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Financial Accounting & Information
Systems
Objectives:
Session 6
• Quiz
• Recap of last session
• Case Study: Accounting for Inventories
• Brief Summery: Accounting for Inventories
(Chapter 6)
• Accounting for Receivables (Chapter 9)
Chapter
6-1
Financial Accounting & Information
Systems
Objective 1:
Quiz
Chapter
6-2
Financial Accounting & Information
Systems
Objective :
Case Study
Context: Inventory Accounting
Chapter
6-3
Chapter
6
Inventories
Chapter
6-4
Accounting Principles, Ninth Edition
Study Objectives
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.
Chapter
6-5
Reporting and Analyzing Inventory
Classifying
Inventory
Finished
goods
Work in
process
Raw materials
Determining
Inventory
Quantities
Taking a
physical
inventory
Determining
ownership of
goods
Inventory
Costing
Specific
identification
Cost flow
assumptions
Financial
statement
and tax
effects
Consistent
use
Chapter
6-6
Lower-ofcost-ormarket
Inventory
Errors
Income
statement
effects
Balance sheet
effects
Statement
Presentation
and Analysis
Presentation
Analysis
Classifying Inventory
Merchandising
Company
One Classification:
Merchandise Inventory
Manufacturing
Company
Three Classifications:
Raw Materials
Work in Process
Finished Goods
Regardless of the classification, companies report all
inventories under Current Assets on the balance sheet.
Chapter
6-7
Chapter
6-8
Determining Inventory Quantities
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.
Chapter
6-9
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Taking a Physical Inventory
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.
Chapter
6-10
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
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
6-11
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Terms of Sale
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.
Chapter
6-12
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Review Question
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.
Chapter
6-13
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
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.
Chapter
6-14
SO 1 Describe the steps in determining inventory quantities.
Inventory Costing
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)
Cost Flow
Assumptions
Average-cost
Chapter
6-15
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing
Specific Identification Method
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.
Chapter
6-16
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing
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
6-17
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing
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
6-18
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
Cost Flow Assumption
does not need to equal
Physical Movement of
Goods
Illustration 6-11
Use of cost flow methods in
major U.S. companies
Chapter
6-19
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Earliest goods purchased are first to be sold.
Often parallels actual physical flow of
merchandise.
Generally good business practice to sell oldest
units first.
Chapter
6-20
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Illustration 6-5
Chapter
6-21
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
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.
Chapter
6-22
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Illustration 6-7
Chapter
6-23
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“Average-Cost”
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.
Chapter
6-24
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“Average Cost”
Chapter
6-25
Illustration 6-10
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
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
6-26
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Cost Flow Methods in Perpetual Systems
Example
Appendix 6A
Assuming the Perpetual Inventory System, compute Cost of Goods
Sold and Ending Inventory under FIFO, LIFO, and Average cost.
Chapter
6-27
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“First-In-First-Out (FIFO)”
Cost of Goods Sold
Chapter
6-28
Illustration 6A-2
Ending Inventory
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“Last-In-First-Out (LIFO)”
Cost of Goods Sold
Chapter
6-29
Illustration 6A-3
Ending Inventory
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“Average Cost” (Moving-Average System)
Illustration 6A-4
Cost of Goods Sold
Chapter
6-30
Ending Inventory
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Inventory Costing – Cost Flow Assumptions
Review Question
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
6-31
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
Review Question
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.
Chapter
6-32
SO 3 Explain the financial effects of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
Discussion Question
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
See notes page for discussion
Chapter
6-33
SO 3 Explain the financial effects of the inventory cost flow assumptions.
Inventory Costing
Using Cost Flow Methods Consistently
Method should be used consistently, enhances
comparability.
Although consistency is preferred, a company
may change its inventory costing method.
Illustration 6-14
Disclosure of change
in cost flow method
Chapter
6-34
SO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter
6-35
Inventory Costing
Lower-of-Cost-or-Market
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
6-36
SO 4 Explain the lower-of-cost-or-market
basis of accounting for inventories.
Inventory Costing
Lower-of-Cost-or-Market
Illustration: Assume that Ken Tuckie TV has the
following lines of merchandise with costs and market
values as indicated.
