Financial & Managerial

Accounting
The Basis for Business Decisions
FOURTEENTH EDITION

Williams Haka Bettner Carcello

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Chapter

7
Financial Assets

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To define financial assets

and explain their valuation
in the balance sheet.

LO1
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?

Every
business
needs
enough

McGraw-Hill/Irwin
$ cash to pay
its bills!
© The McGraw-Hill Companies, Inc., 2008
 How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?

Financial
Assets

Cash Receivables

Short-term
Investments
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 How
How Much
Much Cash
Cash Should
Should aa Business
Business
Have?
Have?
Collections
from Cash (and cash
customers equivalents) Cash
Accounts payments

receivable
“Excess” Investments
cash is are sold as
invested cash is
temporarily needed
Marketable
securities
(short-term
investments)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 The
The Valuation
Valuation of
of Financial
Financial Assets
Assets
Basis for Valuation in
Type of Financial Assets the Balance Sheet
Cash (and cash equivalents) Face amount
Short-term investments Current market value
(marketable securities)
Receivables Net realizable value

Estimated
Estimated collectible
collectible amount
amount

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Cash
Cash

Coins and
paper money Cash is Checks

defined as
any deposit
Bank credit
card sales
banks will Money orders
accept.

Travelers’ checks

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reporting
Reporting Cash
Cash in
in the
the Balance
Balance
Sheet
Sheet

Combined with
cash on
balance sheet

Liquid short- Matures within

Cash
term 90 days of
investments Equivalents acquisition

Stable market
values

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reporting
Reporting Cash
Cash in
in the
the Balance
Balance
Sheet
Sheet

Not available for

paying current
liabilities

“Restricted”
Not a current Cash Listed as an
asset investment

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reporting
Reporting Cash
Cash in
in the
the Balance
Balance
Sheet
Sheet

Bank agrees in
advance to lend
money.

Lines of
Credit

Liability is incurred
Unused line of credit
when line of credit is
is disclosed in notes.
used.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 The
The Statement
Statement of
of Cash
Cash Flows
Flows

Statement of Cash Flows Summarizes

Summarizes cash
cash
transactions
transactions for
for an
an
accounting
accounting period.
period.

Includes
Includes cash
cash and
and cash
cash
equivalents.
equivalents.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To describe the objectives

of cash management and
internal controls over cash.

LO2
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Cash
Cash Management
Management
 Accurately
 Accurately account
account for
for cash.
cash.
 Prevent
 Prevent theft
theft and
and fraud.
fraud.
 Assure
 Assure the
the availability
availability of
of
adequate
adequate amounts
amounts of
of cash.
cash.
 Prevent
 Prevent unnecessarily
unnecessarily large
large
amounts
amounts of
of idle
idle cash.
cash.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Using
Using Excess
Excess Cash
Cash Balances
Balances
Efficiently
Efficiently

Cash available for

Cash not needed for
long-term investment
business purposes
may be used to finance
may be distributed to
growth and expansion
the company’s
of the business, or to
stockholders.
repay debt.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Internal
Internal Control
Control Over
Over Cash
Cash
•• Segregate
Segregate authorization,
authorization, custody
custody and
and
recording
recording of
of cash.
cash.
•• Prepare
Prepare aa cash
cash budget
budget (or(or forecast).
forecast).
•• Prepare
Prepare aa control
control listing
listing of
of cash
cash receipts.
receipts.
•• Require
Require daily
daily deposits.
deposits.
•• Make
Make all
all payments
payments by by check.
check.
•• Verify
Verify every
every expenditure
expenditure before
before payment.
payment.
•• Promptly
Promptly reconcile
reconcile bank
bank statements.
statements.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Cash
Cash Over
Over and
and Short
Short

On May 5, XBAR, Inc.’s cash drawer

was counted and found to be $10 over.

Cash
Cash Over
Over and
and Short
Short is
is debited
debited for
for
shortages
shortages and
and credited
credited for
for overages.
overages.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To prepare a bank
reconciliation and explain
its purpose.

LO3
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Bank
Bank Statements
Statements

Shows the beginning bank balance,

deposits made, checks paid, other
debits and credits in the month, and
the ending bank balance.

Bank
Statement
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Reconciling
Reconciling the
the Bank
Bank Statement
Statement

Explains the difference between cash

reported on bank statement and cash
balance in depositor’s accounting
records.

