Short-Term Investments

and Receivables
Chapter 5

Learning Objective 1
Account for short-term
investments.

Short-term Investments
Short-term investments (marketable securities)
are investments that a company plans
to hold for one year or less.
Short-term investments are the most liquid
asset after cash.

Short-term Investments
Suppose that Celestica Inc. purchases
McCain Foods Ltd. shares on Dec. 18,
paying $100,000 cash.
December 18

Short-term Investments
On Dec. 27, Celestica receives a cash
dividend of $4,000 from McCain.

Dec. 27

Short-term Investments
Celestica year ends on Dec. 31, and
the investment in McCain has a current
market value of $102,000 on this date.
GAIN
because the market value ($102,000) is
Greater than Celesticas investment cost

Short-term Investments
Unrealized Gain because Celestica has
not yet sold the investment

Dec 31

Short-term Investment
Unrealized Gain on
Investment

2,000
2,000

Short-term Investments
If the Celestica investment in McCain shares
had decreased in value to $95,000
Unrealized Loss because Celestica has
not yet sold the investment
Dec 31

Unrealized Loss on
Investment
5,000
Short Term Investment 5,000

Realized Gains and Losses

Only reported when investment is sold

If sales price >

carrying amount

Gain

If sales price <

carrying amount

Loss

Reporting on the Balance Sheet

and 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)

Question #1
ABC Co. purchased a temporary investment in shares of
XYZ Co. for $14,000. At year end, the investment had
a market value of $12,000. The $2,000 decrease in
value in the temporary investment should be:
a. recorded as a realized loss on the income statement
b. deducted from the value of the asset on the balance
sheet
c. only disclosed as part of the market value of
marketable securities
d. both A and B.

Learning Objective 2

Account for and

control receivables

Accounts and Notes Receivable

Receivables are the third most liquid assets after cash
and short-term investments
Results from selling goods and services on credit
(accounts receivable) and by lending money (notes
receivable)
Accounts receivable are a current asset on the balance
sheet
Notes receivable may be current or non-current assets

Accounts Receivable
GENERAL LEDGER

Accounts Receivable
Bal. 9,000

ACCOUNTS RECEIVABLE
SUBSIDIARY RECORD

Aston
Bal. 5,000
Harris
Bal. 1,000
Salazar
Bal. 3,000

Establishing Internal Control over

Collections on Account
Businesses that sell on credit receive most of their cash
receipts by mail
Some controls over accounts receivable are:
a)

Learning Objective 3
Estimate and account for
uncollectible accounts receivable.

Accounting for
Uncollectible 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. This cost is called
bad debt or uncollectible account expense

Bad debt or
Uncollectible Account Expense
Expense on the income statement
Must record the expense in the period of sale.
If not, assets and earnings will be overstated
The entry for the uncollectible account
amount is an adjusting journal entry
Can use the allowance method for
estimating the uncollectible receivables

The Allowance Method

The allowance method records collection losses on the
basis of estimates, not waiting to see which customers
will pay
Sets up the Allowance for Uncollectible Accounts
is a contra account to Accounts Receivable
Shows amount of receivables expected not to be
collected
Journal entry: Dr Uncollectible-account expense
Cr Allowance for uncollectible a/c

The Allowance Method

Balance Sheet (partial)
Accounts receivable
Less: Allowance for uncollectible accounts
Accounts receivable, net

$10,000
900
$ 9,100

Income Statement (partial)

Expenses:
Uncollectible-account expense

$ 2,000

Accounting for Uncollectible Accounts

Allowance method
Direct write-off method

Income Statement
Approach
Balance Sheet
Approach

The Allowance Method

Percentage-of-Sales
It computes uncollectible-account expense as a
percentage of revenue.

This method is also called the income

statement approach

The Allowance Method

Percentage-of-Sales
The credit department estimates that
uncollectible-account expense is 0.4% of
total revenues, which were $200 for 2014.
Dec. 31 (in millions)
Uncollectible-Account Expense
($200 0.004)
0.8
Allowance for Uncollectible Accounts
Recorded expense for the year

0.8

The Allowance Method

Percentage-of-Sales
Dec. 31, 2014 (in millions)
after adjustment
Accounts Receivable
Bal. 50

Allowance for
Uncollectible Accounts
0.6
0.8
1.4

The Allowance Method

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. A percentage
of Accounts receivable could also be used.

