Financial Assets Valuation and Reporting
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This document discusses various topics relating to financial assets, including cash, marketable securities, receivables, and notes receivable. It provides information on how these assets are valued for financial statements, cash management techniques, accounting for uncollectible accounts receivable, and calculating interest revenue for notes receivable. Worked examples are provided to illustrate estimating credit losses and recording interest earned on a short-term note receivable.
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Financial Assets Valuation and Reporting
- 1. Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin Financial AssetsFinancial Assets otaleem.blogspot.comotaleem.blogspot.com for more presentation(follow me)for more presentation(follow me) Chapter 7
- 2. 7-2 How much cash should a businessHow much cash should a business Have?Have? “As little as necessary” Cash Marketable Securities Receivable
- 3. 7-3 TheValuation of Financial AssetsTheValuation of Financial Assets Type of Financial Assets 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
- 4. 7-4 REPORTING CASH INREPORTING CASH IN THE BALANCE SHEETTHE BALANCE SHEET
- 5. 7-5 CashCash Coins and paper money Checks Money orders Travelers’ checks Bank credit card sales Cash is defined as any deposit banks will accept.
- 6. 7-6 Restricted CashRestricted Cash Investments and Restricted Funds Line of Credit
- 7. 7-7 Cash ManagementCash Management Provide accurate accounting for cash receipts, cash disbursements, and cash balances. Prevent or minimize losses from theft or fraud. Anticipate the need of borrowing Prevent unnecessary bank deposits.
- 8. 7-8 Bank StatementsBank Statements Reconciling the bank statement Difference b/w bank record and depositor record: Outstanding checks. Deposits in transit Service charges Charges for depositing NSF checks Credit for interest earned Miscellaneous bank charges and credits
- 9. 7-9 Reconciling the Bank StatementReconciling the Bank Statement Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Adjustments = Adjusted Balance Balance per Depositor + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Adjustments = Adjusted Balance
- 10. 7-10 Petty cash FundsPetty cash Funds A small amount of cash on hand with which to make some minor expenditures. Office supplies Taxi fares Doughnuts for an office meeting
- 11. 7-11 Short-Term InvestmentsShort-Term Investments Bond Investments Capital Stock Investments Current Assets Almost As Liquid As Cash Readily Marketable Marketable Securities are . . .
- 12. 7-12 Accounting for marketableAccounting for marketable securitiessecurities Purchase of marketable securities Recognition of investment revenue Sale of investment
- 13. 7-13 ReceivablesReceivables Uncollectable account Reflecting uncollectible accounts in the financial statements
- 14. 7-14 The Allowance for DoubtfulThe Allowance for Doubtful AccountsAccounts The net realizable value is the amount of accounts receivable that the business expects to collect. Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable
- 15. 7-15 Writing Off an UncollectibleWriting Off an Uncollectible Account ReceivableAccount 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.
- 16. 7-16 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. Writing Off an UncollectibleWriting Off an Uncollectible Account ReceivableAccount Receivable
- 17. 7-17 Estimating Credit Losses — TheEstimating Credit Losses — The Balance Sheet ApproachBalance 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.
- 18. 7-18 Estimating Credit Losses — TheEstimating Credit Losses — The Balance Sheet ApproachBalance Sheet Approach At December 31, the receivables for EastCo, Inc. were categorized as follows:
- 19. 7-19 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 — TheEstimating Credit Losses — The Balance Sheet ApproachBalance Sheet Approach
- 20. 7-20 Estimating Credit Losses — TheEstimating Credit Losses — The Income Statement ApproachIncome Statement Approach Net Credit Sales × % Estimated Uncollectible Amount of Journal Entry Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales.
