1. Receivables and Investments
Chapter 7
Receivables and Investments

2. Learning Objectives
LO1 Explain how to account for accounts receivable, including bad debts.
LO2 Explain how information about sales and receivables can be combined to evaluate how efficient a company is in collecting its receivables.
LO3 Explain how to account for interest-bearing notes receivable.
LO4 Explain various techniques that companies use to accelerate the inflow of cash from sales.
LO5 Explain the accounting for and disclosure of various types of investments that companies make.
LO6 Explain the effects of transactions involving liquid assets on the statement of cash flows.

3. Module 1 Accounting for Accounts Receivable
Companies report accounts receivable on the balance sheet
An allowance is subtracted from the balance of accounts receivable
The relationship between sales on the income statement and accounts receivable on the balance sheet can be used to assess a company’s performance
Module 1

4. Accounts Receivable
Account receivable: A receivable arising from the sale of goods or services with a verbal promise to pay
Companies track the balance owed by each customer on a subsidiary ledger
Module 1: LO 1

5. Subsidiary Ledger
Subsidiary ledger: detail for a number of individual items that collectively make up a single general ledger account
Control account: general ledger account that is supported by a subsidiary ledger
Module 1: LO 1

6. The Use of a Subsidiary Ledger
Assume that Apple sells $25,000 of hardware to a school. The journal entry to record the sale would be as follows:
Module 1: LO 1

7. Subsidiary Ledger
Module 1: LO 1

8. Two Methods to Account for Bad Debts
Direct write-off method: recognition of bad debts expense at the point an account is written off as uncollectible
Allowance method: estimating bad debts on the basis of either net credit sales or accounts receivable
Allowance for doubtful accounts: a contra-asset account—reduce accounts receivable to its net realizable value
Module 1: LO 1

9. Example 7-1—Using the Direct Write-Off Method for Bad Debts
Assume that Roberts Corp. makes a $500 sale to Dexter Inc. on November 10, 2016, with credit terms of 2/10, n/60. Roberts makes the following entry on its books on this date:
Module 1: LO 1

10. Example 7-1—Using the Direct Write-Off Method for Bad Debts (continued)
Assume further that Dexter is unable to pay and that the account has to be written off. To do so, the accounting department makes the following entry:
Module 1: LO 1

11. Deficiencies of the Direct Write-Off Method
Balance sheet effect:
By ignoring the possibility that not all of its outstanding accounts receivable will be collected, Roberts is overstating the value of this asset at December 31, 2016
Income statement effect:
By ignoring the possibility of bad debts on sales made during 2016, Roberts has violated the matching principle and has overstated net income for 2016 by ignoring bad debts as expense
Module 1: LO 1

12. Example 7-2—Using the Allowance Method for Bad Debts
Assume that Roberts’ total sales during 2016 amount to $600,000 and that at the end of the year, the outstanding accounts receivable total $250,000. Also, assume that Roberts estimates that 1% of the sales of the period, or $6,000, will prove to be uncollectible
Under the allowance method, Roberts makes the following adjusting entry at the end of 2016:
Module 1: LO 1

13. Example 7-2—Using the Allowance Method for Bad Debts (continued)
Assume, as we did earlier, that Dexter’s $500 account is written off on May 1, 2017
Under the allowance method, the following entry is recorded:
Module 1: LO 1

14. Two Approaches to the Allowance Method of Accounting for Bad Debts
Percentage of Net Credit Sales Approach
Uses the past relationship between bad debts and net credit sales to predict bad debt amounts
Percentage of Accounts Receivable Approach
Estimate bad debts by relating them to the balance in the Accounts Receivable
Module 1: LO 1

15. Example 7-3—Percentage of Net Credit Sales Approach
Assume that the accounting records for Bosco Corp. reveal the following:
Average percentage = 2% ($153,700/$7,560,000 = )
Module 1: LO 1

16. Example 7-3—Percentage of Net Credit Sales Approach (continued)
Assuming that it uses the 2% rate and that its net credit sales during 2016 are $2,340,000, Bosco makes the following entry:
Module 1: LO 1

17. Example 7-4—Percentage of Accounts Receivable Approach
Assume that the records for Cougar Corp. reveal the following:
Average percentage = 0.8% ($32,330/$4,038,000 = 0.008)
Module 1: LO 1

18. Example 7-4—Percentage of Accounts Receivable Approach (continued)
Assuming balances in Accounts Receivable and Allowance for Doubtful Accounts on December 31, 2016, of $865,000 and $2,100, respectively, Cougar records the following entry:
Module 1: LO 1

19. Exhibit 7-1—Aging Schedule
Aging schedule: categorizes the various accounts according to their length of time outstanding
Module 1: LO 1

20. Example 7-5—Using an Aging Schedule to Estimate Bad Debts
The totals on the aging schedule are used as the basis for estimating bad debts, as shown below:
Module 1: LO 1

21. Example 7-5—Using an Aging Schedule to Estimate Bad Debts (continued)
Assume that Allowance for Doubtful Accounts has a balance of $1,230 before adjustment, the adjusting entry is as follows:
Module 1: LO 1

