Chapter 6-1 Financial Accounting & Information Systems :Session 6 Objectives:Session 6 Quiz Quiz...

Chapter 6-1

Financial Accounting & Financial Accounting & Information SystemsInformation Systems

Objectives:: Session 6Session 6•QuizQuiz•Recap of last sessionRecap of last session•Case Study: Accounting for InventoriesCase Study: Accounting for Inventories•Brief Summery: Accounting for Inventories Brief Summery: Accounting for Inventories (Chapter 6)(Chapter 6)•Accounting for Receivables (Chapter 9)Accounting for Receivables (Chapter 9)

Chapter 6-2


Objective 1:

Quiz

Chapter 6-3


Objective :

Case StudyContext: Inventory AccountingContext: Inventory Accounting

Chapter 6-4

Chapter 6

Inventories

Accounting Principles, Ninth Edition

Chapter 6-5

1. Describe the steps in determining inventory quantities.

2. Explain the accounting for inventories and apply the inventory cost flow methods.

3. Explain the financial effects of the inventory cost flow assumptions.

4. Explain the lower-of-cost-or-market basis of accounting for inventories.

5. Indicate the effects of inventory errors on the financial statements.

6. Compute and interpret the inventory turnover ratio.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 6-6

Statement Statement Presentation Presentation and Analysisand Analysis

Statement Statement Presentation Presentation and Analysisand Analysis

Reporting and Analyzing InventoryReporting and Analyzing InventoryReporting and Analyzing InventoryReporting and Analyzing Inventory

Taking a Taking a physical physical inventoryinventory

Determining Determining ownership of ownership of goodsgoods

Classifying Classifying InventoryInventory

Classifying Classifying InventoryInventory

Determining Determining Inventory Inventory QuantitiesQuantities

Determining Determining Inventory Inventory QuantitiesQuantities

Inventory Inventory CostingCosting

Inventory Inventory CostingCosting

Inventory Inventory ErrorsErrors

Inventory Inventory ErrorsErrors

Finished Finished goodsgoods

Work in Work in processprocess

Raw materialsRaw materials

Specific Specific identificationidentification

Cost flow Cost flow assumptionsassumptions

Financial Financial statement statement and tax and tax effectseffects

Consistent Consistent useuse

Lower-of-Lower-of-cost-or-cost-or-marketmarket

Income Income statement statement effectseffects

Balance sheet Balance sheet effectseffects

PresentationPresentation

AnalysisAnalysis

Chapter 6-7

Classifying InventoryClassifying InventoryClassifying InventoryClassifying Inventory

One Classification:

Merchandise Inventory

Three Classifications:

Raw Materials

Work in Process

Finished Goods

Merchandising Company

Manufacturing Company

Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.

Chapter 6-8

Chapter 6-9

Physical Inventory taken for two reasons:Perpetual System

1. Check accuracy of inventory records.

2. Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft).

Periodic System

1. Determine the inventory on hand

2. Determine the cost of goods sold for the period.

Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities

SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.

Chapter 6-10

Involves counting, weighing, or measuring each kind of inventory on hand.

Taken,

when the business is closed or when business is slow.

at end of the accounting period.

Taking a Physical InventoryTaking a Physical Inventory



Chapter 6-11

Goods in Transit

Purchased goods not yet received.

Sold goods not yet delivered.

Determining Ownership of Determining Ownership of GoodsGoods



Goods in transit should be included in the inventory of the company that has legal title to

the goods. Legal title is determined by the terms of sale.

Chapter 6-12



Illustration 6-1

Ownership of the goods passes to the buyer

when the public carrier accepts the goods from

the seller.

Ownership of the goods remains with the seller

until the goods reach the buyer.

Terms of SaleTerms of Sale

Chapter 6-13

Goods in transit should be included in the inventory of the buyer when the:

a. public carrier accepts the goods from the seller.

b. goods reach the buyer.

c. terms of sale are FOB destination.

d. terms of sale are FOB shipping point.

Review QuestionReview Question



Chapter 6-14

Consigned Goods

In some lines of business, it is common to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of goods.

These are called consigned goods.

