short-term investments & receivables

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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Short-Term Investments & ReceivablesChapter 5


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Account for short-term investments


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Short-Term Investments

•Also called marketable securities•Easily convertible into cash

▫Next most liquid asset after cash•Expected to be held one year or less


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Short-Term Investment Categories


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Trading Securities

•Held for a short time and then sold▫If market price of investment increases, a

gain results▫If market price of investment decreases, a

loss results•Can be debt or equity securities of

another company•Earn interest or dividend revenue


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Accounting for Trading Securities

JOURNAL

Date

Accounts and explanation Debit Credit

Investment in ABC stock

Cash

Purchased investment

Cash

Dividend Revenue

Received cash dividend


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Unrealized Gains and Losses

If fair value has

increased

If fair value has

increased

If fair value has

decreased

If fair value has

decreased

Unrealized gain

Unrealized gain

Unrealized loss

Unrealized loss

Trading securities are reported on the balance sheet at current fair (market)

value

Trading securities are reported on the balance sheet at current fair (market)

value


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Adjusting Trading Securities to Fair Value

JOURNAL

Date



Unrealized Gain on Investments

Adjusted investment to fair value

JOURNAL

Date


Unrealized Loss on Investment



If fair value increases over

period

If fair value decreases over

period


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Balance Sheet & Income Statement Reporting

Balance Sheet Income Statement

Current assets: Revenues $XXX

Cash $XXX Expenses XXX

Short-term investments, at fair value XXX

Other revenue, gains, and (losses):

Accounts receivable XXX Interest revenue XXX

Dividend revenue XXX

Unrealized gain on investments XXX

Net income $XXX


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Realized Gains and Losses

If sales price > carrying

amount

If sales price > carrying

amount

If sales price < carrying amount

If sales price < carrying amount

GainGain

LossLoss

Only reported when investment is sold

Only reported when investment is sold


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Exercise 5-21A1. Trading securities – company intends to hold a short period and then sell

JOURNAL

Date Accounts and explanation Debit Credit

12-15

Investment in Dream Stock 57,000

Cash 57,000

Purchased investment

12-31

Investment in Dream Stock 1,000

Unrealized Gain on Investments 1,000



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Exercise 5-21A

Eastern CorporationPartial Balance SheetDecember 31, 2012

Current assets:

Short-term investments at fair value $58,000

Eastern CorporationPartial Income Statement

Year Ended December 31, 2012

Other income, revenue, gains, and (losses):

Unrealized gain on investments $1,000


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Apply GAAP for proper revenue recognition


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Revenue Recognition

•Revenue recognized when earned▫Seller has transferred good or service to

customer▫Price is fixed or determinable▫Collection reasonably assured

•Amount is cash value of goods or services transferred

•Impacted by shipping terms and payment incentives offered


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FOB Shipping Point FOB Destination• Ownership changes

hands• Revenue recognized

▫When goods leave seller’s shipping dock

• Ownership changes hands

• Revenue recognized▫At point of delivery

to customer

Shipping Terms


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Sales Discounts

•Offered to customers to speed up cash flow

2/10, n/302% discount if paid within 10

days

2% discount if paid within 10

days

Full amount due in 30 days

Full amount due in 30 days

JOURNAL

Date


Cash

Sales Discount

Accounts Receivable

Collected cash from customer on account and provided discount


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Sales Returns and Allowances

•Right to return unsatisfactory or damaged merchandise

JOURNAL

Date


Sales Returns and Allowances

Accounts Receivable

Merchandise returned by customer on account


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Net Revenue

Gross revenue $100,000

− Sales discounts (1,000)

− Sales returns and allowances (400)

= Net revenue $98,600


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Account for and control accounts receivable


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Receivables

•Third most liquid asset•Monetary claims against others•Acquired mainly by:

▫selling goods and services (accounts receivable)

▫lending money (notes receivable)


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Accounts Receivable

•Amounts collectible from customers•Balance in general ledger

▫Control account: summarizes total amount due from all customers

•Subsidiary ledger▫Separate account for each customer


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Accounts Receivable

9,000

Customer A

Customer B

5,000

1,000

Customer C

3,000

General LedgerAccounts Receivable

Subsidiary Record

Total

$9,000

Balance

Balance

Balance

Balance


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Notes Receivable

•More formal than accounts receivable•Written promise to pay a sum at the

maturity date▫Plus interest

•Also called promissory notes


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Internal Control over Cash Collections on Account•Separate cash-handling and cash

accounting duties▫Bookkeeper should not handle cash

Should record amounts from remittance advices

▫Separate employee should open incoming mail and make deposit

•Another option:▫Lockbox system


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Risks of Selling on CreditIssues Plan of actionWhat are the benefits and costs of extending credit to customers?

