Chapter 8 Accounting for Receivables

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1 Chapter 8 Accounting for Receivables Accounts Receivable Accounts Receivables are current assets. They are usually expected to be collected within 30 days. Allowance Method and Bad Debt Expense 2 methods: 1. % of Accounts Receivable Example: Dec.31, you have an A/R balance of $450,000. It is estimated that 5% of A/R will become uncollectible. The unadjusted balance in Allowance for Doubtful Accounts is $4000 credit. 450,000 x 0.05= Allowance for Doubtful Accounts Dec.31 Bal Dec.31 Bal % of Net Sales Example: Dec.31, you have an A/R balance of $450,000. It is estimated that 5% of Net Sales will become uncollectible. The Gross Sales for the period is $650,000. Sales Returns and Allowances is $100,000 and Sales Discounts is $23,000. The unadjusted balance in Allowance for Doubtful Accounts is $2000 debit. Net Sales=Gross Sales Sales Returns and Allowances Sales Discounts Net Sales= 650, ,000-23,000 Net Sales= 527,000 Allowance for Doubtful Accounts x 0.05 = Dec.31. Bal Dec.31.Bal March.30, 2012 Page 1

2 [Note: Allowance for Doubtful Accounts may have a debit balance if the write off is larger than the amount of Bad Debts previously estimated.] Net Realizable Value=Accounts Receivable Ending/Adjusted Balance of AFDA [AFDA stands for Allowance for Doubtful Accounts] Notes Receivable Notes Receivable usually requires debtors to pay interest. Interest Expense per year = Face Value of the note x Annual interest rate Disposing of Notes Receivable Honouring of Notes Receivable Cash Notes Receivable Interest Revenue Interest Receivable Dishonouring of Notes Receivable If collection is expected: Accounts Receivable Notes Receivable Interest Revenue Interest Receivable If collection is not expected: Allowance for Doubtful Accounts Notes Receivable Interest Receivable March.30, 2012 Page 2

3 Chapter 9 Long-Lived Assets Different Depreciation Methods 1. Straight-Line Method Annual Depreciation Expense Cost Residual Value Estimated Useful Life (in years) 2. Diminishing balance method Annual Depreciation Expense = Carrying amount x Depreciation Rate Carrying amount= Cost Accumulated Depreciation [Note: the carrying amount at the beginning of the first year would be the same as the asset s cost because no depreciation was taken yet so you would have a zero balance for Accumulated Depreciation.] Depreciation Rate is sometimes given in the question, otherwise you ll have to calculate it. Double declining rate is most commonly used. For example, if equipment has an estimated useful life of 5 years what is the double declining rate? Straight-line rate = 100% 5 = 20% Double declining rate = 20% x 2= 40% 3. Units-of-production method Annual Depreciation Cost Residual Value units of production Expense Total estimated units of production of the year Revised Depreciation Calculations: Annual Depre. Exp. (Old cost + New cost) (Accumulated Depreciation) (New Residual Value) New REMAINING number of periods or production units March.30, 2012 Page 3

4 Disposal of Property, Plant, and Equipment Carrying Amount > Proceeds = Loss Carrying Amount < Proceeds = Gain Recording disposal Dr. Cash or Accounts Receivable Dr. Accumulated Depreciation Dr. Loss on Disposal or Cr. Gain on Disposal Cr. Property plant and equipment account March.30, 2012 Page 4

5 Chapter 10 Current Liabilities and Payroll Determinable (Certain) Current Liabilities Short-Term Notes Payable Example: On October 1, Wonderkeys Corporation borrows a $15,000 fivemonth note payable at an interest rate of 8%. Interest and principal are due on maturity. Assume Wonderkeys has a December 31 year end. Oct. 1 Cash 15,000 Notes Payable 15,000 Dec.31 Interest Expense 300 Interest Payable 300 [The above transaction is Wonderkeys year-end adjustment. 15,000 x 0.08 x = 300] Mar.1 Interest Expense 200 Interest Payable 300 Notes Payable 15,000 Cash 15,500 Sales Taxes HST Tax Example: ABC Corporation made sales of $48,000. HST rate is 13%. (a) Assume the $48,000 sales doesn t include tax. Cash 54,240 Sales 48,000 HST Payable 6240 [48,000 x 0.13=6240] March.30, 2012 Page 5

6 (b) Assume the $48,000 sales includes tax. Cash 48,000 Sales 42, HST Payable [ = 42,477.88] GST + PST Tax PST tax should be added on top of GST tax. Example: ABC Corporation made sales of $48,000. GST rate is 5%. PST rate is 7%. (a) Assume the $48,000 sales doesn t include tax. Cash 53,928 Sales 48,000 GST Payable 2400 PST Payable 3528 [GST Payable = 48,000 x 0.05=2400 PST Payable = (48, ) x 0.07=3528] (b) Assume the $48,000 sales includes tax. Cash 48,000 Sales 42, GST Payable PST Payable [Let sales be X. X X (X+0.05X)=48,000 Solve for X. Sales=X= 42, GST Payable = 0.05X = PST Payable = 0.07(X+0.05X)= 0.07(42, ) = ] March.30, 2012 Page 6