Illustration 6-15
Chapter
6-37
SO 4 Explain the lower-of-cost-or-market
basis of accounting for inventories.
Inventory Errors
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
6-38
SO 5 Indicate the effects of inventory errors on the financial statements.
Inventory Errors
Income Statement Effects
Inventory errors affect the computation of cost of
goods sold and net income.
Illustration 6-16
Illustration 6-17
Chapter
6-39
SO 5 Indicate the effects of inventory errors on the financial statements.
Inventory Errors
Income Statement Effects
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.
Chapter
6-40
SO 5 Indicate the effects of inventory errors on the financial statements.
Inventory Errors
Illustration 6-18
2010
2011
Incorrect
Correct
Incorrect
Correct
$ 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
$ 22,000
$ 25,000
$ 13,000
$ 10,000
Sales
Net income
Combined income for
2-year period is correct.
Chapter
6-41
($3,000)
Net Income
understated
$3,000
Net Income
overstated
SO 5 Indicate the effects of inventory errors on the financial statements.
Inventory Errors
Review Question
Understating ending inventory will overstate:
a. assets.
b. cost of goods sold.
c. net income.
d. owner's equity.
Chapter
6-42
SO 5 Indicate the effects of inventory errors on the financial statements.
Inventory Errors
Balance Sheet Effects
Effect of inventory errors on the balance sheet is
determined by using the basic accounting equation:.
Illustration 6-16
Illustration 6-19
Chapter
6-43
SO 5 Indicate the effects of inventory errors on the financial statements.
Statement Presentation and Analysis
Presentation
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
6-44
Statement Presentation and Analysis
Analysis
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.
Chapter
6-45
SO 6 Compute and interpret the inventory turnover ratio.
Statement Presentation and Analysis
Inventory turnover measures the number of times
on average the inventory is sold during the period.
Inventory
Turnover
=
Cost of Goods Sold
Average Inventory
Days in inventory measures the average number of
days inventory is held.
Days in Year (365)
Days in
=
Inventory
Inventory Turnover
Chapter
6-46
SO 6 Compute and interpret the inventory turnover ratio.
Statement Presentation and Analysis
Illustration: Wal-Mart reported in its 2008 annual
report 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-Mart
are 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
6-47
SO 6 Compute and interpret the inventory turnover ratio.
Estimating Inventories
Gross Profit Method
The gross profit method estimates the cost of ending
inventory by applying a gross profit rate to net sales.
Illustration 6B-1
Chapter
6-48
SO 8 Describe the two methods of estimating inventories.
Estimating Inventories
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
6-49
SO 8 Describe the two methods of estimating inventories.
Estimating Inventories
Retail Inventory Method
Leave this
Company applies the cost-to-retail percentage to ending
inventory at retail prices to determine inventory at cost.
Illustration 6B-3
Chapter
6-50
SO 8 Describe the two methods of estimating inventories.
Estimating Inventories
Illustration:
Leave this
Illustration 6B-4
Note that it is not necessary to take a physical inventory to
determine the estimated cost of goods on hand at any given time.
Chapter
6-51
SO 8 Describe the two methods of estimating inventories.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
This is regarding
Illustration 6-5
periodic inventory
system
Leave this
Chapter
6-52
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”Leave this
Illustration 6-7
Chapter
6-53
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
“Average Cost”
Chapter
6-54
Leave this
Illustration 6-10
SO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.
Inventory Costing – Cost Flow Assumptions
Financial Statement and Tax Effects
Illustration 6-12
Chapter
6-55
SO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter
9
Accounting for
Receivables
Chapter
6-56
Accounting Principles, Ninth Edition
Study Objectives
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.
Chapter
6-57
Accounting for Receivables
Types of
Receivables
Accounts
receivable
Accounts
Receivable
Notes receivable
Recognizing
accounts
receivable
Other
receivables
Valuing accounts
receivable
Disposing of
accounts
receivable
Notes Receivable
Determining
maturity date
Computing
interest
Recognizing
notes receivable
Valuing notes
receivable
Disposing of notes
receivable
Chapter
6-58
Statement
Presentation and
Analysis
Presentation
Analysis
Types of Receivables
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.
