©2008 Pearson Prentice Hall. All rights reserved.
5-1
Short-Term Investments & Receivables
Chapter 5
©2008 Pearson Prentice Hall. All rights reserved.
5-2
Learning Objective 1
Account for short-term investments
©2008 Pearson Prentice Hall. All rights reserved.
5-3
Accounting for Short-Term Investments
• Also called marketable securities
• Held for one year or less
• Most liquid asset other than cash
• Placed into three categories:
Trading Investments
Available-for-Sale
Held-to-Maturity
©2008 Pearson Prentice Hall. All rights reserved.
5-4
Trading Investments
• Held for short time and then sold Gain or loss recorded
• Dividend revenue may also be received
• At year-end, trading investments are adjusted to equal their market value Results in an unrealized gain or loss
Selling price > cost = Gain Selling price < cost = Loss
©2008 Pearson Prentice Hall. All rights reserved.
5-5
Unrealized Gains & Losses
• Difference between market price and cost of investment at year-end
• Unrealized – investment has not been sold
Market price > cost =
Unrealized gain
Market price < cost =
Unrealized loss
©2008 Pearson Prentice Hall. All rights reserved.
5-6
Realized vs. Unrealized
Realized• Investment sold to
third party• Gain or loss =
difference between selling price and cost
• Word “realized” usually dropped from title
Unrealized • Company still owns
investment• Gain or loss =
difference between market value and cost
• Word “unrealized” is kept in account title
©2008 Pearson Prentice Hall. All rights reserved.
5-7
Entries to Adjust to Market
JOURNAL
Date Accounts Debit Credit
Short-term investments $$$
Unrealized gain on investments $$$
Adjusted investment to market value (when greater than cost)
Unrealized loss on investments $$$
Short-term investments $$$
Adjusted investment to market value (when less than cost)
©2008 Pearson Prentice Hall. All rights reserved.
5-8
Reporting on Financial Statements
Balance Sheet• Trading Investment
Reported at current market value
Listed directly under “cash” in the current asset section
Income Statement• Gains and losses
From sales of investments
• Investment revenue From dividends or
interest earned
• Unrealized gain or loss From entry to adjust to
market value
©2008 Pearson Prentice Hall. All rights reserved.
5-9
E5-18
JOURNAL
Date Accounts Debit Credit
Nov 6 Trading investment $35,000
Cash $35,000
Nov 27 Cash $850
Dividend revenue $850
©2008 Pearson Prentice Hall. All rights reserved.
5-10
E5-18
JOURNAL
Date Accounts Debit Credit
12-31 Unrealized loss _______
Trading Investments ________
What would be the amount of the
unrealized loss?
Compute the difference between the cost and
market value.
©2008 Pearson Prentice Hall. All rights reserved.
5-11
E5-18
JOURNAL
Date Accounts Debit Credit
1-11 Cash $36,000
Trading Investments $33,000
Gain on sale of investments $3,000
©2008 Pearson Prentice Hall. All rights reserved.
5-12
Receivables
• Monetary claims against others
• Third most liquid asset
• Accounts Receivable Amounts owed by customers for selling goods
or services
• Notes Receivable Lending money to outsiders More formal than accounts receivable
©2008 Pearson Prentice Hall. All rights reserved.
5-13
Learning Objective 2
Apply internal controls to receivables
©2008 Pearson Prentice Hall. All rights reserved.
5-14
Internal Control over Cash Collections on Account
• Separate cash-handling from cash-accounting duties
• Cash-handling One person receives customer checks and
makes deposits
• Cash-accounting Another person makes entries to customer
accounts
©2008 Pearson Prentice Hall. All rights reserved.
5-15
Accounting for Uncollectible Receivables
• Extending credit to customers bears some risk
• Risk: Some customers do not pay the amount owed
• Cost: Uncollectible accounts
©2008 Pearson Prentice Hall. All rights reserved.
5-16
Learning Objective 3
Use the allowance method for uncollectible receivables
©2008 Pearson Prentice Hall. All rights reserved.
5-17
Allowance Method
• Amount of uncollectible accounts is estimated
• An expense is recorded as part of the adjusting process
• A contra-asset is recorded that reduces accounts receivable on the balance sheet
A contra-asset is always pairedwith an asset and reduces
its balance
©2008 Pearson Prentice Hall. All rights reserved.
5-18
Entry to Record Uncollectible accounts
JOURNAL
Date Accounts Debit Credit
Uncollectible accounts expense
Allowance for uncollectible accounts
Goes on theIncome Statement
Goes on the Balance Sheet netted with accounts receivable
©2008 Pearson Prentice Hall. All rights reserved.
5-19
Balance Sheet
Current assets:
Accounts receivable $$,$$$
Less: Allowance for
Uncollectible Accounts ( $,$$$)
Accounts receivable, net $$,$$$
Accounts receivable, net $$,$$$
OR
©2008 Pearson Prentice Hall. All rights reserved.