Benefit – increase in salesCost – risk of not collecting

Run a credit check on prospective customers

Extend credit to only creditworthy customers

Design internal control system to separate duties

Separate cash-handling and accounting duties to keep employees from stealing cash from customers

Keep a close eye on customers. Send additional statements to slow-paying customers

Pursue collection from customers to maximize cash flow


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Evaluate collectibility using the allowance for uncollectible accounts


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Benefit of selling on credit Cost of selling on credit

• Customers that do not have cash available can buy on credit

• Sales and profits increase

• Company cannot collect from some customers

• This cost is called “uncollectible-account expense”, “doubtful-account expense”, or “bad debt expense”

Uncollectible Receivables


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The Allowance Method

•Records collection losses based on company’s collection experience

•Estimates Uncollectible-Account Expense•Also sets up Allowance for

Uncollectible Accounts Contra-account to Accounts Receivable Shows amount of receivables expected not to

be collected


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Net Realizable Value

Partial Balance Sheet

Current assets:

Accounts receivable $100,000

Less: Allowance for uncollectible accounts

(5,000)

Accounts receivable, net $95,000


Current assets:

Accounts receivable, less allowance of $5,000

$95,000


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Methods to Estimate Uncollectibles


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Percent-of-Sales Method

•Emphasizes the expense recognition (matching ) concept

RevenueRevenue

JOURNAL

Date


Uncollectible–Account Expense

Allowance for Uncollectible Accounts

Recorded expense for the year

Estimated %

uncollectible

Uncollectible- Account Expense

Uncollectible- Account Expense


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Aging-of-Receivables

•Focuses on proper valuation of accounts receivable on the balance sheet

•Individual customer balances analyzed based on time outstanding▫Aging schedule

•Allowance for Uncollectible Accounts adjusted to equal amount from aging schedule


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Age of Account

Customer

1-30 days

31-60 days

61-90 days

Over 90 days

Total Balance

Customer A $XXX $XXX $ XX

Customer B XXX XXX XXX

Totals $5,559

$ 600 $ 200 $ 64 $6,423

Est. percent uncollectible × 1.1%

× 2% × 7%

× 20%

Allowance balance should be:

$61 $12 $14 $13 $100Allowance for Uncollectible Accounts

25Balance before adjustment

100

75 Adjustment needed

Ending balance equals aging schedule


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JOURNAL

Date


Uncollectible-Account Expense 100

Allowance for Uncollectible Accounts 100

Recorded expense for the year


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Writing Off Uncollectible Accounts

JOURNAL

Date


Allowance for Uncollectible Accounts 900

Accounts Receivable 900

Write off uncollectible receivableAllowance for Uncollectible

AccountsAccounts Receivable

$50,000 $3,000Bal. Bal.$900$900

$49,100 $2,100


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Impact of Write-Off

Partial Balance Sheet – Before Write Off

Current assets:



(3,000)


Partial Balance Sheet – After Write Off

Current assets:



(2,100)



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The Allowance Method: Two Approaches

Percent-of-SalesPercent-of-Sales Aging-of-Receivables


Adjusts Allowance for Uncollectible Accounts

Adjusts Allowance for Uncollectible Accounts

BYBY TOTO

The amount of UNCOLLECTIBLE-ACCOUNT

EXPENSE

The amount of UNCOLLECTIBLE-ACCOUNT

EXPENSE

The amount of UNCOLLECTIBLE ACCOUNTS

RECEIVABLE

The amount of UNCOLLECTIBLE ACCOUNTS

RECEIVABLE


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Exercise 5-25AJOURNAL

Date

Accounts Debit Credit

Accounts Receivable 159,000

Sales Revenue 159,000

Cash 130,000


Allowance for Uncollectible Accounts 2,700



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Exercise 5-25AJOURNAL

Date

Accounts Debit Credit

Uncollectible-Account Expense 1,590

Allowance for Uncollectible Accounts 1,590

Accounts receivable Allowance for Uncollectible Accounts

$34,000 $3,000$159,000

$130,000 $2,700

$1,590

Bal.

