Survey 5e ch6_lecture

203 views

Published on

Published in: Economy & Finance, Business
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
203
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
2
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide
  • The term “receivables” includes all money claims a company has against other entities, including people, customers, and other organizations. The most common receivable on a company’s books is Accounts Receivable. Accounts receivable represents money owed to the company from customers for sales of merchandise or services on account (on credit). Accounts receivable are generally short-term credit, usually due in 30 – 60 days. Notes Receivable are amounts that customers owe for which a formal, written promissory note has been issued by the customer. Notes receivable generally have longer terms than Accounts receivable and usually bear interest. Other Receivables are normally recorded separately on the balance sheet. If they are expected to be collected within one year, they are reported in the Current Asset section. Longer term other receivables are classified as noncurrent assets and reported under the Investments section.
  • A promissory note is a written promise to pay the face amount, usually with interest, on demand or at a date in the future. The makes is the party making the promise to pay, the payee is the party to whom the note is payable. Interest on a note is computed as follows: Interest = Face Amount * Interest Rate * (Term/360 days) The maturity value of a note is the amount that must be paid at the due date of the note. Maturity value equals the face amount of the note plus the interest accrued over the life of the note.
  • Some customers will not pay their accounts receivable balances, that is, some accounts receivables will become uncollectible. Companies can mitigate this risk in a variety of ways: Not accept credit sales except for credit cards – this shifts the risk of non-payment to the credit card company Sell receivables to another company for collection – this shifts the risk on non-payment to another company. This is common in organizations like Home Depot or JC Penney, who issue their own credit cards. Regardless of how careful a company is in granting credit, some credit sales will become uncollectible. Some warning signs are: Receivable is past due Customers do not respond to the company’s attempts to collect Customer files for bankruptcy Customer closes its business Customer can not be located
  • If a customer does not pay, a company may turn the account over to a collection agency. After the collection agency attempts to collect payment are complete, any balance remaining will need to be written off. There are two methods to account for uncollectible accounts, the direct write-off method and the allowance method. The direct write-off method is only used by small companies or companies with a small amount of receivables. Generally accepted accounting principles (GAAP) require large companies or companies with a material amount of receivables to use the allowance method.
  • Under the direct write-off method, the bad debt expense is not recorded until the time the account is determined to be worthless. At that time, the accounts receivable account is reduced and the bad debt is recorded as an expense, reducing Retained Earnings.
  • In some instances, an account that has been written off may be collected at a later date. In such cases, the account is reinstated by reversing the write-off. The payment is then applied as a receipt on the account.
  • The allowance method estimates the uncollectible accounts receivable at the end of the accounting period. Based on this estimate, Bad Debt Expense is recorded by an adjustment before it is known that any specific account balance is uncollectible.
  • Based on industry averages, a company estimates that of the $200,000 accounts receivable balance, $30,000 is estimated to be uncollectible. However, the company will not know which customers will be uncollectible so specific customer accounts can not be adjusted. Instead, a contra asset account, Allowance for Doubtful Accounts, is used. This adjustment affects both the income statement and balance sheet. On the Income Statement, the $30,000 of Bad Debts Expense will be matched against the related sales revenues of the period. On the Balance Sheet, the value of Accounts Receivable is reduced to then amount that is expected to be collected or realized. This amount, $170,000, is the net realizable value of Accounts Receivable.
  • Once a specific customer account is determined to be worthless, it is written off against the allowance account. The expense for that worthless account had already been estimated and recorded in a prior period that related to when the original sale was made. This transaction removes the specific accounts receivable and an equal amount from the allowance account.
  • An account receivable that has been written off may be collected later. Like the direct write-off method, the account is reinstated by reversing the write-off. The cash received in payment is then applied as a receipt on the account. Reinstating the account requires an increase to the Accounts Receivable account for the amount to be reinstated; to reverse the original write-off, the Allowance for that receivable is also re-established. In the second transaction, the cash payment is applied to the account.
