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Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

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Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

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    1. Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin

    2. 7- 2 Chapter 7 Accounting for Accruals: Advanced Topics- Receivables and Payables

    3. 7- 3 Advanced topics include: Accounting for bad debts Accounting for interest-bearing notes and noninterest bearing (discounted) notes Warranties

    4. 7- 4 Accounts and Notes Receivable A/R are the expected future cash receipts of a company. They are typically small and are expected to be received within 30 days. N/R are used when longer credit terms are necessary. The promissory note specifies the maturity date, the rate of interest, and other credit terms.

    5. 7- 5 Value of Receivables Receivables are reported at their face value less an allowance for accounts which are likely to be uncollectible. The amount which is actually expected to be collected is called the net realizable value (NRV).

    6. 7- 6 Allowance Method vs. Direct Write-Off Method GAAP requires that A/R be reported at NRV. (A/R minus Allowance) This is done using a valuation allowance: An ALLOWANCE METHOD. % of Sales (or “Income Statement”) approach. Aging (or “Balance Sheet”) approach. With the ALLOWANCE METHOD, an estimate of the amount that will NOT be collected is recorded in the same period that the sales revenue is recorded. Thus,

    7. 7- 7 Allowance Method vs. Direct Write-Off Method (continued) The DIRECT WRITE-OFF method violates GAAP because it does NOT follow the MATCHING principle. With the Direct Write-off method, no estimate of bad debts is recorded at the time of the sale. Rather, only after a specific account is deemed “uncollectible” is a Bad Debt Expense recorded. Since GAAP is only required if the amounts are MATERIAL (significant), if the amount of uncollectible A/R is immaterial the Direct Write-off method may be used.

    8. 7- 8 Transaction Analysis: Assume the following selected events occurred at Cell-It. For each event: Determine how the accounting equation was affected and fill in the horizontal model. (Assume GAAP must be followed.) Determine the effect on the financial statements. Record the event in t-accounts.

    9. 7- 9 Transaction Analysis: The following selected events occurred at Cell-It during 2004. 1. Provided services to customers for $10,000 on account. 2. Collected $7,000 on account receivables. 3. At year-end it was estimated that 2% of year’s credit sales will never be collected. 4. Jane Doe’s $50 account was written-off as “uncollectible”. 5A&B. $50 cash is unexpectedly received from Jane Doe.

    10. 7- 10 Record the five transactions in this horizontal statements model. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 2 3 4 5A 5B Bal. ..

    11. 7- 11 Provided services to customers for $10,000 on account. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 2 3 4 5A 5B Bal. ..

    12. 7- 12 Provided services to customers for $10,000 on account. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 3 4 5A 5B Bal. ..

    13. 7- 13 2. Collected $7,000 from account receivable. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 3 4 5A 5B Bal. ..

    14. 7- 14 2. Collected $7,000 from account receivable. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    15. 7- 15 3. At year-end it was estimated that 2% of the year’s credit sales will not be collected. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    16. 7- 16 3. At year-end it was estimated that 2% of the year’s credit sales will not be collected. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    17. 7- 17 4. Jane Doe’s $50 account was written-off as uncollectible. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    18. 7- 18 4. Jane Doe’s $50 account was written-off as uncollectible. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    19. 7- 19 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $ A/R $ Allow. Allow. N.R.V. $ N.R.V. $

    20. 7- 20 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 Allow. (200) N.R.V. $2,800

    21. 7- 21 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 A/R $ Allow. (200) Allow. N.R.V. $2,800 N.R.V. $

    22. 7- 22 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 A/R $2,950 Allow. (200) Allow. (150) N.R.V. $2,800 N.R.V. $2,800 When using an ALLOWANCE method, the Net Realizable Value of accounts receivable does not change as a result of the write-off.

    23. 7- 23 Before recording Transaction #5: What happens when an account that has been written off later pays off his/her account? Reinstate the account by recording an entry that undoes (reverses) the write-off: increase (debit) Accounts Receivable increase (credit) Allowance for Doubtful Accounts (a contra-asset) Record the entry to show the cash collection and A/Rec. reduction: increase (debit) Cash decrease (credit) Accounts Receivable

    24. 7- 24 5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    25. 7- 25 5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    26. 7- 26 Calculate all ending balances. Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    27. 7- 27 What’s the result? After completing the horizontal model fill in below.

    28. 7- 28 Final Account Balances Remember, the Bad Debt EXPENSE is accrued in the year of sale, NOT when the account is written off! Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    29. 7- 29 What’s the result? After completing the horizontal model fill in below.

    30. 7- 30 Final Account Balances Net Realizable Value (NRV) = Acct.Rec. - Allowance Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 10000 10000 10000 10000 n.a. 2 7000 (7000) 7000 OA 3 4 5A 5B Bal. ..

    31. 7- 31 What’s the result? After completing the horizontal model fill in below.

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    41. 7- 41 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 A/R $2,950 Allow. (200) Allow. (150) N.R.V. $2,800 N.R.V. $2,800 Net realizable value of accounts receivable did not change as a result of the write-off.

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    49. 7- 49 Summary: Accounting for Bad Debts Allowance method GAAP Required if company has a significant amount of bad debts. Matches bad debt expense (on the income statement) with the sale. Requires an adjusting journal entry before closing the books.

