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1 ACG 2021 Financial Accounting Chapter 5 – Accounting for Short- Term Investments and Accounts Receivable.

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Presentation on theme: "1 ACG 2021 Financial Accounting Chapter 5 – Accounting for Short- Term Investments and Accounts Receivable."— Presentation transcript:

1 1 ACG 2021 Financial Accounting Chapter 5 – Accounting for Short- Term Investments and Accounts Receivable

2 2 Short-Term Investments Next most liquid Asset after Cash Investments that a company plans to hold for one year or less. Three Types: –Held-to-maturity securities Usually Cash Loans –Trading investments Stocks or Bonds –Available-for-sale investments Discussed later (Held-to-maturity and available-for-sale securities could also be long-term.)

3 3 Trading Investments Use of Excess Cash Buy Low, Sell High Most often, stock or bonds of another company

4 4 Held-to-Maturity Investments Typically Note Receivable –Business organization lends excess cash, expecting interest in return Investor expects to hold until maturity date These Investments earn interest revenue for the investor

5 5 Reporting Short-Term Investments Balance Sheet –Current Assets current market value –Trading investments reported at current market value Income Statement –Interest and dividend revenue reported under Other Revenue. –Gains and losses reported under Other Revenue. Including Unrealized Gains and Losses

6 6 Accounting for Trading Investments Record Purchase Adjust at end of period to Market Value –Unrealized Gain Increases Trading Investment balance (debit) –Unrealized Loss Decreases Trading Investment balance (credit) Record Sale –Compare Sale price to ENDING balance Which includes all previous adjustments to market value –Sale price > ENDING balance = Gain –Sale price < Ending balance = Loss

7 Accounting for Trading Investments Investments that can be traded –Stocks, Bonds Oracle Corporation purchases Ford Motor Company stock on May 18, paying $100,000, with the intention of selling the stock within a few months. May 18Short-term investment100,000 Cash100,000 Purchased investment

8 Accounting for Unrealized Gain/(Loss) Oracle fiscal year ends on May 31, and the investment in Ford has a current market value of $102,000 on this date. May 31Short-Term Investment2,000 Unrealized Gain on Investments 2,000 Adjusted investment to market value

9 9 Short-Term Investments Cost100,000 Adjustment to market value2,000 Balance102,000 What happens if at the next reporting period, if we sell Fords stock for $105,000? Whats the entry? What if we sell the stock for $95,000? Whats the entry?

10 10 Realized Gain / (Loss) When Investor Sells Asset Realized Gain –Sales Price > Investment Balance Realized Loss –Sales Price < Investment Cash105,000 Short-Term Invest102,000 Gain on Sale of Invest 3,000 Sold at a gain Cash 95,000 Loss on Sale of Invest 7,000 Short-Term Invest102,000 Sold at a loss

11 Accounting for Dividends Rcvd On May 27, Oracle receives a cash dividend of $4,000 from Ford. May 27Cash4,000 Dividend revenue4,000 Received cash dividend

12 12 Reporting on the Balance Sheet and the Income Statement

13 13 ACG 2021 Financial Accounting Accounting for: Accounts Receivable

14 14 Receivables Receivables are the 3 rd most liquid Assets after: –Cash –Short-term Investments Receivables are monetary claims against the business organization customers. –Business organization extends credit to customers to make a sale How many business do you know where you can only pay with cash? Two major types: –Accounts receivable (trade receivables) – amount to be collected from customers from the sale of goods and services –Notes receivable – written promise to pay Secured –Collateralized loan Unsecured

15 15 Issues When Extending Credit Benefits Increase Sales Volume Grow market share Grow Business Consequences Customers take a long time to pay –Ratio: Days Sales in Receivables Customers dont pay at all Additional expense from management of collection process Higher risk of $s being stolen by employee

16 16 Accounting for Accounts Receivable Main Account Receivable Account –Debits are for new amounts owed by ALL customers –Credits are for payments made by ALL customers –Account balance is total owed by ALL customers Subsidiary Account Receivables –Separate accounts maintained for each customer Debits are only for new amounts owed by particular customer Credits are only for payments paid by particular customer Account balance is total owed by particular customer

