ch06 fundamental of financial accounting by edmonds (4th edition)

Fundamental Fundamental Financial Accounting Financial Accounting

ConceptsConceptsFourth EditionFourth Edition

bybyEdmonds, McNair, Milam, OldsEdmonds, McNair, Milam, Olds

PowerPoint® presentation byJ. Lawrence Bergin

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

7- 2

Chapter 7

Accounting for Accruals:

Advanced Topics- Receivables and Payables


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Advanced topics include:Advanced topics include:

Accounting for bad debts

Accounting for interest-bearing notes and noninterest bearing (discounted) notes

Warranties

Want tolearn someaccounting?


7- 4

Accounts and Notes ReceivableAccounts and Notes Receivable

A/R are the expected future cash receipts of a company. They are typically small and are expected to be received within 30 days.

N/R are used when longer credit terms are necessary. The promissory note specifies the maturity date, the rate of interest, and other credit terms.


7- 5

Value of ReceivablesValue of Receivables

Receivables are reported at their face value less an allowance for accounts which are likely to be uncollectible.

The amount which is actually expected to be collected is called the net realizable value (NRV).


7- 6

Allowance Method vs. Direct Write-Off MethodAllowance Method vs. Direct Write-Off Method

GAAP requires that A/R be reported at NRV. (A/R minus Allowance)

This is done using a valuation allowance: An ALLOWANCE METHOD. % of Sales (or “Income Statement”) approach. Aging (or “Balance Sheet”) approach.

With the ALLOWANCE METHOD, an estimate of the amount that will NOT be collected is recorded in the same period that the sales revenue is recorded. Thus, the MATCHING PRINCIPLE is being followed.


7- 7

Allowance Method vs. Direct Write-Off Method (continued)Allowance Method vs. Direct Write-Off Method (continued)

The DIRECT WRITE-OFF method violates GAAP because it does NOT follow the MATCHING principle.

With the Direct Write-off method, no estimate of bad debts is recorded at the time of the sale. Rather, only after a specific account is deemed “uncollectible” is a Bad Debt Expense recorded.

Since GAAP is only required if the amounts are MATERIAL (significant), if the amount of uncollectible A/R is immaterial the Direct Write-off method may be used.


7- 8

Transaction Analysis: Transaction Analysis:

Assume the following selected events occurred at Cell-It. For each event: Determine how the accounting equation

was affected and fill in the horizontal model. (Assume GAAP must be followed.)

Determine the effect on the financial statements.

Record the event in t-accounts.


7- 9


The following selected events occurred at Cell-It during 2004.

1. Provided services to customers for $10,000 on account.2. Collected $7,000 on account receivables.3. At year-end it was estimated that 2% of year’s credit sales will never be collected.4. Jane Doe’s $50 account was written-off as “uncollectible”.5A&B. $50 cash is unexpectedly received from Jane Doe.


7- 10

Record the five transactions in this horizontal statements model.

Record the five transactions in this horizontal statements model.

Assets = Liab.+ Stk. Equity

Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA

1

2

3

4

5A

5B Bal.

Balance Sheet Inc. Statement Cashflow


7- 11

1. Provided services to customers for $10,000 on account.




1

2

3

4

5A

5B Bal.



7- 12





1 10000 10000 10000 10000 n.a.

2

3

4

5A

5B Bal.



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2. Collected $7,000 from account receivable.2. Collected $7,000 from account receivable.



1 10000 10000 10000 10000 n.a.

2

3

4

5A

5B Bal.



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2. Collected $7,000 from account receivable.2. Collected $7,000 from account receivable.



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.



7- 15

3. At year-end it was estimated that 2% of the year’s credit sales will not be collected.3. At year-end it was estimated that 2% of the year’s credit sales will not be collected.



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.

2% x $10,000 = $200


7- 16

3. At year-end it was estimated that 2% of the year’s credit sales will not be collected.3. At year-end it was estimated that 2% of the year’s credit sales will not be collected.



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.

2% x $10,000 = $200

Allowance for Doubtful Accounts is a CONTRA- ASSET account. This account balance is INCREASING by $200 causing TOTAL assets to decrease.


