Chapter 6Chapter 6

Receivables and InventoryReceivables and InventoryReceivables and InventoryReceivables and Inventory

Learning ObjectivesLearning Objectives

After 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

Learning Objectives Learning Objectives (continued)(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

Learning Objective 1Learning Objective 1

Describe the common classifications of receivables

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

Accounting for Notes Receivable

Learning Objective 2Learning Objective 2

Describe the nature of and the accounting for uncollectible receivables

Uncollectible Receivables

Q. What if a customer does not pay the balance owed to the company?

R. Companies must recognize an operating expense for accounts that are not collectible. It is called Bad Debt Expense.

Bad Debt Expense

Two Methods

Direct Direct Write-Off Write-Off MethodMethod

AllowanceAllowanceMethodMethod

Learning Objective 3Learning Objective 3

Describe the direct write-off method of accounting for uncollectible receivables

Direct Write-Off Method

• Bad Debt Expense is recorded and the receivable written off when the account is determined to be worthless.

If payment is collected after the write-off, the write-off entry is reversed and the cash collection is recorded

Learning Objective 4Learning Objective 4

Describe the allowance method of accounting for uncollectible

receivables

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

Estimate of Uncollectible Accounts Receivable: $30,000

• If the total accounts receivable balance is $200,000, the new net realizable value is $170,000

Write-Offs to the Allowance Account

• When a customer’s account is identified as uncollectible, it is written off against the allowance account

If payment is collected after the write-off, the write-off entry is reversed and the cash collection is recorded.

• Assume a $5,000 account had been previously written off.

Estimating Uncollectible Accounts

• Based on past experiences and forecasts of the future

• Two common methods:

Percent ofPercent ofSalesSales

AnalysisAnalysisof theof the

ReceivablesReceivables

Sample Aging Schedule

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.

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.

Learning Objective 5Learning Objective 5

Describe the common classifications of inventory

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.)

Merchandising Inventories

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

Manufacturing Inventories

Footnote Disclosure of Manufacturing Inventories

Learning Objective 6Learning Objective 6

Describe three inventory cost flow assumptions and how they impact the

financial statements

Inventory Cost Flow

• 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

Units Purchased Units Sold

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)

Three Inventory Methods

First-In, First-Out (FIFO)

• One unit is sold on May 30 for $20

Last-In, First-Out (LIFO)

• One unit is sold on May 30 for $20

Average Cost

• One unit is sold on May 30 for $20

Learning Objective 7Learning Objective 7

Compare and contrast the use of the three inventory costing methods

Comparing Methods - Rising Prices

METHOD I/S EFFECT B/S EFFECT RESULT

FIFO Lower COGS

Higher gross profit

Inventory shows replacement cost

Benefit lost in higher future costs

LIFO Higher COGS

Lower gross profit

Lower inventory values Matches current cost with current revenue

AVERAGE Average (middle) gross profit

Average inventory value Compromise between LIFO & FIFO

Learning Objective 8Learning Objective 8

Describe how receivables and inventory are reported on the

financial statements

Balance Sheet Presentation

Lower of Cost or Market

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)

End of Chapter 6End of Chapter 6