Current Assets

Current Assets

Prepaid
Cash Receivables Inventory
Expenses
Claims held against customers Inventory classification
Examples: coin, Common prepaid
and others for money, goods, (merchandiser or
currency, available expenses included :
or services. manufacturer)
funds on deposit at the prepaid rent, prepaid,
bank, money orders, Inventories control insurance,
certified checks, Oral promises of (perpetual or periodic advertising, taxes, &
cashier’s checks, the purchaser to system) office or operating
personal checks, bank pay for goods and Valuation of inventories: supplies
drafts and services sold.
• Physical goods in
savings accounts
Accounts inventory (goods in Reporting:
Receivable Written promises transit, consigned goods,
Company report
What is cash? to pay a sum of special sales agreement
prepaid expenses at
Management Recognition of money on a • Costs included in the amount of the
Acc Receivables specified future inventory (product costs,
and control of unexpired or
(trade & cash date. period costs, purchase unconsumed cost.
cash discounts) discounts)
Reporting Reporting Rec.: Notes
• Cost Flow Assumptions
cash Uncollectible? Receivable
(specific identification,
Cash-related Recognition & average cost, FIFO,
reporting LIFO)
items
Notes? Inventory errors
 Cash
What is Cash?
A financial asset—also a financial instrument.
Financial Instrument - Any contract that gives rise to a
financial asset of one entity and a financial liability or
equity interest of another entity.
Types of Assets
 Cash
What is Cash?

► Most liquid asset.

► Standard medium of exchange.

► Basis for measuring and accounting for all other items.

► Current asset.

Examples: coin, currency, available funds on deposit at the

bank, money orders, certified checks, cashier’s checks, personal
checks, bank drafts and savings accounts.
 Cash
Reporting Cash

Cash Equivalents
Short-term, highly liquid investments that are both
(a) readily convertible to cash, and

(b) so near their maturity that they present insignificant

risk of changes in interest rates.

Examples: Treasury bills, commercial paper, and money market

funds.
 Cash
Restricted Cash

When material in amount:

Segregate restricted cash from “regular” cash.

Current assets or non-current assets

Examples, restricted for: (1) plant expansion, (2) retirement of

long-term debt, and (3) compensating balances.
 Cash
Bank Overdrafts

When a company writes a check for more than the

amount in its cash account.

Generally reported as a current liability.

Offset against cash account only when available cash is

present in another account in the same bank on which
the overdraft occurred.
 Cash
Summary of Cash-Related Items
 Accounts Receivable
Receivables are claims held against customers and
others for money, goods, or services.

Oral promises of the Written promises to pay a

purchaser to pay for goods sum of money on a specified
and services sold. future date.

Accounts Notes
Receivable Receivable
 Accounts Receivable
Non-trade Receivables
1. Advances to officers and employees.
2. Advances to subsidiaries.
3. Deposits to cover potential damages or losses.
4. Deposits as a guarantee of performance or payment.
5. Dividends and interest receivable.
6. Claims against:
a) Insurance companies for casualties sustained.
b) Defendants under suit.
c) Governmental bodies for tax refunds.
d) Common carriers for damaged or lost goods.
e) Creditors for returned, damaged, or lost goods.
f) Customers for returnable items (crates, containers, etc.).
 Accounts Receivable
Non-trade Receivables Receivables Statement
of Financial Position
Presentations
 Accounts Receivable
Recognition of Accounts Receivable

Trade Discounts
Reductions from the list price
10 %
Not recognized in the Discount
accounting records for new
Customers are billed net of Retail
discounts Store
Customer
s
 Accounts Receivable
Recognition of Accounts Receivable

Cash Discounts
(Sales Discounts)
Inducements for prompt
payment Payment
terms are
Gross Method vs. Net Method 2/10, n/30
 Accounts Receivable
Valuation of Accounts Receivables
Classification

Valuation (cash realizable value)

Uncollectible Accounts Receivable

Sales on account raise the possibility of accounts not

being collected.
Valuation of Accounts Receivables

Uncollectible Accounts Receivable

An uncollectible account receivable is a loss of revenue

that requires,
 a decrease in the asset accounts receivable and
 a related decrease in income and shareholders’
equity.
Valuation of Accounts Receivables

Methods of Accounting for Uncollectible Accounts

Direct Write-Off Allowance Method

Theoretically undesirable: Losses are Estimated:
No matching Percentage-of-sales
Receivable not stated at Percentage-of-receivables
cash realizable value
IFRS requires when material
Not IFRS when material in in amount
amount
Uncollectible Accounts Receivable

Emphasis on
the Income
Statement

Emphasis on
the Statement
of Financial
Position
Uncollectible Accounts Receivable
Percentage-of-Sales Approach

Percentage based upon past experience and

anticipate credit policy.