  • The allowance method require an estimate of uncollectible accounts at the end of the period. The estimate can be made using two different methods, both based on past experience. The estimate based on percent of sales determines the uncollectible amount as a percentage of credit sales. Since credit sales create the account receivable, if the portion of credit sales to total sales is relatively constant, this estimate can be a reliable forecast of the future. The analysis of receivables method is based on the experience that the longer a receivable is outstanding, the more likely that receivable will become uncollectible.
  • In preparing an aging schedule, the first step is to always determine the due date of each receivable. Then, based on the date of the analysis (the date the aging schedule is being prepared), the number of days each account is past due is determined. The accounts are then assigned to the category that matches their number of days past due. Typical categories start at “not past due” and increase to higher days outstanding. Once all the accounts are classified, the totals for each aged category are determined. Each category will have an estimated percentage of uncollectible accounts for that class. This percentage is usually determined by historical experience. Finally, the estimated total of all uncollectible accounts is determined as the sum of all the estimates of uncollectible balances for each category.
  • Under this method, the Bad Debt Expense is calculated by multiplying total credit sales by the estimated percentage of sales expected to be uncollectible: $3,000,000 * .0075 = $22,500 The transaction records this amount as the Bad Debt Expense for the period and increases the allowance account. After the adjustment, the total balance in the allowance account is $25,750 ($3,250 + $22,500). Under the percent of sales method, the amount of the adjustment is always the amount estimated for the Bad Debt Expense, or the percent applied against credit sales.
  • The sum of the estimated uncollectible accounts balances for each category on the aging schedule is the estimated uncollectible accounts at the end of the accounting period. This is what the balance in the contra-asset account, Allowance for Doubtful Accounts, should be after adjustment. The actual adjustment amount for the period is then determined by calculating the difference between the current balance reported in the allowance account and the what the balance in the allowance account should be based on the current analysis of the aging schedule. For example, the aging schedule determined the total in the allowance account should be a total of $26,490. The current balance reported is a negative $3,250. The difference between $26,490 and $3,250 is $23,240. This represents the amount of adjustment needed to bring the balance in the allowance account to $26,490. Bad Debt Expense is recorded in the amount of $23,240 and the Allowance for Doubtful Accounts balance is also increased by $23,240. After this adjustment, the balance in the Allowance for Doubtful Accounts equals $26,490.
  • For a merchandising company, units of products on hand (not sold) at the end of an accounting period is called Merchandise Inventory on the Balance Sheet. As units of merchandise are sold, their related costs are transferred from Merchandise Inventory on the Balance Sheet to Cost of Goods Sold expense on the Income Statement, matching the cost of units sold to the revenue generated from the sale of those units. The cost of merchandise is its purchase price, less any purchase discounts. Merchandise inventory also includes other costs, such as freight, import duties, insurance, etc.
  • Merchandise inventory is a large asset for most merchandising companies, both as a percentage of current assets and a percentage of total assets. For many merchandising companies, a material percentage of current assets is in their inventory. Managing those inventory levels becomes an important business strategy for merchandising companies.
  • Manufacturers convert raw materials into final products and these final products are often sold to merchandising businesses. Every manufacturing business has three types of inventory: materials inventory, work in process inventory, and finished goods inventory.
  • The manufacturing costs for Hershey candy bars includes: Materials inventory of cocoa and sugar Work-in-Process which accounts for the materials put into production and labor costs and overhead costs incurred to make the candy bars. Work-in-Process inventory accounts for units started, but not yet completed. Finished Goods for a manufacturing organization represents the costs of completed candy bars, which are made up of materials, labor, and overhead. When finished goods are sold, the related costs of the units sold moves from the Finished Goods inventory account on the Balance Sheet to the Cost of Goods Sold expense account on the Income Statement, matching the cost of units sold to the revenue generated from the sale of those units.
