Electronic Presentation by Douglas Cloud Pepperdine University Survey of Accounting Electronic Presentation by Douglas Cloud Pepperdine University Carl S.Warren

Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

Chapter 6 Receivables and Inventories

After studying this chapter, you should be able to: Learning Objectives 1. Describe the common classifications of receivables. 2. Describe the nature of uncollectible receivables. 3. Describe methods of estimating uncollectible receivables. 4. Describe the common classifications of inventories. After studying this chapter, you should be able to: Continued

Learning Objectives 5. Describe the three inventory cost flow assumptions and how they impact the financial statements. 6. Compare and contrast the use of inventory costing methods. 7. Describe how receivables and inventories are reported on the financial statements. 8. Compute and interpret the accounts receivable and inventory turnover ratios.

Learning Objective 1 Describe the common classifications of receivables.

When merchandise or services are sold on credit, an account receivable is established.

Most accounts receivable are expected to be collected in 30 to 60 days; so, they are current assets.

Notes receivable are amounts that customers owe for which a formal, written instrument of credit has been issued. Dec. 13, 2005 I promise to pay__________________________________ ____________________________________________ at an interest rate of _____% within ______ days. ________________________ Douglas Cloud One Thousand Dollars and no/100 6 90 T. Wood

Learning Objective 2 Describe the nature of uncollectible receivables.

Often when a company issues its own credit card, it sells its receivables to other companies. This is called factoring and the buyer is called the factor.

Regardless of the care used in granting credit and the collection procedure used, normally a part of the credit sales will not be collectible.

The two methods of accounting for receivables that appear to be uncollectible are the allowance method and the direct-write-off method.

Learning Objective 3 Describe methods of estimating uncollectible receivables.

Estimating Uncollectibles Estimate Based on Sales

Estimating Uncollectibles Estimate Based on Aging of Receivables The process of determining how long a receivable has been outstanding and attaching a percentage to that time period is referred to as aging the receivables.

Estimating Uncollectibles Estimate Based on Aging of Receivables The longer an account has been outstanding, the less like the receivable will be collected.

Accounts Receivable Aging and Uncollectibles Not Days Past Due Past over Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365 Ashby & Co. $ 150 $ 150 B. T. Barr 610 $ 350 $260 Brock Co. 470 $ 470 J. Zimmer Co. 160 160 Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300 Total accounts receivable shown by age.

Accounts Receivable Aging and Uncollectibles Not Days Past Due Past over Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365 Ashby & Co. $ 150 $ 150 B. T. Barr 610 $ 350 $260 Brock Co. 470 $ 470 J. Zimmer Co. 160 160 Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300 Uncollectibles PERCENT 2% 5% 10% 20% 30% 50% 80% Uncollectible percentages based on experience and industry averages.

Accounts Receivable Aging and Uncollectibles Not Days Past Due Past over Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365 Ashby & Co. $ 150 $ 150 B. T. Barr 610 $ 350 $260 Brock Co. 470 $ 470 J. Zimmer Co. 160 160 Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300 Uncollectibles PERCENT 2% 5% 10% 20% 30% 50% 80% AMOUNT $3,390 = $1,500 $200 $310 $380 $360 $400 $240

Estimating Uncollectibles Estimate Based on Aging of Receivables

Estimating Uncollectibles Estimate Based on Aging of Receivables Notice that when the estimation is based on accounts receivable, the calculated amount is the desired ending balance in the allowance account.

Write-Offs to the Allowance Account On January 21 John Parker, one of Richards Company’s receivables, files for bankruptcy. Thus, his account of $6,000 is deemed uncollectible.

Collecting a Written-Off Account John Parker won the state lottery, so he is paying all of his bankruptcy debts. On June 10, Richards Co. receive a check for $6,000.

Learning Objective 4 Describe the common classifications of inventories.

Materials inventory consists of the cost of raw materials used in manufacturing a product. Work in process inventory consists of the costs for partially completed products. Direct materials Direct labor costs Factory overhead

Finished goods inventory consists of the costs of direct materials, direct labor, and factory overhead for completed products. When the merchandise is sold, the costs are transferred to Cost of Goods Sold

Learning Objective 5 Describe the three inventory cost flow assumptions and how they impact the financial statements.

Three identical units of Item X are purchased during May. One unit is sold on May 30 for $20, the unit that was purchased on May 18. Three identical units of Item X are purchased during May. Item X Units Cost May 10 Purchase 1 $ 9 18 Purchase 1 13 24 Purchase 1 14 Total 3 $36 Average cost per unit $12 Specific Identification

The gross profit from this sale would be $7, which is the selling price of $20 less the May 18th cost of $13.

