Chapter 5 Accounting - Lecture 6
Chapter 5 (lecture 6)! Short-Term Investment and Receivables! February 25th, 2014 !
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Account for Short Term Investments ! - Cashed within 12 months of date ! - company have extra money on hand ! Short-term investments: ! - (marketable securities) are investments that a company plans to hold for one year or less.! - Bought shares of another company (hold on to less than one year) ! - are the most liquid asset after cash.! Short term asset account: ! - Debit current asset ! - Credit Cash ! Ex.! Suppose that Celestica Inc. purchases McCain Foods Ltd. shares on Dec. 18, paying $100,000 cash.! Short term investment 100,000! ! Cash ! ! ! 100, 000! Purchased investments ! Ex. ! On Dec. 27, Celestica receives a cash dividend of $4,000 from McCain.! Cash ! ! ! 4,000! ! Dividend Revenue ! 4,000! Received cash dividend ! - Dividend revenue is considered other revenues* ! Ex. ! Celestica fiscal year ends on Dec. 31, and the investment in McCain has a current market value of $102,000 on this date.! GAIN: because the market value ($102,000) is Greater than Celestica’s investment cost! Cost = 100,000! FMV= 102, 000! Gain = $2,000 (Unrealized - because the shares have not been sold, it means the cost of the shares have changed) ! - therefore journal entry is required. ! - Cr Unrealized gain (other gains) ! Short-term Investments ! ! 2,000! ! Unrealized gain on investment ! 2,000! Ex.! If the Celestica investment in McCain shares had decreased in value to $95,000! Unrealized Loss – because Celestica has not yet sold the investment! Unrealized loss on investment ! 5,000! ! Temporary investment ! ! 5,000! Balance Sheet – temporary assets are current assets!
Income Statement – temporary asset can either earn Interest Revenue or dividend revenue. All gains & losses are also reported on the income!
Question #1! ABC Co. purchased a temporary investment in shares of XYZ Co. for $14,000. At year end, the investment had a market value of $12,000. The $2,000 decrease in value in the temporary investment should be:! a. recorded as a realized loss on the income statement! b. deducted from the value of the asset on the balance sheet! c. only disclosed as part of the market value of marketable securities! d. both A and B.! Answer: ! Accounts and Notes Receivable! Receivables are the third most liquid assets after cash and short-term investments! Results from selling goods and services on credit and by lending money! Accounts receivable are a current asset on the balance sheet! Apply internal controls to receivables! Establishing Internal Control over Collections! Businesses that sell on credit receive most of their cash receipts by mail!
Some controls over accounts receivable are:! Businesses that sell on credit receive most of their cash receipts by mail! Some controls over accounts receivable are: ! a)! b) ! c) ! d) ! Use the allowance method for uncollectible receivables.! Accounting for Uncollectible Receivables! Selling on credit creates both a benefit and a cost:! The benefit:! Customers who cannot pay cash immediately can buy on credit, so company profits rise as sales increase.! The cost:! The company will be unable to collect from some credit customers.! The Allowance Method! The allowance method records collection losses on the basis of estimates, not waiting to see which customers will pay! The Allowance for Uncollectible Accounts (Allowance for Doubtful Accounts) is a contra account to Accounts Receivable! Journal entry: ! Dr Uncollectible - account expense ! Cr. Allowance for uncollectible a/c!
Accounting for Uncollectible Account! 1) Allowance method! Income Statement Approach! Balance Sheet Approach! 2) Direct write-off method! Percentage-of-sales! - computes uncollectible-account expense as a percentage of revenue.! - This method is also called the income statement approach! Ex. !
Aging-of-Receivables! - This method is a balance-sheet approach because it focuses on accounts receivable.! - Individual receivables from specific customers are analyzed based on how long they have been outstanding. A percentage of Accounts receivable could also be used.!
