Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 1

22 Short-Term Investments & Receivables Chapter 5

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 3 Account for short-term investments

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 4 Short-Term Investments Also called marketable securities Easily convertible into cash ▫Next most liquid asset after cash Expected to be held one year or less

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 5 Short-Term Investment Categories

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 6 Trading Securities Held for a short time and then sold ▫If market price of investment increases, a gain results ▫If market price of investment decreases, a loss results Can be debt or equity securities of another company Earn interest or dividend revenue

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 7 Accounting for Trading Securities JOURNAL DateAccounts and explanationDebitCredit Investment in ABC stock Cash Purchased investment Cash Dividend Revenue Received cash dividend

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 8 Unrealized Gains and Losses If fair value has increased If fair value has decreased Unrealized gain Unrealized loss Trading securities are reported on the balance sheet at current fair (market) value

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 9 Adjusting Trading Securities to Fair Value JOURNAL DateAccounts and explanationDebitCredit Investment in ABC stock Unrealized Gain on Investments Adjusted investment to fair value JOURNAL DateAccounts and explanationDebitCredit Unrealized Loss on Investment Investment in ABC stock Adjusted investment to fair value If fair value increases over period If fair value decreases over period

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 10 Balance Sheet & Income Statement Reporting Balance SheetIncome Statement Current assets:Revenues $XXX Cash $XXX Expenses XXX Short-term investments, at fair value XXX Other revenue, gains, and (losses): Accounts receivable XXX Interest revenue XXX Dividend revenue XXX Unrealized gain on investments XXX Net income $XXX

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 11 Realized Gains and Losses If sales price > carrying amount If sales price < carrying amount Gain Loss Only reported when investment is sold

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 12 Exercise 5-21A 1. Trading securities – company intends to hold a short period and then sell JOURNAL DateAccounts and explanationDebitCredit 12-15Investment in Dream Stock57,000 Cash57,000 Purchased investment 12-31Investment in Dream Stock1,000 Unrealized Gain on Investments1,000 Adjusted investment to fair value

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 13 Exercise 5-21A Eastern Corporation Partial Balance Sheet December 31, 2012 Current assets: Short-term investments at fair value$58,000 Eastern Corporation Partial Income Statement Year Ended December 31, 2012 Other income, revenue, gains, and (losses): Unrealized gain on investments$1,000

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 14 Apply GAAP for proper revenue recognition

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 15 Revenue Recognition Revenue recognized when earned ▫Seller has transferred good or service to customer ▫Price is fixed or determinable ▫Collection reasonably assured Amount is cash value of goods or services transferred Impacted by shipping terms and payment incentives offered

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 16 FOB Shipping PointFOB Destination Ownership changes hands Revenue recognized ▫When goods leave seller’s shipping dock Ownership changes hands Revenue recognized ▫At point of delivery to customer Shipping Terms

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 17 Sales Discounts Offered to customers to speed up cash flow 2/10, n/30 2% discount if paid within 10 days Full amount due in 30 days JOURNAL DateAccounts and explanationDebitCredit Cash Sales Discount Accounts Receivable Collected cash from customer on account and provided discount

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 18 Sales Returns and Allowances Right to return unsatisfactory or damaged merchandise JOURNAL DateAccounts and explanationDebitCredit Sales Returns and Allowances Accounts Receivable Merchandise returned by customer on account

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 19 Net Revenue Gross revenue $100,000 − Sales discounts (1,000) − Sales returns and allowances (400) = Net revenue $98,600

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 20 Account for and control accounts receivable

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 21 Receivables Third most liquid asset Monetary claims against others Acquired mainly by: ▫selling goods and services (accounts receivable) ▫lending money (notes receivable)

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 22 Accounts Receivable Amounts collectible from customers Balance in general ledger ▫Control account: summarizes total amount due from all customers Subsidiary ledger ▫Separate account for each customer

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 23 Accounts Receivable 9,000 Customer A Customer B 5,000 1,000 Customer C 3,000 General Ledger Accounts Receivable Subsidiary Record Total $9,000 Balance

