Short-Term Investments Short-term investments are investments that a company plans to hold for one year or less. – Held-to-maturity securities – Trading investments – Available-for-sale investments Held-to-maturity and available-for-sale securities could also be long-term.
Short-Term Investments Held-to-maturity investments are securities that the investor expects to hold until their maturity date. They earn interest revenue for the investor. Accounting for these securities is the same as accounting for notes receivable.
Short-Term Investments Trading Investments Suppose that Oracle Corporation purchases Ford Motor Company stock on May 18, paying $100,000, with the intention of selling the stock within a few months.
Short-Term Investments May 18 Short-Term Investment 100,000 Cash 100,000 Purchased investment On May 27, Oracle receives a cash dividend of $4,000 from Ford.
Short-Term Investments May 27 Cash 4,000 Dividend Revenue 4,000 Received cash dividend Oracle fiscal year ends on May 31, and the investment in Ford has a current market value of $102,000 on this date.
Short-Term Investments May 31 Short-Term Investment 2,000 Unrealized Gain on Investments 2,000 Adjusted investment to market value Short-Term Investments Cost 100,000 Adjustment to market value 2,000 Balance 102,000
Reporting on the Balance Sheet and the Income Statement Balance Sheet Current Assets: $ XXX Cash XXX Short-term investments at market value 102,000 Accounts receivable XXX Income Statement Revenues $ XXX Expenses XXX Other revenues, gains, and (losses): Interest revenue XXX Dividend revenue 4,000 Unrealized gain on investment 2,000
Accounts and Notes Receivable Receivables are the third most liquid asset – after cash and short-term investments. Receivables are monetary claims against others.
Types of Receivables Accounts receivable Notes receivable Other receivables (miscellaneous)
Accounts Receivable GENERAL LEDGER Accounts Receivable Bal. 9,000 ACCOUNTS RECEIVABLE SUBSIDIARY RECORD Aston Bal. 5,000 Harris Salazar Bal. 1,000 Bal. 3,000
Learning Objective 3 Use the allowance method for uncollectible receivables.
Accounting for Uncollectible Accounts Selling on credit creates both a benefit and a cost: The benefit : Customers who cannot pay cash immediately can buy on credit, so company profits rise as sales increase. The cost : The company will be unable to collect from some credit customers.
The Allowance Method The allowance method records collection losses on the basis of estimates, not waiting to see which customers will not pay. The Allowance for Uncollectible Accounts (Allowance for Doubtful Accounts) is a contra account to Accounts Receivable.
The Allowance Method Balance Sheet (partial) Accounts receivable $10,000 Less: Allowance for uncollectible accounts – 900 Accounts receivable, net $ 9,100 Income Statement (partial) Expenses: Uncollectible-account expense $ 900
Methods for Estimating Uncollectibles Percent-of-sales Aging-of-Receivables
Percent-of-Sales It computes uncollectible-account expense as a percentage of revenue. This method is also called the income-statement approach .
Percent-of-Sales The credit department estimates that uncollectible-account expense is 5% of total revenues, which were $11 billion for 20x1. Dec 31 (in millions) Uncollectible-Account Expense ($11,000 × 0.05) 550 Allowance for Uncollectible Accounts 550 Recorded expense for the year
Percent-of-Sales December 31, 20x1 (in millions) After Adjustment Accounts Receivable Bal. 11,000 Allowance for Uncollectible Accounts 550
Aging-of-Receivables This method is a balance-sheet approach because it focuses on accounts receivable. Individual receivables from specific customers are analyzed based on how long they have been outstanding.
