Short-Term Investments & Receivables

Pr. Zoubida SAMLAL

Learning Objective 1

Account for short-term investments

Account for short-term investments

Accounting for Short-Term Investments

• Also called marketable securities• Held for one year or less• Most liquid asset other than cash• Placed into three categories:

Trading Investments

Available-for-Sale

Held-to-Maturity

Trading Investments

• Held for short time and then sold– Gain or loss recorded

• Dividend revenue may also be received• At year-end, trading investments are adjusted

to equal their market value– Results in an unrealized gain or loss

Selling price > cost = Gain Selling price < cost = Loss

Unrealized Gains & Losses

• Difference between market price and cost of investment at year-end

• Unrealized – investment has not been sold

Market price > cost =

Unrealized gain

Market price < cost =

Unrealized loss

Realized vs. Unrealized

Realized• Investment sold to third

party• Gain or loss = difference

between selling price and cost

• Word “realized” usually dropped from title

Unrealized • Company still owns

investment• Gain or loss = difference

between market value and cost

• Word “unrealized” is kept in account title

Entries to Adjust to Market

JOURNAL

Date Accounts Debit Credit

  Short-term investments $$$  

  Unrealized gain on investments   $$$

Adjusted investment to market value (when greater than cost)

       

  Unrealized loss on investments $$$  

  Short-term investments   $$$

Adjusted investment to market value (when less than cost)

Reporting on Financial Statements

Balance Sheet• Trading Investment

– Reported at current market value

– Listed directly under “cash” in the current asset section

Income Statement• Gains and losses

– From sales of investments

• Investment revenue– From dividends or

interest earned• Unrealized gain or loss

– From entry to adjust to market value

Exercise 1

Part of your job responsibilities as a finance manager is to invest in short term trading investments.

1.On 1 dec . You bought 1000 shares of XYZ company at USD 10

2.On 15 dec. You received a cash dividend of USD 1 per share

3.On 31 dec the price of XYZ share dropped to USD 8 per share

4. On 31 dec you decided to sell off all your investment at USD 8 per share

a)Please post the account entries of each transaction

b)How transaction 3 is different from transaction 4

Solution 1

JOURNAL

Date Accounts Debit Credit

Dec 1 Trading investment $10,000  

  Cash   $10,000

 a.  Short term trading investment XYZ at

USD 10    

 Dec 15 Cash $1000  

  Dividend revenue   $1000

b. Dividend distribution received in cash USD 1 per share

Solution 1 ( con´t)

JOURNAL

Date Accounts Debit Credit

Dec 31 Unrealized loss $2,000  

  Trading investment   $2,000

 

c.  Adjusting our short term investment to the market value of USD 8 per share    

Dec 31 Cash $8000  

Loss from selling the investment $2000

  Trade Investment ( initial purchase price)

  $10000

d. Investment sold at loss of USD2 per share

Solution 1 ( con´t)

How transaction 3 is different from transaction 4

-> Our transaction n° 3 is a readjustment to our investment or what we call mark to market our investment. --> Unrealized loss because the investment is not yet sold.

-> Our transaction n° 4 is a sell off to our investment or selling at loss of 2USD (selling price–purchasing price or USD 8 – USD 10) . --> here we have a realized loss that we posted into our revenues account.

When Unrealized loss

JOURNAL

Date   Accounts   Debit   Credit

12-31   Unrealized loss   _______    

    Trading Investments       ________

           

What would be the amount of the

unrealized loss?

Compute the difference between the cost and

market value.

JOURNAL

Date   Accounts   Debit   Credit

1-11  

Cash

     

   

Gain on sale of investments    

   

Trading Investments

       

Your selling price?

Your loss=Sell- buy

Initial purchase

When realized loss

When Unrealized Gain

JOURNAL

Date   Accounts   Debit   Credit

 

Trading Investments

  _______    

   

Unrealized gain

      ________

What would be the amount of the unrealized

gain?

Compute the difference

between the cost and

market value.

JOURNAL

Date   Accounts   Debit   Credit

 

Cash

     

   

Gain on sale of investments    

   

Trading Investments

       

Your selling price?

Your gain =Sell- buy

Initial purchase

When realized Gain

Learning Objective 2

Apply internal controls to receivables

Receivables

• Monetary claims against others• Third most liquid asset• Accounts Receivable

– Amounts owed by customers for selling goods or services

• Notes Receivable– Lending money to outsiders– More formal than accounts receivable

Internal Control over Cash Collections on Account

• Separate cash-handling from cash-accounting duties

• Cash-handling– One person receives customer checks and makes

deposits

• Cash-accounting– Another person makes entries to customer

accounts

Accounting for Uncollectible Receivables

• Extending credit to customers bears some risk

• Risk: Some customers do not pay the amount owed

• Cost: Uncollectible accounts

Application exercise

CasePerinity Inc. is a company that sells 50% of its product cash while. 80% of its credit sales are paid on time

a. What is the total amount of account receivable if the sales revenues are USD 1 million?

b. How much uncollectible does it have?