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4. Jane Doe’s $50 account was written-off as uncollectible.




1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.


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1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.

(50) (50) NO EXPENSE!

Note: This is NOT the Direct Write-off method. Rather, it is a write-off under the ALLOWANCE Method.


7- 19

Effect of Transaction 4 on Acct. Rec. Net Realizable ValueEffect of Transaction 4 on Acct. Rec. Net Realizable Value

Before Event 4 After Event 4

A/R $ A/R $

Allow. Allow.

N.R.V. $ N.R.V. $

Acme Collection

Agency


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A/R $3,000

Allow. (200)

N.R.V. $2,800

Acme Collection Agency

The check is in the mail.


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A/R $3,000 A/R $

Allow. (200) Allow.

N.R.V. $2,800 N.R.V. $

2,950

(150)

2,800


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A/R $3,000 A/R $2,950

Allow. (200) Allow. (150)

N.R.V. $2,800 N.R.V. $2,800

When using an ALLOWANCE method, the Net Realizable Value of accounts receivable does not change as a result of the write-off.


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Before recording Transaction #5: Before recording Transaction #5: What happens when an account that has been What happens when an account that has been written off later pays off his/her account?written off later pays off his/her account?

Before recording Transaction #5: Before recording Transaction #5: What happens when an account that has been What happens when an account that has been written off later pays off his/her account?written off later pays off his/her account?

Reinstate the account by recording an entry that undoes (reverses) the write-off: increase (debit) Accounts Receivable increase (credit) Allowance for

Doubtful Accounts (a contra-asset) Record the entry to show the cash

collection and A/Rec. reduction: increase (debit) Cash decrease (credit) Accounts

Receivable


7- 24

5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect)5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect)



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.


50 50


7- 25

5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect)5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect)



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.


50 50

50 (50) 50 OA


7- 26

Calculate all ending balances.Calculate all ending balances.



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.


50 50

50 (50) 50 OA

7050 2950 200 9800 10000 200 9800 7050 bal.


7- 27

What’s the result? the result?After completing the horizontal model fill in below.After completing the horizontal model fill in below.


How did the previous transactions affect the financial statements?

20X1 How much Bad Debt Expense should appear on the income statement?….

What is the A/R: NRV at year end?……

How much A/R should be added to the other current assets on the year-end balance sheet?………………………….


7- 28

Final Account BalancesRemember, the Bad Debt EXPENSE is accrued in the year of sale, NOT when the account is written off!

Final Account BalancesRemember, the Bad Debt EXPENSE is accrued in the year of sale, NOT when the account is written off!



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.


50 50

50 (50) 50 OA

7050 2950 200 9800 10000 200 9800 7050 bal.

MATCHING PRINCIPLE


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$ 200


7- 30

Final Account BalancesNet Realizable Value (NRV) = Acct.Rec. - AllowanceFinal Account BalancesNet Realizable Value (NRV) = Acct.Rec. - Allowance



1 10000 10000 10000 10000 n.a.

2 7000 (7000) 7000 OA

3

4

5A

5B Bal.


200 (200) 200 (200) n.a.


50 50

50 (50) 50 OA

7050 2950 200 9800 10000 200 9800 7050 bal.


7- 31







$ 200

$ 2,750

$ 2,750


7- 32

Transactions Posted to T-accountsTransactions Posted to T-accounts

Post the five transactions to these Ledger accounts.

Cash Acct. Rec. Allow. for D.A.

Service Revenue Bad Debt Exp. Retain. Earn.