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! Allownce of Unc A/C 0.6 x=uncollected a/c exp 1.50 (from aging schedule or % of A/R)
! Allowance for uncollectible: ! Beg Balance: 0.6 ! x=uncollectible a/c ex ! ! ! ! 1.5 (aging schedule) ! therefore x - 2.1 (above is a t-account lol)! Jounral: ! Dr Uncollectible A/C exp ! ! 2.1! ! ! Cr. Allow for unc a/c ! ! 2.1!
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Use % of receivables for more accuracy ! Writing off uncollectible account (not direct write off) - Allowance method! - Suppose that early in 2012, the credit department determines that the company cannot collect from two customers.! - These accounts must be written off.! How? ! Dr Allowance for uncollectible accounts(doubtful) 0.6! ! ! Accounts receivable customer #! ! 0.4! ! ! Accounts receivable customer #! ! 0.2! Write off uncollectible receivables ! Recovery of Uncollectible Accounts Previously Written Off! (Reverse entry since you got money) ! 1. Reinstate the Accounts Receivable! Dr. Account Receivables ! ! Cr. Allowance for uncollectible accounts ! 2. Record the collection of cash! Dr. Cash! ! Cr. Accounts receivables ! Combining the Percentage-of-Sales and the Aging Methods! - For interim statements (monthly or quarterly), companies use the percentage-of-sales method because it is easier to apply! - At the end of the year, companies use the aging method to ensure that Accounts Receivable is reported at net realizable value! Direct Write-Off Method! No estimate is made (You just wait) ! - Using this method, an account is written off only when it is decided that a specific customer’s receivable is uncollectible.! Ex. ! February 2, 2011! Uncollectible-Account Expense 3,000! ! Accounts Receivable – Smith Inc. 3,000 ! Wrote off a bad account! Problems! 1) Since no allowance for uncollectibles is established, assets are overstated on the balance sheet. Overstate balance sheet! 2) It causes a poor matching of uncollectible- account expense against revenue and overstates net income.! Question #2! ABC Co. has the following information on its unadjusted trial balance at Dec. 31, 2011:! Accounts receivable ! 40,000 ! Allowance for uncollectible accounts 1,200 (debit)!
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The company uses the aging of receivables method and determined that $2,000 of receivables would not be collected. What amount should be reported as the bad debt expense on the Dec. 31, 2011 income statement?! a. $2,000 b. $800 c. $2,400 d. $3,200!
Answer: D ! Allowance for DA ! 1200! ! x-BD Exp ! ! ! 2000! (T account) ! Account for notes receivable! - Notes receivable are more formal than accounts receivable! - The principal amount of the note is the amount borrowed by the debtor! - The maturity value includes principal plus interest! - The creditor has a note receivable The debtor has a note payable!
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! ! ! ! ! ! ! ! !
! ! ! ! !
How to Speed up Cash Flow! Credit card sales – the merchant sells merchandise and lets the customer pay with a credit card such as Visa, Mastercard, etc.! Debit card sales – the customer uses their debit card to pay for the merchandise! Selling (factoring) receivables – the company sells its receivables to another business!
