Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Revenue and Monetary Assets © The McGraw-Hill Companies, Inc., Part One: Financial Accounting

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 The Business Operating Cycle Slide 5-1 Purchase materials Convert materials into a finished product Inspect the product Receive an order for the product from a customer Ship the product and send the customer an invoice Customer acknowledges receipt of the item Store the product in a warehouse Collect cash from the customer

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., Sales order receivednonone 2.Deposit or advancenonone payment received 3.Goods being producedFor certain long-percentage of term contractscompletion 4.Production completed;For precious metalsproduction goods storedand certain agri- cultural products 5.Goods shipped orusuallydelivery 6.Customer pays accountcollection isinstallment receivableuncertain Timing of Revenue Recognition Slide 5-2 Typical Revenue Recognition Revenue Recognition Event at This Time Method

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 dr.Inventory on consignment1,000 cr.Merchandise inventory1,000 Consignment Shipments Slide 5-3 Goods costing $1,000 were shipped out on consignment.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 dr.Cost of goods sold1,000 cr.Inventory on consignment1,000 dr.Accounts receivable1,400 cr.Sales revenue1,400 Consignment Shipments Slide 5-4 These goods are sold by the consignee for $1,400.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Customer Project Year-End Payments Costs Percent Year Received Incurred Complete Revenues Expenses Income 1$120,000$160,00020$ 0$ 0$ ,000400, ,000240, ,000800,000100,000 Total$900,000$800,000$900,000$800,000$100,000 Completed-Contract Method Slide 5-5 If the amount of income to be earned on the contract cannot be reliably estimated, then revenue is to be recognized only when the project has been completed.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., $120,000$160,00020$180,000$160,000$ 20, ,000400, ,000400,00050, ,000240, ,000240,000 30,000 Total$900,000$800,000$900,000$800,000$100,000 Customer Project Year-End Payments Costs Percent Year Received Incurred Complete Revenues Expenses Income Percentage-of-Completion Method Slide 5-6 GAAP assumes that the percentage-of- completion method will be used to account for long-term contracts.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Bad Debts Slide 5-7 Check out the aging schedule in Illustration 5-4. Check out the aging schedule in Illustration 5-4. The firm expects bad debts of $7,132. The firm expects bad debts of $7,132.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 The accounts receivable section of the December 31, 1997 balance sheet would appear as follows: Accounts receivable$262,250 less: allowance for doubtful accounts 7,132 accounts receivable, net$255,118 dr. Bad Debts Expense7,132 cr. Allowance for Doubtful7,132 Bad Debts Slide 5-8 The adjusting entry would be:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Bad Debts Slide 5-9 If sometime in 1998 the Essel Company decided that James Johnson was never going to pay his bill of $250, the following entry would be made: dr. Allowance for Doubtful Accounts250 cr. Accounts Receivable250 The accounts receivable section of the balance sheet immediately after the write-off entry would show-- Accounts receivable$262,000 less: allowance for doubtful accounts 6,882 accounts receivable, net$255,118 Note the the net amount of accounts receivable is unchanged. Note the the net amount of accounts receivable is unchanged.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Sales Discounts Slide 5-10 Sold $1,000 of merchandise on credit terms of 2/10, net/30.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Sales Discounts Slide 5-10 Sold $1,000 of merchandise on credit terms of 2/10, net/30. dr. Accounts Receivable980 cr. Sales Revenue980 If payment is made within the discount period: dr. Cash980 cr. Accounts Receivable980

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Sales Discounts Slide 5-11 If payment is made after the discount period: dr. Cash1,000 cr.Discounts Not Taken20 Accounts Receivable980 The 2 percent discount really amounts to an annual rate of 32 percent. The 2 percent discount really amounts to an annual rate of 32 percent.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Credit Card Sales Slide 5-12 Bank plan (MasterCard and Visa) dr. Cash970 Sales Discounts (Credit Cards)30 cr. Sales Revenue1,000 Other plans (American Express and Discover) dr. Accounts Receivable970 Sales Discounts (Credit Cards)30 cr. Sales Revenue 1,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Interest Revenue Slide 5-13 On September 1, 1997, a bank loaned $10,000 for one year at 9 percent interest, the interest and principal to be paid on August 31, The bank’s entry on September 1, 1997 is: dr. Loan Receivable10,000 cr.Cash10,000 On December 31, 1997, an adjusting entry is made to record the fact that interest for one-third of a year, $300, was earned in 1997: dr. Loan Receivable300 cr.Interest Revenue300

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Interest Revenue Slide 5-14 On September 1, 1997, a bank loaned $10,000 for one year at 9 percent discounted. dr. Loan Receivable10,000 cr. Cash9,100 Unearned Interest Revenue900 On December 31, 1997, an adjusting entry is made to record the fact that $300 of interest was earned in dr. Unearned Interest Revenue300 cr.Interest Revenue300

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Interest Revenue Slide 5-15 On August 31, 1998, when the loan is repaid, the entry is: dr. Cash10,000 cr. Loans Receivable10,000 After repayment by the borrower, an adjusting entry is also made by the bank to record the fact that $600 interest was earned in dr. Unearned Interest Revenue600 cr.Interest Revenue600

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Current Ratio Slide 5-16 Current assets Current liabilities Current Ratio = $1,245.1 $1,214.6 Current Ratio = 1.03 Current Ratio =

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 5-17 Acid-Test Ratio Cash, temporary investments, and accounts receivable (net) Monetary Current assets Current liabilities Acid-Test Ratio = $634.9 $1,214.6 Acid-Test Ratio = 0.52 Acid-Test Ratio =

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 5-18 Cash Cost Per Day Expenses (net of depreciation) 365 Cash Cost Per Day = $5, Cash Cost Per Day = $14.65 per day Cash Cost Per Day =

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 5-20 Days’ Cash Cash Cash costs per day Days’ Cash = $98.1 $14.65 Days’ Cash = 7 daysDays’ Cash =

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Chapter 5 The End