7- 33

Transaction Posted to T-accountsTransaction Posted to T-accounts

1. Provided services to customers for $10,000 which will be collected at a later date.




7- 34


1. Provided services to customers for $10,000 which will be collected at a later date.



(1) 10,000

10,000 (1)


7- 35


2. Collected $7,000 of the Accounts Receivables.



(1) 10,000

10,000 (1)


7- 36


2. Collected $7,000 of the Accounts Receivables.



(2) 7,000 (1) 10,000

7,000 (2)

10,000 (1)


7- 37


3. At Yr. end it was estimated that 2% of the year’s credit sales will never be collected.



(2) 7,000 (1) 10,000

7,000 (2)

10,000 (1)


7- 38


3. At Yr. end it was estimated that 2% of the year’s credit sales will never be collected.



(2) 7,000 (1) 10,000

7,000 (2)

200 (3)

10,000 (1)

(3) 200


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(2) 7,000 (1) 10,000

7,000 (2)

200 (3)

10,000 (1)

(3) 200


7- 40





(2) 7,000 (1) 10,000

7,000 (2) 50 (4)

(4) 50 200 (3)

10,000 (1)

(3) 200


7- 41



A/R $3,000 A/R $2,950

Allow. (200) Allow. (150)

N.R.V. $2,800 N.R.V. $2,800

Net realizable value of accounts receivable did not change as a result of the write-off.


7- 42


5a. Jane Doe’s account is reinstated.



(2) 7,000 (1) 10,000

7,000 (2) 50 (4)

(4) 50 200 (3)

10,000 (1)

(3) 200


7- 43


5a. Jane Doe’s account is reinstated.



(2) 7,000 (1) 10,000

5a 50

7,000 (2) 50 (4)

(4) 50 200 (3)

50 (5a)

10,000 (1)

(3) 200


7- 44


5b. Jane Doe’s account is collected.



(2) 7,000 (1) 10,000

5a 50

7,000 (2) 50 (4)

(4) 50 200 (3)

50 (5a)

10,000 (1)

(3) 200


7- 45


5b. Jane Doe’s account is collected.



(2) 7,000

5b 50

(1) 10,000

5a 50

7,000 (2) 50 (4) 50 (5b)

(4) 50 200 (3)

50 (5a)

10,000 (1)

(3) 200


7- 46


Closing entries at the end of Year 1.



(2) 7,000

5b 50

(1) 10,000

5a 50

7,000 (2) 50 (4) 50 (5b)

(4) 50 200 (3)

50 (5a)

10,000 (1)

(3) 200


7- 47


Closing entries at the end of Year 1.



(2) 7,000

5b 50

(1) 10,000

5a 50

7,000 (2) 50 (4) 50 (5b)

(4) 50 200 (3)

50 (5a)

10,000 (1) (c) 10,000

(3) 200 200 (c)

(c) 200 10,000 (c)


7- 48


Balances of all accounts after Year 1 closings.



(2) 7,000

5b 50

bal. 7,050

(1) 10,000

5a 50 bal 2,950

7,000 (2) 50 (4) 50 (5b)

(4) 50 200 (3)

50 (5a)

200 bal.

10,000 (1) (c) 10,000 0 bal

(3) 200 200 (c) bal. 0

(c) 200 10,000 (c) 9,800 bal.


7- 49

Summary: Accounting for Bad DebtsSummary: Accounting for Bad Debts

Allowance method GAAP Required if company has a

significant amount of bad debts.

Matches bad debt expense (on the income statement) with the sale.

Requires an adjusting journal entry before closing the books.


7- 50

Summary: Accounting for Bad DebtsSummary: Accounting for Bad Debts

Direct Write-off method Violates GAAP (Matching) No estimates of bad debts are made,

so no allowance account is used. Used by small businesses with few

account receivables or large business with few collection problems.

No entry until time specific account is deemed “bad” (uncollectible).


7- 52

Direct Write-off Method for Accounting for Bad DebtsDirect Write-off Method for Accounting for Bad Debts

Direct Write-off method

Entry to write off J. Jones’ $100 account:

Bad Debt Expense 100

Acct. Rec.-Jones 100

Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow


7- 53

Direct Write-off Method for Accounting for Bad DebtsDirect Write-off Method for Accounting for Bad Debts

Direct Write-off method

Entry to write off J. Jones’ $100 account:

Bad Debt Expense 100

Acct. Rec.-Jones 100

Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow

(100) (100) +100 (100) n.a.


