Short-Term Investments & Receivables

Short-Term Investments &ReceivablesPr. Zoubida SAMLAL

Learning Objective 1Account for short-term investments

Account for short-terminvestments

Accounting for Short-TermInvestments Also called marketable securitiesHeld for one year or lessMost liquid asset other than cashPlaced into three -toMaturity

Trading Investments Held for short time and then sold– Gain or loss recordedSelling price cost GainSelling price cost Loss Dividend revenue may also be received At year-end, trading investments are adjustedto equal their market value– Results in an unrealized gain or loss

Unrealized Gains & Losses Difference between market price and cost ofinvestment at year-end Unrealized – investment has not been soldMarket price cost Unrealized gainMarket price cost Unrealized loss

Realized vs. UnrealizedRealized Investment sold to thirdparty Gain or loss differencebetween selling priceand cost Word “realized” usuallydropped from titleUnrealized Company still ownsinvestment Gain or loss differencebetween market valueand cost Word “unrealized” iskept in account title

Entries to Adjust to MarketJOURNALDateAccountsDebitShort-term investments Unrealized gain on investmentsCredit Adjusted investment to market value (when greater than cost)Unrealized loss on investmentsShort-term investments Adjusted investment to market value (when less than cost)

Reporting on Financial StatementsBalance Sheet Trading Investment– Reported at currentmarket value– Listed directly under“cash” in the currentasset sectionIncome Statement Gains and losses– From sales ofinvestments Investment revenue– From dividends orinterest earned Unrealized gain or loss– From entry to adjust tomarket value

Exercise 1Part of your job responsibilities as a finance manager is to invest in short termtrading investments.1. On 1 dec . You bought 1000 shares of XYZ company at USD 102. On 15 dec. You received a cash dividend of USD 1 per share3. On 31 dec the price of XYZ share dropped to USD 8 per share4. On 31 dec you decided to sell off all your investment at USD 8 per sharea) Please post the account entries of each transactionb) How transaction 3 is different from transaction 4

Solution 1JOURNALDateAccountsDec 1 Trading investmentDebitCredit 10,000Cash 10,000a. Short term trading investment XYZ atUSD 10Dec 15CashDividend revenueb. Dividend distribution received in cashUSD 1 per share 1000 1000

Solution 1 ( con t)JOURNALDateAccountsDebitDec 31 Unrealized lossCredit 2,000Trading investment 2,000c. Adjusting our short terminvestment to the market valueof USD 8 per shareDec 31 CashLoss from selling the investmentTrade Investment ( initialpurchase price)d. Investment sold at loss of USD2per share 8000 2000 10000

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 callmark to market our investment. -- Unrealized loss because the investmentis 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 arealized loss that we posted into our revenues account.

When Unrealized lossJOURNALDate12-31AccountsDebitUnrealized lossWhat would be theamount of theCreditunrealized loss?Trading InvestmentsCompute the differencebetween the cost andmarket value.

When realized lossJOURNALDateAccountsDebitCashYour sellingprice?Gain on sale ofinvestmentsYour loss Sell- buyCredit1-11Trading InvestmentsInitialpurchase

When Unrealized GainJOURNALDateAccountsTrading InvestmentsDebitCreditCompute thedifferencebetween thecost andmarket value.Unrealized gainWhat would bethe amount of theunrealized gain?

When realized GainJOURNALDateAccountsCashGain on sale ofinvestmentsTrading InvestmentsDebitCreditYour sellingprice?Your gain Sell- buyInitialpurchase

Learning Objective 2Apply internal controls to receivables

Receivables Monetary claims against others Third most liquid asset Accounts Receivable– Amounts owed by customers for selling goods orservices Notes Receivable– Lending money to outsiders– More formal than accounts receivable

Internal Control over Cash Collectionson Account Separate cash-handling from cash-accountingduties Cash-handling– One person receives customer checks and makesdeposits Cash-accounting– Another person makes entries to customeraccounts

Accounting for Uncollectible Receivables Extending credit to customersbears some risk Risk: Some customers do notpay the amount owed Cost: Uncollectible accounts

Application exerciseCasePerinity Inc. is a company that sells 50% of its product cashwhile. 80% of its credit sales are paid on timea.b.What is the total amount of account receivable if the sales revenues are USD 1million?How much uncollectible does it have?