Learning Objective 3

Use the allowance method for uncollectible receivables

Allowance Method

• Amount of uncollectible accounts is estimated• An expense is recorded as part of the

adjusting process• A contra-asset is recorded that reduces

accounts receivable on the balance sheet

A contra-asset is always pairedwith an asset and reduces

its balance

Entry to Record Uncollectible accounts

JOURNAL

  Accounts   Debit   Credit

 

Uncollectible accounts expense

 

Allowance for uncollectible accounts

 

Goes on theIncome Statement

Goes on the Balance Sheet

netted with aA. receivable

Balance Sheet Current assets:

Accounts receivable $$,$$$

Less: Allowance for

Uncollectible Accounts ( $,$$$)

Accounts receivable, net $$,$$$

Accounts receivable, net $$,$$$

OR

Methods to Estimate Un-collectibles

Percent-of-sales• Expense is estimated

based on credit sales• Income Statement

approach

Aging-of-receivables• Accounts receivable

analyzed based on how long outstanding

• Balance Sheet approach

APPLICATION EXERCISE

Age of Accounts

1 - 30 Days 31 - 60 Days 61 - 90 Days Over 90 Days

sales $ 110,000 $ 60,000 $ 50,000 $ 15,000

%uncollectible 0.5% 1% 60% 40%

During the monthly closing of it’s A/R accounts, Perinity Inc posted its uncollected received classified by their age.

The company has a beginning allowance balance of USD $7,400 . Is it sufficient or should it adjust its allowance?

Solution

Age of Accounts

Age 1 - 30 Days 31 - 60 Days 61 - 90 Days Over 90 Days

sales $ 110,000 $ 60,000 $ 50,000 $ 15,000

% Uncllected 0.5% 1% 60% 40%

uncollected $ 550 $ 600 $ 30,000 $ 6,000

$37,150= Total Uncollected receivable

Solution

Aging Schedule $37,150

Balance in Allowance $7,400

Adjustment needed

JOURNAL

Date   Accounts   Debit   Credit

12-31   Uncollectible accounts expense _______

    Allowance for uncollectible accounts ______

   

Adjustment needed = Aging schedule -

Balance

Solution

Allowance for Uncollectible Accounts

$7,400 Balance before adjustment

$37,150 Balance per aging schedule

$29,750Adjusting entry

Uncollectible Accounts Methods

Percent-of-Sales Aging-of-Receivables

Adjust Allowance for Uncollectible Accounts

Adjust Allowance for Uncollectible Accounts

BY TO

The Amount of UNCOLLECTIBLE ACCOUNT

EXPENSE

The Amount of UNCOLLECTIBLE ACCOUNTS

RECEIVABLE

Writing Off a Specific Account

JOURNAL

Date   Accounts   Debit   Credit

 Allowance for uncollectible accounts   $$$$    

    Accounts receivable       $$$$

         

• The allowance is used to absorb specific accounts that are determined to uncollectible

• When it’s determined a customer cannot pay, the following entry is made:

Learning Objective 4

Account for notes receivable

Notes Receivable Terms

• Creditor• Debtor• Interest• Maturity Date• Maturity Value• Principal• Term

Party to whom money is owed; lender

Date debtor must pay the note

Sum of principal and interest on note

Amount borrowed by debtor

Length of time money is borrowed

Party that owes money; borrower

Cost of borrowing money; percent

Accounting for Notes Receivable

• To record the receipt of a note receivable, the following entry is made:

JOURNAL

Date   Accounts   Debit   Credit

  Notes Receivable   $$,$$$    

    Cash       $$,$$$

             

Accounting for Notes Receivable

• Interest needs to be accrued on any note receivable outstanding at year end:

JOURNAL

Date   Accounts   Debit   Credit

  Interest receivable   $$,$$$    

    Interest revenue       $$,$$$

             

Interest is computed by the formula:Principal x rate x time

Time = date note issigned to end-of-year

ACCOUNTING FOR NOTES RECEIVABLE

When payment is received on note, the following entry is made

JOURNAL

Date Accounts Debit Credit

Cash

  Notes Receivable

  Interest receivable

 

Interest revenue

 

For maturity value

Zeroes out adjustment

For remaininginterest earned

For principal

Credit and Bank Card Sales

• Credit Cards– American Express and Discover

• Bank Cards– VISA and MasterCard

• Both charge the retailer a fee

Learning Objective 5

Use two new ratios to evaluate a business

Days’ Sales in Receivables

• How long it takes a company to collect its average amount of receivable

• Compute one day’s sales

• Days’ sales in receivables

Net Sales

365 Days

Average receivables

One Day’s Sales

Acid-Test Ratio

• Also called quick ratio which measures how much your short term assets represents in terms

of short term liabilities• A more stringent measure of a company’s

ability to pay its current liabilitiesCash + Short-term investments + net receivables

Total current liabilities

Which is better having a high acid ratio or low acid ratio?