7- 54

Accrued Liabilities: Warranty CostsAccrued Liabilities: Warranty CostsAccrued Liabilities: Warranty CostsAccrued Liabilities: Warranty Costs

Why give warranties? When should expense be recognized?

WarrantyWarranty

We will We will repair orrepair orreplace thisreplace thisitem...item...


7- 55

Warranties…When to “expense”? General PrincipleWarranties…When to “expense”? General Principle

According to GAAP, the entire estimated warranty expense must be recorded in the period the sale is made, NOT in the period when the actual warranty cost is paid. (Matching principle is being followed.) A warranty liability is recorded along with the

expense. This liability is REDUCED whenever cash is paid to service a product still under warranty.


7- 56

Transaction AnalysisTransaction Analysis

The following selected warranty related events occurred at Cell-It.

For each event: Determine how the financial statements

are affected and fill in the horizontal model. Record each event directly in LEDGER

accounts.


7- 57

Transaction AnalysisTransaction Analysis

The following selected events occurred at Cell-It. (Perpetual inventory method is used.)

1. On 1/1/04 sold merchandise for $5,000 cash that had originally cost $4,000. These goods were sold with a two-year warranty.2. Estimated that $100 of warranty cost will be incurred over the next two years on the goods sold in #1.3. During 2005 a customer returned for repair, goods still under warranty. The cost of the repair was $30 cash.


7- 59

1a. Sold 1a. Sold (on 1/1/04 with 2 yr. warranty)(on 1/1/04 with 2 yr. warranty) for $5,000 cash, for $5,000 cash,1b. merchandise that originally cost $4,000.1b. merchandise that originally cost $4,000. (perpetual inventory method is used.) (perpetual inventory method is used.)

1a. Sold 1a. Sold (on 1/1/04 with 2 yr. warranty)(on 1/1/04 with 2 yr. warranty) for $5,000 cash, for $5,000 cash,1b. merchandise that originally cost $4,000.1b. merchandise that originally cost $4,000. (perpetual inventory method is used.) (perpetual inventory method is used.)

Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA

1a

1b

Balance Sheet C=CofGS,W=War.exp.

5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.


7- 60

Before recording Transaction #2: Warranties…When to “expense”Before recording Transaction #2: Warranties…When to “expense”

According to GAAP, the entire estimated warranty expense must be recorded in the period the sale is made, NOT in the period when the actual warranty cost is paid. (Matching principle is being followed.) A warranty liability is recorded along with the

expense. This liability is REDUCED whenever cash is paid to service a product still under warranty.


7- 61

2. Estimated that $100 of warranty cost will be2. Estimated that $100 of warranty cost will be incurred over the next two years on the incurred over the next two years on the goods sold in #1. goods sold in #1.

2. Estimated that $100 of warranty cost will be2. Estimated that $100 of warranty cost will be incurred over the next two years on the incurred over the next two years on the goods sold in #1. goods sold in #1.


1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.


7- 62

3. During 2005 a customer returned for repair3. During 2005 a customer returned for repair goods still under warranty. The cost of the goods still under warranty. The cost of the repair was $30 cash. repair was $30 cash.

3. During 2005 a customer returned for repair3. During 2005 a customer returned for repair goods still under warranty. The cost of the goods still under warranty. The cost of the repair was $30 cash. repair was $30 cash.


1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3 (30) (30) n.a. n.a. n.a. n.a. (30) OA


7- 63

SUMMARY QUESTIONSSUMMARY QUESTIONS SUMMARY QUESTIONSSUMMARY QUESTIONS


1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

Questions: 2004 2005

1. Warranty Expense for the year:

2. Warranty liability on year-end bal. sheet:

3. Cash outflow related to warranty work:

$100


7- 64

SUMMARY QUESTIONSSUMMARY QUESTIONS SUMMARY QUESTIONSSUMMARY QUESTIONS


1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3. (30) (30) n.a. n.a. n.a. n.a. (30) OA





$100

$100


7- 65

SUMMARY QUESTIONS SUMMARY QUESTIONS


1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3. (30) (30) n.a. n.a. n.a. n.a. (30) OA





$100

$100

$ 0


7- 66



1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3. (30) (30) n.a. n.a. n.a. n.a. (30) OA





$100

$100

$ 0

$ 0$ 0


7- 67



1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

70 balance Questions: 2004 2005




$100

$100

$ 0

$ 0$ 0

$ 70$ 70


7- 68



1a

1b


5000 5000 5000 5000 5000 OA

(4000) (4000) C 4000 (4000) n.a.

