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Learn how to account for short-term investments, including marketable securities and receivables. Understand the categories of investments, entry adjustments, market reporting, and internal controls over cash collections.
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Short-Term Investments & Receivables Pr. Zoubida SAMLAL
Learning Objective 1 Account for short-term investments
Accounting for Short-Term Investments • Also called marketable securities • Held for one year or less • Most liquid asset other than cash • Placed into three categories: Trading Investments Available-for-Sale Held-to-Maturity
Trading Investments • Held for short time and then sold • Gain or loss recorded • Dividend revenue may also be received • At year-end, trading investments are adjusted to equal their market value • Results in an unrealized gain or loss Selling price > cost = Gain Selling price < cost = Loss
Unrealized Gains & Losses • Difference between market price and cost of investment at year-end • Unrealized – investment has not been sold Market price > cost = Unrealized gain Market price < cost = Unrealized loss
Realized vs. Unrealized Realized • Investment sold to third party • Gain or loss = difference between selling price and cost • Word “realized” usually dropped from title Unrealized • Company still owns investment • Gain or loss = difference between market value and cost • Word “unrealized” is kept in account title
Reporting on Financial Statements Balance Sheet • Trading Investment • Reported at current market value • Listed directly under “cash” in the current asset section Income Statement • Gains and losses • From sales of investments • Investment revenue • From dividends or interest earned • Unrealized gain or loss • From entry to adjust to market value
Exercise 1 Part of your job responsibilities as a finance manager is to invest in short term trading investments. On 1 dec . You bought 1000 shares of XYZ company at USD 10 On 15 dec. You received a cash dividend of USD 1 per share On 31 dec the price of XYZ share dropped to USD 8 per share On 31 dec you decided to sell off all your investment at USD 8 per share Please post the account entries of each transaction How transaction 3 is different from transaction 4
Solution 1 ( con´t) How transaction 3 is different from transaction 4 -> Our transaction n° 3 is a readjustment to our investment or what we call mark to market our investment. --> Unrealized loss because the investment is not yet sold. -> Our transaction n° 4 is a sell off to our investment or selling at loss of 2USD (selling price–purchasing price or USD 8 – USD 10) . --> here we have a realized loss that we posted into our revenues account.
When Unrealized loss What would be the amount of the unrealized loss? Compute the difference between the cost and market value.
When realized loss Your selling price? Your loss= Sell- buy Initial purchase
When Unrealized Gain Compute the difference between the cost and market value. What would be the amount of the unrealized gain?
When realized Gain Your selling price? Your gain = Sell- buy Initial purchase
Learning Objective 2 Apply internal controls to receivables
Receivables • Monetary claims against others • Third most liquid asset • Accounts Receivable • Amounts owed by customers for selling goods or services • Notes Receivable • Lending money to outsiders • More formal than accounts receivable
Internal Control over Cash Collections on Account • Separate cash-handling from cash-accounting duties • Cash-handling • One person receives customer checks and makes deposits • Cash-accounting • Another person makes entries to customer accounts
Accounting for Uncollectible Receivables • Extending credit to customers bears some risk • Risk: Some customers do not pay the amount owed • Cost: Uncollectible accounts
Application exercise Case Perinity Inc. is a company that sells 50% of its product cash while. 80% of its credit sales are paid on time • What is the total amount of account receivable if the sales revenues are USD 1 million? • How much uncollectible does it have?
Learning Objective 3 Use the allowance method for uncollectible receivables
Allowance Method • Amount of uncollectible accounts is estimated • An expense is recorded as part of the adjusting process • A contra-asset is recorded that reduces accounts receivable on the balance sheet A contra-asset is always paired with an asset and reduces its balance
Entry to Record Uncollectible accounts Goes on the Income Statement Goes on the Balance Sheet netted with a A. receivable
Methods to Estimate Un-collectibles Percent-of-sales • Expense is estimated based on credit sales • Income Statement approach Aging-of-receivables • Accounts receivable analyzed based on how long outstanding • Balance Sheet approach
APPLICATION EXERCISE During the monthly closing of it’s A/R accounts, Perinity Inc posted its uncollected received classified by their age. The company has a beginning allowance balance of USD $7,400 . Is it sufficient or should it adjust its allowance?
Solution $37,150= Total Uncollected receivable
Solution Adjustment needed = Aging schedule - Balance
Solution Allowance for Uncollectible Accounts Balance before adjustment $7,400 Adjusting entry $29,750 Balance per aging schedule $37,150
Uncollectible Accounts Methods Percent-of-Sales Aging-of-Receivables Adjust Allowance for Uncollectible Accounts Adjust Allowance for Uncollectible Accounts BY TO The Amount of UNCOLLECTIBLE ACCOUNT EXPENSE The Amount of UNCOLLECTIBLE ACCOUNTS RECEIVABLE
The allowance is used to absorb specific accounts that are determined to uncollectible When it’s determined a customer cannot pay, the following entry is made: Writing Off a Specific Account
Learning Objective 4 Account for notes receivable
Notes Receivable Terms • Creditor • Debtor • Interest • Maturity Date • Maturity Value • Principal • Term Party to whom money is owed; lender Party that owes money; borrower Cost of borrowing money; percent Date debtor must pay the note Sum of principal and interest on note Amount borrowed by debtor Length of time money is borrowed
Accounting for Notes Receivable • To record the receipt of a note receivable, the following entry is made:
Accounting for Notes Receivable • Interest needs to be accrued on any note receivable outstanding at year end: Time = date note is signed to end-of-year Interest is computed by the formula: Principal x rate x time
ACCOUNTING FOR NOTES RECEIVABLE When payment is received on note, the following entry is made For maturity value For principal Zeroes out adjustment For remaining interest earned
Credit and Bank Card Sales • Credit Cards • American Express and Discover • Bank Cards • VISA and MasterCard • Both charge the retailer a fee
Learning Objective 5 Use two new ratios to evaluate a business
Days’ Sales in Receivables • How long it takes a company to collect its average amount of receivable • Compute one day’s sales • Days’ sales in receivables Net Sales 365 Days Average receivables One Day’s Sales
Acid-Test Ratio • Also called quick ratio which measures how much your short term assets represents in terms of short term liabilities • A more stringent measure of a company’s ability to pay its current liabilities Cash + Short-term investments + net receivables Total current liabilities
