Financial accounting the impact on decision makers 9e chapter 7

Chapter Receivables and Investments Accounts Receivable  Receivable arising from the sale of goods or services with a verbal promise to pay  Stated on the balance sheet at net realizable, which takes into account and estimate of the uncollectible amount (bad debts)  Two methods used in estimating bad debts:  Percentage of sales approach  Percentage of receivables approach LO The Use of a Subsidiary Ledger  Assume that Apple sells $25,000 of hardware to a school The sale results in the recognition of an asset and revenue The Use of a Subsidiary Ledger  Contains the necessary detail on items that collectively make up a single general ledger account, called the control account Two Methods to Account for Bad Debts  Direct write-off method: recognition of bad debts expense at the point an account is written off as uncollectible  Allowance method: estimating bad debts on the basis of either net credit sales or accounts receivable  Allowance for doubtful accounts: a contra-asset account—reduce accounts receivable to its net realizable value Example 7.1—Using the Direct WriteOff Method for Bad Debts  Assume that Roberts Corp makes a $500 sale to Dexter Inc on November 10, 2014, with credit terms of 2/10, n/60 Example 7.1—Using the Direct WriteOff Method for Bad Debts (continued)  Assume further that Dexter is unable to pay within 60 days After pursuing the account for four months into 2015, the credit department of Roberts informs the accounting department that it has given up on collecting the $500 from Dexter and advises that the account be written off To so, the accounting department makes an adjustment Example 7.2—Using the Allowance Method for Bad Debts  Assume that Roberts’ total sales during 2014 amount to $600,000 and that at the end of the year, the outstanding accounts receivable total $250,000 Also, assume that Roberts estimates that 1% of the sales of the period, or $6,000, will prove to be uncollectible Under the allowance method, Roberts makes an adjustment at the end of 2014 Example 7.2—Using the Allowance Method for Bad Debts (continued)  Balance sheet presentation of accounts receivable Accounts receivable Less: Allowance for doubtful accounts Net accounts receivable  $250,000 (6,000) $244,000 Dexter’s $500 account is written off on May 1, 2015 Approaches to the Allowance Method of Accounting for Bad Debts  Percentage of Net Credit Sales Approach  Uses the past relationship between bad debts and net credit sales to predict bad debt amounts  Percentage of Accounts Receivable Approach  Estimate bad debts by relating them to the balance in the Accounts Receivable Discounting Notes Receivable  Discounting: the process of selling a promissory note  Sell note prior to maturity date for cash  It is normally done ‘‘with recourse”  If the customer fails to pay the bank, the company that transferred the note to the bank is liable for the full amount Accounting for Investments  Certificate of deposit (CD): highly liquid financial instrument  Equity securities: issued by corporations as a form of ownership in the business  Debt securities: issued by corporations and governmental bodies as a form of borrowing LO Example 7.9—Accounting for an Investment in a Certificate of Deposit  On October 2, 2014, Creston Corp invests $100,000 of excess cash in a 120-day CD The CD matures on January 30, 2015, at which time Creston receives the $100,000 and interest at an annual rate of 6% Example 7.9—Accounting for an Investment in a Certificate of Deposit  December 31 is the end of Creston’s fiscal year, so an entry is needed on this date to record interest earned during 2014 even though no cash will be received until the CD matures in 2015  The basic formula to compute interest is as follows:  Interest (I) = Principal (P) × Interest Rate (R) × Time (T) Example 7.9—Accounting for an Investment in a Certificate of Deposit (continued)  The entry on January 30 to record the receipt of the principal amount of the CD of $100,000 and interest for 120 days is as follows Exhibit 7.3—Interest Calculation Investments in Stocks and Bonds Example 7.10—Accounting for an Investment in Bonds  On January 1, 2014, ABC issues $10,000,000 of bonds that will mature in ten years Assume that Atlantic buys $100,000 of these bonds at face value, which is the amount that will be repaid to the investor when the bonds mature The bonds pay 10% interest semiannually on June 30 and December 31 Example 7.10—Accounting for an Investment in Bonds  Atlantic will receive 5% of $100,000, or $5,000, on June 30 and December 31 On June 30, Atlantic must record the receipt of semiannual interest Example 7.10—Accounting for an Investment in Bonds  On July 1, 2014, Atlantic sells all of its ABC bonds at 99 The amount of cash received is 0.99 × $100,000, or $99,000 Example 7.11—Accounting for an Investment in Stock  On February 1, 2014, Dexter Corp pays $50,000 for shares of Stuart common stock and another $1,000 in commissions Example 7.11—Accounting for an Investment in Stock  On March 31, 2014, Dexter received dividends of $500 from Stuart Example 7.11—Accounting for an Investment in Stock  Dexter sells the Stuart stock on May 20, 2014, for $53,000 In this case, Dexter recognizes a gain for the excess of the cash proceeds, $53,000, over the amount recorded on the books, $51,000 Exhibit 7.4—How Investments and Receivables Affect the Statement of Cash Flows LO End of Chapter [...]