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Chapter 6

Chapter 6. Investments and Receivables. Financial Accounting, Alternate 4e by Porter and Norton. highly liquid. selling on credit. PepsiCo Inc. Consolidated Balance Sheet (partial). ASSETS (in millions) Dec. 28 Dec. 29 2002 2001 . Current Assets:

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Chapter 6

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  1. Chapter 6 Investments and Receivables Financial Accounting, Alternate 4e by Porter and Norton

  2. highly liquid selling on credit PepsiCo Inc. Consolidated Balance Sheet (partial) ASSETS (in millions) Dec. 28 Dec. 29 2002 2001 . Current Assets: Cash and cash equivalents $1,638 $ 683 Short-term investments, at cost 207 966 1,845 1,649 Accounts & notes receivable 2,531 2,142 Inventories 1,342 1,310 Prepaid expenses & other assets 695 752 Total Current Assets $6,413 $5,853

  3. Highly Liquid Less Liquid PepsiCo Inc.Consolidated Balance Sheet (partial) ASSETS (in millions) Current Assets: Cash and cash equivalents Short-term investments, at cost Accounts and notes receivable Inventories Prepaid expenses & other assets Total Current Assets

  4. Investment in CD Example: Invest $100,000 in a 120-day CD. Principal plus interest @ 6% due upon investment maturity. Assets = Liab. + O/E + Rev. – Exp. Short-term Inv. – CD 100,000 Cash (100,000) 4

  5. Investment in CD Year-end adjusting entry : Assets = Liab. + O/E + Rev. – Exp. Interest Rec. 1,500 Interest Inc. 1,500 Interest = Principal x Rate x Time $1,500 = $100,000 x 6% x 90/360 October – 29 days November – 30 days December – 31 days 90 days 5

  6. Investment in CD Upon investment maturity: Assets = Liab. + O/E + Rev. – Exp. Cash 102,000 Interest Inc. 500 Short-Term Inv. – CD 100,000 Interest Rec. 1,500 Interest earned in January: $100,000 x 6% x 30/360 = $500 6

  7. Reasons Companies Invest in Other Companies • Short-term cash excesses • Long-term investing for future cash needs • Exert influence over investee • Obtain control of investee

  8. Fair Value Method Equity Method Consolidated F/S 0% 20% 50% 100% No significant influence Significant influence Control Accounting for Common-Stock Investments Our Focus

  9. Use fair value method to account for these investments Investments Without Significant Influence • Held-to-Maturity Securities • Trading Securities • Available-for-Sale Securities

  10. $100,000 9% Bond Due 2019 Held-to-Maturity Securities • Bonds of other companies • Intent and ability to hold until maturity

  11. Held-to-Maturity Securities Example: On 1/1/04, Homer buys: • $100,000; 10% bonds @ face value. • Bonds mature December 31, 2013 • Interest payable semiannually . Record the purchase of the bonds and receipt of the first interest payment

  12. $100,000 10% Bond Due 2014 Recording Bond Purchase Assets = Liab. + O/E + Rev. – Exp. Inv. in Bonds 100,000 Cash (100,000)

  13. Interest for Investor Borrower Recording Receipt of Interest Payment Assets = Liab. + O/E + Rev. – Exp. Cash 5,000 Interest Inc. 500

  14. Interest for Investor Borrower Recording Bond Sale Assets = Liab. + O/E + Rev. – Exp. Cash 99,000 Loss on Sale of Bonds 1,000 Inv. in Bonds (100,000)

  15. Stocks Bonds • Intent to sell in near term (classified as current assets) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Trading Securities • Purchased to generate profit from short-term appreciation

  16. Stocks Bonds • Unrealized gain or loss recognized on income statement Income Statement Trading Securities • At end of each period, security is “marked to market”

  17. Trading Securities Example: Dexter Corp. holds the following trading securities at 12/31/04: Cost Market Menlo preferred stock $25,000 $27,500 Canby common stock 40,000 39,000 Record the unrealized gain or loss at 12/31/04.

  18. Recording Unrealized Gain or Loss on Trading Securities Assets = Liab. + O/E + Rev. – Exp. Inv. in Menlo Unrealized Gain – Pref. Stock 2,500 Trading Sec.* 1,500 Inv. in Canby Pref. Stock (1,000) * income statement account

  19. Stocks Bonds • Can be classified as short-term or long-term, depending on expected date of disposition Available-for-Sale Securities • Securities not classified as held-to-maturity or trading

  20. Stocks Bonds • Unrealized gain or loss accumulated in stockholders’ equity account Balance Sheet Available-for-Sale Securities • Also “marked to market” at end of accounting period

  21. Available-for-Sale Securities Example: Lenox Corp. holds the following AFS securities at 12/31/04: CostMarket Adair preferred stock $15,000 $16,000 Casey common stock 35,000 32,500 Record the unrealized gain or loss at 12/31/04.