- 21. 7-21 Estimating Credit Losses - TheEstimating Credit Losses - The Income Statement ApproachIncome Statement Approach In 2009, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s credit sales has been uncollectible. For 2009, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600) In 2009, EastCo had credit sales of $60,000. Historically, 1% of EastCo’s credit sales has been uncollectible. For 2009, the estimate of uncollectible accounts expense is $600. ($60,000 × .01 = $600)
- 22. 7-22 Recovery of an Account ReceivableRecovery of an Account Receivable Previously Written OffPreviously Written Off 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. GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Accounts Receivable (X Customer) $$$$ Allowance for Doubtful Accounts $$$$ Cash $$$$ Accounts Receivable (X Customer) $$$$
- 23. 7-23 Notes Receivable and InterestNotes Receivable and Interest RevenueRevenue The interest formula includes three variables: The interest formula includes three variables: Interest = Principal × Interest Rate × Time When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction. When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction. For example, if we needed to compute interest for 3 months, “Time” would be 3 /12. For example, if we needed to compute interest for 3 months, “Time” would be 3 /12.
- 24. 7-24 On November 1, Hall Company loans $10,000 to Porter Company on a 90-day note earning 12 percent interest. On December 31st , Hall Company needs an adjusting entry to record the interest revenue on the Porter Company note. On November 1, Hall Company loans $10,000 to Porter Company on a 90-day note earning 12 percent interest. On December 31st , Hall Company needs an adjusting entry to record the interest revenue on the Porter Company note. Notes Receivable and InterestNotes Receivable and Interest RevenueRevenue $10,000 × 12% × 60 /360 = $200$10,000 × 12% × 60 /360 = $200
- 25. 7-25 What entry would Hall Company make on the maturity date? What entry would Hall Company make on the maturity date? Notes Receivable and InterestNotes Receivable and Interest RevenueRevenue $10,000 × 12% × 90 /360 = $300$10,000 × 12% × 90 /360 = $300 Days remaining in November (30-1) 29 Days in December 31 Days needed in January 30 Note term in Days 90
- 26. 7-26 Self-testing QuestionSelf-testing Question Solve the Demonstration problem Brief Exercise 7.1, 7.4
Editor's Notes
- Chapter 7: Financial Assets
- On the balance sheet, cash and cash equivalents are reported at their face amount. Short-term investments are reported at their current market value. Accounts receivable are reported at their net realizable value. Net realizable value is the amount of the accounts receivable the business estimates it will actually collect.
- Cash includes much more than what we typically think of as currency. It includes the typical items such as paper money and coins, but it also includes bank credit card sales, travelers’ checks, money orders, and checks. Cash is defined as any deposits banks will accept.
- There are two sides to a bank reconciliation. The bank side starts with the balance on the bank statement and is adjusted for deposits in transit, outstanding checks, and errors made by the bank. The book side begins with the Cash balance in the ledger and is adjusted for collections made by the bank on the company’s behalf, interest earned, bank service charges, customer checks drawn on accounts that were insufficient, and errors made. All reconciling items on the book side require an adjusting entry to the Cash account. Examples of collections made by the bank on a company’s behalf are when the bank acts as a collection box for customer payments or when the bank collects a note receivable from a customer.
- Short-term investments are investments in bonds or stocks that are readily marketable. They are classified as current assets on the balance sheet. Due to their liquidity, investments in marketable securities are listed immediately after Cash in the balance sheet and are most often classified as available for sale.
- On the balance sheet, the Allowance for Doubtful Accounts is subtracted from the Accounts Receivable balance. The reported value is called net realizable value and is the amount of Accounts Receivable that will likely be collected.
- Now, let’s see what happens when it’s been determined that a specific customer will not be able to pay the amount owed. When using the allowance method, write off an uncollectible account to Allowance for Doubtful Accounts. The company debits Allowance for Doubtful Accounts and credits Accounts Receivable. Now that the specific customer involved is known, the customer is noted in the transaction so the proper entry in the Accounts Receivable ledger can be made. Now assume that before this write-off entry the balance in Accounts Receivable was $10,000 and the balance in Allowance for Doubtful Accounts was $2,500. Let’s see what effect the write-off had on these accounts.
