Receivables and Short-Term Investments

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Receivables and Short-Term Investments
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Learning Objective 1
Understand short-term investments.
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Short-Term Investments
Short-term investments are investments that a
company plans to hold for one year or less.
Held-to-maturity securities Trading
investments Available-for-sale investments
Held-to-maturity and available-for-sale securities
could also be long-term.
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Short-Term Investments
Held-to-maturity investments are securities that
the investor expects to hold until their maturity
date.
They earn interest revenue for the investor.
Accounting for these securities is the same as
accounting for notes receivable.
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Short-Term Investments
Trading Investments
Suppose that Oracle Corporation purchases Ford
Motor Company stock on May 18, paying 100,000,
with the intention of selling the stock within a
few months.
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Short-Term Investments
May 18 Short-Term Investment 100,000 Cash
100,000 Purchased investment
On May 27, Oracle receives a cash dividend of
4,000 from Ford.
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Short-Term Investments
May 27 Cash
4,000 Dividend Revenue
4,000 Received cash dividend
Oracle fiscal year ends on May 31, and the
investment in Ford has a current market value of
102,000 on this date.
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Short-Term Investments
May 31 Short-Term Investment 2,000 Unrealized
Gain on Investments 2,000 Adjusted
investment to market value
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Reporting on the Balance Sheetand the Income
Statement
Balance Sheet Current Assets
XXX Cash XXX Short-term
investments at market value 102,000 Accounts
receivable XXX
Income Statement Revenues
XXX Expenses XXX Other
revenues, gains, and (losses) Interest
revenue XXX Dividend
revenue 4,000 Unrealized gain on
investment 2,000
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Accounts and Notes Receivable
Receivables are the third most liquid asset
after cash and short-term investments.
Receivables are monetary claims against others.
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Types of Receivables
Accounts receivable
Notes receivable
Other receivables (miscellaneous)
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Accounts Receivable
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Learning Objective 3
Use the allowance method for uncollectible
receivables.
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Accounting forUncollectible Accounts
Selling on credit creates both a benefit and a
cost
The benefit Customers who cannot pay cash
immediately can buy on credit, so company
profits rise as sales increase.
The cost The company will be unable to
collect from some credit customers.
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The Allowance Method
The allowance method records collection losses on
the basis of estimates, not waiting to see which
customers will not pay.
The Allowance for Uncollectible
Accounts (Allowance for Doubtful Accounts) is
a contra account to Accounts Receivable.
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The Allowance Method
Balance Sheet (partial) Accounts
receivable 10,000 Less Allowance for
uncollectible accounts 900 Accounts
receivable, net 9,100
Income Statement (partial) Expenses Uncollectible
-account expense 900
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Methods for Estimating Uncollectibles
Percent-of-sales
Aging-of-Receivables
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Percent-of-Sales
It computes uncollectible-account expense as a
percentage of revenue.
This method is also called the income-statement
approach.
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Percent-of-Sales
The credit department estimates
that uncollectible-account expense is 5 of total
revenues, which were 11 billion for 20x1.
Dec 31 (in millions) Uncollectible-Account
Expense (11,000 0.05) 550 Allowance
for Uncollectible Accounts 550 Recorded
expense for the year
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Percent-of-Sales
December 31, 20x1 (in millions) After Adjustment
Accounts Receivable
Allowance for Uncollectible Accounts
Bal. 11,000
550
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Aging-of-Receivables
This method is a balance-sheet approach because
it focuses on accounts receivable.
Individual receivables from specific customers
are analyzed based on how long they have been
outstanding.
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Aging-of-Receivables
Accounts before the year-end adjustment
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Aging-of-Receivables
Aging the Accounts Receivable
Days Overdue 1-30 days 31-60 days 61-90
days 91 days
Accounts Receivable 1,555 750 311
219 2,835
Estimated Uncollectible 6 10 20 79
Allowance for Uncollectible Accounts 93
75 62 173 403
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Aging-of-Receivables
Uncollectible-Account Expense 283 Allowanc
e for Uncollectible Accounts (403
120) 283 Recorded expense for the year
Accounts after the year-end adjustment
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Writing OffUncollectible Accounts
Suppose that early in 20x2, the credit department
determines that the company cannot collect from
two customers.
These accounts must be written off.
How?
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Writing OffUncollectible Accounts
Allowance for Uncollectible Accounts 100 Accoun
ts Receivable Customer A 61 Accounts
Receivable Customer B 39 Wrote off
uncollectible receivables
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Direct Write-Off Method
An account is written off only when it is decided
that a specific customers receivable is
uncollectible.
January 2, 20x4 Uncollectible-Account
Expense 2,000 Accounts Receivable
Jones 2,000 Wrote off a bad account
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Direct Write-Off Method
This method is defective for two reasons
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Learning Objective 4
Account for notes receivable.
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Notes Receivable
Notes receivable are more formal than accounts
receivable.
The creditor has a note receivable.
The debtor has a note payable.
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Notes Receivable
The principal amount of the note is the amount
borrowed by the debtor.
The maker pays the payee the maturity value.
The maturity value includes principal plus
interest.
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Notes Receivable
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Accounting for Notes Receivable
Continental Bank entry is as follows
August 31, 20x5 Note Receivable 1,000 Cash
1,000 Made a loan
How much interest revenue is accrued at December
31?
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Accounting for Notes Receivable
Interest Principal Rate Time
1,000 9 4/12 30
December 31, 20x5 Interest Receivable 30 Inter
est Revenue 30 Accrued interest revenue
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Accounting for Notes Receivable
The bank collects the note on February 28, 20x6.
February 28, 20x6 Cash 1,045 Note
Receivable 1,000 Interest
Receivable 30 Interest Revenue
(1,000 9 2/12) 15 Collected
note at maturity
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Learning Objective 5
Use the acid-test ratio and the days sales in
receivables to evaluate financial position.
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Reporting Assets inOrder of Liquidity
CURRENT ASSETS 2001 2000 Cash and
cash equivalents 4,449
7,429 Short-term investments 1,438
333 Trade receivables, net 2,432
2,534 Prepaid expenses 644
587 Total current assets
8,963 10,883 Long-term investments
110 Property, net 975
935 Other assets 1,092
1,149 Total assets 11,030 13,077 CURRE
NT LIABILITIES Total current liabilities
3,916 5,892 Long-term debt and
liabilities 836
753 Stockholders equity 6,278
6,462 Total liabilities and stockholders
equity 11,030 13,077
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Days Sales in Receivables
One days sales Net sales 365 days 10,860
365 29.75 per day
Days sales in average accounts receivable
Average net accounts receivable One days
sales (2,534 2,432) 2 29.75 83 days
A smaller number indicates a quick conversion to
cash.
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Acid-Test Ratio
This is a stringent test of liquidity
which measures the entitys ability to pay
its current liabilities immediately.
Acid-test ratio (Cash Short-term
investments Net current receivables) Total
current liabilities (4,449 1,438 2,432)
3,916 2.12
This ratio value is extremely high and indicates
great liquidity for this company.
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End of Chapter 5