1. 5-1 CHAPTER 5 Accounting for and Presentation of Current Assets McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

2. 5-2 Operating Cycle An operating cycle is the average time it takes to convert an investment in inventory back into cash. Merchandise inventory Purchases Merchandise inventory Credit sales Account receivable Cash collection Purchases Cash sales Cash Sale Credit Sale

3. 5-3 Inventorie s Short-term Securities Current assets include cash and those assets that are expected to be converted to cash or used up within one year, or an operating cycle, whichever is longer. What are Current Assets? Cash Current Assets include Deferred Tax Assets Accounts and Notes Receivable Prepaid Expenses

4. 5-4 Cash Coins and paper money Checking accounts Money orders Undeposited receipts Petty cash funds L O 1 Cash includes...

5. 5-5 Commercial paper Cash Equivalents U.S. Treasury securities Bank certificates of deposit Money market mutual funds Cash Equivalents include... L O 1

6. 5-6 Cash Management Goals Invest excess cash with minimal risk. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash. Prevent theft and fraud. Invest excess cash with minimal risk. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash. Prevent theft and fraud. L O 1

7. 5-7 The Internal Control System Internal Control Over Cash Require daily deposits. Make all payments by check. Promptly reconcile bank statements. Internal Control Over Cash Require daily deposits. Make all payments by check. Promptly reconcile bank statements. Internal control objectives are to ensure: 1.Effective and efficient operations. 2.Reliable financial reporting. 3.Compliance with applicable laws and regulations. L O 2

8. 5-8 Bank Statements Beginning Bank Balance + Deposits processed by the Bank - Checks which have cleared the account +/- Other adjustments made by the Bank = Ending Balance Bank Statement L O 3

9. 5-9 Bank Reconciliation - Objective Identify Differences Between Ending cash balance reported on bank statement Compared to Ending cash balance in depositor’s accounting records. Provides information for reconciling journal entries. L O 3

10. 5-10 Bank Reconciliation Process Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors Adjusted Balance Balance per Depositor + Deposits by Bank - Bank Adjustments ± Book Errors Adjusted Balance L O 3 End Result: Adjusted Bank Balance = Adjusted Book Balance =

11. 5-11 Bank Reconciliation All reconciling items on the book side require an adjusting entry to the cash account. Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance L O 3

12. 5-12 Bank Reconciliation Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicates a cash balance of $9,610. The cash ledger account balance is $7,430. L O 3 Difference must be reconciled

13. 5-13 Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not reached the bank at the statement date. The bank returned a customer’s NSF check for $225 received as payment of an account receivable. The bank statement showed $30 interest earned on the bank balance for the month of July. Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously credited to our account by the bank. Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not reached the bank at the statement date. The bank returned a customer’s NSF check for $225 received as payment of an account receivable. The bank statement showed $30 interest earned on the bank balance for the month of July. Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously credited to our account by the bank. Bank Reconciliation L O 3

14. 5-14 Bank Reconciliation L O 3 Bank Records = Depositor records

15. 5-15 Bank Reconciliation L O 3

16. 5-16 Short-Term Marketable Securities Bond Investments Capital Stock Investments Current Assets Almost As Liquid As Cash Readily Marketable Marketable Securities are... L O 4

17. 5-17 Trading Debt & Equity securities actively traded Reported at market value Short-Term Marketable Securities At the end of the period, remember to record interest earned but not yet received related to short-term marketable securities. L O 4 Available for Sale Debt & Equity securities not in the other two categories Reported at market value Market = Current Value of Investment (May be higher or lower than original cost) Held To Maturity Debt securities held to maturity Reported at cost Amount paid at time of purchase

18. 5-18 Let’s turn our attention to accounts receivable. L O 5 Accounts Receivable

19. 5-19 Uncollectible Accounts If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. PAST DUE L O 5

20. 5-20 Bad Debts/Uncollectible Accounts At the end of each period, record an estimate of the uncollectible accounts. Contra-asset account Selling expense L O 5

21. 5-21 Bad Debts/Uncollectible Accounts There are two methods available for estimating bad debt expense: 1.Percentage of sales method (based on the collectibility of all credit sales for the period); or 2.Aging of receivables method (based on an estimate of the accounts receivable to be collected). L O 5

22. 5-22 Balance Sheet Presentation The net realizable value is the amount of accounts receivable that the business expects to collect. L O 5

23. 5-23 Writing Off an Uncollectible Account Receivable When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off. L O 5

