Receivables and Short-Term

Investments

Learning Objective 1

Understand short-term

investments.

Short-Term Investments

Short-term investments are investments thata company plans to hold for one year or less.

– Held-to-maturity securities– Trading investments– Available-for-sale investments

Held-to-maturity and available-for-salesecurities could also be long-term.

Short-Term Investments

Held-to-maturity investments aresecurities that the investor expectsto hold until their maturity date.

They earn interest revenue for the investor.

Accounting for these securities is thesame as accounting for notes receivable.

Short-Term Investments

Suppose that Oracle Corporation purchasesFord Motor Company stock on May 18,paying $100,000, with the intention ofselling the stock within a few months.

Short-Term Investments

May 18Short-Term Investment 100,000

Cash 100,000Purchased investment

On May 27, Oracle receives a cashdividend of $4,000 from Ford.

Short-Term Investments

May 27Cash 4,000

Dividend Revenue 4,000Received cash dividend

Oracle fiscal year ends on May 31, andthe investment in Ford has a current

market value of $102,000 on this date.

Short-Term Investments

May 31Short-Term Investment 2,000

Unrealized Gain on Investments 2,000Adjusted investment to market value

Short-Term InvestmentsCost 100,000Adjustment to market value 2,000Balance 102,000

Reporting on the Balance Sheetand the Income Statement

Balance SheetCurrent Assets: $ XXX

Cash XXXShort-term investments at market value 102,000Accounts receivable XXX

Income StatementRevenues $ XXXExpenses XXXOther revenues, gains, and (losses):

Interest revenue XXXDividend revenue 4,000Unrealized gain on investment 2,000

Accounts and Notes Receivable

Receivables are the third most liquid asset – after cash and short-term investments.

Receivables are monetary claims against others.

Accounts receivable

Types of Receivables

Notes receivable

Other receivables(miscellaneous)

Accounts Receivable

GENERAL LEDGER

Accounts ReceivableBal. 9,000

ACCOUNTS RECEIVABLESUBSIDIARY RECORD

AstonBal. 5,000

Harris

Salazar

Bal. 1,000

Bal. 3,000

Learning Objective 3

Use the allowance method

for uncollectible receivables.

Accounting forUncollectible Accounts

Selling on credit creates both a benefit and a cost:

The benefit:Customers who cannot pay cash immediately

can buy on credit, so company profitsrise as sales increase.

The cost:The company will be unable to collect

from some credit customers.

The Allowance Method

The allowance method records collectionlosses on the basis of estimates, not waiting

to see which customers will not pay.

The Allowance for Uncollectible Accounts(Allowance for Doubtful Accounts) is acontra account to Accounts Receivable.

The Allowance Method

Balance Sheet (partial)Accounts receivable $10,000Less: Allowance for uncollectible accounts – 900Accounts receivable, net $ 9,100

Income Statement (partial)Expenses:Uncollectible-account expense $ 900

Methods for Estimating Uncollectibles

Percent-of-sales

Aging-of-Receivables

Percent-of-Sales

It computes uncollectible-accountexpense as a percentage of revenue.

This method is also called theincome-statement approach.

Percent-of-Sales

The credit department estimates thatuncollectible-account expense is 5% of

total revenues, which were $11 billion for 20x1.Dec 31 (in millions)Uncollectible-Account Expense($11,000 × 0.05) 550

Allowance for Uncollectible Accounts 550Recorded expense for the year

Percent-of-Sales

December 31, 20x1 (in millions)After Adjustment

Accounts ReceivableBal. 11,000

Allowance forUncollectible Accounts

550

Aging-of-Receivables

This method is a balance-sheet approachbecause it focuses on accounts receivable.

Individual receivables from specificcustomers are analyzed based on

how long they have been outstanding.