7 Property Taxes Bills for property tax are usually issued in the spring. Property tax usually covers the full calendar year. Example: DreamBig Ltd. received a property bill of $8000 on April 1, 2011 for the calendar year of The property bill is paid on July 31. Assume DreamBig s fiscal year is the same as the calendar year. April 1 Property Tax Expense 2000 [8000 x = 2000] Property Tax Payable 2000 July 31 Property Tax Expense Property Tax Payable 2000 Prepaid Property Tax Cash 8000 [8000 x = = ] Dec. 31 Property Tax Expense Prepaid Property Tax March.30, 2012 Page 7

8 Uncertain Liabilities Product Warranties Example: BestMusic Corporation sold 10,000 walkmans at $150 each in The walkmans are covered for a one-year warranty. It is estimated that around 3% of the walkmans sold might become defective. It will cost $50 for fix each defective walkman. By the end of the year, 200 walkmans were fixed. Record the estimation of warranty costs. Warranty Expenses 15,000 Warranty Liability 15,000 [Number of walkman that might become defective=10,000 x 0.03=300 Total estimated cost=50 x 300=15,000] Record the actual cost for fixing defective walkmans Warranty Liability 10,000 Repair Parts Inventory or Wages Payable 10,000 Customer Loyalty Programs Example: Light Blue Corporation offers customers a redemption reward of $0.01 for each dollar they purchase at Light Blue. On Feb.1, Light Blue made sales of $5600. On March 18, customers redeem $50 of rewards while making a purchase of $290. Feb.1 Sales Discount for Redemption Rewards Issued 56 [5600 x 0.01=56] Redemption Rewards Liability 56 Mar.18 Rewards Redemption Liability 50 Cash 240 Sales Revenue 290 March.30, 2012 Page 8

9 Chapter 13 Corporations: Organization and Share Capital Transactions Difference between Common and Preferred Shares Common Shares Give the holder voting rights May receive any dividends that are left after dividends have been paid to preferred shareholders. Get assets after Preferred shareholders if the company is liquidated. Preferred Shares Doesn t provide voting rights. Receive dividends before common shareholders do. Get assets before common shareholders if company is liquidated. Common Shares Issuing Shares for cash Cash Common Shares Issuing Shares for Services Example: lawyer had provided legal services for the company for $2000. The company s shares currently have a market price of $2 per share. Assume the lawyer agreed to accept 1200 shares for the service provided. Legal Fees Expense 2000 Common Shares 2000 [Note: The lawyer may agree to accept 1000 or more shares for the service provided because she can sell them in the market for $2000 or more. We record using the value of legal fees not the share s market value.] Issuing Shares for Assets Example: Issuing shares to acquire machine. Machinery Common Shares March.30, 2012 Page 9

10 [Note: If the fair value of the machine can be determined, we use this value. If not we may use the fair value of the common shares issued] Reacquisition at Average Cost Example: Company s common shares have an average cost of $1.50 per share of common shares were reacquired for $3000. Common Shares 3000 Cash 3000 Reacquisition below Average Cost Example: Company s common shares have an average cost of $1.50 per share of common shares were reacquired for $2500. Common Shares 3000 Contributed Capital-Reacquisition of Shares 500 Cash 2500 Reacquisition above Average Cost Example: Company s common shares have an average cost of $1.50 per share of common shares were reacquired for $3700. Common Shares 3000 Retained Earnings 700 Cash 3700 [Note: For reacquiring above average cost, if the company has Contributed Capital Reacquisition of Shares, we have to deduct the amount ($700) from it first. If the amount in Contributed Capital Reacquisition of Shares is lower than $700, we deduct the rest from Retain Earnings.] Preferred Shares Cumulative Preferred Shares dividends must be paid for the current year as well as for any unpaid portion in previous years before dividends can be paid to Common Shareholders. Dividends that are not paid in the period are dividends in arrears. March.30, 2012 Page 10

