme of classifying the cash and maintaining in the general ledger separate accounts for each kind or class is largely used. Where there is cash in bank, petty cash and working funds, there should be separate accounts in the general ledger for cash in bank, petty cash and working funds. It is highly important that all cash receipts of whatever nature should be deposited in the bank. If such method be followed the general cash book will show only receipts on the one side and disbursements by check on the other side. The balance in the cash book will agree with the balance shown in the ledger and may be easily reconciled to the balance reported by the bank. For miscellaneous disbursements and the establishment of working funds checks should be drawn and the amounts involved charged to the respective accounts, namely petty cash and working funds. A separate cash book will be kept for petty cash which will show on the debit side only receipts from general cash or cash in bank and on the credit side actual cash disbursements. The balance in the petty cash book at the end of the month will agree with the account for petty cash in the general ledger after the posting has been made. Such a segregation makes it possible to control the petty cash and in reality it partakes of the nature of a working fund except that the amounts transferred from the general cash may vary from month to month.
A working fund or an imprest cash fund is a definite sum, adequate to meet the demand for disbursements which the volume of transactions during a definite period necessitates, and which will at all times if properly conducted show either actual cash, or cash and paid vouchers, agreeing in total with the amount set aside. Such provisions are frequently made for general cashiers, department cashiers, traveling salesmen, or other employees engaged in traveling, and branch office managers or cashiers. For example, suppose that the expenses of the Chicago office of a New York concern amounted approximately to $1,200 a month. In order that the manager of the Chicago office might at all times have ample funds on hand out of which to meet current expenses, it is probable that not less than $1,500 would be forwarded to him by check. This would constitute his working fund. The amount would be charged on the general ledger at New York to a Chicago fund account. The cashier of the Chicago office would from time to time, as he made disbursements, replace the cash with vouchers. At all times if his accounts were correct he should have $1,500, either in cash or represented by vouchers. At the end of the month when he made up his cash report hewould classify the expenses in accordance with instructions and forward it to the New York office. There would of course be an interval of a few days during which time he would have nothing to show for his disbursements except a copy of the report He would, however, in effect have an account receivable from the New York office for the exact amount of vouchers which he had transmitted. Upon receipt of the report at the New York office it might be journalized, put through a distribution book or put through the voucher register. Regardless of how it was handled the expenses would be charged to the appropriate account and the amount of the disbursements credited to the Chicago fund account. A check would subsequently be issued for the amount of the disbursements to the Chicago office, thereby restoring the fund to $1,500.
The question sometimes arises as to whether the credits to the working fund account for disbursements and subsequent charges to the account in precisely similar amounts for reimbursements should be shown in the ledger account for working funds. It seems that this should be done if for no other than historical purposes. It is true of course that the account will show the amount of the fund as an opening item, with offsetting debits and credits each month, resulting in a balance representing the amount of the fund. This may appear to be of no value but it would seem to have the effect of showing that disbursements had been reported from time to time and checks for reimbursement had been issued. Working funds will usually be carried in the balance sheet as current assets.
Accounts receivable as a balance sheet caption may represent merely accounts with regular customers or it may comprise accounts receivable of every description. The accounts with customers will usually be represented by a controlling account supported by underlying ledgers, whereas occasion may require that separate general ledger accounts be opened with parties other than customers, who are indebted to the concern. The books for customer accounts vary in form and arrangement. The accounts are sometimes separated into several volumes for the purpose of facilitating the bookkeeping work, controlling individually the work of various bookkeepers, controlling certain classes of business, or certain territories.
For balance sheet purposes accounts are frequently classified as good, doubtful and bad, and reserves are introduced to provide for the bad and doubtful ones. It is a matter of question as to how long an account should be carried before being considered bad. It is questionable further as to whether an account which is considered bad shall actually be charged off against the reserve until it is proven absolutely that the amount will not be collected. A good account may become tainted and doubtful. It may subsequently be declared bad and impossible of collection. Such a decision, however, is merely as a rule an opinion. Accounts which are undisputably bad may eventually produce something. A man who will not pay may be sued, a judgment secured and the amount collected, if he has anything. Sometimes a man would like to pay and cannot. Bankruptcy follows and the creditors receive a pro rata share of their claims in liquidation. In the writer’s opinion an account should not be written off against a reserve until such time as a judgment has been returned unsatisfied or if the account is involved in bankruptcy where the final liquidation dividend has been received. Writing off accounts promiscuously frequently leads to trouble, for the reason that accounts written off may subsequently be collected and upon receipt of the money, if no record of the account has been kept, it may be appropriated by dishonest employees. If bad accounts are carried on the books and adequate provision is made in the reserve, it would seem to have the desired effect in so far as” valuation is concerned and still preclude any possibility of writing off an account and having it subsequently collected without a record of the collection being made.
