Uses of Cash: Companies use cash to repay creditors from whom they borrowed cash, pay owners for their investments, pay for costs involved in management operations, and to acquire other resources. Each of these uses of cash is examined below.

Paying for borrowed cash: The payment to creditors for borrowed cash is one common way that companies use cash. For example, consider the June 16 cash loan discussed earlier. If the loan is repaid on September 13, the company will have to pay the $12,000 principal plus $295.89 interest ($12,000 x .10 x 90/365 = $295.89). If the company pays the principal and interest on September 13, show the effects on the company's resources and sources of resources.

 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $12,295.89
cash

=

- $12,000
notes payable

- $295.89
interest payable

 

 

 

 

 

When the company pays the loan and interest, its resources (cash) decrease. Since the cash was paid to the creditor, the company's liabilities to that creditor decrease as well because the company no longer owes the cash to the creditor. The $295.89 interest payable liability resulted from four monthly journal entries that recorded the interest expense of using the $12,000. June's interest expense was $49.32, as shown earlier in this chapter as a debit to interest expense and a credit to interest payable ($12,000 x .10 x 15/365). July's interest expense was $101.92 ($12,000 x .10 x 31/365), August's interest expense was $101.92 ($12,000 x .10 x 31/365), and September's interest expense was $42.73 ($12,000 x .10 x 13/365).

Remembering that assets increase with debits (and decrease with credits) and that debits equal credits, prepare the journal entry to record the cash payment of the loan and interest.

Date

Description

Post.
Ref.

Debits

Credits

Sept. 13

Notes Payable

 

12,000.00

 

 

Interest Payable

 

295.89

 

 

     Cash

 

 

12,295.89

 

Loan repayment

 

 

 

 

Cash was credited in the above journal entry because cash decreased, cash is an asset, and assets increase with debits and decrease with credits. The debits required because debits must equal credits were to the liability accounts. If you remember that liability accounts decrease with debits, you support the debits to notes payable, short-term and interest payable.

 

Practice Exercise

 

On September 21, the Christopher Corporation borrowed $10,000 from the Yanco Cooperative Bank by signing a 12%, 30-day note payable.

1. Determine the Christopher Corporation's total cost of borrowing the $10,000.

Interest is the cost of borrowing.

Interest = principal x interest rate x time.

Interest = $10,000 x .12 x 30/365.

Interest = $98.63.

2. Determine the Christopher Corporation's interest expense for using the $10,000 in September.

The Christopher Corporation used the $10,000 cash for 10 days in September: September 21 through September 30. Therefore, the Christopher Corporation should recognize interest expense for 10 days, as follows.

Interest = principal x interest rate x time.

Interest = $10,000 x .12 x 10/365.

Interest = $32.88

3. Determine the Christopher Corporation's interest expense for using the $10,000 in October.

The Christopher Corporation used the $10,000 cash for 20 days in October: October 1 through October 20. Therefore, the Christopher Corporation should recognize interest expense for 20 days, as follows.

Interest = principal x interest rate x time.

Interest = $10,000 x .12 x 20/365.

Interest = $65.75

Notice that the Christopher Corporation's September interest expense ($32.88) plus its October interest expense ($65.75) equals its total cost of borrowing ($98.63).
 

Paying cash to owners: Owners receive cash from corporations after management has generated resources for the corporation (net income) and the board of directors declares dividends. Show the effects on the company's resources and sources of resources if the company pays a $2,000 cash dividend declared by the board of directors on June 22.

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $2,000
cash

=

 

 

 

 

- $2,000
dividends

 

The effect of paying a cash dividend is a decrease in the company's resources (assets) as cash flows out of the company. Since the cash is paid to the owners, their rights to the company's resources decrease as well. Thus, stockholders' equity also decreases. The specific stockholders' equity account affected is the dividends account.

Remembering that assets increase with debits (and decrease with credits) and that debits equal credits, prepare the journal entry to record the $2,000 cash dividend payment.

Date

Description

Post.
Ref.