- After the $500 write-off, the Accounts Receivable balance is reduced to $9,500 and the Allowance for Doubtful Accounts balance is reduced to $2,000. Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts.
- When using the Balance Sheet Approach, first classify the Accounts Receivable by age. Second, for each age group determine the likelihood of being uncollectible. Third, for each age group calculate a separate allowance amount. Finally, add up all the allowance amounts to get the balance in the Allowance for Doubtful Accounts.
- Part I First, EastCo’s accounts receivable have been broken up into aged categories such as current, 1 to 30 days past due, 31 to 60 days past due, and so on. Part II Then, for each of these age groups, it was determined how much would be uncollectible. For the current age group, one percent is expected to be uncollectible. For the 1 to 30 days past due age group, three percent is expected to be uncollectible, and so on. Notice that the older the age group the higher the uncollectible percentage. Part III Next, the balance of each age group is multiplied by its uncollectible percentage. Then, all of the uncollectible amounts are added up to $1,350, and this should be the balance in the Allowance for Doubtful Accounts.
- Assume EastCo already had a $500 balance in Allowance for Doubtful Accounts. Since the balance should be $1,350, the account will need to be credited for $850. The entry would be to debit Uncollectible Accounts Expense and credit Allowance for Doubtful Accounts for $850.
- When using the Income Statement Approach, the estimate at the end of the period is determined by taking current period sales and multiplying by an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. The sales transactions included in this computation are typically only the credit sales. There are not any collection issues to consider for cash sales transactions. The credit loss estimate is calculated as net credit sales times the estimated uncollectible percentage.
- Part I EastCo has credit sales of $60,000 in 2009. Management estimates that one percent of credit sales will eventually prove to be uncollectible. What is East Company’s adjusting entry for uncollectible accounts in 2009? Part II EastCo would debit Uncollectible Accounts Expense and credit Allowance for Doubtful Accounts for $600, which is one percent of $60,000 in credit sales.
- Sometimes after an account receivable has been written off, a customer will send in a payment. If this happens, should the customer’s payment be returned since the account has been written off? Of course not. When this happens, two entries are necessary. The first entry is required to reverse the write-off and re-establish the account receivable. It includes a debit to Accounts Receivable an a credit to Allowance for Doubtful Accounts. The second entry records the receipt of cash with a debit to Cash and a credit to Accounts Receivable.
- Part I Most Notes Receivable have an interest rate associated with them. Interest is a charge made for the use of money. For the borrower, this is the interest expense they will incur and for the lender, this is the interest revenue they will receive. Interest is calculated as Principal times the Interest Rate times the Time the note was outstanding. Part II When computing interest for one year, “Time” equals 1. When the computation period is less than one year, then “Time” is a fraction.
- On November 1, Hall Company loans $10,000 to Porter Company on 90-day note earning 12 percent interest. On December 31st, Hall Company needs an adjusting entry to record the interest revenue on the Porter Company note. This entry is a debit to Interest Receivable and a credit to Interest Revenue for $100. The $200 in interest is calculated as the original note amount of $10,000 times the interest rate of 12 percent times the outstanding time of 60 days over 360 days.
- Part I What entry would Hall Company make on the maturity date of the note? Part II The maturity date of the note is January 30th of the next year. On January 30th, Hall Company would debit Cash for $10,300. That is the original note amount of $10,000 plus the interest of $300. They would credit Notes Receivable for $10,000. The interest is divided between two accounts. Interest Receivable is credited for $200. Remember, this is removing the Interest Receivable created in the previous adjusting entry. Interest Revenue is credited for $100. This is the interest revenue Hall Company earned in the current year. If Porter Company defaulted on the note, Hall Company would make a similar entry, except instead of debiting Cash they would debit Accounts Receivable for the entire amount.