The Allowance Method

Aging-of-Receivables
Accounts before the year-end adjustment:
Dec. 31, 2014 (in millions)
Accounts Receivable
Bal.
50

Allowance for
Uncollectible Accounts
0.6

The Allowance Method

Aging-of-Receivables
Aging the Accounts Receivable
Days
Overdue
1-30 days
31-60 days
61-90 days
91 + days

Allowance for
Accounts Estimated % Uncollectible
Receivable Uncollectible
Accounts
$ 16.5
2
$ 0.33
12.2
5
0.61
3.6
10
0.36
0.7
35
0.20
$ 33.0
$ 1.50

The Allowance Method

Aging-of-Receivables
Uncollectible-Account Expense
0.9
Allowance for Uncollectible Accounts ($ 1.5 - $ 0.6)
Recorded expense for the year

Accounts after the year-end adjustment:

Dec. 31, 2014 (in millions)
Accounts Receivable
Bal. 50

Allowance for
Uncollectible Accounts
0.6
Adj. 0.9
1.5

0.9

Comparing the Percentage-of-Sales

and Aging Methods
Allowance Method
Percentage-of-Sales Method

Aging-of-Receivables Method

Adjusts Allowance for

Uncollectible Accounts

Adjusts Allowance for

Uncollectible Accounts

BY

TO

Amount of
UNCOLLECTIBLEACCOUNT EXPENSE

Amount of
UNCOLLECTIBLE
RECEIVABLES

The Allowance Method:

Writing Off
Uncollectible Accounts
Suppose that early in 2015, the credit
department determines that the company
cannot collect from two customers.
These accounts must be written off.

The Allowance Method:

Writing Off
Uncollectible Accounts

Allowance for Uncollectible Accounts

Accounts Receivable Customer #
Accounts Receivable Customer #
Wrote off uncollectible receivables

0.6
0.4
0.2

The Allowance Method:

Recovery of Uncollectible Accounts
Previously Written Off
1. Reinstate the Accounts Receivable

2. Record the collection of cash

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 realizable value

Direct Write-Off Method

Using this method, an account is written off
only when it is decided that a specific
customers receivable is uncollectible.
February 2, 2014
Uncollectible-Account Expense
3,000
Accounts Receivable Smith Inc.
3,000
Wrote off a bad account

Direct Write-Off Method

This method is defective for two reasons:
Since no allowance for uncollectibles
is established, assets are overstated
on the balance sheet.
It causes a poor matching of uncollectibleaccount expense against revenue
and overstates net income.

Question #2
ABC Co. has the following information on its unadjusted
trial balance at Dec. 31, 2014:
Accounts receivable
40,000
Allowance for uncollectible accounts
1,200 (debit)
The company uses the aging of receivables method and
determined that $2,000 of receivables would not be
collected. What amount should be reported as the bad
debt expense on the Dec. 31, 2014 income statement?
a. $2,000

b. $800

c. $2,400

d. $3,200

Computing Cash Collections

from Customers
Accounts Receivable
Beginning balance
200

Write-offs of uncollectiblesWrite100
offs of uncollectibles

Sales on creditSales
1,800
on credit

Collections from customers

Ending 400
balance

Learning Objective 4
Account for notes
receivable.

Notes Receivable
Notes receivable are more formal than accounts receivable
The principal amount of the note is the amount borrowed by
the debtor
Interest cost of borrowing money; stated as annual
percentage rate
The creditor has a note receivable
The debtor has a note payable

Accounting for Notes Receivable

On August 31, 2014, Alberta Treasury
loaned money at 9% interest due on Feb. 28/15.
The entry is as follows:
August 31, 2014
Note Receivable
Cash
Made a loan

1,000
1,000

How much interest revenue

is accrued at December 31, 2014?