17 17 Accounts Receivable GENERAL LEDGER Accounts Receivable Bal. 9,000 ACCOUNTS RECEIVABLE SUBSIDIARY RECORD Aston Bal. 5,000 Harris Salazar Bal. 1,000 Bal. 3,000

18 18 Issues in Accounting for Receivables net realizable value Measure and report receivables at net realizable value. –The amount the business organization expects to collect Total Accounts receivable – Estimated Uncollectible $s –Estimate reduces Accounts Receivable (credit) and creates an expense (debit) Measure and report the expense associated with failure to collect. –Why? What accounting principle requires us to report this expense? Matching: Must match costs with revenues that the costs generate… –Extending credit creates revenue, we must record the cost of extending credit Two accounting methods for recording uncollectible accounts receivable –Allowance Method (based on Estimation) Estimation technique #1: Percent of Sales Estimation technique #2: Aging of Accounts Receivable –Direct Write-off Method

19 19 Uncollectible Receivables Allowance method –record losses based on an estimate of uncollectible accounts. Percent-of-sales method expense –computes expense as a percent of revenue –income statement approach Aging-of-receivables method ending allowance account balance –Computes ending allowance account balance –individual receivables are analyzed based on how long they have been outstanding –balance sheet approach

20 20 Contra Accounts Allowance account = Contra Accounts Receivable –Contra Account is related to a main account –Contra Account has opposite normal balance from main account Accounts Receivable = Assets = Normal Debit Balance Allowance for Uncollectible Accounts = Contra Asset = Normal Credit Balance Accounts Receivable – Allowance for Uncollectible Accounts = Net Realizable Value

21 21 Estimating Uncollectible A/R We need 3 T-Accounts –Bad Debt Expense (debit) Cost of not collecting A/Rs –Allowance for Uncollectible Accounts (credit) Contra account that indicates what we expect not to collect –Accounts Receivable (no adjustment, used to calculate NRV) Total (Gross) amount owed by customers Step 1: Determine Estimate –Know what that estimate is Step 2: Record Estimate –% of Sales Debit Bad Debt Expense Credit Allowance for Uncollectible Accounts –Aging of A/R New Ending Balance in Allowance Account Subtract Beginning Balance from Ending Balance = –Credit Allowance for Uncollectible Accounts –Debit Bad Debt Expense

22 22 Percent-of-Sales Total sales are $33,000. The credit department estimates that uncollectible-account expense is 1% of total revenues. Dec 31Uncollectible-Account Expense ($33,000 x.01)330 Allowance for Uncollectible Accounts330 Recorded expense for the year Accounts Receivable 3,105 Bal. 3,105 Allowance for Uncollectible Accounts Bal. 350 Net Accounts Receivable $3,105 – 350 = $2,755

23 23 Aging-of-Receivables Critical Point!!!!

24 24 Aging-of-Receivables Dec 31Uncollectible-Account Expense214 Allowance for Uncollectible Accounts214 Recorded expense for the year Accounts Receivable 3,105 Bal. 3,105 Allowance for Uncollectible Accounts Bal. 384 Net Accounts Receivable $3,105 – 384 = $2,721 End Bal (384) – Beg Bal (170) = Expense (214)

25 25 Aging-of-Receivables Current balance in allowance account is $170. Calculate the adjustment needed to bring the balance to $384. Expense: $384 – $170 = $214

26 26 Financial Statements using The Allowance Method Balance Sheet (partial) Accounts receivable $10,000 Less: Allowance for uncollectible accounts – 900 Accounts receivable, net $ 9,100 Income Statement (partial) Expenses: Uncollectible-account expense $ 2,000 Accounts receivable, net of allowance for doubtful accounts of $701 and $767 at December 31, 2005 and 2006, respectively ,136 52,394

27 27 Writing off Uncollectible Accounts Decrease the Allowance account and remove the account receivable. Mar 31 Allowance for Uncollectible Accounts 100 Accounts Receivable 100 What is the effect on total assets? Why is there no expense recorded?