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 24 Notes Receivable More formal than accounts receivable Written promise to pay a sum at the maturity date ▫Plus interest Also called promissory notes

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 25 Internal Control over Cash Collections on Account Separate cash-handling and cash accounting duties ▫Bookkeeper should not handle cash  Should record amounts from remittance advices ▫Separate employee should open incoming mail and make deposit Another option: ▫Lockbox system

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 26 Risks of Selling on Credit IssuesPlan of action What are the benefits and costs of extending credit to customers? Benefit – increase in sales Cost – risk of not collecting Run a credit check on prospective customers Extend credit to only creditworthy customers Design internal control system to separate duties Separate cash-handling and accounting duties to keep employees from stealing cash from customers Keep a close eye on customers. Send additional statements to slow-paying customers Pursue collection from customers to maximize cash flow

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 27 Evaluate collectibility using the allowance for uncollectible accounts

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 28 Benefit of selling on creditCost of selling on credit Customers that do not have cash available can buy on credit Sales and profits increase Company cannot collect from some customers This cost is called “uncollectible-account expense”, “doubtful- account expense”, or “bad debt expense ” Uncollectible Receivables

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 29 The Allowance Method Records collection losses based on company’s collection experience Estimates Uncollectible-Account Expense Also sets up Allowance for Uncollectible Accounts  Contra-account to Accounts Receivable  Shows amount of receivables expected not to be collected

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 30 Net Realizable Value Partial Balance Sheet Current assets: Accounts receivable$100,000 Less: Allowance for uncollectible accounts(5,000) Accounts receivable, net$95,000 Partial Balance Sheet Current assets: Accounts receivable, less allowance of $5,000$95,000

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 31 Methods to Estimate Uncollectibles

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 32 Percent-of-Sales Method Emphasizes the expense recognition (matching ) concept Revenue JOURNAL DateAccounts and explanationDebitCredit Uncollectible–Account Expense Allowance for Uncollectible Accounts Recorded expense for the year Estimated % uncollectible Uncollectible- Account Expense

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 33 Aging-of-Receivables Focuses on proper valuation of accounts receivable on the balance sheet Individual customer balances analyzed based on time outstanding ▫Aging schedule Allowance for Uncollectible Accounts adjusted to equal amount from aging schedule

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 34 Age of Account Customer 1-30 days days days Over 90 days Total Balance Customer A$XXX $ XX Customer BXXX Totals$5,559$ 600$ 200$ 64$6,423 Est. percent uncollectible× 1.1%× 2%× 7%× 20% Allowance balance should be:$61$12$14$13$100 Allowance for Uncollectible Accounts 25 Balance before adjustment Adjustment needed Ending balance equals aging schedule

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 35 Aging-of-Receivables JOURNAL DateAccounts and explanationDebitCredit Uncollectible-Account Expense100 Allowance for Uncollectible Accounts100 Recorded expense for the year

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 36 Writing Off Uncollectible Accounts JOURNAL DateAccounts and explanationDebitCredit Allowance for Uncollectible Accounts900 Accounts Receivable900 Write off uncollectible receivable Allowance for Uncollectible Accounts Accounts Receivable $50,000 $3,000 Bal. $900 $49,100 $2,100

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 37 Impact of Write-Off Partial Balance Sheet – Before Write Off Current assets: Accounts receivable$50,000 Less: Allowance for uncollectible accounts(3,000) Accounts receivable, net$47,000 Partial Balance Sheet – After Write Off Current assets: Accounts receivable$49,100 Less: Allowance for uncollectible accounts(2,100) Accounts receivable, net$47,000

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 38 The Allowance Method: Two Approaches Percent-of-Sales Aging-of-Receivables Adjusts Allowance for Uncollectible Accounts BY TO The amount of UNCOLLECTIBLE-ACCOUNT EXPENSE The amount of UNCOLLECTIBLE-ACCOUNT EXPENSE The amount of UNCOLLECTIBLE ACCOUNTS RECEIVABLE The amount of UNCOLLECTIBLE ACCOUNTS RECEIVABLE