Debits

Credits

June 22

Dividends

 

2,000

 

 

     Cash

 

 

2,000

 

June dividends

 

 

 

 

Cash was credited in the above journal entry because cash decreased, cash is an asset, and assets increase with debits and decrease with credits. The debit required because debits must equal credits was to the stockholders' equity account dividends. If you remember that stockholders' equity decreases with debits, you support the debits to dividends because dividends reduce stockholders' equity.

As will be discussed more fully in Chapter 12, the accounting for cash dividends is not quite as simple as was presented above. The net effects, however, are decreases in the company's resources (assets) and sources of resources (stockholders' equity).
 
 

** You now have the background to do text exercise 6.3.

 

Cash used by management: Companies often use cash to pay for products and services that are quickly used up. For example, companies pay cash for renting office space, for insurance protection, or for electricity. Show the effects on the company's resources and sources of resources if the company pays $120 on June 27 for telephone services used during June.

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $120
cash

=

 

 

 

 

- $120
telephone expense

 

When the company pays $120 cash, its resources (assets) decrease. Since the cash is paid for resources that were used up by management, the company's sources of resources, stockholders' equity, decrease as well. Stockholders' equity decreases because owners are responsible for resources used up by management. The specific stockholders' equity account affected is the telephone expense account.

Remembering that assets increase with debits (and decrease with credits) and that debits equal credits, prepare the journal entry to record the $120 cash payment for telephone services

Date

Description

Post.
Ref.

Debits

Credits

June 27

Telephone Expense

 

120

 

 

     Cash

 

 

120

 

June telephone expense

 

 

 

 

Cash was credited in the above journal entry because cash decreased, cash is an asset, and assets increase with debits and decrease with credits. The debit required because debits must equal credits was to the stockholders' equity account telephone expense. If you remember that stockholders' equity decreases with debits, you support the debits to telephone expense because expenses reduce stockholders' equity.
 

Using cash to obtain other resources: Companies often use cash to acquire other resources. For example, companies pay cash for supplies and insurance protection. Show the effects on the company's resources and sources of resources if the company pays $900 on June 7 for supplies it will use in June and July.

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $900
supplies

- $900
cash

 

 

 

 

 

 

 

When the company pays $900 cash, its resources (assets) decrease. Since the cash is paid for other resources, the company's resources increase by $900 as well. Thus, the conversion of cash resources into other resources, like supplies, does not change the company's total resources or total sources of resources. The company's total resources and sources of resources will both decrease, however, when the supplies are used up by management.

Remembering that assets increase with debits (and decrease with credits) and that debits equal credits, prepare the journal entry to record the $900 cash payment for supplies.

Date

Description

Post.
Ref.

Debits

Credits

June 7

Supplies

 

900

 

 

     Cash

 

 

900

 

Supplies purchase

 

 

 

 

Supplies were debited in the above journal entry because supplies increased, supplies are assets, and assets increase with debits. The credit required because debits must equal credits was to the cash account. If you remember that asset accounts decrease with credits, you support the credit to cash because cash decreased when it was paid out.


Practice Exercise

During March, the Christopher Corporation engaged in many transactions, three of which were the following. $22,000 cash was paid to employees for work they did in March. Utility bills for $2,000 were received for utilities services used up by the company in March. The utility bills will be paid in April. $5,000 cash was paid to suppliers for supplies purchased in January.

1. Determine the total dollar amount of cash the Christopher Corporation paid out during March.

Cash paid to employees in March

$22,000

Cash paid to suppliers in March

$5,000

Total cash paid in March

$27,000

 

The $2,000 utility bills received did not result in cash going out of the Christopher Corporation in March because they will be paid in April.

2. Determine the total dollar amount of the Christopher Corporation's March expenses.

Employee services used up in March

$22,000

Utility services used up in March

$2,000

Total March expenses

$24,000

 

Expenses are recorded when resources are used up through management operations. Resources decrease and stockholders' equity decreases. The $5,000 cash paid to suppliers for supplies purchased prior to March resulted in a decrease in cash and a decrease in accounts payable. An expense would be recognized when the supplies are used, not when they are purchased or when suppliers are paid.


** You now have the background to do text exercise 6.4.

 

 

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