Learning Objective 3Use the allowance method for uncollectiblereceivables

Allowance Method Amount of uncollectible accounts is estimated An expense is recorded as part of theadjusting process A contra-asset is recorded that reducesaccounts receivable on the balance sheetA contra-asset is always pairedwith an asset and reducesits balance

Entry to Record Uncollectible accountsJOURNALAccountsUncollectible accounts expenseAllowance for uncollectible accountsDebitCreditGoes on theIncome StatementGoes on theBalance Sheetnetted with aA. receivable

Balance SheetCurrent assets:Accounts receivable , Less: Allowance forUncollectible Accounts ( , )Accounts receivable, net , ORAccounts receivable, net ,

Methods to Estimate UncollectiblesPercent-of-sales Expense is estimatedbased on credit sales Income StatementapproachAging-of-receivables Accounts receivableanalyzed based on howlong outstanding Balance Sheet approach

APPLICATION EXERCISEDuring the monthly closing of it’s A/R accounts, Perinity Inc posted its uncollectedreceived classified by their age.The company has a beginning allowance balance of USD 7,400 . Is it sufficient orshould it adjust its allowance?Age of Accounts1 - 30 Days31 - 60 Days61 - 90 DaysOver 90 Dayssales 0

SolutionAge of AccountsAge1 - 30 Days31 - 60 Days61 - 90 DaysOver 90 Dayssales % Uncllecteduncollected110,0000.5% 55060,0001% 60050,00060% 30,00015,00040% 6,000 37,150 Total Uncollected receivable

SolutionAging ScheduleBalance in AllowanceAdjustment needed 37,150 7,400Adjustment needed Aging schedule BalanceJOURNALDate1231AccountsDebitUncollectible accounts expenseAllowance for uncollectible accountsCredit

SolutionAllowance for Uncollectible Accounts 7,400Adjusting entryBalance beforeadjustment 29,750 37,150Balance peragingschedule

Uncollectible Accounts MethodsPercent-of-SalesAdjust Allowance forUncollectible AccountsBYThe Amount ofUNCOLLECTIBLE ACCOUNTEXPENSEAging-of-ReceivablesAdjust Allowance forUncollectible AccountsTOThe Amount ofUNCOLLECTIBLE ACCOUNTSRECEIVABLE

Writing Off a Specific Account The allowance is used to absorb specific accountsthat are determined to uncollectible When it’s determined a customer cannot pay, thefollowing entry is made:JOURNALDateAccountsAllowance for uncollectibleaccountsAccounts receivableDebitCredit

Learning Objective 4Account for notes receivable

Notes Receivable Terms CreditorDebtorInterestMaturity DateMaturity ValuePrincipalTermParty to whom money is owed; lenderParty that owes money; borrowerCost of borrowing money; percentDate debtor must pay the noteSum of principal and interest on noteAmount borrowed by debtorLength of time money is borrowed

Accounting for Notes Receivable To record the receipt of a note receivable,the following entry is made:JOURNALDateAccountsNotes ReceivableCashDebitCredit , ,

Accounting for Notes Receivable Interest needs to be accrued on any notereceivable outstanding at year end:JOURNALDateAccountsInterest receivableInterest revenueInterest is computed by the formula:Principal x rate x timeDebitCredit , , Time date note issigned to end-of-year

ACCOUNTING FOR NOTESRECEIVABLEWhen payment is received on note, the following entry is madeJOURNALDateAccountsDebitCreditFor maturityvalueCashNotes ReceivableInterestreceivableInterest revenueFor principalZeroes outadjustmentFor remaininginterest 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 5Use two new ratios to evaluate a business

Days’ Sales in Receivables How long it takes a company to collect itsaverage amount of receivable Compute one day’s salesNet Sales365 Days Days’ sales in receivablesAverage receivablesOne Day’s Sales

Acid-Test Ratio Also called quick ratio which measures howmuch your short term assets represents in termsof short term liabilities A more stringent measure of a company’sability to pay its current liabilitiesCash Short-term investments net receivablesTotal current liabilities

Which is better having a high acid ratio orlow acid ratio?

Amount of uncollectible accounts is estimated An expense is recorded as part of the . with an asset and reduces its balance. Entry to Record Uncollectible accounts JOURNAL Accounts Debit Credit Uncollectible accounts expense Goes on the Income Statement Allowance for uncollectible accounts Goes on the . received classified by their age.