    50. 7- 50 Summary: Accounting for Bad Debts Direct Write-off method Violates GAAP (Matching) No estimates of bad debts are made, so no allowance account is used. Used by small businesses with few account receivables or large business with few collection problems. No entry until time specific account is deemed “bad” (uncollectible).

    51. 7- 51 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method

    52. 7- 52 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method

    53. 7- 53 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method

    54. 7- 54 Accrued Liabilities: Warranty Costs Why give warranties? When should expense be recognized?

    55. 7- 55 Warranties…When to “expense”? General Principle According to GAAP, the entire estimated warranty expense must be recorded in the period the sale is made, NOT in the period when the actual warranty cost is paid. (Matching principle is being followed.) A warranty liability is recorded along with the expense. This liability is REDUCED whenever cash is paid to service a product still under warranty.

    56. 7- 56 Transaction Analysis The following selected warranty related events occurred at Cell-It. For each event: Determine how the financial statements are affected and fill in the horizontal model. Record each event directly in LEDGER accounts.

    57. 7- 57 Transaction Analysis The following selected events occurred at Cell-It. (Perpetual inventory method is used.) 1. On 1/1/04 sold merchandise for $5,000 cash that had originally cost $4,000. These goods were sold with a two-year warranty. 2. Estimated that $100 of warranty cost will be incurred over the next two years on the goods sold in #1. 3. During 2005 a customer returned for repair, goods still under warranty. The cost of the repair was $30 cash.

    58. 7- 58 Horizontal Model Transaction Analysis Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a

    59. 7- 59 1a. Sold (on 1/1/04 with 2 yr. warranty) for $5,000 cash, 1b. merchandise that originally cost $4,000. (perpetual inventory method is used.) Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    60. 7- 60 Before recording Transaction #2: Warranties…When to “expense” According to GAAP, the entire estimated warranty expense must be recorded in the period the sale is made, NOT in the period when the actual warranty cost is paid. (Matching principle is being followed.) A warranty liability is recorded along with the expense. This liability is REDUCED whenever cash is paid to service a product still under warranty.

    61. 7- 61 2. Estimated that $100 of warranty cost will be incurred over the next two years on the goods sold in #1. Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    62. 7- 62 3. During 2005 a customer returned for repair goods still under warranty. The cost of the repair was $30 cash. Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    63. 7- 63 SUMMARY QUESTIONS Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    64. 7- 64 SUMMARY QUESTIONS Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    65. 7- 65 SUMMARY QUESTIONS Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    66. 7- 66 SUMMARY QUESTIONS Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    67. 7- 67 SUMMARY QUESTIONS Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    68. 7- 68 SUMMARY QUESTIONS Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1a 1b ..

    69. 7- 69

    70. 7- 70 Notes Payable: Transaction Analysis

    71. 7- 71 Notes Payable: Transaction Analysis Assume the following events occurred at Cell-It. 1. On Oct. 1, 2004 Cell-It borrowed $8,000 cash by issuing a note payable with a one-year term and an 8% stated interest rate. All interest will be paid at maturity. This is an “interest bearing” note. 2. On Oct. 1, 2004 Cell-It issued an $8,000 face value, discounted note payable with a one-year term and an 8% stated discount rate. This is called a “Discounted” or “Non-interest bearing” note. 3. On Dec. 31, 2004 recorded interest related to the 8% interest-bearing note issued on Oct. 1st (see #1). 4. On Dec. 31, 2004 recorded interest related to the 8% discounted (non-interest bearing) note issued on Oct. 1st (see #2). 5. On Sept. 30, 2005 repaid the 8% non-discounted note payable (#1), plus all interest. 6. On Sept. 30, 2005 repaid the 8% discounted note payable (#2).

    72. 7- 72 Horizontal Model Transaction Analysis Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1

    73. 7- 73 T1: On Oct. 1, 2004 Cell-it borrowed $8,000 at 8% for 1 year on an interest bearing note. All interest to be paid at maturity. Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    74. 7- 74 T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    75. 7- 75 T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.) Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    76. 7- 76 T3: On Dec. 31, 2004 recorded interest related to the note in #1. Oct. 1-Dec. 31 = 3 mo. (8000 x .08 x 3/12=160) Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    77. 7- 77 T4: On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    78. 7- 78 T5: On Sept. 30, 2005 repaid the 8% note from Transaction #1 and all its interest. a= accrue the remaining interest. b= payment. (Jan. 1-Sept. 30 = 9 mo. (8000 x .08 x 9/12= $480) Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    79. 7- 79 T6: On Sept. 30, 2005 repaid the 8% discounted note payable from Trans. #2. a= accrue the remaining interest. b= payment. Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 ..

    80. 7- 80 Comparison of Journal Entries for Interest Bearing and Discounted Notes

    81. 7- 81 Comparison of Ledger Accounts for Interest Bearing and Discounted Notes

    82. 7- 82 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. No effect No effect +8,000 FA 2. No effect No effect +7,360 FA 3. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq, n.a. 4. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq. n.a. 5. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq. -8000FA,-640 OA

    83. 7- 83 Financial Statement Analysis Accounts Receivable Turnover

    84. 7- 84 Accounts Receivable Ratios Accts. Rec. Turnover: (A measure of how fast receivables are collected. Higher is better.) Sales $50,000 Accounts. Receiv. $ 5,000

    85. 7- 85 Chapter 7

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