Determining Ownership of Determining Ownership of GoodsGoods



Chapter 6-15

Unit costs can be applied to quantities on hand using the following costing methods:

Specific Identification

First-in, first-out (FIFO)

Last-in, first-out (LIFO)

Average-cost

Inventory CostingInventory CostingInventory CostingInventory Costing

SO 2 Explain the accounting for SO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Cost Flow Assumptio

ns

Chapter 6-16

An actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory.

Practice is relatively rare.

Most companies make assumptions (Cost Flow Assumptions) about which units were sold.

Specific Identification MethodSpecific Identification Method



Chapter 6-17

Illustration: Assume that Crivitz TV Company purchases three identical 46-inch TVs on different dates at costs of $700, $750, and $800. During the year Crivitz sold two sets at $1,200 each.



Illustration 6-2

Chapter 6-18

Illustration: If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is $1,500 ($700 $800), and its ending inventory is $750.



Illustration 6-3

Chapter 6-19


Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions

Illustration 6-11Use of cost flow methods in major U.S. companies

Cost Flow

Assumption

does not need to

equal

Physical Movement

of Goods

Chapter 6-20

Earliest goods purchased are first to be sold.

Often parallels actual physical flow of merchandise.

Generally good business practice to sell oldest units first.

““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”



Chapter 6-21



““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”Illustration 6-5

Chapter 6-22

Latest goods purchased are first to be sold.

Seldom coincides with actual physical flow of merchandise.

Exceptions include goods stored in piles, such as coal or hay.

““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)”



Chapter 6-23



Illustration 6-7

“Last-In-First-Out (LIFO)”

Chapter 6-24

Allocates cost of goods available for sale on the basis of weighted average unit cost incurred.

Referred to as moving average in perpetual inventory system

Assumes goods are similar in nature.

Applies weighted average unit cost to the units on hand to determine cost of the ending inventory.

““Average-Cost”Average-Cost”



Chapter 6-25



“Average Cost”Illustration 6-10

Chapter 6-26



Illustration: Assume that Houston Electronics uses a periodic inventory system.

Illustration 6-4

A physical inventory at the end of the year determined that during the year Houston sold 550 units and had 450 units in inventory at December 31.

Chapter 6-27

Example

Cost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystemsCost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystems

SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.

Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost.

Appendix 6AAppendix 6AAppendix 6AAppendix 6A

Chapter 6-28



““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”

Cost of Goods SoldEnding Inventory

Illustration 6A-2

Chapter 6-29



Cost of Goods SoldEnding Inventory

““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)” Illustration 6A-3

Chapter 6-30



““Average Cost” Average Cost” (Moving-Average (Moving-Average System)System) Illustration 6A-4

Cost of Goods Sold Ending Inventory

Chapter 6-31

The cost flow method that often parallels the actual physical flow of merchandise is the:

a. FIFO method.

b. LIFO method.

c. average cost method.

d. gross profit method.




Chapter 6-32

In a period of inflation, the cost flow method that results in the lowest income taxes is the:

a. FIFO method.

b. LIFO method.

c. average cost method.

d. gross profit method.



SO 3 Explain the financial effects of the inventory cost flow SO 3 Explain the financial effects of the inventory cost flow assumptions.assumptions.

Chapter 6-33

Q6-12 Casey Company has been using the

FIFO cost flow method during a prolonged

period of rising prices. During the same

time period, Casey has been paying out all

of its net income as dividends. What

adverse effects may result from this

policy?

Liquidation of LIFO Reserve Concept

Discussion QuestionDiscussion Question

See notes page for discussion



Chapter 6-34

Using Cost Flow Methods ConsistentlyUsing Cost Flow Methods Consistently


Method should be used consistently, enhances comparability.

Although consistency is preferred, a company may change its inventory costing method.

Illustration 6-14Disclosure of change in cost flow method


Chapter 6-35

Chapter 6-36

Lower-of-Cost-or-MarketLower-of-Cost-or-Market


SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.

When the value of inventory is lower than its cost

Companies can “write down” the inventory to its market value in the period in which the price decline occurs.

Market value = Replacement Cost

Example of conservatism.

Normally referred to as NRV method in financial reporting

Chapter 6-37


SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.

Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated.

Illustration 6-15

Lower-of-Cost-or-MarketLower-of-Cost-or-Market

Chapter 6-38

Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors

SO 5 Indicate the effects of inventory errors on the financial SO 5 Indicate the effects of inventory errors on the financial statements.statements.

Common Cause:

Failure to count or price inventory correctly.

Not properly recognizing the transfer of legal title to goods in transit.

Errors affect both the income statement and balance sheet.

Chapter 6-39



Inventory errors affect the computation of cost of goods sold and net income.

Income Statement EffectsIncome Statement Effects

Illustration 6-17

Illustration 6-16

Chapter 6-40



Inventory errors affect the computation of cost of goods sold and net income in two periods.

An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period.

Over the two years, the total net income is correct because the errors offset each other.

The ending inventory depends entirely on the accuracy of taking and costing the inventory.

Income Statement EffectsIncome Statement Effects

Chapter 6-41



I ncorrect Correct Incorrect Correct

Sales 80,000$ 80,000$ 90,000$ 90,000$

Beginning inventory 20,000 20,000 12,000 15,000

Cost of goods purchased 40,000 40,000 68,000 68,000

Cost of goods available 60,000 60,000 80,000 83,000

Ending inventory 12,000 15,000 23,000 23,000

Cost of good sold 48,000 45,000 57,000 60,000

Gross profit 32,000 35,000 33,000 30,000

Operating expenses 10,000 10,000 20,000 20,000

Net income 22,000$ 25,000$ 13,000$ 10,000$

2010 2011

($3,000)Net Income understated

$3,000Net Income overstated

Combined income for 2-year period is

correct.

Illustration 6-18

Chapter 6-42

Understating ending inventory will overstate:

a. assets.

b. cost of goods sold.

c. net income.

d. owner's equity.




Chapter 6-43



Effect of inventory errors on the balance sheet is determined by using the basic accounting equation:.

Balance Sheet EffectsBalance Sheet Effects

Illustration 6-16

Illustration 6-19

Chapter 6-44

Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis

Balance Sheet - Inventory classified as current asset.

Income Statement - Cost of goods sold subtracted from sales.

There also should be disclosure of

1) major inventory classifications,

2) basis of accounting (cost or LCM), and

3) costing method (FIFO, LIFO, or average).


Chapter 6-45


Inventory management is a double-edged sword

1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage).

2. Low Inventory Levels – may lead to stockouts and lost sales.

AnalysisAnalysis

SO 6 Compute and interpret the inventory turnover ratio.SO 6 Compute and interpret the inventory turnover ratio.

Chapter 6-46

Inventory turnover measures the number of times on average the inventory is sold during the period.

Cost of Goods Sold

Average Inventory

Inventory Turnover

=


Days in inventory measures the average number of days inventory is held.

Days in Year (365)

Inventory Turnover

Days in Inventory

=


Chapter 6-47

Illustration: Wal-Mart reported in its 2008 annualreport a beginning inventory of $33,685 million, an ending inventory of $35,180 million, and cost of goods sold for the year ended January 31, 2008, of $286,515 million. The inventory turnover formula and computation for Wal-Martare shown below.



Illustration 6-21

Days in Inventory: Inventory turnover of 8.3 times divided into 365 is approximately 44 days. This is the approximate time that it takes a company to sell the inventory.

Chapter 6-48

Estimating InventoriesEstimating InventoriesEstimating InventoriesEstimating Inventories

The gross profit method estimates the cost of ending inventory by applying a gross profit rate to net sales.

Gross Profit MethodGross Profit Method

SO 8 Describe the two methods of estimating inventories.SO 8 Describe the two methods of estimating inventories.

Illustration 6B-1

Chapter 6-49


Illustration: Kishwaukee Company’s records for January show net sales of $200,000, beginning inventory $40,000, and cost of goods purchased $120,000. The company expects to earn a 30% gross profit rate. Compute the estimated cost of the ending inventory at January 31 under the gross profit method.


Illustration 6B-2

Chapter 6-50


Company applies the cost-to-retail percentage to ending inventory at retail prices to determine inventory at cost.

