ShortTerm Investments Receivables Chapter 5 5 1 2008

Learning Objective 1 Account for short-term investments 5 -2 © 2008 Pearson Prentice Hall.

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 Availablefor-Sale Held-to. Maturity 5 -3 © 2008 Pearson Prentice Hall. All rights reserved.

Trading Investments • Held for short time and then sold § Gain or loss recorded Selling price > cost = Gain Selling price < cost = Loss • 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 5 -4 © 2008 Pearson Prentice Hall. All rights reserved.

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 5 -5 © 2008 Pearson Prentice Hall. All rights reserved.

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 5 -6 © 2008 Pearson Prentice Hall. All rights reserved.

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) © 2008 Pearson Prentice Hall. All rights reserved. 5 -7

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 5 -8 © 2008 Pearson Prentice Hall. All rights reserved.

E 5 -18 JOURNAL Date Accounts Nov 6 Trading investment Debit Credit $35, 000

E 5 -18 JOURNAL Date Accounts Debit 12 -31 Unrealized loss Trading Investments What would be the amount of the Credit unrealized loss? _______ Compute the difference between the cost and market value. ____ 5 -10 © 2008 Pearson Prentice Hall. All rights reserved.

E 5 -18 JOURNAL Date Accounts 1 -11 Cash Debit Credit $36, 000 Trading

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 5 -12 © 2008 Pearson Prentice Hall. All rights reserved.

Learning Objective 2 Apply internal controls to receivables 5 -13 © 2008 Pearson Prentice

Internal Control over Cash Collections on Account • Separate cash-handling from cashaccounting duties • Cash-handling § One person receives customer checks and makes deposits • Cash-accounting § Another person makes entries to customer accounts 5 -14 © 2008 Pearson Prentice Hall. All rights reserved.

Accounting for Uncollectible Receivables • Extending credit to customers bears some risk • Risk: Some customers do not pay the amount owed • Cost: Uncollectible accounts 5 -15 © 2008 Pearson Prentice Hall. All rights reserved.

Learning Objective 3 Use the allowance method for uncollectible receivables 5 -16 © 2008

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 paired with an asset and reduces its balance 5 -17 © 2008 Pearson Prentice Hall. All rights reserved.

Entry to Record Uncollectible accounts JOURNAL Date Accounts Debit Uncollectible accounts expense Allowance for uncollectible accounts Credit Goes on the Income Statement Goes on the Balance Sheet netted with accounts receivable 18 © 2008 Pearson Prentice Hall. All rights reserved.

Balance Sheet Current assets: Accounts receivable $$, $$$ Less: Allowance for Uncollectible Accounts ( $, $$$) Accounts receivable, net $$, $$$ OR Accounts receivable, net $$, $$$ 5 -19 © 2008 Pearson Prentice Hall. All rights reserved.

Methods to Estimate Uncollectibles 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 5 -20 © 2008 Pearson Prentice Hall. All rights reserved.

E 5 -23 Age of Accounts 1 - 30 Days 31 - 60 Days 61 - 90 Days Over 90 Days $ 110, 000 $ 60, 000 $ 50, 000 $ 15, 000 0. 5% 1% 60% 40% $ 550 $ 600 $ 30, 000 $ 6, 000 $37, 150 © 2008 Pearson Prentice Hall. All rights reserved. 5 -21

E 5 -23 Aging Schedule Balance in Allowance Adjustment needed = Aging schedule - Balance $37, 150 $7, 400 Adjustment needed JOURNAL Date Accounts Debit 12 -31 Uncollectible accounts expense Allowance for uncollectible accounts Credit _______ 5 -22 © 2008 Pearson Prentice Hall. All rights reserved.

E 5 -23 Allowance for Uncollectible Accounts $7, 400 Adjusting entry Balance before adjustment

Uncollectible Accounts Methods Percent-of-Sales Adjust Allowance for Uncollectible Accounts Aging-of-Receivables Adjust Allowance for Uncollectible Accounts BY TO The Amount of UNCOLLECTIBLE ACCOUNT EXPENSE The Amount of UNCOLLECTIBLE ACCOUNTS RECEIVABLE 5 -24 © 2008 Pearson Prentice Hall. All rights reserved.

Writing Off a Specific Account • 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: JOURNAL Date Accounts Debit Allowance for uncollectible accounts Accounts receivable $$$$ © 2008 Pearson Prentice Hall. All rights reserved. Credit $$$$ 5 -25

Direct Write-Off Method • Less preferable than allowance method § Does not match expenses with revenues § Accounts Receivable overstated • Uncollectible Accounts Expense used for write offs • No Allowance for Uncollectible Accounts 5 -26 © 2008 Pearson Prentice Hall. All rights reserved.

Accounts Receivable Sales on account Payments on account Uncollectible accounts written off 5 -27

Allowance for Uncollectible Accounts Uncollectible accounts written off Uncollectible account adjustment What is the normal balance of the Allowance? 5 -28 © 2008 Pearson Prentice Hall. All rights reserved.

Learning Objective 4 Account for notes receivable 5 -29 © 2008 Pearson Prentice Hall.

Notes Receivable Terms • • Creditor Debtor Interest Maturity Date Maturity Value Principal Term Party to whom money is owed; lender Party that owes money; borrower Cost of borrowing money; percent Date debtor must pay the note Sum of principal and interest on note Amount borrowed by debtor Length of time money is borrowed 5 -30 © 2008 Pearson Prentice Hall. All rights reserved.

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 $$, $$$ 31 © 2008 Pearson Prentice Hall. All rights reserved.

Accounting for Notes Receivable • Interest needs to be accrued on any note receivable outstanding at year end: JOURNAL Date Accounts Debit Interest receivable Interest revenue Interest is computed by the formula: Principal x rate x time Credit $$, $$$ Time = date note is signed to end-of-year 32 © 2008 Pearson Prentice Hall. All rights reserved.

Accounting for Notes Receivable When payment is received on note, the following entry is made JOURNAL Date Accounts Cash Debit For maturity value Notes Receivable Interest revenue Credit For principal Zeroes out adjustment For remaining interest earned © 2008 Pearson Prentice Hall. All rights reserved. 33

Credit and Bank Card Sales • Credit Cards § American Express and Discover •

Learning Objective 5 Use two new ratios to evaluate a business 5 -35 ©

Days’ Sales in Receivables • How long it takes a company to collect its average amount of receivable • Compute one day’s sales Net Sales 365 Days • Days’ sales in receivables Average receivables One Day’s Sales 5 -36 © 2008 Pearson Prentice Hall. All rights reserved.

Acid-Test Ratio • Also called quick ratio • A more stringent measure of a company’s ability to pay its current liabilities Cash + Short-term investments + net receivables Total current liabilities 5 -37 © 2008 Pearson Prentice Hall. All rights reserved.