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THESE ARE BOTH CASH SALES ! Question #3! If the adjusting entry to accrue interest on a note receivable is omitted, then:! a. Assets, net income, and shareholders’ equity are overstated! b. Assets, net income, and shareholders’ equity are understated! c. Liabilities are understated, net income is overstated and shareholders’ equity is overstated! d. Assets are overstated, net income and shareholders’ equity are understated! Solution: ! To accrue interest! Dr Interest receivable (asset) ! ! Cr Interest revenue (net income, rev) ! Answer: B! Use ratios to evaluate a business! Decision Making: Using Ratios! Investors and creditors use ratios to evaluate the financial health of a company! To help them measure the liquidity of companies, they use:! a) Current ratio! This measures the entity’s ability to pay its current liabilities with current assets.! Current ratio = Current assets / Current liabilities! Rule of thumb: A strong current ratio is 1.50! b) Acid-Test Ratio (Quick)! This is a stringent test of liquidity which measures the entity’s ability to pay its current liabilities immediately.! (Cash + Short-term investments + receivable)/ Total current liabilities! - This ratio value is extremely high and indicates great liquidity for this company.! Excludes: Inventory —> takes too long to sell + collect cash ! Prepaid expense: cash has already been spent ! c) Days’ sales in receivables! One day’s sales = Net sales ÷ 365 days! Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales! A smaller number indicates a quick conversion to cash.! Reporting on the Cash Flow Statement! - Receivables bring in cash when the business collects from customers.! - These transactions are reported as operating activities on the cash flow statement.! Question #4! Net sales total $600,000. Beginning and ending accounts receivable are $52,000 and $38,000 respectively. Calculate days’ sales in receivables (rounded).! a. 32 days! b. 23 days! c. 43 days! d. 27 days! Days sales in A/R ! (one step process) !
((52+38)/2)/(600/365)=27 ! Answer: D !
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Class Decision Exercise 5-23! ($110,000 x 0.005) + (60,000 x 0.010) + (50,000 x 0.06) + (15,000 x 0.40) = $10,150. The current balance is $6,500! Allowance for DA 6,500! x = BD expense 10,150
The balance is too low ! Journal ! Doubtful account expense! ! ! ! ! ! ! Allowance for doubtful account! ! ! ! B/S! Current Assets: ! Cash! ! ! ! ! ! ! ! ! A/R! ! ! ! ! ! 235,000! Less: Allowance for Doubtful ! ! 10,150! ! accounts (aging schedule) ! 5-50A! a) Accounts receivables ! ! 37,953! ! Service Revenue ! ! ! 37,953! b) Cash ! ! ! ! 37, 314! ! Accounts receivables! ! 37, 314! c) Uncollectible-Account Expense 380! ! Accounts for uncollectible accounts ! ! (37,953 x 0.01) ! ! ! 380! d) Allowance for uncollectible Accounts 200! ! Accounts receivables ! ! 200! e) (After year end)!
! !
3,650! ! !
!
xx!
!
224,850!
3,650!
AR 4078! 37,953!
37, 314! 200 4517
Allowance for DA 200 136! 380 316
A/R ! ! 2! ! allowance for bad debt 2!
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cash! ! ! ar !
!
2! !
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I/S ! Service revenue ! ! ! Uncollectible a/c Expense !! Case #2:! Trends in sale: ! 2011! ! ! ! ! 1,745! ! ! ! !
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2010! = (1001-902)/902! ! = 10.9 or 11%! 2011 ! = (1475-1001)/1001 ! ! = 47% ! ! ! ! ! ! A/R! ! ! ! ! Less: Allow for DA! ! ! Net A/R ! ! ! !
2! ! !
37, 953! (380) !
! !
2010! ! 1,001! !
! !
! !
! !
! !
2009! 902!
! ! ! !
2011! 128! 13! 115!
! ! ! !
2010! 107! 11! 96!
! ! ! !
! ! ! !
2009! 94! 9 .! 85!
! ! ! ! !
2011! $96! 1475! (115)! 1456!
! ! ! ! !
! ! ! ! !
2010! $85! 1001! (96)! 990!
! ! ! !
! The trends increased by 47% in 2011 and 11% in 2010! ! Days sales in Receivables ! 2011 ! = [(115+96)/2]/[(1,475/365)]! = 26 days ! 2010 ! = [(96+85)/2]/[1001/365] ! *net accounts receivable!
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Cash collections from customers for 2011 and 2010 ! ! ! ! ! ! ! ! ! Beginning net accounts receivables ! ! ! + sales revenue ! ! ! ! ! ! -Ending net account receivables ! ! ! ! = estimated cash collections ! ! ! !
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Collections from customer increased dramatically during 2011. ! Based on the improving trends of sales and collections from customers, and the drop in days sales in receivables, we would lend 500,000 to Dean Young Sports Equipment
!