Retail Inventory MethodRetail Inventory Method


Illustration 6B-3

Leave this

Chapter 6-51



Note that it is not necessary to take a physical inventory to determine the estimated cost of goods on hand at any given time.

Illustration 6B-4

Illustration: Leave this

Chapter 6-52



““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”Illustration 6-5

This is regarding periodic inventory

systemLeave this

Chapter 6-53

“Last-In-First-Out (LIFO)”



Illustration 6-7Leave this

Chapter 6-54

“Average Cost”



Illustration 6-10Leave this

Chapter 6-55 SO 3 Explain the financial effects of the inventory cost flow SO 3 Explain the financial effects of the inventory cost flow

assumptions.assumptions.

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsFinancial Statement and Tax EffectsFinancial Statement and Tax Effects

Illustration 6-12

Chapter 6-56

Chapter 9

Accounting for Receivables

Accounting Principles, Ninth Edition

Chapter 6-57

1. Identify the different types of receivables.

2. Explain how companies recognize accounts receivable.

3. Distinguish between the methods and bases companies use to value accounts receivable.

4. Describe the entries to record the disposition of accounts receivable.

5. Compute the maturity date of and interest on notes receivable.

6. Explain how companies recognize notes receivable.

7. Describe how companies value notes receivable.

8. Describe the entries to record the disposition of notes receivable.

9. Explain the statement presentation and analysis of receivables.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 6-58

Types of Types of

ReceivablesReceivables

Types of Types of

ReceivablesReceivables

Accounts Accounts receivablereceivable

Notes receivableNotes receivable

Other Other receivablesreceivables

Accounts Accounts

ReceivableReceivable

Accounts Accounts

ReceivableReceivableNotes ReceivableNotes ReceivableNotes ReceivableNotes Receivable

Statement Statement Presentation and Presentation and

AnalysisAnalysis

Statement Statement Presentation and Presentation and

AnalysisAnalysis


AnalysisAnalysis

Determining Determining maturity datematurity date

Computing Computing interestinterest

Recognizing Recognizing notes receivablenotes receivable

Valuing notes Valuing notes receivablereceivable

Disposing of Disposing of notes receivablenotes receivable

Recognizing Recognizing accounts accounts receivablereceivable

Valuing accounts Valuing accounts receivablereceivable

Disposing of Disposing of accounts accounts receivablereceivable

Accounting for ReceivablesAccounting for ReceivablesAccounting for ReceivablesAccounting for Receivables

Chapter 6-59

Amounts due from individuals and other companies that are expected to be collected in cash.

Amounts owed by customers that

result from the sale of goods and

services.

Accounts Accounts ReceivableReceivable

Accounts Accounts ReceivableReceivable

Types of ReceivablesTypes of ReceivablesTypes of ReceivablesTypes of Receivables

SO 1 Identify the different types of receivables.SO 1 Identify the different types of receivables.

Claims for which formal instruments of credit are issued

as proof of debt.

“Nontrade” (interest, loans to officers, advances

to employees, and income taxes

refundable).

Notes Notes ReceivableReceivable

Notes Notes ReceivableReceivable

Other Other ReceivablesReceivables

Other Other ReceivablesReceivables

Chapter 6-60

Three accounting issues:

1. Recognizing accounts receivable.

2. Valuing accounts receivable.

3. Disposing of accounts receivable.

Accounts ReceivableAccounts ReceivableAccounts ReceivableAccounts Receivable

SO 1 Identify the different types of receivables.SO 1 Identify the different types of receivables.

The following exercise was illustrated in Chapter 5. For simplicity, inventory and cost of goods sold have been omitted.

Recognizing Accounts Receivable

Chapter 6-61

Illustration: Assume that Jordache Co. on July 1, 2010, sells merchandise on account to Polo Company for $1,000 terms 2/10, n/30. Prepare the journal entry to record this transaction on the books of Jordache Co.

Accounts receivable 1,000Jul. 1

Sales1,000

SO 2 Explain how companies recognize accounts receivable.SO 2 Explain how companies recognize accounts receivable.

