2. Accounting for Receivables Chapter Seven McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

3. 2 Accounts 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.

4. 3 Value 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).

5. 4 Allowance 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.

6. 5 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. 6 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.

8. 7 Transaction Analysis: 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.

9. 8 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 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow

10. 9 1.Provided services to customers for $10,000 on account. 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 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow

11. 10 1.Provided services to customers for $10,000 on account. Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow

12. 11 2. Collected $7,000 from account receivable. Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow

13. 12 3. At year-end it was estimated that $200 of the current accounts receivable balance will not be collected. Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a.

14. 13 3. At year-end it was estimated that 2% of the year’s credit sales will not be collected. Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a. Allowance for Doubtful Accounts is a CONTRA- ASSET account. This account balance is INCREASING by $200 causing TOTAL assets to decrease.

15. 14 4. Jane Doe’s $50 account was written-off as uncollectible. Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow 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.

16. 15 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4After Event 4 A/R$3,000 Allow. (200) N.R.V.$2,800 Acme Collection Agency The check is in the mail.

17. 16 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4After Event 4 A/R$3,000A/R $ Allow. (200)Allow. N.R.V.$2,800N.R.V. $ 2,950 (150) 2,800

18. 17 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4After Event 4 A/R$3,000A/R $2,950 Allow. (200)Allow. (150) N.R.V.$2,800N.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.

19. 18 Before recording Transaction #5: What happens when an account that has been 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

20. 19 5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a. (50) (50)NO EXPENSE! 50 50

21. 20 5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5 A 5 B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a. (50) (50)NO EXPENSE! 50 50 50 (50) 50 OA

22. 21 Calculate all ending balances. Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a. (50) (50)NO EXPENSE! 50 50 50 (50) 50 OA 7050 2950 200 9800 10000 200 9800 7050 bal.

23. 22 the result? After completing the horizontal model fill in below. What’s the result? 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?………………………….

24. 23 Final Account Balances Remember, the Bad Debt EXPENSE is accrued in the year of sale, NOT when the account is written off! Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a. (50) (50)NO EXPENSE! 50 50 50 (50) 50 OA 7050 2950 200 9800 10000 200 9800 7050 bal. MATCHING PRINCIPLE

25. 24 the result? After completing the horizontal model fill in below. What’s the result? 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?…………………………. $ 200

26. 25 Final Account Balances Net Realizable Value (NRV) = Acct.Rec. - Allowance Assets = Liab.+ Stk. Equity Cash+ A/Rec.- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. Balance Sheet Inc. Statement Cashflow 200 (200) 200 (200) n.a. (50) (50)NO EXPENSE! 50 50 50 (50) 50 OA 7050 2950 200 9800 10000 200 9800 7050 bal.

27. 26 the result? After completing the horizontal model fill in below. What’s the result? 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?…………………………. $ 200 $ 2,750

28. 27 Transaction Posted to T-accounts 1. Provided services to customers for $10,000 which will be collected at a later date. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn.

29. 28 Transaction Posted to T-accounts 1. Provided services to customers for $10,000 which will be collected at a later date. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (1) 10,000 10,000 (1)

30. 29 Transaction Posted to T-accounts 2. Collected $7,000 of the Accounts Receivables. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (1) 10,000 10,000 (1)

31. 30 Transaction Posted to T-accounts 2. Collected $7,000 of the Accounts Receivables. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 7,000 (2) 10,000 (1)

32. 31 Transaction Posted to T-accounts 3. At Yr. end it was estimated that 2% of the year’s credit sales will never be collected. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 7,000 (2) 10,000 (1)

33. 32 Transaction Posted to T-accounts 3. At Yr. end it was estimated that 2% of the year’s credit sales will never be collected. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 7,000 (2) 200 (3) 10,000 (1) (3) 200

34. 33 Transaction Posted to T-accounts 4. Jane Doe’s $50 account was written-off as uncollectible. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 7,000 (2) 200 (3) 10,000 (1) (3) 200

35. 34 Transaction Posted to T-accounts 4. Jane Doe’s $50 account was written-off as uncollectible. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 7,000 (2) 50 (4) (4) 50 200 (3) 10,000 (1) (3) 200