Accounting for Notes Receivable

Interest = Principal Rate Time
$1,000 9% 4/12 = $30
December 31, 2014
Interest Receivable
Interest Revenue
Accrued interest revenue

30
30

Accounting for Notes Receivable

The bank collects the note on February 28, 2015.
February 28, 2015
Cash
1,045
Note Receivable
Interest Receivable
Interest Revenue
($1,000 9% 2/12)
Collected note and interest at maturity

1,000
30
15

Question #3
If the adjusting entry to accrue interest on a note
receivable is omitted, then:
a. Assets, net income, and shareholders equity are
overstated
b. Assets, net income, and shareholders equity are
understated
c. Liabilities are understated, net income is
overstated and shareholders equity is overstated
d. Assets are overstated, net income and
shareholders equity are understated

Learning Objective 5
Explain how to Improve Cash Flows
From Sales and Receivables.

5- 44

How to Speed up Cash Flow

Credit card sales the merchant sells
merchandise and lets the customer pay with a
credit card such as Visa, Mastercard, etc.
Debit card sales the customer uses their debit
card to pay for the merchandise
Selling (factoring) receivables the company
sells its receivables to another business

How to Speed Up Cash Flow

Recording
Recording aa credit
credit card
card sale.
sale.
Cash
485
Cash
485
Financing
15
Financing Expense
Expense
15
Sales
500
Sales Revenue
Revenue
500
To
Torecord
record aa credit
credit card
card sale
sale of
of $500
$500 and
and
aa 3%
3% financing
financing expense
expense

How to Speed Up Cash Flow

Recording
Recording aa debit
debit card
card sale.
sale.

Cash
64.48
Cash
64.48
Interac
Interac fee
fee (assumed
(assumed rate)
rate) 1.00
1.00
Sales
65.48
Sales Revenue
Revenue
65.48
To
Torecord
record aa sale
sale of
of groceries
groceries for
for 65.48
65.48

How to Speed Up Cash Flow

Recording
Recording the
the sale
sale of
of receivables.
receivables.
Cash
Cash
Financing
Financing Expense
Expense
Accounts
Accounts Receivable
Receivable
Sold
Sold accounts
accounts receivable
receivable

95,000
95,000
5,000
5,000

100,000
100,000

Sales Discounts
Full flow
amount
Offered
to customers to speed up cash
2%
discount
2/10, n/30

if paid within 10
days

due in 30
days

JOURNAL
Date

Accounts and explanation

Cash

Debit

Credit
98

Sales Discount
Accounts Receivable
Collected cash from customer on account and provided
discount

2
100

Sales Returns and Allowances

Right to return unsatisfactory or damaged
merchandise
JOURNAL
Date

Accounts and explanation

Sales Returns and Allowances
Accounts Receivable
Merchandise returned by customer on account

Debit

Credit

Learning Objective 6
Evaluate a companys
liquidity

Decision Making: Using Ratios

Investors and creditors use ratios to evaluate the
financial health of a company
To help them measure the liquidity of companies,
they use:
a) Current ratio
b) Acid-test or Quick ratio
c) Days sales in receivables

Current Ratio
This measures the entitys ability to pay its
current liabilities with current assets.
Current ratio =

Current assets
Current liabilities

Rule of thumb: A strong current ratio is 1.50

Acid-Test or Quick Ratio

This is a stringent test of liquidity which
measures the entitys ability to pay its
current liabilities immediately.
(Cash + Short-term investments + receivable)
Total current liabilities

This ratio value is extremely high and

indicates great liquidity for this company.

Days Sales in Receivables

One days sales = Net sales 365 days
Days sales in average accounts receivable =
Average net accounts receivable One days sales

A smaller number indicates

a quick conversion to cash.

Reporting on the
Statement of Cash Flows
Receivables bring in cash when the
business collects from customers.
These transactions are reported
as operating activities on the
cash flow statement.

Question #4
Net sales total $600,000. Beginning and ending
accounts receivable are $52,000 and $38,000
respectively. Calculate days sales in
receivables (rounded).
a.
b.
c.
d.

32 days
23 days
43 days
27 days

End of Chapter 5