Account for Short Term Investments ! - Cashed within 12 months of date ! - company have extra money on hand ! Short-term investments: ! - (marketable securities) are investments that a company plans to hold for one year or less.! - Bought shares of another company (hold on to less than one year) ! - are the most liquid asset after cash.! Short term asset account: ! - Debit current asset ! - Credit Cash ! Ex.! Suppose that Celestica Inc. purchases McCain Foods Ltd. shares on Dec. 18, paying $100,000 cash.! Short term investment 100,000! ! Cash ! ! ! 100, 000! Purchased investments ! Ex. ! On Dec. 27, Celestica receives a cash dividend of $4,000 from McCain.! Cash ! ! ! 4,000! ! Dividend Revenue ! 4,000! Received cash dividend ! - Dividend revenue is considered other revenues* ! Ex. ! Celestica fiscal year ends on Dec. 31, and the investment in McCain has a current market value of $102,000 on this date.! GAIN: because the market value ($102,000) is Greater than Celestica’s investment cost! Cost = 100,000! FMV= 102, 000! Gain = $2,000 (Unrealized - because the shares have not been sold, it means the cost of the shares have changed) ! - therefore journal entry is required. ! - Cr Unrealized gain (other gains) ! Short-term Investments ! ! 2,000! ! Unrealized gain on investment ! 2,000! Ex.! If the Celestica investment in McCain shares had decreased in value to $95,000! Unrealized Loss – because Celestica has not yet sold the investment! Unrealized loss on investment ! 5,000! ! Temporary investment ! ! 5,000! Balance Sheet – temporary assets are current assets!
Income Statement – temporary asset can either earn Interest Revenue or dividend revenue. All gains & losses are also reported on the income!
Question #1! ABC Co. purchased a temporary investment in shares of XYZ Co. for $14,000. At year end, the investment had a market value of $12,000. The $2,000 decrease in value in the temporary investment should be:! a. recorded as a realized loss on the income statement! b. deducted from the value of the asset on the balance sheet! c. only disclosed as part of the market value of marketable securities! d. both A and B.! Answer: ! Accounts and Notes Receivable! Receivables are the third most liquid assets after cash and short-term investments! Results from selling goods and services on credit and by lending money! Accounts receivable are a current asset on the balance sheet! Apply internal controls to receivables! Establishing Internal Control over Collections! Businesses that sell on credit receive most of their cash receipts by mail!
Some controls over accounts receivable are:! Businesses that sell on credit receive most of their cash receipts by mail! Some controls over accounts receivable are: ! a)! b) ! c) ! d) ! Use the allowance method for uncollectible receivables.! Accounting for Uncollectible Receivables! Selling on credit creates both a benefit and a cost:! The benefit:! Customers who cannot pay cash immediately can buy on credit, so company profits rise as sales increase.! The cost:! The company will be unable to collect from some credit customers.! The Allowance Method! The allowance method records collection losses on the basis of estimates, not waiting to see which customers will pay! The Allowance for Uncollectible Accounts (Allowance for Doubtful Accounts) is a contra account to Accounts Receivable! Journal entry: ! Dr Uncollectible - account expense ! Cr. Allowance for uncollectible a/c!
Accounting for Uncollectible Account! 1) Allowance method! Income Statement Approach! Balance Sheet Approach! 2) Direct write-off method! Percentage-of-sales! - computes uncollectible-account expense as a percentage of revenue.! - This method is also called the income statement approach! Ex. !
Aging-of-Receivables! - This method is a balance-sheet approach because it focuses on accounts receivable.! - Individual receivables from specific customers are analyzed based on how long they have been outstanding. A percentage of Accounts receivable could also be used.!
!