Aging-of-Receivables Accounts before the year-end adjustment: December 31, 20x1 (in millions) Accounts Receivable Bal. 2,835 Allowance for Uncollectible Accounts 120
Aging-of-Receivables Days Overdue 1-30 days 31-60 days 61-90 days 91 + days Accounts Receivable $1,555 750 311 219 $2,835 Estimated % Uncollectible 6 10 20 79 Allowance for Uncollectible Accounts $ 93 75 62 173 $403 Aging the Accounts Receivable
Aging-of-Receivables Accounts after the year-end adjustment: Uncollectible-Account Expense 283 Allowance for Uncollectible Accounts ($403 – $120) 283 Recorded expense for the year December 31, 20x1 (in millions) Accounts Receivable Bal. 2,835 Allowance for Uncollectible Accounts 120 Adj. 283 403
Writing Off Uncollectible Accounts Suppose that early in 20x2, the credit department determines that the company cannot collect from two customers. These accounts must be written off. How?
Writing Off Uncollectible Accounts Allowance for Uncollectible Accounts 100 Accounts Receivable Customer A 61 Accounts Receivable Customer B 39 Wrote off uncollectible receivables
Direct Write-Off Method An account is written off only when it is decided that a specific customer’s receivable is uncollectible. January 2, 20x4 Uncollectible-Account Expense 2,000 Accounts Receivable – Jones 2,000 Wrote off a bad account
Direct Write-Off Method This method is defective for two reasons: Since no allowance for uncollectibles is established, assets are overstated on the balance sheet. 1 It causes a poor matching of uncollectible- account expense against revenue and overstates net income. 2
Learning Objective 4 Account for notes receivable.
Notes Receivable Notes receivable are more formal than accounts receivable. The creditor has a note receivable. The debtor has a note payable. Note
Notes Receivable The principal amount of the note is the amount borrowed by the debtor. The maker pays the payee the maturity value. The maturity value includes principal plus interest.
Notes Receivable PROMISSORY NOTE $1,000 August 31, 20x5 Amount For value received, I promise to pay to the order of Continental bank Chicago, Illinois One thousand and no/100………… …………D ollars on February 28, 20x6 plus interest at the annual rate of 9 percent Principal Interest period starts Payee (creditor) Interest rate Interest period ends on the maturity date Maker (Debtor)
Accounting for Notes Receivable Continental Bank entry is as follows: August 31, 20x5 Note Receivable 1,000 Cash 1,000 Made a loan How much interest revenue is accrued at December 31?
Accounting for Notes Receivable Interest = Principal × Rate × Time December 31, 20x5 Interest Receivable 30 Interest Revenue 30 Accrued interest revenue $1,000 × 9% × 4 / 12 = $30
Accounting for Notes Receivable February 28, 20x6 Cash 1,045 Note Receivable 1,000 Interest Receivable 30 Interest Revenue ($1,000 × 9% × 2 / 12 ) 15 Collected note at maturity The bank collects the note on February 28, 20x6.
Learning Objective 5 Use the acid-test ratio and the days’ sales in receivables to evaluate financial position.
Reporting Assets in Order of Liquidity CURRENT ASSETS 2001 2000 Cash and cash equivalents $ 4,449 $ 7,429 Short-term investments 1,438 333 Trade receivables, net 2,432 2,534 Prepaid expenses 644 587 Total current assets $ 8,963 $10,883 Long-term investments – 110 Property, net 975 935 Other assets 1,092 1,149 Total assets $11,030 $13,077 CURRENT LIABILITIES Total current liabilities 3,916 5,892 Long-term debt and liabilities 836 753 Stockholders’ equity 6,278 6,462 Total liabilities and stockholders’ equity $11,030 $13,077
Days’ Sales in Receivables One day’s sales = Net sales ÷ 365 days = 10,860 ÷ 365 = 29.75 per day Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales = [(2,534 + 2,432) ÷ 2] ÷ 29.75 = 83 days A smaller number indicates a quick conversion to cash.
Acid-Test Ratio Acid-test ratio = (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities = (4,449 + 1,438 + 2,432) ÷ 3,916 = 2.12 This is a stringent test of liquidity which measures the entity’s ability to pay its current liabilities immediately. This ratio value is extremely high and indicates great liquidity for this company.