11 Dividends in arrears is not a liability because the company doesn t have the obligation to pay for it until it s declared. Noncumulative Preferred Shares Dividends that are not paid in the current year are gone forever. Convertible Preferred Shares give preferred shareholders an option to convert their shares to Common Shares at a specified ratio. Example: 200 Preferred Shares were converted to 400 Common Shares. These Preferred Shares have an average cost of $1 per share. The company s common shares currently have a market value of $1.5 per share. Preferred Shares 200 Common Shares 200 [Note: we used $1 per share instead of $1.5 because the total amount of contributed capital was not changed so we should use the average cost value.] Redeemable/Callable Preferred Shares Give the company an option to purchase back the shares at specified dates and prices. Retractable Preferred Shares Give the shareholder an option to redeem their shares usually at an arranged price and date. Balance Sheet Shareholder s equity section The following chart is presented to help you clarify the order of shareholder s equity. Contributed Capital Share Capital Preferred Shares S/E Common Shares Contributed Capital reacquisition of common shares Retained Earnings Accumulated other comprehensive income For the format of writing Shareholder s equity section of the Balance Sheet please refer to your textbook on page737. March.30, 2012 Page 11

12 Chapter 14 Corporations: Income and Equity Reporting Cash Dividends For a corporation to pay cash dividend it must meet all three of the following requirements: Enough Retained Earnings because dividends are paid from Retained Earnings. Enough Cash A declaration of dividends by the board of directors the corporation does not have the obligation to pay dividends even for cumulative preferred shares. Dividend becomes the corporation s liability when it is declared by the board of directors. Journal Entries Declaration of cash dividend Cash Dividends Dividends Payable Payment of cash dividend Dividends Payable Cash Stock Dividends Stock dividend is paid in shares. It does not change total shareholder s equity. However, it results in a decrease of Retained Earnings and increase in Share Capital. Declaration of stock dividend Stock Dividends Common Common Stock Dividends Distributable March.30, 2012 Page 12

13 Issuing common shares for stock dividend Common Stock Dividends Distributable Common Shares Ratios Earnings per share = How to calculate the weighted average number of common shares: Assume on Jan.1 the company has 2000 common shares. On March 31, the company issued 150,000 shares. On November 1, the company issued 5000 common shares. Company s fiscal year is the same as the calendar year and it calculates for ratios at the end of each year. Weighted Average = # of shares issued fraction of year outstanding Weighted Average = , = 115,334 Price-Earnings Ratio = Payout Ratio = March.30, 2012 Page 13

14 Chapter 15 Long-Term Liabilities Bond Payable Three Possible Cases: Bond Contractual Interest Rate < Market Interest Rate Discount Bond Contractual Interest Rate > Market Interest Rate Premium Bond Contractual Interest Rate = Market Interest Rate Face Value Issuing Bond at Face Value Example: Candyland Corporation issues 6-year, 4%, 1.8 million bonds on January 1, 2010, to yield a market interest rate of 4%. Interest is payable semi-annually on July 1 and January 1. Record the issue of the bond Cash 1,800,000 Bond Payable 1,800,000 Record interest payment on July 1,2010 Bond Interest Expense 36,000 Cash 36,000 [ 1,800,000 x 0.04 x = 36,000] Adjusting entry at year end for Bond Interest Payable Bond Interest Expense 36,000 Bond Interest Payable 36,000 March.30, 2012 Page 14

15 Calculations when bond was issued at Premium or Discount The Total Present Value of the bond Total Present Value = Present Value of Face Value + Present Value of each Interest Paid Present value of face value = face value x PVIF (i%, n) PVIF (Present Value Interest Factor) value may be found on the first table of your textbook on PV4 APPENDIX PV. If the corresponding interest rate or period cannot be found in the table the following formula can be used: PVIF = Present value of each interest paid = interest x PVIFA (i%, n) Interest per year = face value x bond contractual interest rate PVIFA (Present Value Interest Factor Annuity) value may be found on the second table of your textbook on page PV6 APPENDIX PV. If the corresponding interest rate or period cannot be found in the table the following formula can be used: PVIFA = The total present value of the bond is the issuing price of the bond. Calculate for interest for each period - The amount of Cash paid or Bond Interest Payable is the same regardless whether the bond was issued at premium or discount. Cash/Bond Interest Payable per year = Face Value x Contractual interest rate - The amount of Bond Interest Expense changes while bond was amortized. Bond Interest Expense per year =Bond Amortized Cost x market interest rate March.30, 2012 Page 15

16 Bond Issued at Premium Example: Candyland Corporation issues 6-year, 6%, 1.8 million bonds on January 1, 2010, to yield a market interest rate of 4%. Interest is payable semiannually on July 1 and January 1. Recording the sale of bonds at premium on January 1,2010. PV of face value = 1800,000 x PVIF ( i=2%, n=6x2=12) PV of face value = 1800,000 x = $1,419,282 Interest payment = 1800,000 x 0.06 x = $54000 PV of interest payment = x PVIFA (i=2%, n=12) PV of interest payment = x = $571, Total Present Value = 1,419, , = $1,990, Jan.1 Cash 1,990, Bond Payable 1,990, Recording semi-annual interest payment on July 1,2010. July 1 Bond Interest Expense 39, Bonds Payable 14, Cash [1,990, x 0.04 x = 39,807.01] Record the adjusting entry at year end. Assume Candyland s year end is December 31. Dec.31 Bond Interest Expense 39, Bond Payable 14, Bond Interest Payable March.30, 2012 Page 16