36. 35 Transaction Posted to T-accounts 5a. Jane Doe’s account is reinstated. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 7,000 (2) 50 (4) (4) 50 200 (3) 10,000 (1) (3) 200

37. 36 Transaction Posted to T-accounts 5a. Jane Doe’s account is reinstated. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 5a 50 7,000 (2) 50 (4) (4) 50 200 (3) 50 (5a) 10,000 (1) (3) 200

38. 37 Transaction Posted to T-accounts 5b. Jane Doe’s account is collected. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (2) 7,000 (1) 10,000 5a 50 7,000 (2) 50 (4) (4) 50 200 (3) 50 (5a) 10,000 (1) (3) 200

39. 38 Transaction Posted to T-accounts 5b. Jane Doe’s account is collected. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (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

40. 39 Transaction Posted to T-accounts Closing entries at the end of Year 1. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (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

41. 40 Transaction Posted to T-accounts Closing entries at the end of Year 1. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (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)

42. 41 Transaction Posted to T-accounts Balances of all accounts after Year 1 closings. Cash Acct. Rec.Allow. for D.A. Service Revenue Bad Debt Exp. Retain. Earn. (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.

43. 42 Summary: 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.

44. 43 Summary: 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).

45. 44 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method Entry to write off J. Jones’ $100 account: Bad Debt Expense100 Acct. Rec.-Jones100 Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow (100) (100) +100 (100) n.a.

46. 7-45 Notes Receivable Event 1 Loan of Money On November 1, 2013, ATS loans $15,000 cash to Stanford Cummings. Cummings issues ATS a note promising to repay the loan, with interest, in one year.

47. Let’s review how to calculate interest. The basic formula is: Principal X Rate X Time $ borrowed or invested ANNUAL rate Time since interest was last recorded. On Nov. 1, 2013 ATS loans $15,000 cash to Cummings at 6% for 1 year. How much interest should be accrued on December 31, 2013? How much interest should be accrued on December 31, 2013? Principal X Rate X Time = Interest $15,000 X.06 X 2/12 = $150.00 rate for 12 mo.November through December Calculating and recording interest earned on the Note…

48. 7-47 Interest Revenue Event 2 Recognition of Interest Revenue At the end of 2011, ATS must accrue interest on its note receivable. $15,000 × 6% × 2/12 = $150 interest revenue Interest Receivable

49. 7-48 Collection of a Note Receivable Event 3 Collection of Principal and Interest On November 1, 2012, ATS collects the principal and interest due on the note receivable. ATS first recognizes interest revenue for the 10 months of 2012. $15,000 × 6% × 10/12 = $750 interest revenue Interest Receivable

50. 7-49 Collection of a Note Receivable Event 3 Collection of Principal and Interest Now that the entire $900 of interest receivable has been accrued, ATS records the collection of $15,900 in principal and interest on the note. Asset Exchange Transaction

51. 50 Credit Card Sales Rather than maintaining a credit granting department, many companies find it cost beneficial to accept credit cards. The credit card company deducts a fee, usually between 2% and 8%, from the gross amount of the sales, and pays the merchant the net balance (gross sales less credit card fee).

52. 51 Credit Card Sales Event 1 Recording a Credit Card Sale Matrix, Inc. accepts a credit card in payment for services of $10,000. The credit card company charges a fee of 2% of the gross sale.

53. 52 Credit Card Sales Event 2 Collection of a Credit Card Receivable Matrix, Inc. collects the full amount due from the credit card company.

54. 53 Financial 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

55. 54 Accounts 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?) 365 365 Accts. Rec. Turnover10.0 = = 36.5 days Generally, lower means better.

56. 55 Length of Operating Cycle Ave. days to sell inventory 60.8 days + Ave. days to collect receivables 36.5 days Length of Operating Cycle 97.3 days Remember from Chapter 6 that a company’s operating cycle is the time it takes to convert inventory to cash by selling it plus the time it takes to convert accounts receivable back into cash. So, the Operating Cycle is:

57. 56 Chapter 7 The End

58. 57 Notes Payable: Transaction Analysis - Appendix n Assume the following selected events occurred at Cell-It. For each event: p Determine how the financial statements are affected and fill in the horizontal statements model. p Record the event in the Journal and Post to the Ledger.

