©2008 Pearson Prentice Hall. All rights reserved. 5-1 Short-Term Investments & Receivables Chapter 5

©2008 Pearson Prentice Hall. All rights reserved. 5-2 Learning Objective 1 Account for short-term investments

©2008 Pearson Prentice Hall. All rights reserved. 5-3 Accounting for Short-Term Investments Also called marketable securities Held for one year or less Most liquid asset other than cash Placed into three categories: Trading Investments Available- for-Sale Held-to- Maturity

©2008 Pearson Prentice Hall. All rights reserved. 5-4 Trading Investments Held for short time and then sold  Gain or loss recorded Dividend revenue may also be received At year-end, trading investments are adjusted to equal their market value  Results in an unrealized gain or loss Selling price > cost = GainSelling price < cost = Loss

©2008 Pearson Prentice Hall. All rights reserved. 5-5 Unrealized Gains & Losses Difference between market price and cost of investment at year-end Unrealized – investment has not been sold Market price > cost = Unrealized gain Market price < cost = Unrealized loss

©2008 Pearson Prentice Hall. All rights reserved. 5-6 Realized vs. Unrealized Realized Investment sold to third party Gain or loss = difference between selling price and cost Word “realized” usually dropped from title Unrealized Company still owns investment Gain or loss = difference between market value and cost Word “unrealized” is kept in account title

©2008 Pearson Prentice Hall. All rights reserved. 5-7 Entries to Adjust to Market JOURNAL DateAccountsDebitCredit Short-term investments$$$ Unrealized gain on investments $$$ Adjusted investment to market value (when greater than cost) Unrealized loss on investments$$$ Short-term investments $$$ Adjusted investment to market value (when less than cost)

©2008 Pearson Prentice Hall. All rights reserved. 5-8 Reporting on Financial Statements Balance Sheet Trading Investment  Reported at current market value  Listed directly under “cash” in the current asset section Income Statement Gains and losses  From sales of investments Investment revenue  From dividends or interest earned Unrealized gain or loss  From entry to adjust to market value

©2008 Pearson Prentice Hall. All rights reserved. 5-9 E5-18 JOURNAL DateAccountsDebitCredit Nov 6Trading investment$35,000 Cash $35,000 Nov 27Cash$850 Dividend revenue $850

©2008 Pearson Prentice Hall. All rights reserved E5-18 JOURNAL Date Accounts Debit Credit Unrealized loss _______ Trading Investments ________ What would be the amount of the unrealized loss? Compute the difference between the cost and market value.

©2008 Pearson Prentice Hall. All rights reserved E5-18 JOURNAL Date Accounts Debit Credit 1-11 Cash $36,000 Trading Investments $33,000 Gain on sale of investments $3,000

©2008 Pearson Prentice Hall. All rights reserved Receivables Monetary claims against others Third most liquid asset Accounts Receivable  Amounts owed by customers for selling goods or services Notes Receivable  Lending money to outsiders  More formal than accounts receivable

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 2 Apply internal controls to receivables

©2008 Pearson Prentice Hall. All rights reserved Internal Control over Cash Collections on Account Separate cash-handling from cash- accounting duties Cash-handling  One person receives customer checks and makes deposits Cash-accounting  Another person makes entries to customer accounts

©2008 Pearson Prentice Hall. All rights reserved Accounting for Uncollectible Receivables Extending credit to customers bears some risk Risk: Some customers do not pay the amount owed Cost: Uncollectible accounts

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 3 Use the allowance method for uncollectible receivables

©2008 Pearson Prentice Hall. All rights reserved Allowance Method Amount of uncollectible accounts is estimated An expense is recorded as part of the adjusting process A contra-asset is recorded that reduces accounts receivable on the balance sheet A contra-asset is always paired with an asset and reduces its balance

©2008 Pearson Prentice Hall. All rights reserved Entry to Record Uncollectible accounts JOURNAL Date Accounts Debit Credit Uncollectible accounts expense Allowance for uncollectible accounts Goes on the Income Statement Goes on the Balance Sheet netted with accounts receivable

©2008 Pearson Prentice Hall. All rights reserved Balance Sheet Current assets: Accounts receivable$$,$$$ Less: Allowance for Uncollectible Accounts( $,$$$) Accounts receivable, net$$,$$$ Accounts receivable, net$$,$$$ OR