Sales

Payments Bal.

$2,700 Write-offsWrite-offs

Adj.

$60,300 $1,890

Net AR = $58,410Net AR = $58,410


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Exercise 5-25A


Current assets:



(1,890)



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Direct Write-Off Method•Waits until a specific account is

uncollectible to record the expense•Inferior to Allowance method

▫Receivables reported at full amount Assets overstated on Balance Sheet

▫Poor matching of uncollectible-account expense against revenue

JOURNAL

Date


Uncollectible-Account Expense

Accounts Receivable

Write off customer account


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Computing Cash Collections from Customers

Accounts Receivable

Ending balance

Sales on credit

Write-offs of uncollectibles

Collections from customers

Beginning balance200

1,800

100

400

?1,500


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Account for notes receivable


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Notes Receivable

•Can be current or long-term assets•Terms:

Creditor Party to whom money is owed; Lender

Debtor Party that borrowed and owes money; Maker, borrower

Interest Cost of borrowing money; stated as annual percentage rate

Maturity date

Date when debtor must pay note

Maturity value

Sum of principal and interest

Principal Amount borrowed by debtor

Term Length of time from when note was signed to when payment must be made


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Amount Date

For value received, I promise to pay to the order of

Continental BankChicago, Illinois

Dollars

On

plus interest at the annual rate of 9 percent

$1,000 Aug 31, 2012

One thousand and no/100--------------------------------

February 28, 2013

Lauren Halland

PROMISSORY NOTE

Principal Interest period starts

Payee (Creditor)

Principal Interest period ends on the

maturity date

Maker (Debtor)


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Accounting for Notes Receivable

JOURNAL


2012

8-31 Notes Receivable—L. Holland 1,000

Cash 1,000

Made a loan

12-31 Interest Receivable 30

Interest Revenue 30

Accrued interest revenue

2013

2-28 Cash 1,045

Notes Receivable—L. Holland 1,000

Interest Receivable 30

Interest Revenue 15

Collected note at maturity


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Interest

•Interest rates are usually expressed as an annual percent

•For time periods less than a year, a fraction is used▫Months/12

•Often interest is computed based on days▫Denominator would be days/365


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Show how to speed up cash flow from receivables


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Rapid Cash Flow

•Allows companies to pay current liabilities faster and finance new projects

•Strategies to shorten credit cycle:▫Sales discounts▫Interest on older accounts▫Effective credit and collection procedures▫Emphasize credit card and bankcard sales


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Credit Card or Bankcard Sales

•Increases sales•Retailer charged fee

JOURNAL


Cash 4,900

Credit Card Discount Expense 100

Sales 5,000

Recorded bankcard sales

2% of sale


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Selling (Factoring) Receivables

•Company sells receivables to a factor•Factor pays discounted price•Benefit to company

▫Immediate cash•Disadvantage to company

▫Expense and loss of control•Used by company with weak or

insufficient credit history


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Evaluate liquidity using two new ratios


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Quick (or Acid-Test) Ratio

Cash + Short-term investments + Net current receivables

Cash + Short-term investments + Net current receivables

Total current liabilitiesTotal current liabilities


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Days’ Sales in Receivables

Average daily sales

Average daily sales

Net salesNet sales

365 days365 days

Days’ sales in average receivables

Average receivables

Average daily sales

(Beginning net receivables + Ending net receivables)/2(Beginning net receivables + Ending net receivables)/2


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Short Exercise 5-19

Acid-test ratio

$9,600 + $14,500+ $74,800$9,600 + $14,500+ $74,800

$101,000$101,000

.98


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Short Exercise 5-19 Days’ sales in receivables

$803,000 $803,000

365365

Days’ sales in receivables

$73,300

$2,200

(Beginning net receivables + Ending net receivables)/2

= 33 days

Average daily sales

Average daily sales


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short-term investments & receivables

Business

prentice hall

pearson education

fair valuejournaldate

fair value xxxand losses

marketable securities

thetrading securities

amountif sales price

abc stockadjusted investment