To pacify ledger clerks, or bookkeepers on underlying ledgers, accounts which are considered bad are sometimes transferred to a suspense ledger. This procedure has the effect of relieving the bookkeeper from including such accounts in his trial balance month after month and still makes it possible to preserve the record of the accounts until they are lost beyond question. Many concerns provide against losses on bad accounts by carrying credit indemnity or credit insurance, in which case a premium is paid the same as in the case of fire, life or other insurance.
As an asset a note is apt to be looked upon as better than an account. This opinion is questionable since neither is preferred over the other in bankruptcy proceedings or in liquidation. The main legal difference between a note and an account is that the former in effect confesses judgment as to the amount and requires no further proof in this respect, whereas in bringing action to collect on an account all the items making up the account must be proven. Care should be taken to distinguish notes from bills. This distinction is made very clear in the New York negotiable instruments law which requires that the word note shall only be used for the purpose of describing a promissory note, whereas the word bill shall be understood to mean a bill of exchange, either foreign or domestic. A bill of exchange is a draft which in reality partakes somewhat of the nature of a check. It is a request addressed to party number one by party number two to pay a certain amount of money to party number three. If accepted by party number two it becomes in effect a note, except for the /act that it does not usually bear interest.
Notes may be interest bearing or non-interest bearing. In some cases the note will, for example, call for the payment of $1,000 on a certain date with interest at 6%. In other instances where it is the intention to pay interest on $1,000, instead of such sum being specified in the body of the note, it might call, for example, for the payment of $1,023.59 at a given date. It is important that notes should be scrutinized carefully in this respect on account of the effect which one or the other of these conditions may have upon the treatment of interest. If the balance in the account of a given customer is $1,000, and the customer remits in settlement of the account a note for $1,000 bearing interest at 6%, upon receipt of the note one entry only is necessary; a credit to accounts receivable and a charge to notes receivable. If, however, the end of the accounting period falls within the period covered by the time stated in the note, then in closing the books, cognizance must be taken of the interest on such note which has run from the date of the note to the end of the accounting period. The entry covering this accrual would consist in charging interest on notes receivable and crediting interest earned on notes receivable. When subsequently the note is paid with interest a somewhat more involved entry becomes necessary. The amount of cash received covers not only the face of the note, but the interest thereon. The amount involved will presumably be greater than the face of the note and accrued interest which was set up at the previous closing date. Therefore the payment in reality includes three things, namely, the face of the note which appeared among the notes receivable, the amount of the accrued interest which was contained in the corresponding account, and an amount of interest which has as yet received no treatment so far as the books are concerned. Thus to cover such a transaction when cash is charged, the three accounts to be credited are notes receivable, accrued interest on notes receivable, and interest earned on notes receivable.
Where the face of the note includes the interest, the interest must be credited upon receipt of the note to the interest earned account rather than to the customer. In such an event care must be taken upon closing the books to see that the unearned proportion of such interest received in advance is properly set up. If a note for $1,030, dated June 1st and payable six months later appeared upon the books, at closing time provision should be made for the unearned proportion by deferring it to a subsequent period. When the note for $1,030 was received, presumably notes receivable were charged with $1,030, while the customer was credited with $1,000, and interest earned with $30.00. Upon closing the books on June 30th, 5/6 of the interest appears to have been unearned and the proper entry charging interest earned on notes receivable and crediting interest unearned on notes receivable would be in order.