5-20
Methods to Estimate Uncollectibles
Percent-of-sales• Expense is estimated
based on credit sales• Income Statement
approach
Aging-of-receivables• Accounts receivable
analyzed based on how long outstanding
• Balance Sheet approach
©2008 Pearson Prentice Hall. All rights reserved.
5-21
E5-23
Age of Accounts
1 - 30 Days 31 - 60 Days 61 - 90 Days Over 90 Days
$ 110,000 $ 60,000 $ 50,000 $ 15,000
0.5% 1% 60% 40%
$ 550 $ 600 $ 30,000 $ 6,000
$37,150
©2008 Pearson Prentice Hall. All rights reserved.
5-22
E5-23
Aging Schedule $37,150
Balance in Allowance $7,400
Adjustment needed
JOURNAL
Date Accounts Debit Credit
12-31 Uncollectible accounts expense _______
Allowance for uncollectible accounts ______
Adjustment needed = Aging schedule -
Balance
©2008 Pearson Prentice Hall. All rights reserved.
5-23
E5-23
Allowance for Uncollectible Accounts
$7,400 Balance before adjustment
$37,150 Balance per aging schedule
$29,750Adjusting entry
©2008 Pearson Prentice Hall. All rights reserved.
5-24
Uncollectible Accounts Methods
Percent-of-Sales Aging-of-Receivables
Adjust Allowance for Uncollectible Accounts
Adjust Allowance for Uncollectible Accounts
BY TO
The Amount of UNCOLLECTIBLE ACCOUNT
EXPENSE
The Amount of UNCOLLECTIBLE ACCOUNTS
RECEIVABLE
©2008 Pearson Prentice Hall. All rights reserved.
5-25
Writing Off a Specific Account
• The allowance is used to absorb specific accounts that are determined to uncollectible
• When it’s determined a customer cannot pay, the following entry is made:
JOURNAL
Date Accounts Debit Credit
Allowance for uncollectible accounts $$$$
Accounts receivable $$$$
©2008 Pearson Prentice Hall. All rights reserved.
5-26
Direct Write-Off Method
• Less preferable than allowance method Does not match expenses with revenues Accounts Receivable overstated
• Uncollectible Accounts Expense used for write offs
• No Allowance for Uncollectible Accounts
©2008 Pearson Prentice Hall. All rights reserved.
5-27
Accounts Receivable
Sales on account Payments on account
Uncollectible accounts written off
©2008 Pearson Prentice Hall. All rights reserved.
5-28
Allowance for Uncollectible Accounts
Uncollectible accounts written off
Uncollectible account adjustment
What is the normal balance of
the Allowance?
©2008 Pearson Prentice Hall. All rights reserved.
5-29
Learning Objective 4
Account for notes receivable
©2008 Pearson Prentice Hall. All rights reserved.
5-30
Notes Receivable Terms
• Creditor
• Debtor
• Interest
• Maturity Date
• Maturity Value
• Principal
• Term
Party to whom money is owed; lender
Date debtor must pay the note
Sum of principal and interest on note
Amount borrowed by debtor
Length of time money is borrowed
Party that owes money; borrower
Cost of borrowing money; percent
©2008 Pearson Prentice Hall. All rights reserved.
5-31
Accounting for Notes Receivable
• To record the receipt of a note receivable, the following entry is made:
JOURNAL
Date Accounts Debit Credit
Notes Receivable $$,$$$
Cash $$,$$$
©2008 Pearson Prentice Hall. All rights reserved.
5-32
Accounting for Notes Receivable
• Interest needs to be accrued on any note receivable outstanding at year end:
JOURNAL
Date Accounts Debit Credit
Interest receivable $$,$$$
Interest revenue $$,$$$
Interest is computed by the formula:Principal x rate x time
Time = date note issigned to end-of-year
©2008 Pearson Prentice Hall. All rights reserved.
5-33
Accounting for Notes Receivable
When payment is received on note, the following entry is made
JOURNAL
Date Accounts Debit Credit
Cash
Notes Receivable
Interest receivable
Interest revenue
For maturity value
Zeroes out adjustment
For remaininginterest earned
For principal
©2008 Pearson Prentice Hall. All rights reserved.
5-34
Credit and Bank Card Sales
• Credit Cards American Express and Discover
• Bank Cards VISA and MasterCard
• Both charge the retailer a fee
©2008 Pearson Prentice Hall. All rights reserved.
5-35
Learning Objective 5
Use two new ratios to evaluate a business
©2008 Pearson Prentice Hall. All rights reserved.
5-36
Days’ Sales in Receivables
• How long it takes a company to collect its average amount of receivable
• Compute one day’s sales
• Days’ sales in receivables
Net Sales365 Days
Average receivables
One Day’s Sales
©2008 Pearson Prentice Hall. All rights reserved.
5-37
Acid-Test Ratio
• Also called quick ratio
• A more stringent measure of a company’s ability to pay its current liabilities
Cash + Short-term investments + net receivables
Total current liabilities