Aging-of-Receivables

December 31, 20x1 (in millions)

Accounts ReceivableBal. 2,835

Allowance forUncollectible Accounts

120

Accounts before the year-end adjustment:

Aging-of-Receivables

DaysOverdue 1-30 days31-60 days61-90 days91 + days

AccountsReceivable

$1,555 750 311 219$2,835

Estimated %Uncollectible

6102079

Allowance forUncollectible

Accounts$ 93 75 62 173$403

Aging the Accounts Receivable

Aging-of-Receivables

Accounts after the year-end adjustment:

Uncollectible-Account Expense 283Allowance for Uncollectible Accounts ($403 – $120) 283

Recorded expense for the year

December 31, 20x1 (in millions)

Accounts ReceivableBal. 2,835

Allowance forUncollectible Accounts

120Adj. 283

403

Writing OffUncollectible Accounts

Suppose that early in 20x2, the creditdepartment determines that the company

cannot collect from two customers.

These accounts must be written off.

Writing OffUncollectible Accounts

Allowance for Uncollectible Accounts 100Accounts Receivable Customer A 61Accounts Receivable Customer B 39

Wrote off uncollectible receivables

Direct Write-Off Method

An account is written offonly when it is decided that a specificcustomer’s receivable is uncollectible.

January 2, 20x4Uncollectible-Account Expense 2,000

Accounts Receivable – Jones 2,000Wrote off a bad account

Direct Write-Off Method

This method is defective for two reasons:

Since no allowance for uncollectiblesis established, assets are overstated

on the balance sheet.

It causes a poor matching of uncollectible-account expense against revenue

and overstates net income.

Learning Objective 4

Account for notes

receivable.

Notes Receivable

Notes receivable are more formalthan accounts receivable.

The creditor has a note receivable.

The debtor has a note payable.

Note

Notes Receivable

The principal amount of the note isthe amount borrowed by the debtor.

The maker pays the payee the maturity value.

The maturity value includes principal plus interest.

Notes Receivable

PROMISSORY NOTE

$1,000 August 31, 20x5Amount

For value received, I promise to pay to the order ofContinental bankChicago, Illinois

One thousand and no/100……………………Dollarson February 28, 20x6plus interest at the annual rate of 9 percent

Principal

Interest period starts

Payee(creditor)

Interestrate

Interest period endson the maturity date Maker (Debtor)

Accounting for Notes Receivable

Continental Bank entry is as follows:

August 31, 20x5Note Receivable 1,000

Cash 1,000Made a loan

How much interest revenueis accrued at December 31?

Interest = Principal × Rate × Time

Accounting for Notes Receivable

December 31, 20x5Interest Receivable 30

Interest Revenue 30Accrued interest revenue

$1,000 × 9% × 4/12 = $30

Accounting for Notes Receivable

February 28, 20x6Cash 1,045

Note Receivable 1,000Interest Receivable 30Interest Revenue ($1,000 × 9% × 2/12) 15

Collected note at maturity

The bank collects the note on February 28, 20x6.

Learning Objective 5

Use the acid-test ratio and

the days’ sales in receivables

to evaluate financial position.

Reporting Assets inOrder of Liquidity

CURRENT ASSETS 2001 2000Cash and cash equivalents $ 4,449 $ 7,429Short-term investments 1,438 333Trade receivables, net 2,432 2,534Prepaid expenses 644 587

Total current assets $ 8,963 $10,883Long-term investments – 110Property, net 975 935Other assets 1,092 1,149

Total assets $11,030 $13,077CURRENT LIABILITIES

Total current liabilities 3,916 5,892Long-term debt and liabilities 836 753Stockholders’ equity 6,278 6,462

Total liabilities and stockholders’ equity $11,030 $13,077

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

Days’ Sales in Receivables

A smaller number indicatesa quick conversion to cash.

Acid-test ratio = (Cash + Short-term investments+ Net current receivables) ÷ Total current liabilities

= (4,449 + 1,438 + 2,432) ÷ 3,916 = 2.12

Acid-Test Ratio

This is a stringent test of liquidity whichmeasures the entity’s ability to pay its

current liabilities immediately.

This ratio value is extremely high andindicates great liquidity for this company.

End of Chapter 5