Gary A. Porter and Curtis L. Norton Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Apple’s Consolidated Balance Sheets (Partial) ASSETS (in millions) September 25, 2004 September 27, 2003 Current assets: Cash and cash equivalents $2,969 $3,396 Short-term investments 2,495 1,170 Accounts receivable, less allowances of $47 and $49 774 766 Inventories 101 56 Deferred tax assets 231 190 Other current assets 485 309 Total current assets $7,055 $5,887 higher higher

Apple’s Consolidated Balance Sheets (Partial) ASSETS (in millions) Current assets: Cash and cash equivalents Short-term investments Accounts receivable Inventories Deferred tax assets Other current assets Total current assets Highly liquid Less liquid

Reasons Companies Invest in Other Companies Short-term cash excesses Long-term investing for future cash needs Exert influence over investee Obtain control of investee LO1

Accounting for Common-Stock Investments No significant influence 0% 20% Fair Value Method Significant influence 50% Equity Method Control 100% Consolidated Financial Statements Our focus in Appendix

Credit Sales Slows inflow of cash Risk of uncollectible accounts Trade Credit Terms: 2/10, net 30 Sales Invoice Retail Customer Receivables LO2

Apple Corporation Sample Accounts Receivable Subsidiary Ledger Total Due Acme $ 10,000 Baxter 50,000 Jones 15,000 Martin 20,000 Smith 5,000 $100,000 Gross Accounts Receivable

Apple’s Consolidated Balance Sheets (Partial) (amounts in millions) 2004 2003 Accounts receivables, less allowances of $47 and $49, respectively $774 $766 Net Realizable Value Estimated Uncollectible Accounts

Accounting for Bad Debts: Direct Write-off Method Future period charged with expense of bad debt write-off Period of sale Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Acct. Rec- Bad Debt Expense Baxter (500) (500)

Accounting for Bad Debts: Allowance Method Period of sale Estimated bad debt expense (and allowance account) recorded in the same period 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27

Accounting for Bad Debts: Allowance Method Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Allowance for Bad Debt Expense Doubtful Acct. (6,000) (6,000) (1% X $600,000 = $6,000)

Balance Sheet Presentation – Allowance Method Roberts Corp. Partial Balance Sheet Accounts receivable $250,000 Less: Allowance for doubtful accounts 6,000 Net accounts receivable $244,000 6

Accounting for Bad Debts: Allowance Method To write-off of account determined uncollectible: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Allowance for Doubtful Acct 500 Acct. Rec. – Dexter (500)

Approaches to Allowance Method % of Net Credit Sales % of Accounts Receivable Aging Method Income Statement Approach Balance Sheet Approach

Percentage of Net Credit Sales Method Example: Assume prior years’ net credit sales and bad debt expense is as follows: Year Net Credit Sales Bad Debts 2002 $1,250,000 $ 26,400 2003 1,340,000 29,350 2004 1,200,000 23,100 2005 1,650,000 32,150 2006 2,120,000 42,700 $7,560,000 $153,700 3

Percentage of Net Credit Sales Method Example: Develop bad debt percentage: $153,700 $7,560,000 = 0.02033 use 2% 3

Percentage of Net Credit Sales Method Example: 2007 Net credit sales $2,340,000 (given) Bad debt percentage 2% Bad debts expense $ 46,800 Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Allowance for Bad Debt Expense Doubt Acct (46,800) (46,800) 4

Aging Method Estimated Percent Estimated Amount Category Amount Uncollectible Uncollectible Current $ 85,600 1% $ 856 Past due: 1–30 days 31,200 4% 1,248 31–60 days 24,500 10% 2,450 61–90 days 18,000 30% 5,400 90+ days 9,200 50% 4,600 Totals $168,500 $14,554

Aging Method Assume the Allowance for Doubtful Accounts has a beginning credit balance of $1,230: Credit balance required in allowance account after adjustment $14,554 Less: Credit balance in allowance account before adjustment 1,230 Amount for bad debt expense entry $13,324

Aging Method Assume the Allowance for Doubtful Accounts has a beginning balance of $1,230: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues – Expense Equity Allowance for Bad Debts Expense Doubt Accts (13,324) (13,324)

Aging Method The net realizable value of accounts receivable would be determined as follows: Accounts receivable $168,500 Less: Allowance for doubtful accounts 14,554 Net realizable value $153,946

Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable Indicates how quickly a company is collecting (i.e., turning over) its receivables LO3