22. The Accounts Receivable Turnover Ratio
Measures the number of times an accounts receivable is collected during the period
Accounts Receivable = Net Credit Sales
Turnover Ratio Average Accounts Receivable
Module 1: LO 2

23. Number of Days’ Sales in Receivables
Measures how long it takes to collect receivables
Number of Days' = Number of Days in the Period
Sales in Receivables Accounts Receivable Turnover Ratio
Module 1: LO 2

24. The Ratio Analysis Model
How many times a year does a company turn over its accounts receivable?
Gather the information about net credit sales and average accounts receivable
Calculate accounts receivable turnover ratio
Compare the ratio with prior years and with competitors
Interpret the ratios—measures how long it takes to collect receivables
Module 1: LO 2

25. Calculate the Ratio Analysis
Module 1: LO 2

26. The Business Decision Model
If you were a banker, would you loan money to a company?
Gather information from the financial statements and other sources
Compare the company's accounts receivable turnover ratio with industry averages and look at trends
Lend money or find an alternative use for the money
Monitor the loan periodically
Module 1: LO 2

27. Module 2 Accounting for Notes Receivable
Companies report interest-bearing notes receivable on the balance sheet
Module 2

28. Accounting for Notes Receivable
Asset resulting from the acceptance of a promissory note from another entity
Over the life of the note the payee earns interest revenue on its note receivable
Module 2: LO 3

29. Notes Receivable
Promissory note: a written promise to repay a definite sum of money on demand or at a fixed or determinable date in the future
Maker: party that agrees to repay the money
Payee: party that will receive the money
Note payable: a liability resulting from the signing of a promissory note
Module 2: LO 3

30. Relationship Between Maker and Payee
Module 2: LO 3

31. Important Terms Connected with Promissory Notes
Principal: the cash received, or the fair value of the products or services received, by the maker when a promissory note is issued
Maturity date: the due date of promissory note
Term: the length of time a note is outstanding
Maturity value: the amount to be paid by the maker on the maturity date
Interest: the difference between the principal amount and the maturity value
Module 2: LO 3

32. Example 7-7—Accounting for a Note Receivable
Assume that on December 13, 2016, High Tec sells a computer to Baker Corp. at an invoice price of $15,000
Because Baker is short of cash, it gives High Tec a 90-day, 12% promissory note. The total amount of interest due on the maturity date is determined as follows:
Interest earned = $15,000 × 0.12 × (90/360) = $450
Module 2: LO 3

33. Example 7-7—Accounting for a Note Receivable (continued)
The entry to record receipt of the note by High Tec is as follows:
Module 2: LO 3

34. Example 7-7—Accounting for a Note Receivable (continued)
In computing interest, it is normal practice to count the day a note matures but not the day it is signed
Interest would be earned for 18 days (December 14 to December 31) during 2016 and for 72 days in 2017:
Module 2: LO 3

35. Example 7-7—Accounting for a Note Receivable (continued)
The amount of interest earned during 2016 is $15,000 x 0.12 x 18/360, or $90
An adjusting entry is made on December 31 to record interest earned during 2016:
Module 2: LO 3

36. Example 7-7—Accounting for a Note Receivable (continued)
On March 13, 2017, High Tec collects the principal amount of the note and interest from Baker and records this entry:
Interest earned = $15,000 × 0.12 × (72/360) = $360
Module 2: LO 3

37. Accelerating the Inflow of Cash from Sales
Credit card sales
Accelerate collection of cash from a customer
Pass the risk of nonpayment to credit card company
Discounting notes receivable
Allows a company to accelerate the inflow of cash
Module 2: LO 4

38. Exhibit 7-2—Basic Relationships Among Parties with Credit Card Sales
Module 2: LO 4

39. Example 7-8—Accounting for Credit Card Sales
Assume that Joe Smith buys an iPad in an Apple store and charges the $500 cost to his VISA card
Assume that total credit card sales on June 5 amount to $8,000
The entry on Apple’s books is as follows:
Module 2: LO 4

40. Example 7-8—Accounting for Credit Card Sales (continued)
Assume that Apple remits the credit card receipts to VISA once a week and that the total sales for the week ending June 11 amount to $50,000
Further assume that on June 13, VISA pays the amount due to Apple after deducting a 5% collection fee
The entry on Apple’s books is as follows:
Module 2: LO 4

41. Example 7-8—Accounting for Credit Card Sales (continued)
Assume that on July 9, Apple presents VISA credit card receipts to its bank for payment in the amount of $20,000 and that the collection charge is 4%.
The entry on its books on the date of deposit is as follows:
Module 2: LO 4

42. Discounting Notes Receivable
Discounting: the process of selling a promissory note
Company can sell note prior to maturity date for cash
It is normally done ‘‘with recourse”
If the original customer fails to pay the bank, the company that transferred the note to the bank is liable for the full amount
Module 2: LO 4

43. Module 3 Accounting for Investments
Companies make different types of investments
Companies report short-term investments on the balance sheets
Companies earn income from these investments
Module 3

