1 Chapter 6 Investments and Receivables Financial Accounting, Alternate 4e by Porter and Norton

2 PepsiCo Inc. Consolidated Balance Sheet (partial) ASSETS (in millions) Dec. 28 Dec Current Assets: Cash and cash equivalents $1,638 $ 683 Short-term investments, at cost ,845 1,649 Accounts & notes receivable 2,531 2,142 Inventories 1,342 1,310 Prepaid expenses & other assets Total Current Assets $6,413 $5,853 selling on credit highly liquid

3 PepsiCo Inc. Consolidated Balance Sheet (partial) ASSETS (in millions) Current Assets: Cash and cash equivalents Short-term investments, at cost Accounts and notes receivable Inventories Prepaid expenses & other assets Total Current Assets Less Liquid Highly Liquid

Investment in CD Assets = Liab. + O/E + Rev. – Exp. Short-term Inv. – CD 100,000 Cash (100,000) Invest $100,000 in a 120-day CD. Principal plus 6% due upon investment maturity. Example: 4

Year-end adjusting entry : Assets = Liab. + O/E + Rev. – Exp. Interest Rec. 1,500 Interest Inc. 1,500 Investment in CD Interest = Principal x Rate x Time $1,500 = $100,000 x 6% x 90/360 5 October – 29 days November – 30 days December – 31 days 90 days

Upon investment maturity: Assets = Liab. + O/E + Rev. – Exp. Cash 102,000 Interest Inc. 500 Short-Term Inv. – CD 100,000 Interest Rec. 1,500 Investment in CD 6 Interest earned in January: $100,000 x 6% x 30/360 = $500

7 Reasons Companies Invest in Other Companies l Short-term cash excesses l Long-term investing for future cash needs l Exert influence over investee l Obtain control of investee

8 Accounting for Common-Stock Investments No significant influence 0%20% Fair Value Method Significant influence 50% Equity Method Control 100% Consolidated F/S Our Focus

9 Investments Without Significant Influence l Held-to-Maturity Securities l Trading Securities l Available-for-Sale Securities Use fair value method to account for these investments

10 Held-to-Maturity Securities l Bonds of other companies l Intent and ability to hold until maturity $100,000 9% Bond Due 2019

11 Held-to-Maturity Securities On 1/1/04, Homer buys: l $100,000; 10% face value. l Bonds mature December 31, 2013 l Interest payable semiannually. Example: Record the purchase of the bonds and receipt of the first interest payment

12 Recording Bond Purchase Assets = Liab. + O/E + Rev. – Exp. Inv. in Bonds 100,000 Cash (100,000) $100,000 10% Bond Due 2014

13 Recording Receipt of Interest Payment Assets = Liab. + O/E + Rev. – Exp. Cash 5,000 Interest Inc. 500 Interest for Investor Borrower

14 Recording Bond Sale Assets = Liab. + O/E + Rev. – Exp. Cash 99,000 Loss on Sale of Bonds 1,000 Inv. in Bonds (100,000) Interest for Investor Borrower

15 Trading Securities l Purchased to generate profit from short-term appreciation Stocks Bonds l Intent to sell in near term (classified as current assets)

16 Trading Securities Income Statement l Unrealized gain or loss recognized on income statement l At end of each period, security is “marked to market” Stocks Bonds

17 Trading Securities Dexter Corp. holds the following trading securities at 12/31/04: Cost Market Menlo preferred stock$25,000$27,500 Canby common stock 40,000 39,000 Example: Record the unrealized gain or loss at 12/31/04.

18 Recording Unrealized Gain or Loss on Trading Securities Assets = Liab. + O/E + Rev. – Exp. Inv. in MenloUnrealized Gain – Pref. Stock 2,500 Trading Sec.* 1,500 Inv. in Canby Pref. Stock (1,000) * income statement account

19 Available-for-Sale Securities l Securities not classified as held- to-maturity or trading Stocks Bonds l Can be classified as short-term or long- term, depending on expected date of disposition

20 Available-for-Sale Securities Balance Sheet l Unrealized gain or loss accumulated in stockholders’ equity account l Also “marked to market” at end of accounting period Stocks Bonds

21 Available-for-Sale Securities Lenox Corp. holds the following AFS securities at 12/31/04: CostMarket Adair preferred stock$15,000$16,000 Casey common stock 35,000 32,500 Example: Record the unrealized gain or loss at 12/31/04.

