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Intermediate_Accounting_Chapter07 - 1460T_c07.qxd 11:08 am...

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Learning Objectives After studying this chapter, you should be able to: 1 Identify items considered as cash. 2 Indicate how to report cash and related items. 3 Define receivables and identify the different types of receivables. 4 Explain accounting issues related to recognition of accounts receivable. 5 Explain accounting issues related to valuation of accounts receivable. 6 Explain accounting issues related to recognition of notes receivable. 7 Explain accounting issues related to valuation of notes receivable. 8 Explain accounting issues related to disposition of accounts and notes receivable. 9 Describe how to report and analyze receivables. C H A P T E R S E V E N C A S H A N D R E C E I VA B L E S Recently, Nortel announced that its net income for 2003 was really half what it originally reported. In addition, the company had understated net income for 2002. How could this happen? One reason: It appears that Nortel set up “cookie jar” reserves, using the allowance for doubtful accounts as the cookie jar. As the following chart shows, in 2002 Nortel overestimated the amount of bad debt expense (with a sizable allowance for doubt- ful accounts). Then, in 2003 Nortel slashed the amount of bad debt expense, even though the total money owed by customers remained nearly unchanged. In 2002, its allowance was 19 percent of receivables compared to 10 percent in 2003—quite a difference. It is difficult to determine if the allowance was too high in 2002 or too low in 2003, or both.Whatever the case, the use of the allowance cookie jar permitted Nortel to report higher operating margins and net income in 2003. This analysis suggests the importance of looking carefully at the amount of bad debt expense reported in annual reports. Sometimes companies use it to artificially decrease in- come. Others understate bad debt expense to increase income. For example, analysts have noted that many large hospitals, such as Tenet Healthcare and HCA , may be facing in- creasing uncollectible accounts that are presently not fully reflected in their balance sheets. No-Tell Nortel 313 Adapted from J. Weil, “At Nortel, Warning Signs Existed Months Ago, Wall Street Journal (May 18, 2004), p. C3; and B. McLean, “Reality Checkup,” Fortune (January 12, 2004), p. 140. Amount customers owe, gross Allowance for doubtful accounts Allowance as % of gross Source : Company reports $2.62 billion $2.68 billion $256 million $517 million 10% 2003 2002 19%
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WHAT IS CASH? Cash , the most liquid of assets, is the standard medium of exchange and the basis for measuring and accounting for all other items. Companies generally classify cash as a current asset. Cash consists of coin, currency, and available funds on deposit at the bank. Negotiable instruments such as money orders, certified checks, cashier’s checks, personal checks, and bank drafts are also viewed as cash. What about sav- ings accounts? Banks do have the legal right to demand notice before withdrawal.
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Intermediate_Accounting_Chapter07 - 1460T_c07.qxd 11:08 am...

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