Recognizing Accounts ReceivableRecognizing Accounts ReceivableRecognizing Accounts ReceivableRecognizing Accounts Receivable

Chapter 6-62

Illustration: On July 5, Polo returns merchandise worth $100 to Jordache Co.

Sales returns and allowances 100Jul. 5

Accounts receivable100

SO 2 Explain how companies recognize accounts receivable.SO 2 Explain how companies recognize accounts receivable.

Recognizing Accounts ReceivableRecognizing Accounts ReceivableRecognizing Accounts ReceivableRecognizing Accounts Receivable

Illustration: On July 11, Jordache receives payment fromPolo Company for the balance due.

Cash 882Jul. 11

Sales discounts ($900 x .02) 18


Chapter 6-63

Valuing Accounts Receivables

Are reported as a current asset on the balance sheet.

Are reported at the amount the company thinks they will be able to collect.

Sales on account raise the possibility of accounts not being collected.

Valuation can be difficult because an unknown amount of receivables will become uncollectible.

SO 3 Distinguish between the methods and SO 3 Distinguish between the methods and bases companies use to value accounts bases companies use to value accounts

receivable.receivable.

Accounts ReceivableAccounts ReceivableAccounts ReceivableAccounts Receivable

Chapter 6-64

Allowance MethodAllowance MethodLosses are estimated:

better matching.receivable stated at net realizable value.required by GAAP.

Methods of Accounting for Uncollectible Accounts

Direct Write-OffDirect Write-OffTheoretically undesirable:

no matching.receivable not stated at net realizable value.not acceptable for financial reporting.

Valuing Accounts ReceivableValuing Accounts ReceivableValuing Accounts ReceivableValuing Accounts Receivable



Chapter 6-65

AssetsAssets

Current Assets:Current Assets:

CashCash $ 346$ 346

Accounts receivableAccounts receivable 500500

Less: Allowance for doubtful accountsLess: Allowance for doubtful accounts 25 25 475 475

Merchandise inventory Merchandise inventory 812 812

Prepaid expensesPrepaid expenses 4040

Total current assetsTotal current assets 1,6731,673



Presentation of Accounts ReceivablePresentation of Accounts ReceivablePresentation of Accounts ReceivablePresentation of Accounts Receivable

Chapter 6-66

AssetsAssets

Current Assets:Current Assets:

CashCash $ 346$ 346

Accounts receivable, net of $25 allowanceAccounts receivable, net of $25 allowance

for doubtful accountsfor doubtful accounts 475 475

Merchandise inventory Merchandise inventory 812 812

Prepaid expensesPrepaid expenses 4040

Total current assetsTotal current assets 1,6731,673



Presentation of Accounts ReceivablePresentation of Accounts ReceivablePresentation of Accounts ReceivablePresentation of Accounts Receivable

Chapter 6-67


Allowance Method for Uncollectible Accounts

1. Companies estimate uncollectible accounts receivable.

2. To record estimated uncollectibles, companies debit Bad Debts Expense and credit Allowance for Doubtful Accounts (a contra-asset account).

3. When companies write off specific uncollectible accounts, they debit Allowance for Doubtful Accounts and credit Accounts Receivable.



Chapter 6-68




Recording Estimated Uncollectibles: Assume that Hampson Furniture has credit sales of $1,200,000 in 2010. Of this amount, $200,000 remains uncollected at December 31. The credit manager estimates that $12,000 of these sales will be uncollectible. The adjusting entry to record the estimated uncollectibles is:

Bad debt expense 12,000Dec. 31 Allowance for doubtful accounts

12,000

Chapter 6-69




Illustration 9-2Presentation of allowance for doubtful accounts

Chapter 6-70




Recording the Write-Off of an Uncollectible Account:Assume that the financial vice-president of Hampson Furniture authorizes a write-off of the $500 balance owed by R.A.Wareon March 1, 2011.The entry to record the write-off is:

Allowance for doubtful accounts 500Mar. 1


Illustration 9-3

Chapter 6-71

Accounts receivable 500




Recovery of an Uncollectible Account: Assume that on July 1, R. A. Ware pays the $500 amount that Hampson had written off on March 1.These are the entries:

Accounts receivable 500Jul. 1

Allowance for doubtful accounts 500

Cash 500Jul. 1

Chapter 6-72

Bases Used for Allowance Method




Illustration 9-5

Chapter 6-73

Illustration: Assume that Gonzalez Company elects to usethe percentage-of-sales basis. It concludes that 1% of net credit sales will become uncollectible. If net credit sales for 2010 are $800,000, the adjusting entry is:




Bad debts expense 8,000Dec. 31 Allowance for doubtful accounts

8,000

Percentage-of-Sales

* $800,000 x 1%

*

Chapter 6-74

Emphasizes the matching of expenses with revenues.