22 Recording Unrealized Gain or Loss on AFS Securities Assets = Liab. + O/E + Rev. – Exp. Inv. in Adair Unrealized Gain/Loss Pref. Stock 1,000 – AFS Sec.* (1,500) Inv. in Casey Com. Stock (2,500) * part of Stockholders’ Equity

23 Accounting for Investments Without Significant Influence RecognizeReportReport FV Categories as incomeon BS atchanges on Held-to-maturityinterestcostN/A Tradinginterest, div.fair valueIncome stmt. Avail.-for-Saleinterest, div.fair valueBalance sheet

24 Credit Sales l Slows inflow of cash l Risk of uncollectible accounts Trade Credit Retail Customer Receivables Terms: 2/10, net 30 Sales Invoice

25 Menkhaus Corporation Sample Accts. Rec. Subsidiary Ledger Total Due ABC Distributors$ 25 HIJ Distributors 336 : XYZ Distributors 108 $ 1,105 Gross Accounts Receivable In 000s

26 Winnebago Industries, Inc. Consolidated Balance Sheet (partial) Receivables, less allowance for doubtful accounts ($120 and $244, respectively) $28,616 $21,571 Net Realizable Value Estimated Uncollectible Accounts

27 Accounting for Bad Debts: Direct Write-off Method Adjustment to write off uncollectible account: Assets = Liab. + O/E + Rev. – Exp. Accts. Rec. Bad Debts – Dexter (500) Exp. (500) Period of Sale Future Period charged with expense of bad debt write-off

28 Accounting for Bad Debts: Allowance Method Period of Sale Estimated bad debt expense (and allowance account) recorded in same period

29 Roberts Corp. Partial Balance Sheet Current assets: Accounts receivable $ 250,000 Less: Allowance for doubtful accounts ( 6,000) Net accounts receivable $ 244,000 Balance Sheet Presentation - Allowance Method

30 Accounting for Bad Debts: Allowance Method Adjustment for estimated bad debt expense : Assets = Liab. + O/E + Rev. – Exp. Allow. for Bad Debts Doubtful Exp. (6,000) Accts (6,000) I estimate...

31 Accounting for Bad Debts: Allowance Method Adjustment to write off uncollectible account: Assets = Liab. + O/E + Rev. – Exp. Allow. for Doubtful Accts 500 Accts. Rec. – Dexter (500) Bankrupt

32 Approaches to Allowance Method % of Net Credit Sales % of Accounts Receivable »Aging Method Income Statement Approach Balance Sheet Approach

33 Example: Percentage of Net Credit Sales Method Assume prior years’ net credit sales and bad debt expense are as follows: YearNet credit salesBad debts 1999 $1,250,000 $ 26, ,340,000 29, ,200,000 23, ,650,000 32, ,120,000 42,700 $7,560,000 $153,700

34 Example: Percentage of Net Credit Sales Method Develop bad debt percentage: $153,700 $7,560,000 use 2% =

35 Percentage of Net Credit Sales Method 2004 Net credit sales (given) $2,340,000 Bad debt percentage 2% Bad debts expense 46,800 Example: Assets = Liab. + O/E + Rev. – Exp. Allow. for Bad Debts Doubtful Exp. (46,800) Accts (46,800)

36 Est. Percent Est. Amount Category Amount Uncollectible Uncollectible Current $ 85,600 1%$ 856 Past due: 1-30 days 31,200 4% 1, days 24,50010% 2, days 18,00030% 5, days 9,20050% 4,600 Totals $168,500$14,554 Aging Method

37 Aging Method To determine the amount recognized as bad debts: Bal. required in allow. acct. after adj. $14,554 Less: Bal. in allow. acct. before adj. 1,230 Amount of adjustment $13,324

38 Aging Method Example Adjustment for estimated bad debt expense : Assets = Liab. + O/E + Rev. – Exp. Allow. for Bad Debts Doubtful Exp. (13,324) Accts (13,324)

39 Comparison of Methods % of Net Sales Computes bad debt expense Aging Computes ending balance in the allowance account

40 Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable Indicates how quickly a company is collecting (i.e., turning over) its receivables

41 Accounts Receivable Turnover l Too fast credit policies too stringent; may be losing sales l Too slow credit department not operating effectively; dissatisfied customers

42 Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on March 13, Date: December 13, 2004 Signed:_________ Interest-Bearing Promissory Note Baker Corporation Maturity Date Principal Interest

43 In exchange for $9,000 applied toward my purchase today, I promise to pay $9,900 in six months. Date: November 1, 2004 Signed:_________ J.E. Privett Non-Interest-Bearing Promissory Note Effective interest rate on note = 20% $ $9,000 x 6

44 12/31/044/30/05 Notes receivable$ 9,900$ 9,900 Less: Discount on notes receivable ( 600) $ 9,300$ 9,900 Balance Sheet Presentation of Discounted Notes Discount transferred to interest revenue over life of note Upon Maturity

45 Accelerating Cash Inflow From Sales l Sales Discounts l Credit Card Sales l Discounting Notes Receivable

46 Credit Card Sales l Competitive necessity l Credit card company: » Charges fee » Assumes risk of nonpayment

47 Discounting Notes Receivable l Sell note prior to maturity date for cash l Receive less than face value (i.e., discounted amount) l Can be sold with or without recourse Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on December 31, Date: January 1, 1998 Signed:_________ Baker Corporation

Operating Activities Net incomexxxx Increase in accounts receivable - Decrease in accounts receivable + Increase in notes receivable - Decrease in notes receivable + Investing Activities Purchases of held-to-maturity and available-for-sale securities - Sales/maturities of held-to-maturity and available-for-sale securities + Financing Activities Liquid Assets and the Statement of Cash Flows - Indirect Method 48

49 End of Chapter 6