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).
Accounts
Receivable
Notes
Receivable
Other
Receivables
Chapter
6-59
SO 1 Identify the different types of receivables.
Accounts Receivable
Three accounting issues:
1. Recognizing accounts receivable.
2. Valuing accounts receivable.
3. Disposing of accounts receivable.
Recognizing Accounts Receivable
The following exercise was illustrated in Chapter 5.
For simplicity, inventory and cost of goods sold have
been omitted.
Chapter
6-60
SO 1 Identify the different types of receivables.
Recognizing Accounts Receivable
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.
Jul. 1
Accounts receivable
Sales
Chapter
6-61
1,000
1,000
SO 2 Explain how companies recognize accounts receivable.
Recognizing Accounts Receivable
Illustration: On July 5, Polo returns merchandise worth $100
to Jordache Co.
Jul. 5
Sales returns and allowances
100
Accounts receivable
100
Illustration: On July 11, Jordache receives payment from
Polo Company for the balance due.
Jul. 11
Cash
882
Sales discounts ($900 x .02)
Accounts receivable
Chapter
6-62
18
900
SO 2 Explain how companies recognize accounts receivable.
Accounts Receivable
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.
Chapter
6-63
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Methods of Accounting for Uncollectible Accounts
Direct Write-Off
Theoretically undesirable:
no matching.
receivable not stated at net
realizable value.
not acceptable for financial
reporting.
Chapter
6-64
Allowance Method
Losses are estimated:
better matching.
receivable stated at net
realizable value.
required by GAAP.
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Presentation of Accounts Receivable
Assets
Current Assets:
Cash
Accounts receivable
Less: Allowance for doubtful accounts
Merchandise inventory
Prepaid expenses
Total current assets
Chapter
6-65
$ 346
500
25
475
812
40
1,673
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Presentation of Accounts Receivable
Assets
Current Assets:
Cash
Accounts receivable, net of $25 allowance
for doubtful accounts
Merchandise inventory
Prepaid expenses
Total current assets
Chapter
6-66
$ 346
475
812
40
1,673
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
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
6-67
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
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:
Dec. 31
Bad debt expense
12,000
Allowance for doubtful accounts
Chapter
6-68
12,000
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Illustration 9-2
Presentation of allowance for doubtful accounts
Chapter
6-69
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
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.Ware
on March 1, 2011.The entry to record the write-off is:
Mar. 1
Allowance for doubtful accounts
Accounts receivable
500
500
Illustration 9-3
Chapter
6-70
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
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:
Jul. 1
Accounts receivable
500
Allowance for doubtful accounts
Jul. 1
Cash
500
Accounts receivable
Chapter
6-71
500
500
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Bases Used for Allowance Method
Illustration 9-5
Chapter
6-72
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Percentage-of-Sales
Illustration: Assume that Gonzalez Company elects to use
the 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:
Dec. 31
Bad debts expense
Allowance for doubtful accounts
8,000 *
8,000
* $800,000 x 1%
Chapter
6-73
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Percentage-of-Sales
Emphasizes the matching of expenses with revenues.
When the company makes the adjusting entry, it
disregards the existing balance in Allowance for Doubtful
Accounts.
Illustration 9-6
Chapter
6-74
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Percentage-of-Receivables
Chapter
6-75
Illustration 9-7
Aging schedule
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Percentage-of-Receivables
Illustration: If the trial balance shows Allowance for
Doubtful Accounts with a credit balance of $528, the company
will make the following adjusting entry.
Dec. 31
Bad debts expense
Allowance for doubtful accounts
1,700 *
1,700
* $2,228 - 528
Chapter
6-76
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Percentage-of-Receivables
Illustration 9-8
Occasionally the allowance account will have a debit
balance prior to adjustment.
Chapter
6-77
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Valuing Accounts Receivable
Summary
Percentage of Sales approach:
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.
Chapter
6-78
SO 3 Distinguish between the methods and bases
companies use to value accounts receivable.
Disposing of Accounts Receivable
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.