The notes receivable are usually represented by a controlling account in the general ledger in which at times the accrued interest is included. It is thought to be better accounting, however, to use a separate account for such items so that as far as possible the notes receivable account will show nothing but the face of the note. Various forms of subsidiary records are in use for the purpose of carrying notes receivable, but whatever the form it is essential that they shall show the date, amount, when due, rate of interest, and the name of the maker.
Notes receivable are sometimes discounted. This happens as a rule when the holders are unable to wait for the notes to mature and be paid. The practice is sometimes indulged in for profit where the difference in interest rates is sufficient to warrant it. The taking of notes at 6% and discounting them at 4% will, if the volume of transactions is sufficiently great, produce quite a tidy sum in interest. This cause of notes being discounted is the exception, probably, rather than the rule. The principal reason for discounting them is usually the need for cash. The taking of a note from a customer will result in a charge to notes receivable and a credit to accounts receivable. If later the note is discounted cash will be charged, and off-hand, it may appear that notes receivable would be credited. There would be no objection to this if a note were like merchandise and the transaction were complete with the passing of title. In the case of a note the promise of the customer to pay is supported by the endorsement of the concern which discounts it and in the event of the customer’s failure to pay the note at maturity, the bank may hold the endorser. The possibility of such an event occurring makes liability in connection with the note a contingency. Hence we speak of the contingent liability for notes receivable discounted. Here then is the objection to crediting notes receivable when cash is charged. The objectors to so doing contend that an account called notes receivable discounted should be credited to show the contingent liability. This contention in turn is met with the objection that the notes physically have passed out of the possession of the company and will in nine cases out of ten never again come into the possession of the company. As a compromise a third method of treatment suggests ignoring each of the above methods in part and making mention of the fact that they are notes receivable discounted and outstanding, with the amount thereof, as a foot note on the balance sheet.
In the matter of showing notes receivable discounted on the balance sheet there is a choice of three ways. The first is to include on the right hand side of the balance sheet among the current liabilities an item for notes receivable discounted, giving it the effect of an offset to the notes receivable shown on the left hand side among the current assets. The second way is to withdraw from the current assets and show separately on the asset side, below the current assets the amount of the notes receivable which have been discounted, referring in parentheses to the contra account on the opposite side of the balance sheet for notes receivable discounted, which item will appear below the current liabilities. Both of these methods have the effect of showing the contingent liability in the balance sheet proper. The third method is to exclude from both the assets and liabilities the notes receivable discounted and refer to them in a foot note at the bottom of the balance sheet. The foot note might read as follows: “Contingent liability for notes receivable discounted and outstanding, $10,000.”
The treatment of the interest involved in notes receivable discounted demands some little attention. To illustrate this point let it be assumed that there is received from the customer a note for $30,000, due in 90 days, and bearing interest at 6%. The interest on such a note would amount to $450. The note would stand on the books at $30,000, while no entry would be made until the end of the month for the interest. At the end of the month accrued interest on notes receivable would be charged and interest on notes receivable credited. If the notes were to be discounted after 45 days had elapsed from the date of its issue, assuming that the discount were figured by the interest method rather than by the true discount method, there would be received from the bank $30,225. This amount is really divisible into three parts, $30,000, $150 and $75. While the total of the three would be chargeable to cash, $30,000 would be credited to the notes receivable account, $150 to the account for accrued interest on notes receivable and $75 to the interest earned on notes receivable.
A slight variation of these steps would result if the note instead of bearing interest at 6% were to have the amount of interest included in the face. Thus upon receipt, notes receivable would be charged with $30,450, and $30,000 would be credited to the customer and $450 to the interest on notes receivable. At the end of the month interest on notes receivable would be charged and interest unearned on notes receivable credited with $300. If as in the preceding instance the notes were discounted 15 days later and realized $30,225, cash would be charged with $30,225, notes receivable would be credited with $30,225, but an adjustment would be necessary between the notes receivable account and the interest unearned on notes receivable in order to close out the difference remaining in the notes receivable account of $225. This could be most easily accomplished by an entry which would charge interest unearned on notes receivable with $300 and credit notes receivable with $225 and interest on notes receivable with $75. For practice purposes complications may be introduced in both of the above mentioned instances by taking the interest on the notes at one rate and the discount at another rate. It is thought that sufficient time has been given to this topic so that no further illustrations on this point will be indulged in.
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