Provides information for

reconciling journal entries.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Balance per Bank Balance per Depositor

+ Deposits by Bank
+ Deposits in Transit
(credit memos)

- Service Charge
- Outstanding Checks
- NSF Checks

± Bank Adjustments ± Book Adjustments

= Adjusted Balance = Adjusted Balance

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reconciling
Reconciling the
the Bank
Bank Statement
Statement

All reconciling Balance per Depositor

items on the + Deposits by Bank

book side (credit memos)

require an - Service Charge

adjusting - NSF Checks

entry to the ± Book Adjustments

cash account.
= Adjusted Balance

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Prepare a July 31 bank reconciliation
statement and the resulting journal entries
for the Simmons Company. The July 31
bank statement indicated a cash balance of
$9,610, while the cash ledger account on
that date shows a balance of $7,430.

Additional information necessary for the

reconciliation is shown on the next page.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
  Outstanding
 Outstanding checks
checks totaled
totaled $2,417.
$2,417.
A
 A $500
$500 check
check mailed
mailed to
to the
the bank
bank for
for deposit
deposit had
had
not
not reached
reached the
the bank
bank at
at the
the statement
statement date.
date.
 The
 The bank
bank returned
returned aa customer’s
customer’s NSF NSF check
check for
for
$225
$225 received
received asas payment
payment of of an
an account
account
receivable.
receivable.
 The
 The bank
bank statement
statement showed
showed $30 $30 interest
interest earned
earned
on
on the
the bank
bank balance
balance for
for the
the month
month of of July.
July.
 Check
 Check 781781 for
for supplies
supplies cleared
cleared the the bank
bank for
for $268
$268
but
but was
was erroneously
erroneously recorded
recorded in in our
our books
books asas
$240.
$240.
A
 A $486
$486 deposit
deposit by
by Acme
Acme Company
Company was was
erroneously
erroneously credited
credited to
to our
our account
account by by the
the bank.
bank.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Reconciling
Reconciling the
the Bank
Bank Statement
Statement

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reconciling
Reconciling the
the Bank
Bank Statement
Statement

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jul 31 Cash 30
Interest Revenue 30

31 Supplies Inventory 28
Accounts Receivable 225
Cash 253

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Petty
Petty Cash
Cash Funds
Funds

Used for minor

expenditures.

Petty Cash
Funds

Has one Replenished

custodian. periodically.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To describe how short-term

investments are reported in the balance
sheet and account for transactions
involving marketable securities.

LO4
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Short-Term
Short-Term Investments
Investments

Bond Capital Stock

Investments Investments

Marketable
Securities
Readily
Marketable
are . . . Current Assets

Almost As
Liquid As Cash

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accounting
Accounting for
for Marketable
Marketable
Securities
Securities
Most short-term investments in marketable securities
are classified as available for sale and appear on the
balance sheet at their current market value.
Treatment of Unrealized
Classification Management's Intent Holding Gains and Losses
Available-for- Held for short-term Reported in stockholders'
sale securities resale (often 6 to 18 equity section of the
months) balance sheet
Trading Held for immediate Reported in "other" revenue
securities resale (often within (expense) section of the
hours or days) income statement
Held-to-maturity Debt securities Not reported. Securities are
securities intended to be held reported on balance sheet
until they mature at amortized cost.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Purchase
Purchase of
of Marketable
Marketable Securities
Securities
Foster
Foster Corporation
Corporation purchases
purchases asas aa short-term
short-term
investment
investment 4,000
4,000 shares
shares of
of The
The Coca-Cola
Coca-Cola
Company
Company onon December
December 1.1. Foster
Foster paid
paid $43.98
$43.98 per
per
share,
share, plus
plus aa brokerage
brokerage commission
commission of of $80.
$80.

Total Cost: (4,000 × $43.98) + $80 = $176,000

Cost per Share: $176,000 ÷ 4,000 =©$44.00
McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2008
 Recognition
Recognition of
of Investment
Investment Revenue
Revenue
On
On December
December 15,15, Foster
Foster Corporation
Corporation receives
receives
aa $0.30
$0.30 per
per share
share dividend
dividend on
on its
its 4,000
4,000
shares
shares of
of Coca-Cola.
Coca-Cola.