! Allownce of Unc A/C 0.6 x=uncollected a/c exp 1.50 (from aging schedule or % of A/R)
! Allowance for uncollectible: ! Beg Balance: 0.6 ! x=uncollectible a/c ex ! ! ! ! 1.5 (aging schedule) ! therefore x - 2.1 (above is a t-account lol)! Jounral: ! Dr Uncollectible A/C exp ! ! 2.1! ! ! Cr. Allow for unc a/c ! ! 2.1!
!
Use % of receivables for more accuracy ! Writing off uncollectible account (not direct write off) - Allowance method! - Suppose that early in 2012, the credit department determines that the company cannot collect from two customers.! - These accounts must be written off.! How? ! Dr Allowance for uncollectible accounts(doubtful) 0.6! ! ! Accounts receivable customer #! ! 0.4! ! ! Accounts receivable customer #! ! 0.2! Write off uncollectible receivables ! Recovery of Uncollectible Accounts Previously Written Off! (Reverse entry since you got money) ! 1. Reinstate the Accounts Receivable! Dr. Account Receivables ! ! Cr. Allowance for uncollectible accounts ! 2. Record the collection of cash! Dr. Cash! ! Cr. Accounts receivables ! Combining the Percentage-of-Sales and the Aging Methods! - For interim statements (monthly or quarterly), companies use the percentage-of-sales method because it is easier to apply! - At the end of the year, companies use the aging method to ensure that Accounts Receivable is reported at net realizable value! Direct Write-Off Method! No estimate is made (You just wait) ! - Using this method, an account is written off only when it is decided that a specific customer’s receivable is uncollectible.! Ex. ! February 2, 2011! Uncollectible-Account Expense 3,000! ! Accounts Receivable – Smith Inc. 3,000 ! Wrote off a bad account! Problems! 1) Since no allowance for uncollectibles is established, assets are overstated on the balance sheet. Overstate balance sheet! 2) It causes a poor matching of uncollectible- account expense against revenue and overstates net income.! Question #2! ABC Co. has the following information on its unadjusted trial balance at Dec. 31, 2011:! Accounts receivable ! 40,000 ! Allowance for uncollectible accounts 1,200 (debit)!
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The company uses the aging of receivables method and determined that $2,000 of receivables would not be collected. What amount should be reported as the bad debt expense on the Dec. 31, 2011 income statement?! a. $2,000 b. $800 c. $2,400 d. $3,200!
Answer: D ! Allowance for DA ! 1200! ! x-BD Exp ! ! ! 2000! (T account) ! Account for notes receivable! - Notes receivable are more formal than accounts receivable! - The principal amount of the note is the amount borrowed by the debtor! - The maturity value includes principal plus interest! - The creditor has a note receivable The debtor has a note payable!
!
! ! ! ! ! ! ! ! !
! ! ! ! !
How to Speed up Cash Flow! Credit card sales – the merchant sells merchandise and lets the customer pay with a credit card such as Visa, Mastercard, etc.! Debit card sales – the customer uses their debit card to pay for the merchandise! Selling (factoring) receivables – the company sells its receivables to another business!
!
THESE ARE BOTH CASH SALES ! Question #3! If the adjusting entry to accrue interest on a note receivable is omitted, then:! a. Assets, net income, and shareholders’ equity are overstated! b. Assets, net income, and shareholders’ equity are understated! c. Liabilities are understated, net income is overstated and shareholders’ equity is overstated! d. Assets are overstated, net income and shareholders’ equity are understated! Solution: ! To accrue interest! Dr Interest receivable (asset) ! ! Cr Interest revenue (net income, rev) ! Answer: B! Use ratios to evaluate a business! Decision Making: Using Ratios! Investors and creditors use ratios to evaluate the financial health of a company! To help them measure the liquidity of companies, they use:! a) Current ratio! This measures the entity’s ability to pay its current liabilities with current assets.! Current ratio = Current assets / Current liabilities! Rule of thumb: A strong current ratio is 1.50! b) Acid-Test Ratio (Quick)! This is a stringent test of liquidity which measures the entity’s ability to pay its current liabilities immediately.! (Cash + Short-term investments + receivable)/ Total current liabilities! - This ratio value is extremely high and indicates great liquidity for this company.! Excludes: Inventory —> takes too long to sell + collect cash ! Prepaid expense: cash has already been spent ! c) Days’ sales in receivables! One day’s sales = Net sales ÷ 365 days! Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales! A smaller number indicates a quick conversion to cash.! Reporting on the Cash Flow Statement! - Receivables bring in cash when the business collects from customers.! - These transactions are reported as operating activities on the cash flow statement.! Question #4! Net sales total $600,000. Beginning and ending accounts receivable are $52,000 and $38,000 respectively. Calculate days’ sales in receivables (rounded).! a. 32 days! b. 23 days! c. 43 days! d. 27 days! Days sales in A/R ! (one step process) !