2 100 (100) w 100 (100) n.a.3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

70 balance Questions: 2004 2005




$100

$100

$ 0

$ 0$ 0

$ 70$ 70

($30)OA


7- 69Transactions Posted to T-accountsTransactions Posted to T-accounts

1. In 2004, sold for $5000 cash (1A), units costing $4000 (1B).

Cash

Bal. X 30 (3) (1A) 5,000

Inventory

Bal. X 4,000 (1B)

Warranty Payable

(3) 30 100 (2)

Sales

5,000 (1A)

Cost of Goods Sold

(1B) 4,000

Warranty Expense

(2) 100

2. During 2004, estimated $100 warranty cost over two years. 3. During 2005, paid $30 cash to repair units sold in 2004.

Entries (not shown here) to close Sales, Cost of Goods Sold, and Warranty Expense to Retained Earnings would have been made at the end of 2004.


7- 70

Notes Payable: Transaction AnalysisNotes Payable: Transaction Analysis

Assume the following selected events occurred at Cell-It. For each event:

Determine how the financial statements are affected and fill in the horizontal statements model.

Record the event in the Journal and Post to the Ledger.


7- 71

Notes Payable: Transaction AnalysisNotes Payable: Transaction Analysis

Assume the following events occurred at Cell-It.

1. On Oct. 1, 2004 Cell-It borrowed $8,000 cash by issuing a note payable with a one-year term and an 8% stated interest rate. All interest will be paid at maturity. This is an “interest bearing” note.

2. On Oct. 1, 2004 Cell-It issued an $8,000 face value, discounted note payable with a one-year term and an 8% stated discount rate. This is called a “Discounted” or “Non-interest bearing” note.

3. On Dec. 31, 2004 recorded interest related to the 8% interest-bearing note issued on Oct. 1st (see #1).

4. On Dec. 31, 2004 recorded interest related to the 8% discounted (non-interest bearing) note issued on Oct. 1st (see #2).

5. On Sept. 30, 2005 repaid the 8% non-discounted note payable (#1), plus all interest.

6. On Sept. 30, 2005 repaid the 8% discounted note payable (#2).


7- 73

T1: On Oct. 1, 2004 Cell-it borrowed $8,0001: On Oct. 1, 2004 Cell-it borrowed $8,000 at 8% for 1 year on an interest bearing at 8% for 1 year on an interest bearing note. All interest to be paid at maturity. note. All interest to be paid at maturity.

T1: On Oct. 1, 2004 Cell-it borrowed $8,0001: On Oct. 1, 2004 Cell-it borrowed $8,000 at 8% for 1 year on an interest bearing at 8% for 1 year on an interest bearing note. All interest to be paid at maturity. note. All interest to be paid at maturity.

Assets = Liabilities + Equity Inc. State. Cashflow

Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA

1

Balance Sheet

8000 8000 8000 FA


7- 74 T2: On Oct. 1, 2004 Cell-it issued an $8,000 face2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at value, one year note payable discounted at 8%. (A noninterest bearing note.) 8%. (A noninterest bearing note.)

T2: On Oct. 1, 2004 Cell-it issued an $8,000 face2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at value, one year note payable discounted at 8%. (A noninterest bearing note.) 8%. (A noninterest bearing note.)



1

Balance Sheet

8000 8000 8000 FA2 7360 8000 640 7360 FA

The interest is INCLUDED in the Note Payable. The interest must be subtracted to calculate the amount of cash the borrower receives on the issue date.

Note Payable $8000Interest ($8000 x .08 x 12/12) (640) Cash to borrower $7360

Since no time has past, the $640 is NOT an EXPENSE yet.