4,000 × $0.30 = $1,200

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
Sales of
of Investments
Investments
On
On December
December 18, 18, Foster
Foster Corporation
Corporation sells
sells 500
500
shares
shares of
of its
its Coca-Cola
Coca-Cola stock
stock for
for $46.04
$46.04 per
per
share,
share, less
less aa $20
$20 brokerage
brokerage commission.
commission.

Sales Proceeds: (500 × $46.04) - $20 = $23,000

Cost Basis: 500 × $44 = $22,000
Gain
McGraw-Hill/Irwin on Sale: $23,000 - $22,000 = $1,000
© The McGraw-Hill Companies, Inc., 2008
 Adjusting
Adjusting Marketable
Marketable Securities
Securities to
to
Market
Market Value
Value
On
On December
December 31,31, Foster
Foster Corporation’s
Corporation’s remaining
remaining
shares
shares of
of Coca-Cola
Coca-Cola capital
capital stock
stock have
have aa current
current
market
market value
value of
of $42,000.
$42,000. Prior
Prior to
to any
any adjustment,
adjustment,
the
the company’s
company’s Marketable
Marketable Securities
Securities account
account has
has aa
balance
balance of
of $44,000
$44,000 (1,000
(1,000 ×× $44
$44 per
per share).
share).

Unrealized Loss: $42,000 - $44,000 = ($2,000)

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To account for uncollectible

receivables using the allowance
and direct write-off methods.

LO5
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accounts
Accounts Receivable
Receivable

IfIf aa company
company makes
makes credit
credit
sales
sales to
to customers,
customers, some
some
accounts
accounts inevitably
inevitably will
will
turn
turn out
out to
to be
be
uncollectible.
uncollectible.
PAST DUE

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Reflecting
Reflecting Uncollectible
Uncollectible Accounts
Accounts in
in
the
the Financial
Financial Statements
Statements

At
At the
the end
end of
of each
each period,
period, record
record
an
an estimate
estimate ofof the
the uncollectible
uncollectible
accounts.
accounts.

Selling
Selling expense
expense Contra-asset
Contra-asset account
account
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 The
The Allowance
Allowance for
for Doubtful
Doubtful
Accounts
Accounts

Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable

The net realizable value is the amount of

accounts receivable that the business
expects to collect.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable

When
When an
an account
account is is determined
determined toto be
be
uncollectible,
uncollectible, itit no
no longer
longer qualifies
qualifies as
as an
an
asset
asset and
and should
should be be written
written off.
off.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable
Assume that on January 5, K-Max
determined that Jason Clark would not pay
the $500 he owes.
K-Max would make the following entry.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable

Assume that before this entry, the Accounts

Receivable balance was $10,000 and the
Allowance for Doubtful Accounts balance
was $2,500.

Let’s see what effect the write-off had on

these accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Writing
Writing Off
Off an
an Uncollectible
Uncollectible Account
Account
Receivable
Receivable

Before After
Write-Off Write-Off
Accounts receivable $ 10,000 $ 9,500
Less: Allow. for doubtful accts. 2,500 2,000
Net realizable value $ 7,500 $ 7,500

Notice that the $500 write-off did not change the net
realizable value nor did it affect any income
statement accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Monthly
Monthly Estimates
Estimates of
of Credit
Credit Losses
Losses

At
At the
the end
end of
of each
each
month,
month, management
management
should
should estimate
estimate thethe
probable
probable amount
amount of of
uncollectible
uncollectible accounts
accounts
and
and adjust
adjust the
the
Allowance
Allowance forfor Doubtful
Doubtful Two Approaches to Estimating
Credit Losses:
Accounts
Accounts to to this
this new
new Balance Sheet Approach
estimate.
estimate.
1.

2. Income Statement Approach

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Balance
Balance Sheet
Sheet Approach
Approach


 Year-end
Year-end Accounts
Accounts Receivable
Receivable is
is
broken
broken down
down into
into age
age
classifications.
classifications.


 Each
Each age
age grouping
grouping has
has aa
different
different likelihood
likelihood of
of being
being
uncollectible.
uncollectible.