28 28 Comparing the Methods Allowance Method Adjusts Allowance for Uncollectible Accounts BY Calculating Expense Aging-of-Receivables Adjusts Allowance for Uncollectible Accounts TO Calculating Ending Allowance Balance Percent-of-Sales ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

29 29 Direct Write-Off Method No allowance is established and the expense is recognized when accounts are written off. Mar 31 Uncollectible Account Expense 100 Accounts Receivable 100 Accounts Receivable – Sarasota Pipe61 Accounts Receivable – Miller Auto Sales39

30 30 Direct Write-Off Method Assets are overstated on the balance sheet because no allowance account is used. Poor matching of uncollectible- account expense against revenue. Net income is overstated.

31 31 Basic Accounting for Accounts Receivable Provided $1,000 Goods/Services on account Accounts Receivable 1,000 Sales Revenue 1,000 Receive $1,000 payment from customer on account Cash 1,000 Accounts Receivable 1,000

32 32 ACG 2021 Financial Accounting Accounting for Notes Receivable and Cash Flow Issues

33 33 Some Definitions Creditor –Who the money is owed to Debtor –Who owes the money Debt Instrument –Legal Document representing debt Represented by a payable for the debtor Represented by a receivable for the creditor Equity Security –Stock certificate, ownership of a corporation Maturity –Date when debt instrument must be paid Term –Time from inception to maturity of debt instrument If < 1 year, listed as Current Asset / Liability If > 1 year –Current Portion is Current Asset / Liability –Portion due after 1 year is Long term Asset/Liability

34 34 Notes Receivable Creditor has a note receivable. Debtor has a note payable. Principal is the amount borrowed. Interest is revenue to the lender/creditor and expense to the borrower/debtor. –Accrues over the period of the note –If period straddles two accounting periods Adjusting Entry must be made to reflect interest earned during each period – recall accrued revenues.

35 35 Notes Receivable Laura Holland signs a $1,000 note dated Aug. 31, 20X5 with a maturity date of Feb. 28, 20X6. To record this on the banks books: (How many months is this loan for? How many accounting periods does it cover? Notes Receivable – L. Holland1,000 Cash1,000 Made a loan To record interest earned at Dec. 31, 20X5: 4 Interest Receivable (1,000 x.09 x 4/12) 30 Interest Revenue30 Accrued interest revenue

36 36 Notes Receivable To record collection of the note on Feb. 28, 20X6: Cash1,045 2 Interest Revenue (1,000 x.09 x 2/12)15 Collected note at maturity Interest Receivable30 Note Receivable – L. Holland1,000

37 37 How to Speed Up Cash Flow Credit card or bankcard sales Selling receivables (Factoring) Discounting notes receivable

38 Cash97,000 Financing Expense3,000 Sales Revenue100,000 To record a credit card sale of $100,000 and a 3% financing fee How to Speed Up Cash Flow Recording a credit card or bankcard sale ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

39 How to Speed Up Cash Flow Recording the sale of receivables Cash95,000 Financing Expense5,000 Trade Accounts Receivable100,000 Sold accounts receivable ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

40 40 Reporting on the Statement of Cash Flows Receivables bring in cash when the business collects from customers. –Operating Activities Investment transactions change Cash –Investing Activities

41 41 ACG 2021 Financial Accounting Acid Test & Days Sales in Receivables Ratios

42 42 Ratios Acid Test Ratio = Cash + ST Investments + Net Receivables Total Current Liabilities Days Sales in Receivables = Average Net Accounts Receivable Average Daily Sales

43 43 A stringent test of liquidity Measures entitys ability to pay its current liabilities immediately Acid-Test Ratio

44 44 How long does it take to collect the average receivables for an organization? Step 1: Determine Organizations sales for a single day –One days sales = Net sales ÷ 365 days Step 2: Determine Organizations Average Receivables –(Beginning Balance + Ending Balance) / 2 Step 3: Calculate Ratio A smaller number indicates a quick conversion to cash. Days Sales in Receivables

45 45 BBBB and BBY Ratios BlackBoard –Acid Test FYE FYE –Days Sales in Receivables FYE Best Buy –Acid Test FYE FYE –Days Sales in Receivables FYE

46 46 End of Chapter 5


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