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© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-1
FINANCIAL ASSETSChapter
7
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-2
How Much Cash Should a Business
Have?
How Much Cash Sho...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-3
How Much Cash Should a Business
Have?
How Much Cash Sho...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-4
How Much Cash Should a Business
Have?
How Much Cash Sho...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-5
The Valuation of Financial AssetsThe Valuation of Finan...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-6
CashCash
Coins and
paper
money
Checks
Money orders
Trav...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-7
Combined
with cash on
balance sheet
Reporting Cash in t...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-8
Not available
for paying
current
liabilities
Reporting ...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-9
Bank agrees in
advance to lend
money.
Reporting Cash in...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-10
The Statement of Cash FlowsThe Statement of Cash Flows...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-11
Cash ManagementCash Management
Accurately account for...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-12
Using Excess Cash Balances
Efficiently
Using Excess Ca...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-13
Internal Control Over Cash
Segregate authorization, c...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-14
Cash Over and ShortCash Over and Short
Cash Over and S...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-15
Bank StatementsBank Statements
Shows the beginning ban...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-16
Reconciling the Bank StatementReconciling the Bank Sta...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-17
Reconciling the Bank StatementReconciling the Bank Sta...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-18
Reconciling the Bank StatementReconciling the Bank Sta...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-19
Reconciling the Bank Statement
Example
Reconciling the...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-20
 Outstanding checks totaled $2,417.
 A $500 check ma...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-21
Reconciling the Bank Statement
Example
Reconciling the...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-22
Reconciling the Bank Statement
Example
Reconciling the...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-23
Used for minor
expenditures.
Petty Cash FundsPetty Cas...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-24
Short-Term InvestmentsShort-Term Investments
Bond
Inve...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-25
Mark-to-Market: A Principle of
Asset Valuation
Mark-to...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-26
Let’s turn our
attention to
accounts receivable.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-27
Uncollectible AccountsUncollectible Accounts
If a comp...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-28
Reflecting Uncollectible Accounts
in the Financial Sta...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-29
The Allowance for Doubtful
Accounts
The Allowance for ...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-30
Writing Off an Uncollectible
Account Receivable
Writin...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-31
Writing Off an Uncollectible
Account Receivable
Writin...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-32
Writing Off an Uncollectible
Account Receivable
Writin...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-33
Writing Off an Uncollectible
Account Receivable
Writin...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-34
Recovery of an Account Receivable
Previously Written O...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-35
Monthly Estimates of Credit LossesMonthly Estimates of...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-36
At December 31, 2005, MusicLand’s accounting
records i...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-37
Desired balance in Allowance
for Doubtful Accounts.
Mo...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-38
Let’s look at
another way
to estimate
the
uncollectibl...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-39
Estimating Credit Losses — The
“Balance Sheet” Approac...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-40
Estimating Credit Losses — The
“Balance Sheet” Approac...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-41
Estimating Credit Losses — The
“Balance Sheet” Approac...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-42
Estimating Credit Losses — The
“Balance Sheet” Approac...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-43
EastCo’s unadjusted balance
in the allowance account i...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-44
Guess What!
There is
another
alternative to
estimate t...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-45
An Alternative Approach to
Estimating Credit Losses
An...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-46
An Alternative Approach to
Estimating Credit Losses
An...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-47
An Alternative Approach to
Estimating Credit Losses
An...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-48
An Alternative Approach to
Estimating Credit Losses
An...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-49
Uncollectible Accounts
Summary
Uncollectible Accounts
...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-50
Direct Write-Off MethodDirect Write-Off Method
This me...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-51
Income Tax Regulations and
Financial Reporting
Income ...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-52
Internal Controls for ReceivableInternal Controls for ...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-53
Management of Accounts
Receivable
Management of Accoun...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-54
Ways to Minimize Amounts in
Accounts Receivable
Ways t...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-55
Financial AnalysisFinancial Analysis
Accounts Receivab...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-56
Financial AnalysisFinancial Analysis
Avg. Number of Da...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-57
Concentration of Credit RiskConcentration of Credit Ri...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Slide
7-58
End of Chapter 7End of Chapter 7
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Transcript of "Williams07"

  1. 1. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-1 FINANCIAL ASSETSChapter 7
  2. 2. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-2 How Much Cash Should a Business Have? How Much Cash Should a Business Have? $ Every business needs enough cash to pay its bills!