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 39 Exercise 5-25A JOURNAL DateAccountsDebitCredit Accounts Receivable159,000 Sales Revenue159,000 Cash130,000 Accounts Receivable130,000 Allowance for Uncollectible Accounts2,700 Accounts Receivable2,700

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 40 Exercise 5-25A JOURNAL DateAccountsDebitCredit Uncollectible-Account Expense1,590 Allowance for Uncollectible Accounts1,590 Accounts receivable Allowance for Uncollectible Accounts $34,000 $3,000 $159,000 $130,000 $2,700 $1,590 Bal. Sales PaymentsBal. $2,700Write-offs Adj. $60,300 $1,890 Net AR = $58,410

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 41 Exercise 5-25A Partial Balance Sheet Current assets: Accounts receivable$60,300 Less: Allowance for uncollectible accounts (1,890) Accounts receivable, net$58,410

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 42 Direct Write-Off Method Waits until a specific account is uncollectible to record the expense Inferior to Allowance method ▫Receivables reported at full amount  Assets overstated on Balance Sheet ▫Poor matching of uncollectible-account expense against revenue JOURNAL DateAccounts and explanationDebitCredit Uncollectible-Account Expense Accounts Receivable Write off customer account

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 43 Computing Cash Collections from Customers Accounts Receivable Ending balance Sales on credit Write-offs of uncollectibles Collections from customers Beginning balance 200 1, ? 1,500

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 44 Account for notes receivable

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 45 Notes Receivable Can be current or long-term assets Terms: CreditorParty to whom money is owed; Lender DebtorParty that borrowed and owes money; Maker, borrower InterestCost of borrowing money; stated as annual percentage rate Maturity dateDate when debtor must pay note Maturity valueSum of principal and interest PrincipalAmount borrowed by debtor TermLength of time from when note was signed to when payment must be made

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 46 AmountDate For value received, I promise to pay to the order of Continental Bank Chicago, Illinois Dollars On plus interest at the annual rate of 9 percent $1,000Aug 31, 2012 One thousand and no/ February 28, 2013 Lauren Halland PROMISSORY NOTE PrincipalInterest period starts Payee (Creditor) Principal Interest period ends on the maturity date Maker (Debtor)

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 47 Accounting for Notes Receivable JOURNAL DateAccounts and explanationDebitCredit Notes Receivable—L. Holland1,000 Cash1,000 Made a loan 12-31Interest Receivable30 Interest Revenue30 Accrued interest revenue Cash1,045 Notes Receivable—L. Holland1,000 Interest Receivable30 Interest Revenue15 Collected note at maturity

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 48 Interest Interest rates are usually expressed as an annual percent For time periods less than a year, a fraction is used ▫Months/12 Often interest is computed based on days ▫Denominator would be days/365

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 49 Show how to speed up cash flow from receivables

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 50 Rapid Cash Flow Allows companies to pay current liabilities faster and finance new projects Strategies to shorten credit cycle: ▫Sales discounts ▫Interest on older accounts ▫Effective credit and collection procedures ▫Emphasize credit card and bankcard sales

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 51 Credit Card or Bankcard Sales Increases sales Retailer charged fee JOURNAL DateAccounts and explanationDebitCredit Cash4,900 Credit Card Discount Expense100 Sales5,000 Recorded bankcard sales 2% of sale

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 52 Selling (Factoring) Receivables Company sells receivables to a factor Factor pays discounted price Benefit to company ▫Immediate cash Disadvantage to company ▫Expense and loss of control Used by company with weak or insufficient credit history

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 53 Evaluate liquidity using two new ratios

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 54 Quick (or Acid-Test) Ratio Cash + Short-term investments + Net current receivables Total current liabilities

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 55 Days’ Sales in Receivables Average daily sales Net sales 365 days Days’ sales in average receivables Average receivables Average daily sales (Beginning net receivables + Ending net receivables)/2

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 56 Short Exercise 5-19 Acid-test ratio $9,600 + $14,500+ $74,800 $101,000.98

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 57 Short Exercise 5-19 Days’ sales in receivables $803, Days’ sales in receivables $73,300 $2,200 (Beginning net receivables + Ending net receivables)/2 = 33 days Average daily sales

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 58

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 59