©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 1 Receivables and Short- Term Investments Chapter 5

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 2 Learning Objective 1 Account for short-term investments.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 3 Short-Term Investments Investments that a company plans to hold for one year or less. Held-to-maturity securities Trading investments Available-for-sale investments (Held-to-maturity and available-for-sale securities could also be long-term.)

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 4 Held-to-Maturity Investments Investor expects to hold until maturity date They earn interest revenue for the investor

Trading Investments Oracle Corporation purchases Ford Motor Company stock on May 18, paying $100,000, with the intention of selling the stock within a few months. May 18Short-term investment100,000 Cash100,000 Purchased investment ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Short-Term Investments On May 27, Oracle receives a cash dividend of $4,000 from Ford. May 27Cash4,000 Dividend revenue4,000 Received cash dividend ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Short-Term Investments Oracle fiscal year ends on May 31, and the investment in Ford has a current market value of $102,000 on this date. May 31Short-Term Investment2,000 Unrealized Gain on Investments 2,000 Adjusted investment to market value ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

8 Short-Term Investments Cost100,000 Adjustment to market value2,000 Balance102,000

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 9 Reporting on the Balance Sheet and the Income Statement Balance Sheet Current Assets: $XXX Cash XXX Short-term investments at market value 102,000 Accounts receivable XXX Income Statement Revenues$ XXX Expenses XXX Other revenues, gains, and (losses): Interest revenue XXX Dividend revenue4,000 Unrealized gain on investment2,000

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 10 Accounts and Notes Receivable Monetary claims against others

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 11 Accounts Receivable GENERAL LEDGER Accounts Receivable Bal. 9,000 ACCOUNTS RECEIVABLE SUBSIDIARY RECORD Aston Bal. 5,000 Harris Salazar Bal. 1,000 Bal. 3,000

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 12 Learning Objective 2 Apply internal controls to receivables.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 13 Establishing Internal Control Over Accounts Receivable Separation of duties Control over mail receipts Approval for write-off

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 14 Learning Objective 3 Use the allowance method for uncollectible receivables.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 15 The Allowance Method Records collection losses on the basis of estimates, not waiting to see which customers will not pay Allowance for Uncollectible Accounts = contra account to Accounts Receivable

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 16 The Allowance Method Balance Sheet (partial) Accounts receivable$10,000 Less: Allowance for uncollectible accounts – 900 Accounts receivable, net$ 9,100 Income Statement (partial) Expenses: Bad Debt expense$ 2,000

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 17 Methods for Estimating Uncollectibles Percent-of-sales Uncollectible-account expense = percentage of revenue Aging-of-Receivables Analyze individual receivables from customers based on how long they have been outstanding

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 18 Percent-of-Sales December 31, 20x5 Accounts Receivable Bal. 28,350 Allowance for Uncollectible Accounts Bal. 730

Percent-of-Sales The credit department estimates that uncollectible-account expense is 3% of total revenues, which were $110,000 for 20x5. Dec 31Bad Debt Expense3,300 Allowance for Uncollectible Accounts3,300 Recorded expense for the year ($110,000 × 0.03) ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

20 Percent-of-Sales December 31, 20x5 After Adjustment Accounts Receivable Bal. 2,8350 Allowance for Uncollectible Accounts 730 3,300 4,030

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 21 Aging-of-Receivables December 31, 20x5 Accounts Receivable Bal. 2,835 Allowance for Uncollectible Accounts 120 Accounts before the year-end adjustment:

Aging-of-Receivables Days Overdue Accounts Receivable Estimated % Uncollectible Allowance for Uncollectible Accounts 1-30 days$1,5556$ days days days $2,835$403 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Aging-of-Receivables Accounts after the year-end adjustment: Dec 31Bad Debt Expense283 Allowance for Uncollectible Accounts283 Recorded expense for the year ($ ) Adjusting Entry ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

24 Aging-of-Receivables Accounts after the year-end adjustment: December 31, 20x5 Accounts Receivable Bal. 2,835 Allowance for Uncollectible Accounts 120 Adj

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 25 Writing Off Uncollectible Accounts Suppose that early in 20x6, the credit department determines that the company cannot collect from two customers. These accounts must be written off.