  3. 3. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-3 How Much Cash Should a Business Have? How Much Cash Should a Business Have? Cash Short-term Investments Receivables Financial Assets
  4. 4. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-4 How Much Cash Should a Business Have? How Much Cash Should a Business Have? Accounts receivable Marketable securities Cash (and cash equivalents) Collections from customers Cash payments “Excess” cash is invested temporarily. Investments are sold as cash is needed.
  5. 5. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-5 The Valuation of Financial AssetsThe Valuation of Financial Assets Type of Financial Asset Basis for Valuation in the Balance Sheet Cash (and cash equivalents) Face amount Short-term investments (marketable securities) Current market value Receivables Net realizable value Estimated collectible amountEstimated collectible amount
  6. 6. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-6 CashCash Coins and paper money Checks Money orders Travelers’ checks Bank credit card sales Cash is defined as any deposit banks will accept.
  7. 7. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-7 Combined with cash on balance sheet Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Liquid short- term investments Stable market values Matures within 90 days of acquisition Cash Equivalents
  8. 8. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-8 Not available for paying current liabilities Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Not a current asset Listed as an investment “Restricted” Cash
  9. 9. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-9 Bank agrees in advance to lend money. Reporting Cash in the Balance Sheet Reporting Cash in the Balance Sheet Liability is incurred when line of credit is used. Unused line of credit is disclosed in notes. Lines of Credit
  10. 10. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-10 The Statement of Cash FlowsThe Statement of Cash Flows Summarizes cash transactions for an accounting period. Statement of Cash Flows Includes cash and cash equivalents.
  11. 11. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-11 Cash ManagementCash Management Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash. Accurately account for cash. Prevent theft and fraud. Assure the availability of adequate amounts of cash. Avoid unnecessarily large amounts of idle cash.
  12. 12. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-12 Using Excess Cash Balances Efficiently Using Excess Cash Balances Efficiently Cash available for long-term investment may be used to finance growth and expansion of the business, or to repay debt. Cash not needed for business purposes should be distributed to the company’s stockholders.
  13. 13. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-13 Internal Control Over Cash Segregate authorization, custody and recording of cash. Prepare a cash budget. Prepare a control listing of cash receipts. Require daily deposits. Make all payments by check. Verify every expenditure before payment. Promptly reconcile bank statements. Internal Control Over Cash Segregate authorization, custody and recording of cash. Prepare a cash budget. Prepare a control listing of cash receipts. Require daily deposits. Make all payments by check. Verify every expenditure before payment. Promptly reconcile bank statements.
  14. 14. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-14 Cash Over and ShortCash Over and Short Cash Over and Short is debited for shortages and credited for overages. Cash Over and Short is debited for shortages and credited for overages. On May 5, XBAR, Inc.’s cash drawer was counted and found to be $10 over.
  15. 15. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-15 Bank StatementsBank Statements Shows the beginning bank balance, deposits made, checks paid, other debits and credits during the month, and the ending bank balance. Bank Statement
  16. 16. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-16 Reconciling the Bank StatementReconciling the Bank Statement Explains the difference between cash reported on bank statement and cash balance in depositor’s accounting records. Provides information for reconciling journal entries.
  17. 17. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-17 Reconciling the Bank StatementReconciling the Bank Statement Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors = Adjusted Balance Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance
  18. 18. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-18 Reconciling the Bank StatementReconciling the Bank Statement All reconciling items on the book side require an adjusting entry to the cash account. Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Adjusted Balance
  19. 19. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-19 Reconciling the Bank Statement Example Reconciling the Bank Statement Example Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicated a cash balance of $9,610, while the cash ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next page.
  20. 20. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-20  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment of an account receivable.  The bank statement showed $30 interest earned on the bank balance for the month of July.  Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.  A $486 deposit by Acme Company was erroneously credited to our account by the bank.  Outstanding checks totaled $2,417.  A $500 check mailed to the bank for deposit had not reached the bank at the statement date.  The bank returned a customer’s NSF check for $225 received as payment of an account receivable.  The bank statement showed $30 interest earned on the bank balance for the month of July.  Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.  A $486 deposit by Acme Company was erroneously credited to our account by the bank.