... Interpret the ratios—measures how long it takes to collect receivables The Business Decision Model 1 2 3 4 5 If you were a banker, would you loan money to a company? Gather information from the financial statements and other sources Compare the company's accounts receivable turnover ratio with industry averages and look at trends Lend money or find an alternative use for the money Monitor the loan periodically... card sales on June 5 amount to $8,000 The entry on Apple’s books is as follows: Example 7. 8 Accounting for Credit Card Sales (continued)  Assume that Apple remits the credit card receipts to VISA once a week and that the total sales for the week ending June 11 amount to $50,000 Further assume that on June 13, VISA pays the amount due to Apple after deducting a 5% collection fee Example 7. 8 Accounting. .. (18/360), or $90 Example 7. 7 Accounting for a Note Receivable (continued)  Adjustment made on December 31 to record interest earned during 2014: Example 7. 7 Accounting for a Note Receivable (continued)  On March 13, 2015, High Tec collects the principal amount of the note and interest from Baker Interest earned during 2015 = $15,000 × 0.12 × (72 /360) = $360 Accelerating the Inflow of Cash from Sales... Terms Connected with Promissory Notes Principal the cash received, or the fair value of the products or services received, by the maker when a promissory note is issued  Maturity date the due date of promissory note  Term the length of time a note is outstanding  Maturity value the amount to be paid by the maker on the maturity date  Interest the difference between the principal amount and the maturity...Example 7. 3—Using the Percentage of Net Credit Sales Approach  Assume that the accounting records for Bosco Corp reveal the following: Average percentage = 2% ($153 ,70 0/ $7, 560,000 = 0.02033) Example 7. 3—Using the Percentage of Net Credit Sales Approach (continued)  Assume the company uses the 2% rate and that its net credit sales during 2014 are $2,340,000,... resulting from the acceptance of a promissory note from another entity  Promissory note: a written promise to repay a definite sum of money on demand or at a fixed or determinable date in the future  Maker: party that agrees to repay the money  Payee: party that will receive the money  Note payable: a liability resulting from the signing of a promissory note LO 3 Summary of Relationship Between... collection of cash from a customer  Pass the risk of nonpayment to credit card company  Discounting notes receivable  Allows a company to accelerate the inflow of cash LO 4 Exhibit 7. 2—Basic Relationships Among Parties with Credit Card Sales Example 7. 8 Accounting for Credit Card Sales  Assume that Joe Smith buys an iPad in an Apple store and charges the $500 cost to his VISA card Collection fee... Example 7. 4—Using the Percentage of Accounts Receivable Approach (continued)  The net realizable value of Accounts Receivable is determined as follows: Exhibit 7. 1—Aging Schedule  Aging schedule: categorizes the various accounts according to their length of time outstanding Example 7. 5—Using an Aging Schedule to Estimate Bad Debts  The totals on the aging schedule are used as the basis for estimating... (continued)  Assume that on July 9, Apple presents VISA credit card receipts to its bank for payment in the amount of $20,000 and that the collection charge is 4% Discounting Notes Receivable  Discounting: the process of selling a promissory note  Sell note prior to maturity date for cash  It is normally done ‘‘with recourse”  If the customer fails to pay the bank, the company that transferred the. .. maturity value  Example 7. 7 Accounting for a Note Receivable  Assume that on December 13, 2014, High Tec sells a computer to Baker Corp at an invoice price of $15,000 Because Baker is short of cash, it gives High Tec a 90-day, 12% promissory note The total amount of interest due on the maturity date is determined as follows: $15,000 × 0.12 × 90/360 = $450 The effect of the receipt of the note by High Tec ... ratios—measures how long it takes to collect receivables The Business Decision Model If you were a banker, would you loan money to a company? Gather information from the financial statements and other sources... Example 7. 7 Accounting for a Note Receivable (continued)  Adjustment made on December 31 to record interest earned during 2014: Example 7. 7 Accounting for a Note Receivable (continued)  On March... pursuing the account for four months into 2015, the credit department of Roberts informs the accounting department that it has given up on collecting the $500 from Dexter and advises that the account