Achieves proper matching of costs with revenues.

Existing balance in Allowance account not

considered.
 Accounts Receivable
Impairment Evaluation Process
Companies assess their receivables for impairment each
reporting period. Possible loss events are:
1. Significant financial problems of the customer.

2. Payment defaults.

3. Renegotiation of terms of the receivable due to

financial difficulty of the customer.
4. Decrease in estimated future cash flows from a group
of receivables since initial recognition, although the
decrease cannot yet be identified with individual
assets in the group.
 Accounts Receivable
Impairment Evaluation Process
 A receivable is considered impaired when a loss event
indicates a negative impact on the estimated future cash
flows to be received from the customer.
 The IASB requires that the impairment assessment should be
performed as follows.
1. Receivables that are individually significant should be
considered for impairment separately.
2. Any receivable individually assessed that is not considered
impaired should be included with a group of assets with
similar credit-risk characteristics and collectively assessed
for impairment.
3. Any receivables not individually assessed should be
collectively assessed for impairment.
 Notes Receivable
Supported by a formal promissory note.
A negotiable instrument.

Maker signs in favor of a Payee.

Interest-bearing (has a stated rate of interest) OR

Zero-interest-bearing (interest included in face

amount).
 Notes Receivable
Generally originate from:

Customers who need to extend payment period of an

outstanding receivable.

High-risk or new customers.

Loans to employees and subsidiaries.

Sales of property, plant, and equipment.

Lending transactions (the majority of notes).

Recognition of Notes Receivable

Short-Term Long-Term
Record at Record at
Face Value, Present Value
less allowance of cash expected
to be collected

Interest Rates Note Issued at

Stated rate = Market rate Face Value
Stated rate > Market rate Premium
Stated rate < Market rate Discount
 Notes Receivable
Notes Received for Property, Goods, or Services

In a bargained transaction entered into at arm’s length, the

stated interest rate is presumed to be fair unless:

1. No interest rate is stated, or

2. Stated interest rate is unreasonable, or

3. Face amount of the note is materially different from the

current cash sales price.
 Notes Receivable
Valuation of Notes Receivable
Short-Term reporting parallels that for trade accounts
receivable.

Long-Term - impairment tests are often done on an

individual assessment basis. Impairment losses are
measured as the difference between the carrying value of
the receivable and the present value of the estimated future
cash flows discounted at the original effective-interest rate.
 Special Issues Related To Receivables
Fair Value Option
Companies have the option to record fair value in their accounts for
most financial assets and liabilities, including receivables. [6]

The IASB believes that fair value measurement for financial

instruments provides more relevant and understandable information
than historical cost because it reflects the current cash equivalent
value of financial instruments.

[6] International Accounting Standard 39, Financial Instruments: Recognition and Measurement
(London, U.K.: International Accounting Standards Committee Foundation, 2003), paras. IN16 and 9.
 Special Issues Related To Receivables
Fair Value Measurement
► Receivables are recorded at fair value.
► Unrealized holding gains or losses reported as
part of net income.
► If a company elects the fair value option for a
receivable, it must continue to use fair value
measurement for that receivable until the company
no longer owns this receivable.
 Special Issues Related To Receivables
Fair Value Measurement
► Receivables are recorded at fair value on the statement
of financial position.
► Unrealized holding gains or losses reported as part
“Other income and expense” on the income statement.
► If a company elects the fair value option, it must
continue to use fair value measurement for that receivable.
► If the company does not elect the fair value option at
the date of recognition, it may not use this option on that
specific receivable in subsequent periods.
 Valuation of Inventories:
Cost-Basis Approach

Physical Goods
Cost Included in Cost Flow
Inventory Issues Included in
Inventory Assumptions
Inventory

Classification Goods in transit Product costs Specific

Cost flow Consigned goods Period costs identification

Control Special sales Purchase Average cost

Basic inventory agreements discounts FIFO

valuation Inventory errors Summary analysis
 Inventory Issues
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory

Merchandiser or Manufacturer
 Inventory Issues
Classification

One inventory
account.