  21. 21. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-21 Reconciling the Bank Statement Example Reconciling the Bank Statement Example Reconciling the Bank Statement Example Reconciling the Bank Statement Example Balance per bank statement, July 31 9,610$ Additions: Deposit in transit 500 Deductions: Bank error 486$ Outstanding checks 2,417 2,903 Adjusted cash balance 7,207$ Balance per depositor's records, July 31 7,430$ Additions: Interest 30 Deductions: Recording error 28$ NSF check 225 253 Adjusted cash balance 7,207$
  22. 22. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-22 Reconciling the Bank Statement Example Reconciling the Bank Statement Example GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Jul 31 Cash 30 Interest Revenue 30 31 Supplies Inventory 28 Accounts Receivable 225 Cash 253
  23. 23. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-23 Used for minor expenditures. Petty Cash FundsPetty Cash Funds Has one custodian. Replenished periodically. Petty Cash Funds
  24. 24. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-24 Short-Term InvestmentsShort-Term Investments Bond Investments Capital Stock Investments Current Assets Almost As Liquid As Cash Readily Marketable Marketable Securities are . . .
  25. 25. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-25 Mark-to-Market: A Principle of Asset Valuation Mark-to-Market: A Principle of Asset Valuation Short-term investments in marketable securities appear on the balance sheet at their current market value as of the balance sheet date. Classification Management's Intent Treatment of Unrealized Holding Gains and Losses Available-for- sale securities Held for short-term resale (often 6 to 18 months) Reported in stockholders' equity section of the balance sheet Trading securities Held for immediate resale (often within hours or days) Reported in "other" revenue (expense) section of the income statement Held to maturity securities Debt securities intended to be held until they mature Reported in stockholders' equity section of the balance sheet
  26. 26. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-26 Let’s turn our attention to accounts receivable.
  27. 27. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-27 Uncollectible AccountsUncollectible Accounts If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. If a company makes credit sales to customers, some accounts inevitably will turn out to be uncollectible. PAST DUE
  28. 28. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-28 Reflecting Uncollectible Accounts in the Financial Statements Reflecting Uncollectible Accounts in the Financial Statements At the end of each period, record an estimate of the uncollectible accounts. At the end of each period, record an estimate of the uncollectible accounts. Contra-asset accountContra-asset accountSelling expenseSelling expense
  29. 29. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-29 The Allowance for Doubtful Accounts The Allowance for Doubtful Accounts Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable The net realizable value is the amount of accounts receivable that the business expects to collect.
  30. 30. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-30 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off. When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off.
  31. 31. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-31 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he owes. K-Max would make the following entry.
  32. 32. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-32 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Doubtful Accounts balance was $2,500. Let’s see what effect the write-off had on these accounts.
  33. 33. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-33 Writing Off an Uncollectible Account Receivable Writing Off an Uncollectible Account Receivable Before Write-Off After Write-Off Accounts receivable 10,000$ 9,500$ Less: Allow. for doubtful accts. 2,500 2,000 Net realizable value 7,500$ 7,500$ Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts.
  34. 34. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-34 Recovery of an Account Receivable Previously Written Off Recovery of an Account Receivable Previously Written Off GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Accounts Receivable (X Customer) $$$$ Allowance for Doubtful Accounts $$$$ Cash $$$$ Accounts Receivable (X Customer) $$$$ Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded. Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
  35. 35. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-35 Monthly Estimates of Credit LossesMonthly Estimates of Credit Losses At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate. At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate.
  36. 36. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-36 At December 31, 2005, MusicLand’s accounting records indicate the following: Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit) Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Uncollectible Accounts Expense for 2005? At December 31, 2005, MusicLand’s accounting records indicate the following: Accounts Receivable = $50,000 Allowance for Doubtful Accounts = $200 (credit) Past experience suggests that 5% of receivables are uncollectible. What is MusicLand’s Uncollectible Accounts Expense for 2005? Monthly Estimates of Credit Losses Example Monthly Estimates of Credit Losses Example
  37. 37. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-37 Desired balance in Allowance for Doubtful Accounts. Monthly Estimates of Credit Losses Example Monthly Estimates of Credit Losses Example
  38. 38. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-38 Let’s look at another way to estimate the uncollectible accounts! Let’s look at another way to estimate the uncollectible accounts!