Fifo Method Purchased goods FIFO Sold goods

Fifo Method Item X Units Cost May 10 Purchase 1 $ 9 18 Purchase 1 13 Total 3 $36 Average cost per unit $12

Effect of Inventory Costing Methods on Financial Statements Fifo Method Effect of Inventory Costing Methods on Financial Statements $14 13 Balance Sheet Merchandise inventory $27 Income Statement Sales $20 Cost of merchandise sold 9 Gross profit $11

Lifo Method Sold goods Purchased goods LIFO

Lifo Method Item X Units Cost May 10 Purchase 1 $ 9 18 Purchase 1 13 Total 3 $36 Average cost per unit $12

Effect of Inventory Costing Methods on Financial Statements Lifo Method Effect of Inventory Costing Methods on Financial Statements Income Statement Sales $20 Cost of merchandise sold 14 Gross profit $ 6 $13 9 Balance Sheet Merchandise inventory $22

Average Cost Method Purchased goods Sold goods Average Cost

Average Cost Method Item X Units Cost May 10 Purchase 1 $ 9 Total 3 $36 Average cost per unit $12

Effect of Inventory Costing Methods on Financial Statements Average Cost Method Effect of Inventory Costing Methods on Financial Statements $12 12 Income Statement Sales $20 Cost of merchandise sold 12 Gross profit $ 8 Balance Sheet Merchandise inventory $24

Learning Objective 6 Compare and contrast the use of inventory costing methods.

First-In, First-Out Net sales $15,000 Cost of merchandise sold: Beginning inventory $ 1,800 Purchases 8,600 Merchandise available for sale $10,400 Less ending inventory 3,400 Cost of merchandise sold 7,000 Gross profit $ 8,000

Average Cost Net sales $15,000 Cost of merchandise sold: Beginning inventory $ 1,800 Purchases 8,600 Merchandise available for sale $10,400 Less ending inventory 3,120 Cost of merchandise sold 7,280 Gross profit $ 7,720

Last-In, First-Out Net sales $15,000 Cost of merchandise sold: Beginning inventory $ 1,800 Purchases 8,600 Merchandise available for sale $10,400 Less ending inventory 2,800 Cost of merchandise sold 7,600 Gross profit $ 7,400

Inventory Costing Methods 600 500 400 300 200 100 Number of firms (> $1Billion Sales) FIFO LIFO Average cost

Learning Objective 7 Describe how receivables and inventories are reported.

Starbucks’ ASSETS Sept. 30, 2001 (in thousands) Current assets: Cash and cash equivalents $113,237 Marketable securities 107,312 Accounts receivable, net of allowance of $4,590 90,425 Inventories 221,253 Prepaid expenses and other current assets 61,698 Total current assets $593,925 Starbucks’

In the lower-of-cost-or-market method, market is the cost to replace the merchandise on the inventory date.

Valuation of Inventory at Lower-of-Cost-or-Market Unit Unit Inventory Cost Market Total Total Lower Item Quantity Price Price Cost Market C or M $ 3,800 2,700 4,650 3,920 Total $15,520 $15,472 $15,070 A 400 $10.25 $ 9.50 $ 4,100 $ 3,800 B 120 22.50 24.10 2,700 2,892 C 600 8.00 7.75 4,800 4,650 D 280 14.00 14.75 3,920 4,130 The market decline is either: 1. Based on total inventory ($15,520 – $15,472) = $48 2. Based on individual items ($15,520 – $15,070) = $450

Learning Objective 8 Compute and interpret the accounts receivable and inventory turnover ratios.

Accounts Receivable Turnover 2006 2005 Net sales on account $1,498,000 $1,200,000 Accounts receivable (net): Beginning of year $ 120,000 $ 140,000 End of year 115,500 120,000 Total $ 235,000 $ 260,000 Average $ 117,500 $ 130,000 12.7 9.2 Use: To assess the efficiency in collecting receivables and in the management of credit Net Sales Average accounts receivable $1,498,000 $117,500 $1,200,000 $130,000

Inventory Turnover Ratios Safeway Inc. Zale Cost of merchandise sold $22,482,400,000 $920,003,000 Inventories: Beginning of year $2,444,900,000 $571,669,000 End of year $2,508,000,000 $630,450,000 Average $2,476,450,000 $601,059,500 Inventory turnover 9.1 times 1.5 times Cost of merchandise sold Average inventory Use: To assess the efficiency in the management of inventory

Chapter 6 The End