Short term Investments and Receivables : Chapter 5

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Jocelyn Hardy
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1 Learning Objective 1: Account for short term investments Short term investments: Marketable securities are investments that a company plans to hold for one year or less most liquid asset after cash e.g. Suppose that Celestica Inc. purchases McCain Foods Ltd. Shares on dec 18, paying 100,000 cash e.g. on dec 27, Celestica receives a cash dividend of $4000 from McCain Celestica fiscal year ends on dec 31, and investment in McCain has a current market value of 102,000 on this date. GAIN because the market value ($102,000) = greater than celestica s investment cost Unrealized Gain: because Celestica has not yet sold the investment Short term Investment 2000 Unrealized Gain on Investments 2000 If Celestica investment in McCain shares had decreased in value to Unrealized Loss: because Celestica has not yet sold the investment Unrealized Loss on Investments 5000 Temporary Investments 5000 Balance Sheet: temporary assets are current assets Income Statement: temporary asset can either earn interest revenue or dividend revenue. All gains and losses are also reported on the income statement Learning Objective 2: Account for receivables Accounts and Notes Receivable Receivables are the 3 rd most liquid assets after cash and short term investments Results from selling g/s on credit and by lending money Accounts receivable are a current asset on the balance sheet Learning Objective 3: Apply internal controls to receivables Establishing internal control over collections Businesses that sell on credit receive most of their cash receipts by mail Some controls over accounts receivable are: a) Learning Objective 4: Use allowance method for uncollectible receivables Selling on credit creates both benefit and cost: Benefit: customers who cannot pay cash immediately can buy on credit, so company profits rise as sales increase Cost: company will be unable to collect from some credit customers

2 Uncollectible Account Expense Expense on income statement Must record expense in the period of sale. If not assets and earnings will be overstated The entry for the uncollectible account amount is an adjusting journal entry Can use the allowance method for estimating the uncollectible receivables The Allowance Method Allowance method: records collection losses on basis of estimates, not waiting to see which customers will pay Allowance for uncollectible accounts(allowance for doubtful accounts): is a contra account to accounts receivable Jounral Entry: Dr Uncollectible-account expense Cr Allowance for uncollectible a/c Accounting for Uncollectible Accounts Allowance method : income statement approach and balance sheet approach Direct write off method Percentage of Sales: computes uncollectible account expense as a percentage of revenue (income statement approach) (Account of UNCOLLECTIBLE ACCOUNT EXPENSE) Aging of receivables: (balance sheet approach) because it focuses on a/r individuals receivables from specific customers are analyzed based on how long they have outstanding. A percentage of accounts receivable could also be used (Amount of UNCOLLECTIBLE RECEIVABLES) Recovery of Uncollectible Accounts Previously Written Off 1. Reinstate the a/r 2. Record the collection of cash Combining the percentage of sales and aging methods For interim statements (monthly/quarterly), companies use the percentage of sales method b/c it is easiet to apply At the end of the year, companies use the aging method to ensure the a/r is reported at net realizable value Direct Write off Method: an account is written off only when it is decided that a specific customer s receivable is uncollectible DR Uncollectible-Account Expense 3000 A/r Smith Inc Wrote off a bad account

3 Direct Write off Method : Method defective for 2 reasons since no allowance for uncollectibles is established, assets are overstated on balance sheet, it causes a poor matching of uncollectible account expense against revenue and overstates net income Learning Objective 5: account for notes receivable Are more formal than a/r The principle amount of note is amount borrowed by the debtor The maturity value includes principle plus interest Creditor has note receivable Debtor has note payable e.g. On aug 31, 2010 alberta treasury loaned 9% interest due on feb 8, The entry is as follows: DR Notes receivable 1000 CR Cash 1000 Made a loan How much interest revenue is accrued at dec 31, 2010? Interest = principal x rate x time How to speed up cash flow Credit Card Sale : merchant sells merchandise and lets customer pay with credit card such as Visa, Mastercard, etc Debit Card Sales: customer uses their debit card to pay for the merchandise Selling (factoring) receivables the company sells its receivables to another business Recording credit sale Cash 485 Financing Expense 15 Sales revenue 500 To record a credit card sale of 500 and a 3% financing expense Recording a debit card sale Cash Interact fee 1.00 Sales revenue To record a sale of groceries for Recording sale of receivables Cash Financing expense 5000 a/r 100,000 sold accounts receivable Learning Objective 6: use ratios to evaluate a business Decision Making : Using Ratios Investors and creditors use ratios to evaluate the financial health of a company To help them measure the liquidity of companies, they use: Current ratio, quick ratio, days sales in receivables Acid Test Ratio : stringent test of liquidity which measures entity s ability to pay its current liabilities immediately. (cash + short term investments + receivable) / total current liabilities The ratio value is extremely high and indicates great liquidity for this company Days Sales in Receivables One day s sales = net sales / 365 days Days sales in average a/r = avg net accounts receivable / one day s sales A smaller number indicates a quick conversion to cash Reporting on Cash Flow Statement

4 Receivables bring in cash when business collects from customers These transactions are reported as operating activities on cash flow statement Question #1: ABC Co. purchased a temporary investment in shares of XYZ Co. for $ At year end, the investment had a market value of $12,000. The $2,000 decrease in value in the temporary investment should be: a) Recorded as realized loss on the income statement b) Deducted from the value of asset on the balance sheet c) Only disclosed as part of the market value of marketable securities d) Both A and B Question # 2: ABC Co. has the following info on its unadjusted trial balance at dec 31, 2011: Accounts receivable 40,000 Allowance for uncollectible accounts 1200 (DR) The company uses the aging of receivables method and determined that $2000 of receivables would not be collected. What amount should be reported as the bad debt expense on dec 31, 2011 income statement? a) 2000 b) 800 c) 2400

5 d) 3200 Question #3: if the adjusting entry to accrue interest on a note receivable is omitted, then: a) Assets, net income, shareholder s equity are overstated b) Assets, net income, and shareholder s equity are understated c) Liabilities are understated, net income is overstated and shareholder s equity is overstated d) Assets are overstated, net income and shareholder s equity are understated Question#4: Net sales total $600,000. Beginning and ending a/r are $52,000 and $38,000 respectively. Calculate days sales in receivables (rounded) a) 32 days b) 23 days c) 43 days d) 27 days

Chapter 10. Learning Objectives. Receivables. Receivables. Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia

Chapter 10. Learning Objectives. Receivables. Receivables. Horngren, Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia PowerPoint to accompany Chapter 10 Receivables Learning Objectives 1. Design internal controls for receivables 2. Use the allowance method to account for bad debts 3. Use the direct write-off method to