24. 5-24 Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he owes. K-Max would make the following entry. L O 5 Writing Off an Uncollectible Account Receivable

25. 5-25 Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Bad Debts balance was $2,500. Let’s see what effect the write-off had on these accounts. L O 5 Writing Off an Uncollectible Account Receivable

26. 5-26 Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts. L O 5 Writing Off an Uncollectible Account Receivable

27. 5-27 Cash Discounts A deduction from the invoice price granted to induce early payment of the amount due. Terms Time Due Discount Period Invoice total less discount Credit Period Invoice total due Purchase or Sale 2/10,n/30 Discount Period Otherwise, Net (or invoice total) is Due Credit Period Discount Percent Discount Percent L O 5

28. 5-28 A note is a written promise to pay a specific amount at a specific future date. Notes Receivable Notes typically include an interest charge for use of the money during the time period of the note. L O 6

29. 5-29 Adjusting Entry for Accrued Interest An adjusting entry is required at the end of the accounting period for any unpaid interest. L O 6 Use the Interest Formula I = P x R x T Use the Interest Formula I = P x R x T

30. 5-30 Inventory Goods owned and held for sale to customers Current asset Current asset Inventories L O 7

31. 5-31 In a perpetual inventory system, inventory entries are as follows: Inventories L O 7 Cost of Goods sold is an Expense

32. 5-32

33. 5-33 Specific identification LIFO Weighted- average FIFO We use one of these inventory valuation methods to determine cost of inventory sold. Inventory Cost-Flow Assumptions L O 8

34. 5-34 The Bike Company (TBC) Inventory Cost-Flow Assumptions L O 8

35. 5-35 Specific Identification When a unit is sold, the specific cost of the unit sold is added to cost of goods sold. L O 8

36. 5-36 Cost of Goods Available for Sale During the Year Units Available for Sale During the Year ÷ Weighted-Average Calculate the average cost of the items in beginning inventory plus purchases made during the year. L O 8

37. 5-37 $5,990  55 = $108.9091 Weighted-Average Cost of Goods Sold $108.9091 × 43 = $4,683.09 Ending Inventory $108.9091 × 12 = $1,306.91 L O 8

38. 5-38 Costs of Goods Sold Oldest Costs Ending Inventory Recent Costs First-In, First-Out (FIFO) L O 8

39. 5-39 First-In, First-Out (FIFO) L O 8

40. 5-40 Recent Costs Ending Inventory Oldest Costs Last-In, First-Out Method (LIFO) L O 8 Costs of Goods Sold Recent Costs

41. 5-41 Last-In, First-Out Method (LIFO) L O 8

42. 5-42 The Impact of Changing Costs In periods of rising costs, LIFO results in lower ending inventory and higher cost of goods sold than FIFO. L O 8

43. 5-43 The Impact of Inventory Quantity Changes Changes in the quantities of inventory will have an impact on profits that is dependent on the cost-flow assumption used and the extent of cost changes during the year. L O 8

44. 5-44 Inventory Accounting System Alternatives Periodic Inventory System Cost of goods sold is determined at the end of the fiscal period. Cost of goods sold is determined each time inventory is sold. Perpetual Inventory System L O 8

45. 5-45 Inventory Accounts Retail Firm Merchandise Inventory Finished Goods Inventory Raw Materials Inventory Work in Process Inventory Manufacturin g Firm L O 8 Product available to be sold Used to produce products Partially completed products

46. 5-46 Inventory Errors Errors in the amount of ending inventory have a direct dollar-for-dollar effect on cost of goods sold and net income. For this reason, independent auditors, income tax auditors, and financial analysts look closely at reported inventory amounts. L O 9

47. 5-47 Lower of Cost or Market Inventory must be reported at market value when market is lower than cost. Can be applied three ways: (1)separately to each individual item. (2)to broad categories of inventory. (3)to the whole inventory. Can be applied three ways: (1)separately to each individual item. (2)to broad categories of inventory. (3)to the whole inventory. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. Defined as current replacement cost (not sales price). Consistent with the conservatism principle.

48. 5-48 Examples: Insurance Rent Prepaid Expenses require adjusting entries Assets are decreased Expenses are increased Expenses that have been paid in the current fiscal period but will not be subtracted from revenue until a subsequent fiscal period. Prepaid Expenses and Other Current Assets L O 10

49. 5-49 Deferred Tax Assets A deferred tax asset arises when an income tax expense is recognized for financial accounting purposes in a fiscal year before the fiscal year in which it is deductible in the determination of taxable income.

50. 5-50 End of Chapter 5