17 [ (1,990, ,192.99) x 0.04 x = 39,523.15] Recording semi-annual interest payment on January 1, 2011 Jan.1 Bond Interest Payable Cash Bond Issued at Discount Example: Candyland Corporation issues 6-year, 4%, 1.8 million bonds on January 1, 2010, to yield a market interest rate of 7%. Interest is payable semiannually on July 1 and January 1. Recording the sale of bonds at discount on January 1,2010. PV of face value = 1800,000 x PVIF (i=3.5%, n=6x2=12) PVIF = = = PV of face value = 1800,000 x = $1,191,204 Interest payment = 1800,000 x 0.04 x = $36,000 PV of interest payment = x PVIFA (i=3.5%, n=12) PVIFA = = = PV of interest payment = x = $347, Total Present Value = 1,191, , = $1,539, Jan.1 Cash 1,539, Bond Payable 1,539, March.30, 2012 Page 17

18 Recording semi-annual interest payment on July 1,2010. July 1 Bond Interest Expense 53, Bonds Payable 17, Cash [1,539,083.88x 0.07 x = 53,867.94] Record the adjusting entry at year end. Assume Candyland s year end is December 31. Dec.31 Bond Interest Expense 54, Bond Payable 18, Bond Interest Payable [ (1,539, ,867.94) x 0.07 x = 54,493.33] Recording semi-annual interest payment on January 1, 2011 Jan.1 Bond Interest Payable Cash Notes Payable Fixed Principal Payments The amount of principle you are reducing stays the same. Interest Expense Notes Payable This number stays the same Cash March.30, 2012 Page 18

19 Blended Payments The amount of total cash payment stays the same Interest Expense Notes Payable Cash This number stays the same March.30, 2012 Page 19

20 Chapter 17 Cash Flow Statement Cash Flow Statements are usually prepared using cash and cash equivalents as its basis rather than just cash. 3 Types of Activities: Operating Activities include cash effects that create revenues and expenses. ie. Inventory, salaries, tax, interests, dividends, revenues and expenses Investing Activities include investments, long-lived assets, lending and collecting loans, short-term investments and long-term asset accounts. ie. Property Plant and Equipment, debt or equity investments, loans, intangibles Financing Activities include short-term notes payable, long-term liability and shareholder s equity accounts. ie. Preferred Shares, Common Shares, dividends, notes, bonds, redeem long-term debt and reacquire shares. Operating Activities Two methods that can be used for operating activities are indirect method and direct method. Indirect Method Net earnings adjustments = net cash provided(used) by operating activities Adjustments: (All adjustments have to be non-cash items!) Add back non-cash expenses. [eg. Depreciation Expense] Add back losses Deduct gains These loss and gains should be from investing and financing activities Add in current asset, in current liabilities Deduct in current asset, in current liabilities March.30, 2012 Page 20

21 Explanations for the adjustments: Selling property plant and equipment is not part of a company s primary activities. It should not be included in the operating activities. Therefore, to eliminate the loss, we have to add it back. Inventory Inventory will increase if we Jan.1 20,000 Purchase 6000 COGS 5000 purchase and decrease if we sell it out. Bal. 21,000 In Net Earnings, we have already accounted for Cost of Goods Sold(COGS). So in this case we don t have to worry about the $5000. However, in total we have purchased $6000. We have not accounted for the additional $1000. Therefore, increase in inventory should be deducted. Cost of Goods Sold + Increase in Inventory = Cost of Goods Purchased Increase in Accounts Payable = Cash Payments to Suppliers Presentation Format: Operating activities Net Earnings $ Adjustments to reconcile net earnings to net cash provided(used) by operating activities: Depreciation Expense $ Accounts Receivable Net cash provided by operating activities March.30, 2012 Page 21

22 Direct Method Cash receipts cash payments = Net cash provided(used) by operating activities. Cash Receipts Revenue + increase in A/R decrease in A/R Interest Revenue + decrease in interest receivable increase in interest receivable Cash Payments COGS + increase in inventory + decrease in A/P decrease in inventory increase in A/P [eg. Cost of Goods Sold+ increase in inventory increase in Accounts Payable] Operating Expenses + increase in Prepaid Expense + decrease in Expense Payable decrease in Prepaid Expense increase in Expense Payable Interest Expense Income Tax Expense + decrease in Interest Payable increase in Interest Payable + decrease in Tax Payable Investing and Financing Activities increase in Tax Payable Regardless of whether direct or indirect method is used, investing and financing activities are measured and reported in the same way. March.30, 2012 Page 22

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