When the company makes the adjusting entry, it disregards the existing balance in Allowance for Doubtful Accounts.




Percentage-of-Sales

Illustration 9-6

Chapter 6-75




Percentage-of-ReceivablesIllustration 9-7Aging schedule

Chapter 6-76

Illustration: If the trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, the company will make the following adjusting entry.




Bad debts expense 1,700Dec. 31 Allowance for doubtful accounts

1,700

Percentage-of-Receivables

* $2,228 - 528

*

Chapter 6-77

Occasionally the allowance account will have a debit balance prior to adjustment.




Illustration 9-8

Percentage-of-Receivables

Chapter 6-78

Percentage of Sales approach:

Summary

Focus on “Bad debt expense” estimate, existing balance in the allowance account is ignored.

Method achieves a matching of cost and revenues.

Percentage of Receivables approach:Accurate valuation of receivables on the balance sheet.

Method may also be applied using an aging schedule.

Existing balance in allowance account considered.SO 3 Distinguish between the methods and SO 3 Distinguish between the methods and

bases companies use to value accounts bases companies use to value accounts receivable.receivable.


Chapter 6-79

Companies sell receivables for two major reasons.

1. Receivables may be the only reasonable source of cash.

2. Billing and collection are often time-consuming and costly.

SO 4 Describe the entries to record the disposition of accounts SO 4 Describe the entries to record the disposition of accounts receivable.receivable.

Disposing of Accounts ReceivableDisposing of Accounts ReceivableDisposing of Accounts ReceivableDisposing of Accounts Receivable

Chapter 6-80 SO 4 Describe the entries to record the disposition of accounts SO 4 Describe the entries to record the disposition of accounts



Sale of ReceivablesA factor buys receivables from businesses and then collects the payments directly from the customers.

Typically the factor charges a commission to the company that is selling the receivables.

The fee ranges from 1-3% of the amount of receivables purchased.

Chapter 6-81

Illustration: Illustration: AAssume that Hendredon Furniture factors$600,000 of receivables to Federal Factors. Federal Factors assesses a service charge of 2% of the amount of receivables sold. The journal entry to record the sale by Hendredon Furniture is as follows.

SO 4 Describe the entries to record the disposition of accounts SO 4 Describe the entries to record the disposition of accounts receivable.receivable.


Accounts receivable

600,000

Cash 588,000

Service charge expense 12,000

($600,000 x 2% = $12,000)




Credit Card Sales

Retailer considers credit card sales the same as cash sales.

Retailer must pay card issuer a fee of 2 to 4% for processing the transactions.

Retailer records the sale in a similar manner as checks deposited from cash sale.




Illustration: Illustration: Anita Ferreri purchases $1,000 of compact discs for her restaurant from Karen Kerr Music Co., using her Visa First Bank Card. First Bank charges a service fee of 3%. The entry to record this transaction by Karen Kerr Music is as follows.

Sales

1,000

Service charge expense 30

Chapter 6-84 SO 5 Compute the maturity date of and interest on notes SO 5 Compute the maturity date of and interest on notes


Notes ReceivableNotes ReceivableNotes ReceivableNotes Receivable

Companies may grant credit in exchange for a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.

Promissory notes may be used:

1. when individuals and companies lend or borrow money,

2. when amount of transaction and credit period exceed normal limits, or

3. in settlement of accounts receivable.

Chapter 6-85 SO 5 Compute the maturity date of and interest on notes SO 5 Compute the maturity date of and interest on notes



To the Payee, the promissory note is a note receivable.

To the Maker, the promissory note is a note payable.