  22. Recording Unrealized Gain or Loss on AFS Securities Assets = Liab. + O/E + Rev. – Exp. Inv. in Adair Unrealized Gain/Loss Pref. Stock 1,000 – AFS Sec.* (1,500) Inv. in Casey Com. Stock (2,500) * part of Stockholders’ Equity

  23. Accounting for Investments Without Significant Influence Recognize Report Report FV Categories as income on BS at changes on Held-to-maturity interest cost N/A Trading interest, div. fair value Income stmt. Avail.-for-Sale interest, div. fair value Balance sheet

  24. Terms: 2/10, net 30 Sales Invoice Credit Sales • Slows inflow of cash • Risk of uncollectible accounts Trade Credit Retail Customer Receivables

  25. Menkhaus Corporation Sample Accts. Rec. Subsidiary Ledger In 000s Total Due ABC Distributors $ 25 HIJ Distributors 336 : : : : XYZ Distributors 108 $ 1,105 Gross Accounts Receivable

  26. Winnebago Industries, Inc.Consolidated Balance Sheet (partial) 20022001 Receivables, less allowance for doubtful accounts ($120 and $244, respectively) $28,616 $21,571 Estimated Uncollectible Accounts Net Realizable Value

  27. Future Period charged with expense of bad debt write-off 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Accounting for Bad Debts:Direct Write-off Method Period of Sale Adjustment to write off uncollectible account: Assets = Liab. + O/E + Rev. – Exp. Accts. Rec. Bad Debts – Dexter (500) Exp. (500)

  28. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Accounting for Bad Debts: Allowance Method Period of Sale Estimated bad debt expense (and allowance account) recorded in same period

  29. Balance Sheet Presentation - Allowance Method Roberts Corp. Partial Balance Sheet Current assets: Accounts receivable $ 250,000 Less: Allowance for doubtful accounts ( 6,000) Net accounts receivable $ 244,000

  30. Accounting for Bad Debts:Allowance Method Adjustment for estimated bad debt expense : Assets = Liab. + O/E + Rev. – Exp. Allow. for Bad Debts Doubtful Exp. (6,000) Accts (6,000) I estimate...

  31. Accounting for Bad Debts:Allowance Method Adjustment to write off uncollectible account: Assets = Liab. + O/E + Rev. – Exp. Allow. for Doubtful Accts 500 Accts. Rec. – Dexter (500) Bankrupt

  32. Approaches to Allowance Method % of Net Credit Sales % of Accounts Receivable • Aging Method Income Statement Approach Balance Sheet Approach

  33. Percentage of Net Credit Sales Method Example: Assume prior years’ net credit sales and bad debt expense are as follows: YearNet credit salesBad debts 1999 $1,250,000 $ 26,400 2000 1,340,000 29,350 2001 1,200,000 23,100 2002 1,650,000 32,150 2003 2,120,000 42,700 $7,560,000 $153,700

  34. Percentage of Net Credit Sales Method Example: Develop bad debt percentage: $153,700 $7,560,000 = 0.02033 use 2%

  35. Percentage of Net Credit Sales Method Example: 2004 Net credit sales (given) $2,340,000 Bad debt percentage 2% Bad debts expense 46,800 Assets = Liab. + O/E + Rev. – Exp. Allow. for Bad Debts Doubtful Exp. (46,800) Accts (46,800)

  36. Est. Percent Est. Amount CategoryAmountUncollectibleUncollectible Current $ 85,600 1% $ 856 Past due: 1-30 days 31,200 4% 1,248 31-60 days 24,500 10% 2,450 61-90 days 18,000 30% 5,400 90+ days 9,200 50% 4,600 Totals $168,500 $14,554 Aging Method 36

  37. Aging Method To determine the amount recognized as bad debts: Bal. required in allow. acct. after adj. $14,554 Less: Bal. in allow. acct. before adj. 1,230 Amount of adjustment $13,324

  38. Aging Method Example Adjustment for estimated bad debt expense : Assets = Liab. + O/E + Rev. – Exp. Allow. for Bad Debts Doubtful Exp. (13,324) Accts (13,324)

  39. % of Net Sales Computes bad debt expense Aging Computes ending balance in the allowance account Comparison of Methods

  40. Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable Indicates how quickly a company is collecting (i.e., turning over) its receivables

  41. Too fast credit policies too stringent; may be losing sales Too slow credit department not operating effectively; dissatisfied customers Accounts Receivable Turnover

  42. Principal Interest Maturity Date Interest-Bearing Promissory Note Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on March 13, 2005. Date: December 13, 2004 Signed:_________ Baker Corporation

  43. In exchange for $9,000 applied toward my purchase today, I promise to pay $9,900 in six months. Date: November 1, 2004 Signed:_________ J.E. Privett Non-Interest-Bearing Promissory Note Effective interest rate on note = 20% $900 12 $9,000 x 6

  44. Discount transferred to interest revenue over life of note Balance Sheet Presentation of Discounted Notes 12/31/044/30/05 Notes receivable $ 9,900 $ 9,900 Less: Discount on notes receivable ( 600) - 0 - $ 9,300 $ 9,900 Upon Maturity

  45. Accelerating Cash Inflow From Sales • Sales Discounts • Credit Card Sales • Discounting Notes Receivable

  46. Credit Card Sales • Competitive necessity • Credit card company: • Charges fee • Assumes risk of nonpayment

  47. Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on December 31, 1998. Date: January 1, 1998 Signed:_________ Baker Corporation Discounting Notes Receivable • Sell note prior to maturity date for cash • Receive less than face value (i.e., discounted amount) • Can be sold with or without recourse

  48. Liquid Assets and the Statement of Cash Flows - Indirect Method Operating Activities Net income xxxx Increase in accounts receivable - Decrease in accounts receivable + Increase in notes receivable - Decrease in notes receivable + Investing Activities Purchases of held-to-maturity and available-for-sale securities - Sales/maturities of held-to-maturity and available-for-sale securities + Financing Activities 48

  49. End of Chapter 6

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