Accounts Receivable Turnover Too fast credit policies too stringent; may be losing sales Too slow credit department not operating effectively; dissatisfied customers

Interest-Bearing Promissory Note Principal Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on March 13, 2008. Date: December 13, 2007 Signed:_________ Interest Maturity Date Baker Corporation LO4 14

Interest-Bearing Promissory Note To record the receipt of the note on December 13 Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Notes Sales Revenue Receivable 15,000 15,000

Interest-Bearing Promissory Note To record interest: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Interest Interest Receivable Revenue 90 90 * *Interest = $15,000 × 12% × 18/360

Interest-Bearing Promissory Note To record the collection of the note on March 13, 2008: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash 15,450 Interest Revenue Notes 360 Receivable (15,000) Interest Receivable (90) *15,000 × 12% × 72/360

Accelerating the Cash Inflow from Sales Credit card sales Discounting notes receivable LO5

Credit Card Sales Competitive necessity Credit card company: Charges fee Assumes risk of nonpayment

Discounting Notes Receivable Sell note prior to maturity date for cash Receive less than face value (i.e., discounted amount) Can be sold with or without recourse Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on December 31, 2007. Date: January 1, 2007 Signed:_________ Baker Corporation $$$

Liquid Assets and the Statement of Cash Flows – Indirect Method Operating Activities Net income xxx Increase in accounts receivable – Decrease in accounts receivable + Increase in notes receivable – Decrease in notes receivable + Investing Activities Purchases of held-to-maturity and available-for-sale securities – Sales/maturities of held-to-maturity and available-for-sale securities + Financing Activities LO6

Accounting for Investments in Stocks and Bonds Appendix Accounting for Investments in Stocks and Bonds

Security Investment Categories Held-to-maturity securities Trading securities Available-for-sale securities Use fair value method to account for these investments LO7

Held-to-Maturity Securities Bonds of other companies Intent and ability to hold until maturity Example: $100,000, 9% bond due 2019

Held-to-Maturity Securities Example: On 1/1/07, Atlantic buys: $100,000, 10% bonds @ face value Bonds mature in ten years Interest payable semiannually Record the purchase of the bonds and receipt of the first interest payment

Recording Bond Purchase To record purchase of ABC bonds: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Investment in Bonds 100,000 Cash (100,000) $100,000, 10% bond due 2017

Recording Receipt of Interest Payment To record interest income on ABC bonds: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash 5,000 Interest Revenue 5,000 Interest for Investor Borrower

Recording Bond Sale To record sale of Investment in ABC bonds: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash 99,000 Loss on Sale of Bonds Investment (1,000) in Bonds (100,000) Interest for Investor Borrower

Trading Securities Stocks Bonds Purchased to generate profit from short-term appreciation Intend to sell in near term (classified as current assets)

Trading Securities Stocks Bonds At end of each period, security is “marked to market” Income Statement Unrealized gain or loss recognized on income statement

Trading Securities Record the unrealized gain or loss at 12/31/07 Example: Dexter Corp. holds the following trading securities at 12/31/07: Total Fair Value On Security Total Cost December 31, 2007 Menlo preferred stock $25,000 $27,500 Canby common stock 40,000 39,000 Record the unrealized gain or loss at 12/31/07

Recording Unrealized Gain/ Loss on Trading Securities To adjust trading securities to fair value: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Investment *Unrealized Gain Trading Menlo 1,500 Securities 2,500 Investment Canby (1,000) *income statement account

Available-for-Sale Securities Securities not classified as either held-to-maturity or trading Stocks Bonds Balance Sheet Unrealized gain or loss accumulated in stockholders’ equity account

Available-for-Sale Securities Example: Lenox Corp. holds the following available-for-sale securities at 12/31/07: Total Fair Value on Security Total Cost December 31, 2007 Adair preferred stock $15,000 $16,000 Casey common stock 35,000 32,500 Record the unrealized gain or loss at 12/31/07

Recording Unrealized Gain/ Loss on Available-for-Sale Securities To adjust available-for-sale securities to fair value: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Investment *Unrealized Loss in Adair 1,000 Avail for Sale Investment Securities (1,500) in Casey (2,500) *part of Stockholders’ Equity

Accounting for Investments without Significant Influence Report Report Recognize on Balance Changes in Categories as Income Sheet at Fair Value on Held-to-maturity Interest Cost N/A Trading Interest, dividends Fair value Income statement Available-for-Sale Interest, dividends Fair value Balance sheet

End of Chapter 7