  39. 39. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-39 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach  Year-end Accounts Receivable is broken down into age classifications.  Year-end Accounts Receivable is broken down into age classifications.  Each age grouping has a different likelihood of being uncollectible.  Each age grouping has a different likelihood of being uncollectible.  Compute a separate allowance for each age grouping.  Compute a separate allowance for each age grouping.
  40. 40. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-40 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
  41. 41. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-41 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
  42. 42. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-42 Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows: 
  43. 43. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-43 EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. EastCo’s unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350. Estimating Credit Losses — The “Balance Sheet” Approach Estimating Credit Losses — The “Balance Sheet” Approach
  44. 44. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-44 Guess What! There is another alternative to estimate the uncollectible accounts! Guess What! There is another alternative to estimate the uncollectible accounts!
  45. 45. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-45 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales. Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.
  46. 46. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-46 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses Net Credit Sales × % Estimated Uncollectible Amount of Journal Entry
  47. 47. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-47 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses In 2005, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s accounts have been uncollectible. For 2005, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600) Now, prepare the adjusting entry for December 31, 2005.
  48. 48. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-48 An Alternative Approach to Estimating Credit Losses An Alternative Approach to Estimating Credit Losses
  49. 49. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-49 Uncollectible Accounts Summary Uncollectible Accounts Summary % of Receivables% of Receivables Emphasis on Realizable Value Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Balance Sheet Focus Aging of Receivables Aging of Receivables Emphasis on Realizable Value Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Balance Sheet Focus % of Sales% of Sales Emphasis on Matching Emphasis on Matching Sales Uncoll. Accts. Exp. Income Statement Focus Income Statement Focus
  50. 50. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-50 Direct Write-Off MethodDirect Write-Off Method This method makes no attempt to match revenue with the expense of uncollectible accounts.
  51. 51. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-51 Income Tax Regulations and Financial Reporting Income Tax Regulations and Financial Reporting Direct write-off method required to calculate taxable income. Taxable Income Financial Statement Income GAAP GAAP GAAP GAAP Allowance methods better match expenses with revenues.
  52. 52. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-52 Internal Controls for ReceivableInternal Controls for Receivable Separate the following duties: Maintenance of the accounts receivable subsidiary ledger. Custody of cash receipts.  Authorization of accounts receivable write- offs. Maintenance of the accounts receivable subsidiary ledger. Custody of cash receipts.  Authorization of accounts receivable write- offs.
  53. 53. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-53 Management of Accounts Receivable Management of Accounts Receivable Credit Terms Minimize Accounts Receivable Extending credit encourages customers to buy from us . . . . . . but it ties up resources in accounts receivable.
  54. 54. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-54 Ways to Minimize Amounts in Accounts Receivable Ways to Minimize Amounts in Accounts Receivable Selling Accounts Receivable Credit Card Sales
  55. 55. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-55 Financial AnalysisFinancial Analysis Accounts Receivable Turnover Ratio This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Accounts Receivable Turnover Ratio This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Net Sales Average Accounts Receivable
  56. 56. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-56 Financial AnalysisFinancial Analysis Avg. Number of Days to Collect A/R This ratio helps judge the liquidity of a company’s accounts receivable. Avg. Number of Days to Collect A/R This ratio helps judge the liquidity of a company’s accounts receivable. Days in Year Accounts Receivable Turnover Ratio
  57. 57. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-57 Concentration of Credit RiskConcentration of Credit Risk A concentration of credit risk exists when many of a business’s credit customers can be affected in a similar manner by certain changes in economic conditions. A concentration of credit risk exists when many of a business’s credit customers can be affected in a similar manner by certain changes in economic conditions. The FASB requires companies to disclose all significant concentrations of credit risk in the notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from changes in specific economic conditions. The FASB requires companies to disclose all significant concentrations of credit risk in the notes to the financial statements to assist users in evaluating the extent of a company’s vulnerability to credit losses stemming from changes in specific economic conditions.
  58. 58. © The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin Slide 7-58 End of Chapter 7End of Chapter 7
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