Question

George Jetson owns and operates a restaurant and catering business which has seen the business show an increase in revenue over the last 6 months. With an increase in revenues George realized the expenses would also increase, but expected to see an increase in the cash position of the business. In reviewing the cash position and bank account, he has realized there has been a decrease in the cash position. The business receives cash and credit cards at the restaurant and also extends credit to customers for the catering business.

1. Explain the internal controls George needs to have in place for the receipt of both cash and credit cards for the restaurant.
2. Explain the issues involved with extending credit to customers in regards to both trade receivables and notes receivables.
3. Select and defend one of the methods to handle the write-off of bad debt.

Answer 1

Answer to 1

Internal Controls for Cash and Credit Cards for the restaurant

For Cash - Purpose of the control on cash is to make sure that there is no fraud / misappropriation of cash etc. This also required to ensure that the employee who has been assigned with the responsibility of cash are accountable and owns up the responsibility.

For receipt of cash following Internal Control measures can be introduced.

1. Duties Separation - Its always advisable to have to different employee for the different work, it also acts as a Checker and Maker process. For receiving cash there should be different employee and for depositing cash there should be different employee. For accounting of the cash employee should be different and also cash checking should be done at the end of the day to ensure whether proper recording has been done or not. Also, for approval of cash payments there should be the person authorized who approves the payment without whose approval no cash payment should be made.

2. Access - All the employees should not be given access to cash. This should be restricted and authorized access only. Cash which should be kept in the locker, access of the same should be given to authorized person only. Also, that should be locked always and to be opened as & when needed. Frequency of opening the locker for cash should also be controlled / reduced.

3. Documentation - There should be proper documentation of all the cash receipts and payments. All, the authorization should be properly documented so that same can be retrieved as & when needed. Documentation also helps in ascertaining whether the proper processes were followed or not and would be helpful while conducting audit.

4. Reconciliation - Proper reconciliation should be done periodically so that any deviation / differences can be figured out and controlled. As & when reconciliation is done same should be documented and signed.

5. Cash Deposit to Bank - Since being in the restaurant business frequency of cash receipt is high hence its always advisable to deposit the cash next day itself into the Bank. This reduces the risks of cash theft and fraud.

6. Fake Notes / Currency - There should be proper training to the person who is handling cash as to how to identify the fake currencies. Any, fake currencies if overlooked would be a big loss for the restaurant business keeping the mind there is too much cash might be involved in the restaurant business.

Internal Controls for Credit Cards

1. Training for using the machine - A proper training should be given to employees as to how to use the machine for swapping the credit card. Although, it seems a small work however an employee who does not know at all can send a wrong message to the customer.

2. Proper tagging of Sales to the Receipt of Credit Card - Credit card payment made against the particular sales bill should be properly tagged for proper tracking and recording purposes.

3. Processors / Equipment for Credit Cards - Its always advisable to use the processors (For Credit Card Payment) form a reputable organisation however always make sure that proper comparison with other banks are also done as far as fees is concerned.

4. Reconciliation - Reconciliation should be done with respect to the sales and credit card payment on everyday basis and also same should be tracked with bank statement as & when payments get credited from the bank.

Answer to 2

Issues Involved with extending credit to customer to both trade receivables and notes receivables

Trade Receivable - Sales made to the customers on credit is considered as trade receivables. This is required for increasing sales as this has been the practice in almost all the companies to extend credit to the customers. Collection terms from customers may differ from company to company as per the negotiations happened between both the parties to the contract involved. Trade Receivable is recorded in the balance sheet as "Current Assets".

Notes Receivable - This is basically "Promissory Notes" and customer while not being in position to pay the due immediately can make the payment through notes in which signature of the customer is also given. This is basically to buy more time for payments by the customer. If the Notes is due in less than 12 months then same is recorded under Current Assets otherwise under Non current Assets. This also involves Interest amount which is mentioned in the Notes itself. Hence, we can say that Note receivable is nothing but extended Trade Receivables with Promise to pay executed through the documents with interest.

Issues are as follows.

1. Risks of Non Payments - Although credit is part & parcel today's business however there is always risks of non-payment form the customer. This can adversely impact the profitability of the company. This also impacts the Cash Flow of the company.

2. Untimely Payment - All the companies prepare the Cash Flows based on the expected collection from customer. Any delay in payment would jeopardize the cash flow position of the company.

3. Further Negotiations - Although, all the terms & conditions are pre-finalized. Its been observed that many times customers at the time of clearing dues further negotiate on the discounts or bring in issues with respect to quality / implementations of the work (Basically for less payment) although there might not be any issue as such.

4. Background of the Customer - If checking of the customer is not properly done before extending credit to the customer then the risks of non-recovery of dues are high. Hence, a proper background checking of the customer is recommended all the time.

Answer to 3

Methods to handle write off of Bad Debt.

There are two methods of write off Bad Debt

1. Direct Write off.

2. Allowance method.

In Direct write off method Bad debt is directly debited receivable accounts is credited. However, In case of Allowance method following steps are followed.

When creating bad Debt for the customer in anticipation that there is possibility of non recovery of amount

1. Bad Debt Expense A/c Dr

To Allowance for Doubtful Debts

When the actual collection is finally not receivable and goes bad.

2. Allowance for Doubtful Debts A/c Dr

To Trade Receivable A/c

Allowance Method should always be followed as the company identifies in advance the amount which can go bad and accordingly profitability of the company is given immediate impact. Also, this gives time and scope to the company to take corrections and measures for recovery of the amount. If after all the negotiations and discussion company fails to recover the amount the same can finally be adjusted with Trade receivables as mentioned above.