Illustration 9-10

Chapter 6-86

Determining the Maturity Date

SO 5 Compute the maturity date of and interest on notes SO 5 Compute the maturity date of and interest on notes receivable.receivable.


Note expressed in terms of

Months

Days

Computing InterestIllustration 9-13

Chapter 6-87 SO 6 Explain how companies recognize notes receivable.SO 6 Explain how companies recognize notes receivable.

Recognizing Notes ReceivableRecognizing Notes ReceivableRecognizing Notes ReceivableRecognizing Notes Receivable

Illustration: Illustration: Assuming that Calhoun Company wrote $1,000, two-month, 12% promissory note to settle an open account, Wilma Company makes the following entry for the receipt of the note.

Notes receivable 1,000

Accounts receivable 1,000

Chapter 6-88

Valuing Notes Receivable

SO 7 Describe how companies value notes receivable.SO 7 Describe how companies value notes receivable.


Like accounts receivable, companies report short-term notes receivable at their cash (net) realizable value.

Estimation of cash realizable value and bad debts expense are done similarly to accounts receivable.

Allowance for Doubtful Accounts is used.

Leave

Chapter 6-89

Disposing of Notes Receivable

SO 8 Describe the entries to record the disposition of notes SO 8 Describe the entries to record the disposition of notes receivable.receivable.


1. Notes may be held to their maturity date.

2. Maker may default and payee must make an adjustment to the account.

3. Holder speeds up conversion to cash by selling the note receivable.

Chapter 6-90

Honor of Notes Receivable



A note is honored when its maker pays it in full at its maturity date.

Dishonor of Notes Receivable

A dishonored note is not paid in full at maturity. A dishonored note receivable is no longer negotiable.

Discounting of Notes Receivables

Disposing of Notes Receivable

Chapter 6-91



Illustration: Assume that Betty Co. lends Wayne Higley Inc. $10,000 on June 1, accepting a five-month, 9% interest-bearing note. Assuming that Betty Co. presents the note to Wayne Higley Inc. on the maturity date, Betty Co.’s entry to record the collection is:

Cash 10,375Nov. 1


Honor of Notes Receivables

Interest revenue 375

Chapter 6-92



Illustration: If Betty Co. prepares financial statements as of September 30, it must accrue interest. Betty Co. would make an adjusting entry to record 4 months’ interest.

Interest receivable 300Sept. 30



Chapter 6-93



Illustration: The entry by Betty Co. to record the honoring of the Wayne Higley Inc. note on November 1 is:

Cash 10,375Nov. 1



Interest receivable 300

Interest revenue 75

Chapter 6-94

Illustration: Assume that Wayne Higley Inc. on November 1 indicates that it cannot pay at the present time. If Betty Co. does expect eventual collection, it would make the following entry at the time the note is dishonored (assuming no previous accrual of interest).



Accounts receivable 10,375Nov. 1


Dishonor of Notes Receivables


Chapter 6-95

Illustration: Assume that Betty instead discounting this note from a bank on 1st October, and bank applied 8.43% discount on maturity value of the note then



Bank / Cash 9,500Oct. 1


Discounting of Notes Receivables

Interest Receivable 300

Finance cost / interest expense 800

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Chapter 6-96

Presentation

SO 9 Explain the statement presentation and analysis of SO 9 Explain the statement presentation and analysis of receivables.receivables.


Identify in the balance sheet or in the notes each major type of receivable.

Report short-term receivables as current assets.

Report both gross amount of receivables and allowance for doubtful account.

Report bad debts expense and service charge expense as selling expenses.

Report interest revenue under “Other revenues and gains.”

B/S

I/S

Chapter 6-97

Analysis of Receivables

This Ratio used to:

Assess the liquidity of the receivables.

Measure the number of times, on average, a company collects receivables during the period.



Illustration 9-15

Chapter 6-98

Variant of the accounts receivable turnover ratio is average collection period in terms of days.

Used to assess effectiveness of credit and collection policies.

Collection period should not exceed credit term period.



Illustration 9-16

Analysis of Receivables

Chapter 6-99

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Chapter 6-1 Financial Accounting & Information Systems :Session 6 Objectives:Session 6 Quiz Quiz...

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