7- 75 T2: On Oct. 1, 2004 Cell-it issued an $8,000 face2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at value, one year note payable discounted at 8%. (A noninterest bearing note.) 8%. (A noninterest bearing note.)

T2: On Oct. 1, 2004 Cell-it issued an $8,000 face2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at value, one year note payable discounted at 8%. (A noninterest bearing note.) 8%. (A noninterest bearing note.)



1

Balance Sheet

8000 8000 8000 FA2 7360 8000 640 7360 FA

Discount on Note Payable is a contra liability account.Its balance is SUBTRACTED from the Note Payable account to obtain the total liability for the Note.

Note Payable 8000Less: Discount on N/P (640) Total Note Liability 7360


7- 76T3: On Dec. 31, 2004 recorded interest3: On Dec. 31, 2004 recorded interest related to the note in #1. related to the note in #1.Oct. 1-Dec. 31 = 3 mo. (8000 x .08 x 3/12=160)

T3: On Dec. 31, 2004 recorded interest3: On Dec. 31, 2004 recorded interest related to the note in #1. related to the note in #1.Oct. 1-Dec. 31 = 3 mo. (8000 x .08 x 3/12=160)



1

Balance Sheet

8000 8000 8000 FA2 7360 8000 640 7360 FA

3 160 (160) 160 (160) n.a.


7- 77

T4: On Dec. 31, 2004 recorded interest related to : On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. the discounted (noninterest bearing) note in #2.T4: On Dec. 31, 2004 recorded interest related to : On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. the discounted (noninterest bearing) note in #2.



1

Balance Sheet

8000 8000 8000 FA2 7360 8000 640 7360 FA

3 160 (160) 160 (160) n.a.

4 (160) (160) 160 (160) n.a.


7- 78T5: On Sept. 30, 2005 repaid the 8% note from: On Sept. 30, 2005 repaid the 8% note from Transaction #1 and all its interest. Transaction #1 and all its interest.a= accrue the remaining interest. b= payment.a= accrue the remaining interest. b= payment. (Jan. 1-Sept. 30 = 9 mo. (8000 x .08 x 9/12= $480)

T5: On Sept. 30, 2005 repaid the 8% note from: On Sept. 30, 2005 repaid the 8% note from Transaction #1 and all its interest. Transaction #1 and all its interest.a= accrue the remaining interest. b= payment.a= accrue the remaining interest. b= payment. (Jan. 1-Sept. 30 = 9 mo. (8000 x .08 x 9/12= $480)



1

Balance Sheet

8000 8000 8000 FA2 7360 8000 640 7360 FA

3 160 (160) 160 (160) n.a.

4 (160) (160) 160 (160) n.a.5a 480 (480) 480 (480) n.ab (8640) (640) (8000) (8000) FA

(640) OA


7- 79T6: On Sept. 30, 2005 repaid the 8% : On Sept. 30, 2005 repaid the 8% discounted note payable from Trans. #2. discounted note payable from Trans. #2. a= accrue the remaining interest. b= payment.a= accrue the remaining interest. b= payment.

T6: On Sept. 30, 2005 repaid the 8% : On Sept. 30, 2005 repaid the 8% discounted note payable from Trans. #2. discounted note payable from Trans. #2. a= accrue the remaining interest. b= payment.a= accrue the remaining interest. b= payment.



1

Balance Sheet

8000 8000 8000 FA2 7360 8000 640 7360 FA

3 160 (160) 160 (160) n.a.

4 (160) (160) 160 (160) n.a.5a 480 (480) 480 (480) n.ab (8640) (640) (8000) (8000) FA

(640) OA 6a (480) (480) 480 (480) n.a.

b (8000) (8000) (7360) FA

(640) OA


7- 80

Comparison of Journal Entries for Interest Bearing and Discounted Notes

Comparison of Journal Entries for Interest Bearing and Discounted Notes

NOTE PAYABLE (Interest bearing) DISCOUNTED NOTE PAYABLEDate Accounts Debit Credit Date Accounts Debit Credit2004 2004

Oct. 1 Cash 8000 Oct. 1 Cash 7360 Note Payable 8000 Discount on Note Payable 640Borrowed $8000 at 8% for one year Note Payable 8000

Borrowed $8000 discounted at 8% for one year

Dec. 31 Interest Expense 160 Dec. 31 Interest Expense 160 Interest Payable 160 Discont on Note Payable 160Accrued 3 mo. interest (8000x.08x3/12) Amortized 3 mo. interest from Discount to Int. Exp.

