Receivables and Short-Term Investments

1. Receivables and Short-Term Investments Chapter 5

2. Learning Objective 1 Understand short-term investments.

3. Short-Term Investments Short-term investments (marketable securities) are investments that a company plans to hold for one year or less. Most Canadian companies combine marketable securities with cash and cash equivalents on the balance sheet.

4. Short-Term Investments Suppose that Celestica Inc. purchases McCain Foods Ltd. shares on Dec. 18, paying $100,000, with the intention of selling the shares within a few months.

5. Short-Term Investments December 18 Short-Term Investment 100,000 Cash 100,000 Purchased investment On Dec. 27, Celestica receives a cash dividend of $4,000 from McCain.

6. Short-Term Investments Dec. 27 Cash 4,000 Dividend Revenue 4,000 Received cash dividend Celestica fiscal year ends on Dec. 31, and the investment in McCain has a current market value of $102,000 on this date.

7. Short-Term Investments Canadian GAAP does not permit the writing up of short-term investments to market to recognize an unrealized gain. Canadian GAAP requires that short-term investments be valued at the lower of cost or market (LCM). Most companies compare aggregate cost to aggregate market value.

8. Short-Term Investments If the investment in McCain shares had decreased to $95,000, then Celestica would have to record a loss: Dec. 27 Unrealized loss on STI 5,000 Short-term investment 5,000 To reduce STI to market value.

9. Reporting on the Balance Sheetand the Income Statement Balance Sheet Current Assets: $ XXX Cash XXX Short-term investments at market value 95,000 Accounts receivable XXX Income Statement Revenues $ XXX Expenses XXX Other revenues, gains, and (losses): Interest revenue XXX Dividend revenue 4,000 Unrealized loss on investment (5,000)

10. Accounts and Notes Receivable Receivables are the third most liquid asset – after cash and short-term investments. Receivables are monetary claims against others.

11. Types of Receivables Accounts receivable Notes receivable Other receivables (miscellaneous)

12. GENERAL LEDGER ACCOUNTS RECEIVABLE SUBSIDIARY RECORD Accounts Receivable Aston Bal. 9,000 Bal. 5,000 Harris Bal. 1,000 Salazar Bal. 3,000 Accounts Receivable

13. Learning Objective 2 Apply internal controls to receivables.

14. Establishing Internal ControlOver Collections Businesses that sell on credit receive most of their cash receipts by mail.

15. Establishing Internal ControlOver Collections Butler Supply Co. is a small business that makes 90% of its sales on account. The office staff consists of a bookkeeper and a supervisor.

16. Establishing Internal ControlOver Collections The bookkeeper maintains the general ledger and the accounts receivable subsidiary ledger. He also makes the daily bank deposits. The supervisor prepares monthly financial statements and special reports. She also takes sales orders from customers and serves as office manager.

17. Establishing Internal ControlOver Collections What are some controls over accounts receivable? Separation of duties Control over mail receipts Approval for write-off

18. Learning Objective 3 Use the allowance method for uncollectible receivables.

19. Accounting forUncollectible Receivables Selling on credit creates both a benefit and a cost: The benefit: Customers who cannot pay cash immediately can buy on credit, so company profits rise as sales increase. The cost: The company will be unable to collect from some credit customers.

20. The Allowance Method The allowance method records collection losses on the basis of estimates, not waiting to see which customers will not pay. The Allowance for Uncollectible Accounts (Allowance for Doubtful Accounts) is a contra account to Accounts Receivable.

21. The Allowance Method Balance Sheet (partial) Accounts receivable $10,000 Less: Allowance for uncollectible accounts – 900 Accounts receivable, net $ 9,100 Income Statement (partial) Expenses: Uncollectible-account expense $ 2,000

22. Methods for Estimating Uncollectibles Percentage-of-sales Aging-of-Receivables

23. Percentage-of-Sales It computes uncollectible-account expense as a percentage of revenue. This method is also called the income-statement approach.

24. Percentage-of-Sales June 30, 2002 (in millions) Accounts Receivable Allowance for Uncollectible Accounts Bal. 33 0.7

25. Percentage-of-Sales The credit department estimates that uncollectible-account expense is 0.5% of total revenues, which were $152 for 2002. June 30 (in millions) Uncollectible-Account Expense ($152× 0.005) 0.8 Allowance for Uncollectible Accounts 0.8 Recorded expense for the year

26. Percentage-of-Sales June 30, 2002 (in millions) After Adjustment Accounts Receivable Allowance for Uncollectible Accounts Bal. 33 0.7 0.8 1.5

27. Aging-of-Receivables This method is a balance-sheet approach because it focuses on accounts receivable. Individual receivables from specific customers are analyzed based on how long they have been outstanding.