Purchase goods in
form ready for
sale.
 Inventory Issues
Classification

Three accounts

• Raw materials

• Work in process

• Finished goods
 Inventory Issues
Inventory Cost Flow
 Inventory Issues
Inventory Cost Flow

Companies use one of two types of systems for maintaining inventory

records — perpetual system or periodic system.
Inventory Cost Flow

Perpetual System

1. Purchases of merchandise are debited to Inventory.

2. Freight-in is debited to Inventory. Purchase returns
and allowances and purchase discounts are credited
to Inventory.
3. Cost of goods sold is debited and Inventory is
credited for each sale.
4. Subsidiary records show quantity and cost of each
type of inventory on hand.
The perpetual inventory system provides a continuous
record of Inventory and Cost of Goods Sold.
Inventory Cost Flow

Periodic System

1. Purchases of merchandise are debited to Purchases.

2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:

Beginning inventory $ 100,000

Purchases, net 800,000
Goods available for sale 900,000
Ending inventory 125,000
Cost of goods sold $ 775,000
 Basic Issues in Inventory Valuation

Valuation requires determining

The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).

The costs to include (product vs. period costs).

The cost flow assumption (specific Identification,

average cost, FIFO, retail, etc.).
Lower-of-Cost-or-Net Realizable Value
Net Realizable Value
Estimated selling price in the normal course of
business less estimated costs to complete and
estimated costs to make a sale.
 Inventories: Additional Valuation Issues

Lower-of-Cost-
Retail
or-Net Valuation Gross Profit Presentation
Inventory
Realizable Bases Method and Analysis
Method
Value (LCNRV)

Net realizable Special Gross profit Concepts Presentation

value valuation percentage Conventional Analysis
Illustration of situations Evaluation of method
LCNRV Relative sales method Special items
Application of value Evaluation of
LCNRV Purchase method
Recording net commitments
realizable
value
Use of an
allowance
Recovery of
inventory loss
Evaluation of
rule
Lower-of-Cost-or-Net Realizable Value
Methods of Applying LCNRV
► In most situations, companies price inventory on an
item-by-item basis.
► Tax rules in some countries require that companies use
an individual-item basis.
► Individual-item approach gives the lowest valuation for
statement of financial position purposes.
► Method should be applied consistently from one period
to another.
Lower-of-Cost-or-Net Realizable Value
Evaluation of LCM Rule
Some Deficiencies:
 Decreases in the value of the asset and the charge to expense are
recognized in the period in which the loss in utility occurs—not in the
period of sale.
 Increases in the value of the asset (in excess of original cost) recognized
only at the point of sale.
 Inconsistency because a company may value inventory at cost in one
year and at net realizable value in the next year.
 LCNRV values inventory conservatively. Net income for the year in
which a company takes the loss is definitely lower. Net income of the
subsequent period may be higher than normal if the expected
reductions in sales price do not materialize.
 Presentation and Analysis
Presentation of Inventories
Accounting standards require disclosure of:
(1) Accounting policies adopted in measuring inventories,
including the cost formula used (weighted-average, FIFO).
(2) Total carrying amount of inventories and the carrying
amount in classifications (merchandise, production supplies,
raw materials, work in progress, and finished goods).
(3) Carrying amount of inventories carried at fair value less costs
to sell.
(4) Amount of inventories recognized as an expense during the
period.
 Presentation and Analysis
Presentation of Inventories
Accounting standards require disclosure of:
(1) Amount of any write-down of inventories recognized as an
expense in the period and the amount of any reversal of
write-downs recognized as a reduction of expense in the
period.
(2) Circumstances or events that led to the reversal of a write-
down of inventories.
(3) Carrying amount of inventories pledged as security for
liabilities, if any.
 Presentation and Analysis
Analysis of Inventories
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days to
sell the inventory.
 Presentation and Analysis
Inventory Turnover Ratio
Measures the number of times on average a company
sells the inventory during the period.

Illustration: In its 2009 annual report Tate & Lyle plc (GBR)
reported a beginning inventory of £562 million, an ending
inventory of £538 million, and cost of goods sold of £2,019 million
for the year.
Illustration 9-25
END