2005 2005Sept. 30 Interest Expense 480 Sept. 30 Interest Expense 480

Interest Payable 480 Discont on Note Payable 480Accrued 9 mo. interest (8000x.08x9/12) Amortized 9 mo. interest from Discount to Int. Exp.

Sept. 30 Interest Payable 640 Sept. 30 Note Payable 8000Note Payable 8000 Cash 8000 Cash 8640 Paid note (which already includes iall nterest)

Paid note and all interest

Contra-liabilities are increased by debiting.


7- 81

Comparison of Ledger Accounts for Interest Bearing and Discounted Notes Comparison of Ledger Accounts for Interest Bearing and Discounted Notes

INTEREST BEARING NOTE PAYABLE2004 Exp.

Cash Note Payable Interest ExpenseBeg. Bal. X 10/01/04 8000 12/31/04 16010/01/04 8000 9/30/05 8000 09/30/05 480

8640 9/30/05 02005 Exp.

Interest Payable 160 12/31/04

480 09/30/05

9/30/05 640 0

NON-INTEREST BEARING (DISCOUNTED) NOTE PAYABLE2004 Exp.

Cash Note Payable Interest ExpenseBeg. Bal. X 10/01/04 8000 12/31/04 16010/01/04 7360 9/30/05 8000 09/30/05 480

8000 9/30/05 02005 Exp.

Discount on Note Pay. 160 12/31/04

480 09/30/05

9/30/05 640 0


7- 82


Effect on Financial Statements

Inc. State. State. of Ch. in Eq CashFlow

1. No effect No effect +8,000 FA

2. No effect No effect +7,360 FA

3. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq, n.a.

4. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq. n.a.

5. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq. -8000FA,-640 OA

Which loan was the better deal for Cell-It?Which loan was the better deal for Cell-It?

Calculate the EFFECTIVE INTEREST % of each.Calculate the EFFECTIVE INTEREST % of each.

Interest bearing note:Interest bearing note:

Eff. Int. %Eff. Int. % = $ Annual Interest ÷ Cash Rec’d.= $ Annual Interest ÷ Cash Rec’d.

= $640= $640 ÷ $8,000 ÷ $8,000

== 8.0%8.0%

Non-Interest bearing note (Discounted note):Non-Interest bearing note (Discounted note):

Eff. Int. %Eff. Int. % = $ Annual Interest ÷ Cash Rec’d.= $ Annual Interest ÷ Cash Rec’d.

= $640= $640 ÷ $7,360 ÷ $7,360

== 8.7%8.7%

With note #2 Cell-It only received $7,360 from the lender, but still had to pay $640 interest for the year. That’s why the effective interest rate is higher for Note #2.

Note #1 (Interest bearing) is a “better deal” in this case.


7- 83

Financial Statement AnalysisFinancial Statement Analysis

Accounts Receivable Turnover Sales

= $ Accounts Receivable*

Accts/Rec. Turnover

This ratio is a measure of how quickly receivables are collected.

Often the AVERAGE Accts. Rec. is used as the denominator.

Ave. A/R = Beginning Accts/Rec. + Ending Accts/Rec. 2


7- 84

Accounts Receivable RatiosAccounts Receivable Ratios

Accts. Rec. Turnover: (A measure of how fast receivables are collected. Higher is better.)

Sales $50,000 Accounts. Receiv. $ 5,000

= = 10.0 times

Average Days to collect A/R: (How many days go by between a credit sale and the time it is collected?) 365 365Accts. Rec. Turnover 10.0= = 36.5 days

Generally, lower means better.


7- 85

Chapter 7

The End

ch06 fundamental of financial accounting by edmonds (4th edition)

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