28. June 30, 2002 (in millions) Accounts Receivable Allowance for Uncollectible Accounts Bal. 33 0.6 Aging-of-Receivables Accounts before the year-end adjustment:

29. Aging-of-Receivables Aging the Accounts Receivable Days Overdue 1-30 days 31-60 days 61-90 days 91 + days Accounts Receivable $ 16.5 12.2 3.6 0.7 $ 33.0 Estimated % Uncollectible 2 5 10 35 Allowance for Uncollectible Accounts $ 0.33 0.61 0.36 0.20 $ 1.50

30. June 30, 2002c(in millions) Accounts Receivable Allowance for Uncollectible Accounts Bal. 33 0.6 Adj. 0.9 1.5 Aging-of-Receivables Uncollectible-Account Expense 0.9 Allowance for Uncollectible Accounts ($ 1.5 - $ 0.6) 0.9 Recorded expense for the year Accounts after the year-end adjustment:

31. Writing OffUncollectible Accounts Suppose that early in 2003, the credit department determines that the company cannot collect from two customers. These accounts must be written off. How?

32. Writing OffUncollectible Accounts Allowance for Uncollectible Accounts 0.5 Accounts Receivable Customer # 0.3 Accounts Receivable Customer # 0.2 Wrote off uncollectible receivables

33. Combining the Percentage-of-Sales and the Aging Methods For interim statements (monthly or quarterly), companies use the percentage-of-sales method because it is easier to apply. At the end of the year, companies use the aging method to ensure that Accounts Receivable is reported at net realizablevalue.

34. Adjusts Allowance for Uncollectible Accounts Adjusts Allowance for Uncollectible Accounts BY TO Amount of UNCOLLECTIBLE- ACCOUNT EXPENSE Amount of UNCOLLECTIBLE RECEIVABLES Comparing the Percentage-of-Salesand Aging Methods Allowance Method Percentage-of-Sales Method Aging-of-Receivables Method

35. Direct Write-Off Method Using this method, an account is written off only when it is decided that a specific customer’s receivable is uncollectible. January 2, 2004 Uncollectible-Account Expense 2,000 Accounts Receivable – Jones Inc. 2,000 Wrote off a bad account

36. Since no allowance for uncollectibles is established, assets are overstated on the balance sheet. 1 It causes a poor matching of uncollectible- account expense against revenue and overstates net income. 2 Direct Write-Off Method This method is defective for two reasons:

37. Learning Objective 4 Account for notes receivable.

38. Note Notes Receivable Notes receivable are more formal than accounts receivable. The creditor has a note receivable. The debtor has a note payable.

39. Notes Receivable The principal amount of the note is the amount borrowed by the debtor. The maker pays the payee the maturity value. The maturity value includes principal plus interest.

40. Interest period starts PROMISSORY NOTE $1,000 August 31, 2005 Amount For value received, I promise to pay to the order of Alberta Treasury Branches Edmonton, Alberta One thousand and no/100……………………Dollars on February 28, 2006 plus interest at the annual rate of 9 percent Principal Payee (creditor) Interest rate Interest period ends on the maturity date Maker (Debtor) Notes Receivable

41. Accounting for Notes Receivable Alberta Treasury entry is as follows: August 31, 2005 Note Receivable 1,000 Cash 1,000 Made a loan How much interest revenue is accrued at December 31?

42. Accounting for Notes Receivable Interest = Principal × Rate × Time $1,000 × 9% × 4/12 = $30 December 31, 2005 Interest Receivable 30 Interest Revenue 30 Accrued interest revenue

43. Accounting for Notes Receivable The bank collects the note on February 28, 2006. February 28, 2006 Cash 1,045 Note Receivable 1,000 Interest Receivable 30 Interest Revenue ($1,000 × 9% × 2/12) 15 Collected note at maturity

44. How to Speed Up Cash Flow Credit card or bankcard sales Selling receivables Discounting notes receivable

45. How to Speed Up Cash Flow Recording a credit card or bankcard sale. Cash 97,000 Financing Expense 3,000 Sales Revenue 100,000 To record a credit card sale of $100,000 and a 3% financing expense

46. How to Speed Up Cash Flow Recording the sale of receivables. Cash 95,000 Financing Expense 5,000 Trade (Accounts) Receivable 100,000 Sold accounts receivable

47. How to Speed Up Cash Flow Discounting notes receivable Credit Notes Receivable instead of Trade or Accounts Receivable. If the maker of the note fails to pay the maturity value to the new payee, then the original payee legally must pay the bank the amount due.

48. Learning Objective 5 Use the days’ sales in receivables and the acid-test ratio to evaluate financial position.

49. Days’ Sales in Receivables One day’s sales = Net sales ÷ 365 days = 10,860 ÷ 365 = 29.75 per day Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales = [(2,534 + 2,432) ÷ 2] ÷ 29.75 = 83 days A smaller number indicates a quick conversion to cash.

50. Acid-Test Ratio This is a stringent test of liquidity which measures the entity’s ability to pay its current liabilities immediately. Acid-test ratio = (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities = (4,449 + 1,438 + 2,432) ÷ 3,916 = 2.12 This ratio value is extremely high and indicates great liquidity for this company.