Writing Off Uncollectible Accounts Allowance for Uncollectible Accounts400 Accounts Receivable – Customer #161 Accounts Receivable – Customer #239 Wrote off uncollectible receivables ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Comparing the Methods Allowance Method Adjusts Allowance for Uncollectible Accounts BY Amount of BAD DEBT EXPENSE Aging-of-Receivables Adjusts Allowance for Uncollectible Accounts TO Amount of UNCOLLECTIBLE RECEIVABLES Percent-of-Sales ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Direct Write-Off Method An account is written off only when it is decided that a specific customer’s receivable is uncollectible. Jan 2Bad Debt Expense2,000 Accounts Receivable-Jones2,000 Wrote off a bad account ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

29 Direct Write-Off Method This method is defective for two reasons 1. Since no allowance for uncollectibles is established, assets are overstated on the balance sheet. 2. It causes a poor matching of uncollectible-account expense against revenue and overstates net income.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 30 Learning Objective 4 Account for notes receivable.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 31 Notes Receivable Principal amount - amount borrowed by the debtor Maker – pays payee the maturity value Maturity value – principal plus interest

Notes Receivable PROMISSORY NOTE $1,000 August 31, 20x5 Amount For value received, I promise to pay to the order of Continental bank Chicago, Illinois One thousand and no/100……………………Dollars on February 28, 20x6 plus interest at the annual rate of 9 percent Principal Interest period starts Payee (creditor) Interest rate Interest period ends on the maturity date Maker (Debtor) ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Accounting for Notes Receivable Continental Bank entry is as follows: 20x5 Aug 31Note Receivable1,000 Cash1,000 Made a loan ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Interest = Principal × Rate × Time Accounting for Notes Receivable $1,000 × 9% × 4 / 12 = $30 20x5 Dec 31Interest Receivable30 Interest Revenue30 Accrued interest revenue 20x5 Dec 31Interest Receivable30 Interest Revenue30 Accrued interest revenue ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Accounting for Notes Receivable The bank collects the note on February 28, 20x6. 20x6 Feb 28Cash1,045 Note Receivable1,000 Interest Receivable30 Interest Revenue15 Collected note at maturity ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

36 How to Speed Up Cash Flow Credit card or bankcard sales Selling receivables Discounting notes receivable

Cash97,000 Financing Expense3,000 Sales Revenue100,000 To record a credit card sale of $100,000 and a 3% financing fee How to Speed Up Cash Flow Recording a credit card or bankcard sale ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

How to Speed Up Cash Flow Recording the sale of receivables Cash95,000 Financing Expense5,000 Trade Accounts Receivable100,000 Sold accounts receivable ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

39 How to Speed Up Cash Flow Discounting notes receivable Credit Notes Receivable instead of Trade or Accounts Receivable. If maker of note fails to pay the maturity value to the new payee, the original payee must pay the bank the amount due.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 40 Learning Objective 5 Use day’s sales in receivables and the acid-test ratio to evaluate financial position.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 41 One day’s sales = Net sales ÷ 365 days $10,860 ÷ 365 = $29.75 per day Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales [(2, ,432) ÷ 2] ÷ = 83 days A smaller number indicates a quick conversion to cash. Days’ Sales in Receivables

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 42 A stringent test of liquidity Measures entity’s ability to pay its current liabilities immediately (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities (4, , ,432) ÷ 3,916 = 2.12 This ratio value is extremely high and indicates great liquidity for this company. Acid-Test Ratio

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 43 Reporting on the Statement of Cash Flows Receivables bring in cash when the business collects from customers. Reported as operating activities

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 44 End of Chapter 5