  • Manufacturing inventory information is normally disclosed in the footnotes to the financial statements of the manufacturing company.
  • An accounting issue arises when identical units of merchandise are acquired over a period of time at different costs. In such cases, when units are sold, it is necessary to determine the cost of units sold by using a cost flow assumption and related inventory cost flow method.
  • Under the specific identification inventory cost flow method, the unit sold can be identified with a specific unit purchased. Then ending inventory is made up of remaining units on hand. This method is not practical unless each inventory unit can be separately identified.
  • If specific identification cannot be used and identical units of merchandise are acquired at different unit costs, an inventory cost flow assumption is needed to determine a unit cost at the time of sale. Three common methods of cost flow assumption are: First-in, First-out (FIFO) Last-in, First-out (LIFO) Average Cost The method used can significantly affect the financial statements.
  • Under the FIFO inventory cost flow method, the first units purchased are assumed to be the first units sold. The ending inventory is made up of the most recent units purchased. In this example, the unit purchased first, on May 10 th , is the unit assumed to be sold. The cost of the unit purchased on May 10 was $9, so the gross profit on the sale is $11 ($20 selling price - $9 cost). The ending inventory under the FIFO method consists of 2 units, the unit purchased on May 18 for a cost of $13 and the unit purchased on May 24 for a cost of $14. Therefore, the total value of ending inventory under the FIFO method is $27.
  • Under the LIFO inventory cost flow method, the last units purchased are assumed to be the first units sold. The ending inventory is made up of the oldest units purchased. In this example, the unit purchased last, on May 24 th , is the unit assumed to be sold. The cost of the unit purchased on May 324 was $14, so the gross profit on the sale is $6 ($20 selling price - $14 cost). The ending inventory under the LIFO method consists of 2 units, the unit purchased on May 18 for a cost of $13 and the unit purchased on May 10 for a cost of $9. Therefore, the total value of ending inventory under the LIFO method is $22.
  • Under the Average Cost inventory cost flow method, the cost of the units sold and the cost of the units in ending inventory is an average of the purchase costs. In this example, the average cost of units purchased is $12 per unit, calculated by adding up the total cost of the purchases and dividing by the number of units purchased ($36 total purchased / 3 units purchased = $12 average cost. The average cost of the units purchased is $12, so the gross profit on the sale is $8 ($20 selling price - $12 average cost). The ending inventory under the Average Cost method consists of 2 units at an average cost of $12 per unit. Therefore, the total value of ending inventory under the Average Cost method is $24.
  • When prices change, the different inventory costing methods affect the income statement and balance sheet differently. When the FIFO method is used during a period of inflation or rising prices, the earlier units cost less than more recent purchases. Therefore, a lower cost of goods sold results in higher profits for the period. The ending inventory is valued at the higher costs, which more represent the current replacement value of unit costs. When the LIFO method is used during a period of inflation or rising prices, the result will be a higher cost of goods sold because the most recent purchases at the higher costs are considered the first units sold. This will result in a lower gross profit for the period. However, it could be argued that the LIFO method results in a better match of current costs with current revenues. The inventory balance on the balance sheet will be comprised of units purchased earlier, at lower cost than more recent purchases. Usually, a footnote to the financial statements will state the estimated difference between inventory values between LIFO and FIFO. The average cost method is, in a sense, a compromise between LIFO and FIFO. The effect of price trends is averaged in determining the cost of units sold and ending inventory values.
  • Receivables and inventory are reported as current assets on the balance sheet. In addition, generally accepted accounting principles require that supplementary information for these accounts be reported in the footnotes that accompany the financial statements.