 Compute
Compute aa separate
separate allowance
allowance for
for
each
each age
age grouping.
grouping.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Balance
Balance Sheet
Sheet Approach
Approach

At December 31, the receivables for EastCo, Inc.

were categorized as follows:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Balance
Balance Sheet
Sheet Approach
Approach

At December 31, the receivables for EastCo, Inc.

were categorized as follows:

 

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Balance
Balance Sheet
Sheet Approach
Approach

At December 31, the receivables for EastCo, Inc.

were categorized as follows:

  

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Balance
Balance Sheet
Sheet Approach
Approach

EastCo’s
EastCo’sunadjusted
unadjustedbalance
balance
in
in the
theallowance
allowance account
account is
is
$500.
$500.
Per
Per the
theprevious
previouscomputation,
computation,
the
thedesired
desired balance
balanceis
is$1,350.
$1,350.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Let’s
Let’s look
look at
at
another
another way
way
to
to estimate
estimate
credit
credit losses!
losses!

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Income
Income Statement
Statement Approach
Approach

Uncollectible accounts’
percentage is based on actual
uncollectible accounts from
prior years’ credit sales.

Focus is on determining the amount to

record on the income statement as
Uncollectible Accounts Expense.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Income
Income Statement
Statement Approach
Approach

Net
Net Credit
Credit Sales
Sales
 %
% Estimated
Estimated Uncollectible
Uncollectible
Amount
Amount of
of Journal
Journal Entry
Entry

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Income
Income Statement
Statement Approach
Approach

In
In 2007,
2007, EastCo
EastCo had
had credit
credit sales
sales of
of $60,000.
$60,000.
Historically,
Historically, 1%
1% of
of EastCo’s
EastCo’s credit
credit sales
sales has
has
been
been uncollectible.
uncollectible.
For
For 2007,
2007, the
the estimate
estimate of
of uncollectible
uncollectible accounts
accounts
expense
expense isis $600.
$600.
($60,000
($60,000 ×× .01
.01 == $600)
$600)
Now,
Now, prepare
prepare the
the adjusting
adjusting entry
entry for
for December
December
31,
31, 2007.
2007.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Estimating
Estimating Credit
Credit Losses
Losses —
— The
The
Income
Income Statement
Statement Approach
Approach

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Uncollectible
Uncollectible Accounts
Accounts
Summary
Summary

Aging
Agingof
of %
% of
of Credit
Credit Sales
Sales
Receivables
Receivables
Emphasis
Emphasisonon Emphasis
Emphasisonon
Realizable
RealizableValue
Value Matching
Matching
Accts. Sales
Rec. All. for Uncoll.
Doubtful Accts.
Accts. Exp.

Income
Income
Balance
BalanceSheet
Sheet Statement
Statement
Focus
Focus Focus
Focus
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Concentrations
Concentrations of
of Credit
Credit Risk
Risk

Concentrations
Concentrations of
of credit
credit risk
risk occur
occur ifif aa significant
significant portion
portion
of
of aa company’s
company’s receivables
receivables are
are due
due fromfrom aa few
few major
major
customers
customers or
or from
from customers
customers operating
operating in in the
the same
same
industry
industry oror geographic
geographic region.
region.

The
The FASB
FASB requires
requires
disclosure
disclosure of of all
all
significant
significant
concentrations
concentrations of of
credit
credit risk
risk in
in the
the
notes
notes to
to the
the financial
financial
statements.
statements.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Recovery
Recovery of
of an
an Account
Account Receivable
Receivable
Previously
Previously Written
Written Off
Off
Subsequent
Subsequent collections
collections require
require that
that the
the original
original write-off
write-off
entry
entry be
be reversed
reversed before
before the
the cash
cash collection
collection is
is recorded.
recorded.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Accounts Receivable (X Customer) $$$$
Allowance for Doubtful Accounts $$$$

Cash $$$$
Accounts Receivable (X Customer) $$$$
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Direct
Direct Write-Off
Write-Off Method
Method

This method makes no attempt to

match revenues with the expense of
uncollectible accounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Income
Income Tax
Tax Regulations
Regulations and
and
Financial
Financial Reporting
Reporting

Direct write-off method

required to calculate
taxable income.

Taxable Income

Allowance methods
GAAP
GAAP
GAAP

GAAP

better match expenses

with revenues.

Financial
Statement Income
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Internal
Internal Controls
Controls for
for Receivables
Receivables

Separate the following duties:


Maintenance
Maintenance of of the
the accounts
accounts receivable
receivable
subsidiary
subsidiary ledger.
ledger.

Custody
Custody of
of cash
cash receipts.
receipts.
 Authorization
Authorization of
of accounts
accounts receivable
receivable write-offs.
write-offs.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Management
Management of
of Accounts
Accounts
Receivable
Receivable

Extending credit encourages

Credit Terms
customers to buy from us . . .