©2008 Pearson Prentice Hall. All rights reserved Methods to Estimate Uncollectibles Percent-of-sales Expense is estimated based on credit sales Income Statement approach Aging-of-receivables Accounts receivable analyzed based on how long outstanding Balance Sheet approach

©2008 Pearson Prentice Hall. All rights reserved E5-23 Age of Accounts Days Days DaysOver 90 Days $ 110,000 $ 60,000 $ 50,000 $ 15, %1%60%40% $ 550 $ 600 $ 30,000 $ 6,000 $37,150

©2008 Pearson Prentice Hall. All rights reserved E5-23 Aging Schedule$37,150 Balance in Allowance$7,400 Adjustment needed JOURNAL Date Accounts Debit Credit Uncollectible accounts expense_______ Allowance for uncollectible accounts______ Adjustment needed = Aging schedule - Balance

©2008 Pearson Prentice Hall. All rights reserved E5-23 Allowance for Uncollectible Accounts $7,400 Balance before adjustment $37,150 Balance per aging schedule $29,750 Adjusting entry

©2008 Pearson Prentice Hall. All rights reserved Uncollectible Accounts Methods Percent-of-SalesAging-of-Receivables Adjust Allowance for Uncollectible Accounts BYTO The Amount of UNCOLLECTIBLE ACCOUNT EXPENSE The Amount of UNCOLLECTIBLE ACCOUNTS RECEIVABLE

©2008 Pearson Prentice Hall. All rights reserved Writing Off a Specific Account The allowance is used to absorb specific accounts that are determined to uncollectible When it’s determined a customer cannot pay, the following entry is made: JOURNAL Date Accounts Debit Credit Allowance for uncollectible accounts $$$$ Accounts receivable $$$$

©2008 Pearson Prentice Hall. All rights reserved Direct Write-Off Method Less preferable than allowance method  Does not match expenses with revenues  Accounts Receivable overstated Uncollectible Accounts Expense used for write offs No Allowance for Uncollectible Accounts

©2008 Pearson Prentice Hall. All rights reserved Accounts Receivable Sales on accountPayments on account Uncollectible accounts written off

©2008 Pearson Prentice Hall. All rights reserved Allowance for Uncollectible Accounts Uncollectible accounts written off Uncollectible account adjustment What is the normal balance of the Allowance?

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 4 Account for notes receivable

©2008 Pearson Prentice Hall. All rights reserved Notes Receivable Terms Creditor Debtor Interest Maturity Date Maturity Value Principal Term Party to whom money is owed; lender Date debtor must pay the note Sum of principal and interest on note Amount borrowed by debtor Length of time money is borrowed Party that owes money; borrower Cost of borrowing money; percent

©2008 Pearson Prentice Hall. All rights reserved Accounting for Notes Receivable To record the receipt of a note receivable, the following entry is made: JOURNAL Date Accounts Debit Credit Notes Receivable $$,$$$ Cash $$,$$$

©2008 Pearson Prentice Hall. All rights reserved Accounting for Notes Receivable Interest needs to be accrued on any note receivable outstanding at year end: JOURNAL Date Accounts Debit Credit Interest receivable $$,$$$ Interest revenue $$,$$$ Interest is computed by the formula: Principal x rate x time Time = date note is signed to end-of-year

©2008 Pearson Prentice Hall. All rights reserved Accounting for Notes Receivable When payment is received on note, the following entry is made JOURNAL DateAccountsDebitCredit Cash Notes Receivable Interest receivable Interest revenue For maturity value Zeroes out adjustment For remaining interest earned For principal

©2008 Pearson Prentice Hall. All rights reserved Credit and Bank Card Sales Credit Cards  American Express and Discover Bank Cards  VISA and MasterCard Both charge the retailer a fee

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 5 Use two new ratios to evaluate a business

©2008 Pearson Prentice Hall. All rights reserved Days’ Sales in Receivables How long it takes a company to collect its average amount of receivable Compute one day’s sales Days’ sales in receivables Net Sales 365 Days Average receivables One Day’s Sales

©2008 Pearson Prentice Hall. All rights reserved Acid-Test Ratio Also called quick ratio A more stringent measure of a company’s ability to pay its current liabilities Cash + Short-term investments + net receivables Total current liabilities

©2008 Pearson Prentice Hall. All rights reserved End of Chapter Five