44. Accounting for Investments
Equity securities (stocks): issued by corporations as a form of ownership in the business
Debt securities (bonds): issued by corporations and governmental bodies as a form of borrowing
Certificate of Deposit (CD): a highly liquid financial instrument
Module 3: LO 5

45. Example 7-9—Accounting for an Investment in a Certificate of Deposit
On October 2, 2016, Creston Corp. invests $100,000 in a 120-day CD
The CD matures on January 30, 2017, at which time Creston receives the $100,000 and interest at an annual rate of 6%
The entry to record the purchase of the CD is as follows:
Module 3: LO 5

46. Example 7-9—Accounting for an Investment in a Certificate of Deposit (continued)
December 31 is the end of Creston’s fiscal year, so an entry is needed on this date to record interest earned during 2016 even though no cash will be received until the CD matures in 2017:
Module 3: LO 5

47. Example 7-9—Accounting for an Investment in a Certificate of Deposit (continued)
The entry on January 30 to record the receipt of the principal amount of the CD of $100,000 and interest for 120 days is as follows:
Module 3: LO 5

48. Exhibit 7-3—Interest Calculation
Module 3: LO 5

49. Investments in Stocks and Bonds
Module 3: LO 5

50. Example 7-10—Accounting for an Investment in Bonds
Assume that Atlantic buys $100,000 bonds at face value
The bonds pay 10% interest semiannually on June 30 and December 31
Atlantic will receive 5% of $100,000, or $5,000, on each of those dates
The entry on Atlantic’s books to record the purchase is as follows:
Module 3: LO 5

51. Example 7-10—Accounting for an Investment in Bonds (continued)
On June 30, Atlantic must record the receipt of semiannual interest
The entry on this date is as follows:
Module 3: LO 5

52. Example 7-10—Accounting for an Investment in Bonds (continued)
On July 1, 2016, Atlantic sells all of its ABC bonds at 99
The amount of cash received is 0.99 x $100,000, or $99,000
The entry on July 1, 2016, is as follows:
Module 3: LO 5

53. Example 7-11—Accounting for an Investment in Stock
On February 1, 2016, Dexter Corp. pays $50,000 for shares of Stuart common stock and another $1,000 in commissions
The entry on Dexter’s books on the date of purchase is as follows:
Module 3: LO 5

54. Example 7-11—Accounting for an Investment in Stock (continued)
Dexter received dividends of $500
The dividends received are recognized as income, as shown in the following entry on Dexter’s books:
Module 3: LO 5

55. Example 7-11—Accounting for an Investment in Stock (continued)
Dexter sells the Stuart stock on May 20, 2016, for $53,000
In this case, Dexter recognizes a gain for the excess of the cash proceeds, $53,000, over the amount recorded on the books, $51,000:
Module 3: LO 5

56. Module 4 How Liquid Assets Affect the Statement of Cash Flows
Receivables and investments affect cash flows
Cash flows from purchases, sales, and maturities of investments are usually classified as investing activities
Module 4

57. Exhibit 7-4—How Investments and Receivables Affect the Statement of Cash Flows
Module 4: LO 6

58. Review
LO1 Explain how to account for accounts receivable, including bad debts.
Accounts receivable arise from sales on credit. Companies with many customers may keep detailed records of accounts receivable in a separate subsidiary ledger.
Because not all customers pay their outstanding bills, an estimate of the accounts receivable less any doubtful accounts must be presented on the balance sheet.
Bad debts are estimated under the allowance method by one of two approaches:
Percentage of net credit sales
Percentage of accounts receivable

59. Review
LO2 Explain how information about sales and receivables can be combined to evaluate how efficient a company is in collecting its receivables.
Information about net credit sales and the average accounts receivable balance may be combined to calculate the accounts receivable turnover to see how well a company is managing its collections on account.
LO3 Explain how to account for interest-bearing notes receivable.
Notes receivable ultimately result in the receipt of both interest and principal to the holder of the notes.
Because interest receipts may not coincide with the end of the period, adjusting entries may need to be made to accrue interest receivable and interest revenue.

60. Review
LO4 Explain various techniques that companies use to accelerate the inflow of cash from sales.
To be competitive, companies must make sales on credit to customers.
One way to avoid bad debts associated with extending credit directly to the customer and to accelerate cash collections from sales is to accept credit cards for payment of goods and services.

61. Review
LO5 Explain the accounting for and disclosure of various types of investments that companies make.
Typically, excess cash expected to last for short periods of time is invested in highly liquid financial instruments such as CDs.
Sometimes cash is invested in securities of other corporations:
Equity securities—securities issued by corporations as a form of ownership in the business.
Debt securities—securities issued by corporations as a form of borrowing.
At times, a company may want to purchase a relatively large portion of another firm’s stock to acquire influence over that firm.

62. Review
LO6 Explain the effects of transactions involving liquid assets on the statement of cash flows.
Changes in cash equivalents are not shown on the statement.
Cash flows related to the purchase and sale of investments are classified as Investing Activities in the statement of cash flows.
Under the indirect method, increases in accounts and notes receivable are deducted and decreases in these accounts are added back in the Operating Activities section of the statement.

63. End of Chapter 7