  • If the cost of replacing the inventory is lower than its recorded purchase cost, the lower-of-cost-or-market (LCM) method is used to value the inventory. Market in this valuation is considered to be the cost to replace the inventory. The cost, market price, and any declines under LCM can be determined in three different ways: Each item in the inventory Each major class or category of the inventory Total inventory as a whole The total amount of any price decline is included in the cost of merchandise sold for the period. This matches the impact of price declines to the period in which they occur. If the example illustrates the applying of LCM to each inventory item, in the illustration, Item A has a replacement cost lower than the original unit cost price. Therefore, the value of the units of Item A is $3,800, the 400 units at a $9.50 market price. For Item B, the current market is more than the original unit cost price, so Item B is valued at the original unit cost price of $22.50 per unit. Item C had a unit market price lower than the original unit cost price, so the inventory value of Item C would be at the market price of $7.75. Item D ending inventory would be valued at the original unit cost price of $14.00 since it is lower than the market price of $14.75 for Unit D. Overall, the inventory under this illustration would be valued at $15,070, the sum of each individual item’s valuation at LCM. If the total inventory method was applied, the value of ending inventory would be $15,472, the total market value of all the items because, in total, the market value is still lower than the total cost.
  • All receivables expected to be realized in cash within the year are presented in the Current Assets section of the Balance Sheet. The allowance for doubtful accounts must be deducted from total Accounts Receivable in order to determine the net realizable value, or amount the company can ultimately expect to collect in cash. Merchandise inventory is also presented in the Current Assets section of the Balance Sheet, usually after Receivables. The method for determining the inventory value (FIFO, LIFO, Average Cost) should also be shown. Merchandise that is out of date, spoiled, or damaged often can only be sold at a price below original cost. Such merchandise must be valued at net realizable value, or the value the company can expect to receive for such inventory. Net realizable value equals the selling price less any direct costs of disposal. Direct costs of disposal could include such items as special advertising or sales commissions to generate the sales. Inventory can also be valued at an amount other than cost when (1) the cost of replacing the inventory would be below the recorded cost, and (2) the inventory is not salable at normal sales prices. The latter case may be due to imperfections, shop wear, style changes, or other causes. In either situation, the method to value the inventory, lower of cost or market, must be disclosed on the balance sheet.
  • Survey 5e ch6_lecture

    1. 1. Chapter 6 Receivables and Inventory
    2. 2. Learning ObjectivesAfter studying this chapter, you should be able to… Describe the common classifications of receivables Describe the nature of and the accounting for uncollectible receivables Describe the direct write-off method of accounting for uncollectible receivables Describe the allowance method of accounting for uncollectible receivables
    3. 3. Learning Objectives (continued)After studying this chapter, you should be able to… Describe the common classifications of inventories Describe three inventory cost flow assumptions and how they impact the financial statements Compare and contrast the use of the three inventory costing methods Describe how receivables and inventory are reported on the financial statements
    4. 4. Learning Objective 1 Describe the common classifications of receivables
    5. 5. Classifying Receivables• Accounts Receivable ─ Credit terms extended to customers• Notes Receivable ─ More formal agreement ─ Includes a maker and payee• Other Receivables ─ Can include interest receivable, taxes receivable, and receivables from employees or officers
    6. 6. Accounting for Notes Receivable
    7. 7. Learning Objective 2 Describe the nature of and the accounting for uncollectible receivables
    8. 8. Uncollectible ReceivablesQ. What if a customer does not pay the balance owed to the company?A. Companies must recognize an operating expense for accounts that are not collectible. It is called Bad Debt Expense.
    9. 9. Bad Debt Expense Two Methods Direct Allowance Write-Off Method Method
    10. 10. Learning Objective 3 Describe the direct write-off method of accounting for uncollectible receivables
    11. 11. Direct Write-Off Method• Bad Debt Expense is recorded and the receivable written off when the account is determined to be worthless.