59. 58 Notes 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).

60. 59 Horizontal Model Transaction Analysis 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

61. 60 1: On Oct. 1, 2004 Cell-it borrowed $8,000 at 8% for 1 year on an interest bearing note. All interest to be paid at maturity. T1: On Oct. 1, 2004 Cell-it borrowed $8,000 at 8% for 1 year on an interest bearing 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

62. 61 2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) 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 2 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 ( Face Value) $8000 Interest ($8000 x.08 x 12 / 12 ) (640) Cash to borrower $7360 (Carrying value)

63. 62 2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) 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 2 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 ( Face Value) $8000 Interest ($8000 x.08 x 12 / 12 ) (640) Cash to borrower $7360 (Carrying value) Since no time has past, the $640 is NOT an EXPENSE yet.

64. 63 2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) 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 2 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 Payable8000 Less: Discount on N/P (640) Total Note Liability7360

65. 64 3: On Dec. 31, 2004 recorded interest related to the note in #1. T3: On Dec. 31, 2004 recorded interest related to the note in #1. Oct. 1-Dec. 31 = 3 mo. (8000 x.08 x 3/12=160) 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 2 7360 8000 640 7360 FA 3 160 (160) 160 (160) n.a.

66. 65 : On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. T4: On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. 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 2 7360 8000 640 7360 FA 3 160 (160) 160 (160) n.a. 4 (160) (160) 160 (160) n.a.

67. 66 : On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. T4: On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. 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 2 7360 8000 640 7360 FA 3 160 (160) 160 (160) n.a. 4 (160) (160) 160 (160) n.a. Discount on Note Payable is a contra liability account. Its balance is SUBTRACTED from the Note Payable account to calculate the current liability for the Note. Note Payable8000 Less: Discount on N/P (480) (640 – 160) Current Note Liability 7520

68. 67 : On Sept. 30, 2005 repaid the 8% note from Transaction #1 and all its interest. a= accrue the remaining interest. b= payment. T5: On Sept. 30, 2005 repaid the 8% note from Transaction #1 and all its interest. a= accrue the remaining interest. b= payment. (Jan. 1-Sept. 30 = 9 mo. (8000 x.08 x 9/12= $480) 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 2 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.a b (8640) (640) (8000) (8000) FA (640) OA

69. 68 : On Sept. 30, 2005 repaid the 8% discounted note payable from Trans. #2. a= accrue the remaining interest. b= payment. T6: On Sept. 30, 2005 repaid the 8% discounted note payable from Trans. #2. a= accrue the remaining interest. b= payment. 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 2 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.a b (8640) (640) (8000) (8000) FA (640) OA 6a (480) (480) 480 (480) n.a. b (8000) (8000) (7360) FA (640) OA

70. 69 Comparison of Journal Entries for Interest Bearing and Discounted Notes Contra-liabilities are increased by debiting.

71. 70 Comparison of Ledger Accounts for Interest Bearing and Discounted Notes

72. 71 Transaction Analysis: 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? Calculate the EFFECTIVE INTEREST % of each. Interest bearing note: Eff. Int. % = $ Annual Interest ÷ Cash Rec’d. = $640 ÷ $8,000 = $640 ÷ $8,000 = 8.0% = 8.0% Non-Interest bearing note (Discounted note): Eff. Int. % = $ Annual Interest ÷ Cash Rec’d. = $640 ÷ $7,360 = $640 ÷ $7,360 = 8.7% = 8.7%

73. 72 Transaction Analysis: 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? Calculate the EFFECTIVE INTEREST % of each. Interest bearing note: Eff. Int. % = $ Annual Interest ÷ Cash Rec’d. = $640 ÷ $8,000 = $640 ÷ $8,000 = 8.0% = 8.0% Non-Interest bearing note (Discounted note): Eff. Int. % = $ Annual Interest ÷ Cash Rec’d. = $640 ÷ $7,360 = $640 ÷ $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.