Chapter 5 Short-Term Investments & Receivables

Learning Objectives Account for short-term investments Apply internal controls to receivables Use the allowance method for uncollectible receivables Account for notes receivable Use days’ sales in receivables and the acid-test ratio to evaluate financial position

Account for short-term investments

Apply internal controls to receivables

Use the allowance method for uncollectible receivables

Account for notes receivable

Use days’ sales in receivables and the acid-test ratio to evaluate financial position

Key Terms Creditor Debtor Debt instrument Equity security Maturity Term

Creditor

Debtor

Debt instrument

Equity security

Maturity

Term

Short-Term Investments Marketable Securities investments company plans to hold one year or less Trading Investments – intent is to sell in the short term to generate profits Trading securities are reported on the balance sheet at current market value Unrealized gains and losses appear on the income statement.

Marketable Securities

investments

company plans to hold one year or less

Trading Investments – intent is to sell in the short term to generate profits

Trading securities are reported on the balance sheet at current market value

Unrealized gains and losses appear on the income statement.

Entry for Unrealized Gain Dec 31 Short-Term Investments 2,000.00 Unrealized Gain on Investments 2,000.00 Adjust investment to market value To record the $2,000 increase in market value of marketable securities held as short-term investments.

Entry for Unrealized Gain Dec 18 Short-Term Investments 100,000 Cash 100,000 Purchased Investment To record the purchase of short-term investments. To record the receipt of a cash dividend from short-term investments. Dec 18 Cash 4,000 Dividend Revenue 4,000 Received cash dividend

Entry for Unrealized Gain Dec 31 Short-Term Investments 2,000.00 Unrealized Gain on Investments 2,000.00 Adjust investment to market value To record the $2,000 increase in market value of marketable securities held as short-term investments.

Reporting Short-Term Investments Balance Sheet Current Assets Trading investments reported at current market value Income Statement Interest and dividend revenue reported under Other Revenue . Gains and losses reported under Other Revenue .

Balance Sheet

Current Assets

Trading investments reported at current market value

Income Statement

Interest and dividend revenue reported under Other Revenue .

Gains and losses reported under Other Revenue .

Receivables Receivables are monetary claims against others. Two major types: Accounts receivable (trade receivables) – amounts collected from customers from the sale of goods and services Notes receivable – written promise to pay secured unsecured

Receivables are monetary claims against others.

Two major types:

Accounts receivable (trade receivables) – amounts collected from customers from the sale of goods and services

Notes receivable – written promise to pay

secured

unsecured

Issues When Extending Credit What are the benefits and cost of extending credit to customers? Extend credit only to creditworthy customers. Separate cash-handling and accounting duties. Pursue collection from customers.

What are the benefits and cost of extending credit to customers?

Extend credit only to creditworthy customers.

Separate cash-handling and accounting duties.

Pursue collection from customers.

Issues in Accounting for Receivables Measure and report receivables at net realizable value. Measure and report the expense associated with failure to collect.

Measure and report receivables at net realizable value.

Measure and report the expense associated with failure to collect.

Uncollectible Receivables Allowance method record losses based on an estimate of uncollectible accounts. Percent-of-sales method computes expense as a percent of revenue income statement approach Aging-of-receivables method individual receivables are analyzed based on how long they have been outstanding balance sheet approach

Allowance method

record losses based on an estimate of uncollectible accounts.

Percent-of-sales method

computes expense as a percent of revenue

income statement approach

Aging-of-receivables method

individual receivables are analyzed based on how long they have been outstanding

balance sheet approach

Percent-of-Sales Total sales are $33,000. The credit department estimates that uncollectible-account expense is 1% of total revenues. Dec 31 Uncollectible-Account Expense ($33,000 x .01) 330 Allowance for Uncollectible Accounts 330 Recorded expense for the year Accounts Receivable 3,105 Bal. 3,105 Allowance for Uncollectible Accounts 54 330 Bal. 384 Net Accounts Receivable $3,105 – 384 = $2,721

Aging-of-Receivables

Aging-of-Receivables Current balance in allowance account is $170. Calculate the adjustment needed to bring the balance to $384. Expense: $384 – $170 = $214

Current balance in allowance account is $170.

Calculate the adjustment needed to bring the balance to $384.

Expense: $384 – $170 = $214

Aging-of-Receivables Dec 31 Uncollectible-Account Expense 214 Allowance for Uncollectible Accounts 214 Recorded expense for the year Accounts Receivable 3,105 Bal. 3,105 Allowance for Uncollectible Accounts 170 214 Bal. 384 Net Accounts Receivable $3,105 – 384 = $2,721

Writing off Uncollectible Accounts Decrease the Allowance account and remove the account receivable. Mar 31 Allowance for Uncollectible Accounts 100 Accounts Receivable – Sarasota Pipe 61 Accounts Receivable – Miller Auto Sales 39 Wrote off uncollectible receivables

Decrease the Allowance account and remove the account receivable.

Direct Write-Off Method No allowance is established and the expense is recognized when accounts are written off. Mar 31 Uncollectible Account Expense 100 Accounts Receivable – Sarasota Pipe 61 Accounts Receivable – Miller Auto Sales 39 Wrote off bad accounts by direct write-off method

No allowance is established and the expense is recognized when accounts are written off.

Direct Write-Off Method Assets are overstated on the balance sheet because no allowance account is used. Poor matching of uncollectible-account expense against revenue. Net income is overstated.

Assets are overstated on the balance sheet because no allowance account is used.

Poor matching of uncollectible-account expense against revenue. Net income is overstated.

Notes Receivable Creditor has a note receivable. Debtor has a note payable. Principal is the amount borrowed. Interest is revenue to the lender and expense to the borrower.

Creditor has a note receivable.

Debtor has a note payable.

Principal is the amount borrowed.

Interest is revenue to the lender and expense to the borrower.

Notes Receivable Laura Holland signs a $1,000 note dated Aug. 31, 20X5 with a maturity date of Feb. 28, 20X6. To record this on the bank’s books: Aug 31 Notes Receivable – L. Holland 1,000 Cash 1,000 Made a loan To record interest earned at Dec. 31, 20X5: Dec 31 Interest Receivable (1,000 x .09 x 4/12) 30 Interest Revenue 30 Accrued interest revenue

Notes Receivable To record collection of the note on Feb. 28, 20X6: Feb 28 Cash 1,045 Interest Revenue 15 Collected note at maturity Interest Receivable 30 Note Receivable – L. Holland 1,000

Speeding Up Cash Flow Credit Card Sales Selling Receivables Both methods result in financing expense.

Credit Card Sales

Selling Receivables

Both methods result in financing expense.

Days’ Sales in Receivables Compute one day’s sales (net sales / 365 days) Compute days’ sales in receivables (average receivables / one day’s sales)

Compute one day’s sales

(net sales / 365 days)

Compute days’ sales in receivables

(average receivables / one day’s sales)

Acid Test Ratio Measure of liquidity More stringent than the current ratio Acid-test ratio Cash Short-term investments Net current receivables + + Total current liabilities =

Measure of liquidity

More stringent than the current ratio

End of Chapter 5