    12. 12. If payment is collected after the write-off, the write-offentry is reversed and the cash collection is recorded
    13. 13. Learning Objective 4 Describe the allowance method of accounting for uncollectible receivables
    14. 14. Allowance Method• Required by GAAP for companies with large accounts receivable• Estimates the accounts receivable that will not be collected and records bad debt expense for this estimate at the end of each period using an allowance account
    15. 15. Estimate of Uncollectible Accounts Receivable:$30,000• If the total accounts receivable balance is $200,000, the new net realizable value is $170,000
    16. 16. Write-Offs to the Allowance Account• When a customer’s account is identified as uncollectible, it is written off against the allowance account
    17. 17. If payment is collected after the write-off, the write-offentry is reversed and the cash collection is recorded.• Assume a $5,000 account had been previously written off.
    18. 18. Estimating Uncollectible Accounts• Based on past experiences and forecasts of the future• Two common methods: Analysis Percent of of the Sales Receivables
    19. 19. Sample Aging Schedule
    20. 20. Estimate Based on Percent of Sales• Assume that on December 31, 2009, the Allowance for Doubtful Accounts for ExTone Company has a negative balance of $3,250. In addition, ExTone estimates that 3/4% of 2009 credit sales will be uncollectible. Credit sales for the year are $3,000,000.
    21. 21. Estimate Based on Analysis of Receivables• Comparing the $26,490 estimate with the unadjusted balance in the allowance account determines the needed adjustment for bad debt expense. Assume the unadjusted balance in the allowance account is a negative $3,250. $23,240 more is needed in the allowance account.
    22. 22. Learning Objective 5 Describe the common classifications of inventory
    23. 23. Inventory Classification for Merchandisers• In Chapter 4, we learned that merchandise on hand is called merchandise inventory. Inventory sold becomes the cost of merchandise sold• Cost of inventory includes all costs of ownership (e.g., purchase price, transportation costs, insurance costs, etc.)
    24. 24. Merchandising Inventories
    25. 25. Manufacturing Inventories• Materials Inventory • Raw material used to make the product• Work In Process Inventory • Cost of partially completed products• Finished Goods Inventory • Total cost of completed goods: material, labor, manufacturing overhead
    26. 26. Manufacturing Inventories
    27. 27. Footnote Disclosure of Manufacturing Inventories
    28. 28. Learning Objective 6 Describe three inventory cost flow assumptions and how they impact the financial statements
    29. 29. Inventory Cost Flow Units Purchased Units Sold• Identical units purchased at different unit costs during a period• When units are sold, it is necessary to determine the cost of units sold• Cost of units sold can be determined using a cost flow assumption
    30. 30. Specific Identification• If the merchandise can be identified with a specific purchase, the specific identification method can be used• Each unit of merchandise can be identified with a specific purchase price• Only practical if each unit has a unique identification number (e.g., VIN for an automobile)
    31. 31. Three Inventory Methods
    32. 32. First-In, First-Out (FIFO) • One unit is sold on May 30 for $20
    33. 33. Last-In, First-Out (LIFO) • One unit is sold on May 30 for $20
    34. 34. Average Cost • One unit is sold on May 30 for $20
    35. 35. Learning Objective 7 Compare and contrast the use of the three inventory costing methods
    36. 36. Comparing Methods - Rising PricesMETHOD I/S EFFECT B/S EFFECT RESULTFIFO Lower COGS Inventory shows Benefit lost in Higher gross profit replacement cost higher future costsLIFO Higher COGS Lower inventory values Matches current Lower gross profit cost with current revenueAVERAGE Average (middle) Average inventory value Compromise gross profit between LIFO & FIFO
    37. 37. Learning Objective 8 Describe how receivables and inventory are reported on the financial statements
    38. 38. Balance Sheet Presentation
    39. 39. Lower of Cost or Market
    40. 40. Reporting Receivables and Inventory• Accounts Receivable • Classified as a current asset if collection is expected within 1 year. • Reported at net realizable value: A/R – Allowance for Doubtful Accounts• Inventory • Reported at the net realizable value • Net realizable value = selling price – direct costs of disposal • Reported at Lower of Cost or Market (LCM)
    41. 41. End of Chapter 6

    ×