Chapter
6-79
SO 4 Describe the entries to record the disposition of accounts receivable.
Disposing of Accounts Receivable
Sale of Receivables
A 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
6-80
SO 4 Describe the entries to record the disposition of accounts receivable.
Disposing of Accounts Receivable
Illustration: Assume 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.
($600,000 x 2% = $12,000)
Cash
Service charge expense
Accounts receivable
Chapter
6-81
588,000
12,000
600,000
SO 4 Describe the entries to record the disposition of accounts receivable.
Disposing of Accounts Receivable
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.
Chapter
6-82
SO 4 Describe the entries to record the disposition of accounts receivable.
Disposing of Accounts Receivable
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.
Cash Bank
Service charge expense
Sales
Chapter
6-83
970
30
1,000
SO 4 Describe the entries to record the disposition of accounts receivable.
Notes 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
6-84
SO 5 Compute the maturity date of and interest on notes receivable.
Notes Receivable
To the Payee, the promissory note is a note receivable.
To the Maker, the promissory note is a note payable.
Illustration 9-10
Chapter
6-85
SO 5 Compute the maturity date of and interest on notes receivable.
Notes Receivable
Determining the Maturity Date
Note expressed in terms of
Months
Days
Computing Interest
Chapter
6-86
Illustration 9-13
SO 5 Compute the maturity date of and interest on notes receivable.
Recognizing Notes Receivable
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
Accounts receivable
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1,000
1,000
SO 6 Explain how companies recognize notes receivable.
Notes Receivable
Valuing Notes Receivable
Leave
Like accounts receivable, companies report shortterm 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.
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SO 7 Describe how companies value notes receivable.
Notes Receivable
Disposing of Notes 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.
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SO 8 Describe the entries to record the disposition of notes receivable.
Notes Receivable
Disposing of Notes Receivable
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
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SO 8 Describe the entries to record the disposition of notes receivable.
Notes Receivable
Honor of Notes Receivables
Illustration: Assume that Betty Co. lends Wayne Higley Inc.
$10,000 on June 1, accepting a five-month, 9% interestbearing 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:
Nov. 1
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Cash
10,375
Notes receivable
10,000
Interest revenue
375
SO 8 Describe the entries to record the disposition of notes receivable.
Notes Receivable
Honor of Notes Receivables
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.
Sept. 30
Interest receivable
Interest revenue
Chapter
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300
300
SO 8 Describe the entries to record the disposition of notes receivable.
Notes Receivable
Honor of Notes Receivables
Illustration: The entry by Betty Co. to record the honoring
of the Wayne Higley Inc. note on November 1 is:
Nov. 1
Cash
Notes receivable
Interest receivable
Interest revenue
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10,375
10,000
300
75
SO 8 Describe the entries to record the disposition of notes receivable.
Notes Receivable
Dishonor of Notes Receivables
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).
Nov. 1
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Accounts receivable
10,375
Notes receivable
10,000
Interest revenue
375
SO 8 Describe the entries to record the disposition of notes receivable.
Notes Receivable
Discounting of Notes Receivables
This concept is
not in your text
book
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
Oct. 1
Bank / Cash
Finance cost / interest expense
Notes receivable
Interest Receivable
Chapter
6-95
9,500
800
10,000
300
SO 8 Describe the entries to record the disposition of notes receivable.
Statement Presentation and Analysis
Presentation
Identify in the balance sheet or in the notes each
major type of receivable.
B/S
Report short-term receivables as current assets.
Report both gross amount of receivables and
allowance for doubtful account.
I/S
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Report bad debts expense and service charge
expense as selling expenses.
Report interest revenue under “Other revenues
and gains.”
SO 9 Explain the statement presentation and analysis of receivables.
Statement Presentation and Analysis
Analysis of Receivables
Illustration 9-15
This Ratio used to:
Assess the liquidity of the receivables.
Measure the number of times, on average, a company
collects receivables during the period.
Chapter
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SO 9 Explain the statement presentation and analysis of receivables.
Statement Presentation and Analysis
Analysis of Receivables
Illustration 9-16
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.
Chapter
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SO 9 Explain the statement presentation and analysis of receivables.
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Chapter
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