((52+38)/2)/(600/365)=27 ! Answer: D !
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Class Decision Exercise 5-23! ($110,000 x 0.005) + (60,000 x 0.010) + (50,000 x 0.06) + (15,000 x 0.40) = $10,150. The current balance is $6,500! Allowance for DA 6,500! x = BD expense 10,150
The balance is too low ! Journal ! Doubtful account expense! ! ! ! ! ! ! Allowance for doubtful account! ! ! ! B/S! Current Assets: ! Cash! ! ! ! ! ! ! ! ! A/R! ! ! ! ! ! 235,000! Less: Allowance for Doubtful ! ! 10,150! ! accounts (aging schedule) ! 5-50A! a) Accounts receivables ! ! 37,953! ! Service Revenue ! ! ! 37,953! b) Cash ! ! ! ! 37, 314! ! Accounts receivables! ! 37, 314! c) Uncollectible-Account Expense 380! ! Accounts for uncollectible accounts ! ! (37,953 x 0.01) ! ! ! 380! d) Allowance for uncollectible Accounts 200! ! Accounts receivables ! ! 200! e) (After year end)!
! !
3,650! ! !
!
xx!
!
224,850!
3,650!
AR 4078! 37,953!
37, 314! 200 4517
Allowance for DA 200 136! 380 316
A/R ! ! 2! ! allowance for bad debt 2!
!
cash! ! ! ar !
!
2! !
!
I/S ! Service revenue ! ! ! Uncollectible a/c Expense !! Case #2:! Trends in sale: ! 2011! ! ! ! ! 1,745! ! ! ! !
!
2010! = (1001-902)/902! ! = 10.9 or 11%! 2011 ! = (1475-1001)/1001 ! ! = 47% ! ! ! ! ! ! A/R! ! ! ! ! Less: Allow for DA! ! ! Net A/R ! ! ! !
2! ! !
37, 953! (380) !
! !
2010! ! 1,001! !
! !
! !
! !
! !
2009! 902!
! ! ! !
2011! 128! 13! 115!
! ! ! !
2010! 107! 11! 96!
! ! ! !
! ! ! !
2009! 94! 9 .! 85!
! ! ! ! !
2011! $96! 1475! (115)! 1456!
! ! ! ! !
! ! ! ! !
2010! $85! 1001! (96)! 990!
! ! ! !
! The trends increased by 47% in 2011 and 11% in 2010! ! Days sales in Receivables ! 2011 ! = [(115+96)/2]/[(1,475/365)]! = 26 days ! 2010 ! = [(96+85)/2]/[1001/365] ! *net accounts receivable!
!
Cash collections from customers for 2011 and 2010 ! ! ! ! ! ! ! ! ! Beginning net accounts receivables ! ! ! + sales revenue ! ! ! ! ! ! -Ending net account receivables ! ! ! ! = estimated cash collections ! ! ! !
!
Collections from customer increased dramatically during 2011. ! Based on the improving trends of sales and collections from customers, and the drop in days sales in receivables, we would lend 500,000 to Dean Young Sports Equipment