. . . but it ties up resources Minimize

in accounts receivable. Accounts
Receivable

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Management
Management of
of Accounts
Accounts
Receivable
Receivable

Factoring Credit
Accounts Card
Receivable Sales

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To explain, compute, and

account for notes receivable
and interest revenue.

LO6
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue

A
A promissory
promissory note
note is
is an
an unconditional
unconditional
promise
promise inin writing
writing to
to pay
pay on
on demand
demand or
or at
at
aa future
future date
date aa definite
definite sum
sum of
of money.
money.

Maker—the
Maker—the person
person who
who
signs
signs the
the note
note and
and thereby
thereby
promises
promises toto pay.
pay.
Payee—the
Payee—the person
person to
to whom
whom
payment
payment is
is to
to be
be made.
made.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue
PROMISSORY NOTE
Miami, Fl Nov. 1, 2007
Location Date
Ninety days after this date Porter Company

promises to pay to the order of Hall Company

the sum of $10,000.00 with interest at the rate

of 12.0% per annum.

John Caldwell
signed
title CFO, Porter Company
Porter Company is replacing an existing Accounts Receivable with this
McGraw-Hill/Irwin Note Receivable with Hall Company.
© The McGraw-Hill Companies, Inc., 2008
 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue

On November 1, 2007, Hall Company

would make the following entry.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue
•• Interest
Interest is
is aa charge
charge made
made for
for
the
the use
use of
of money.
money.
•• The
The borrower
borrower incurs
incurs interest
interest
expense.
expense.
•• The
The lender
lender earns
earns interest
interest Interest
revenue.
revenue. rates
down!

Lender
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue

The
The interest
interest formula
formula includes
includes three
three
variables:
variables:
Interest = Principal × Interest Rate × Time
When
Whencomputing
computinginterest
interestfor
forone
oneyear,
year,“Time”
“Time”
equals
equals1.
1. When
Whenthethecomputation
computationperiod
periodis isless
less
than
thanone
oneyear,
year,then
then“Time”
“Time”isisaafraction.
fraction.
For
Forexample,
example,ififwe
weneeded
neededto tocompute
computeinterest
interestfor for
33months,
months,“Time”
“Time”would
wouldbebe 3/12
3
/12..

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue

What
What entry
entry would
would Hall
Hall Company
Company make
make on
on
December
December 31,
31, the
the fiscal
fiscal year-end?
year-end?

$10,00012% 
$10,00012% 60//360
60
= $200
360 = $200
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue

What
What entry
entry would
would Hall
Hall Company
Company
make
make on
on the
the maturity
maturity date?
date?
$10,00012% 
$10,00012% 90//360
90
360
=
= $300
$300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Notes
Notes Receivable
Receivable and
and Interest
Interest
Revenue
Revenue

IfIf Porter
Porter Company
Company defaulted
defaulted on
on the
the note,
note,
Hall
Hall Company
Company would
would make
make the
the following
following
entry
entry on
on the
the maturity
maturity date.
date.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To evaluate the liquidity of

a company’s accounts
receivable.

LO7
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Financial
Financial Analysis
Analysis and
and Decision
Decision
Making
Making

Accounts
Accounts Receivable
Receivable Turnover
Turnover Rate
Rate
This
This ratio
ratio provides
provides useful
useful information
information for
for
evaluating
evaluating howhow efficient
efficient management
management has has
been
been inin granting
granting credit
credit to
to produce
produce revenue.
revenue.

Net Sales
Average Accounts Receivable

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Financial
Financial Analysis
Analysis and
and Decision
Decision
Making
Making

Avg.
Avg. Number
Number ofof Days
Days to
to Collect
Collect A/R
A/R
This
This ratio
ratio helps
helps judge
judge the
the liquidity
liquidity of
of aa
company’s
company’s accounts
accounts receivable.
receivable.

Days in Year
Accounts Receivable Turnover Ratio

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Ethics,
Ethics, Fraud,
Fraud, and
and
Corporate
Corporate Governance
Governance

Accounts receivable is a significant account for

many companies. Accounts receivable is
particularly prone to misrepresentation because
revenue often increases when accounts receivable
increase. Manipulating accounts receivable can
result in the overstatement of both revenue and
income, which is the objective of many fraudulent
financial reporting schemes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 End
End of
of Chapter
Chapter 77

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008