Ch06 Fundamental Of Financial Accounting By Edmonds (4th Edition)

Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin

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Chapter 7 Accounting for Accruals: Advanced TopicsReceivables and Payables

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Advanced topics include: ■

■

■

Accounting for bad debts Accounting for interest-bearing notes and noninterest bearing (discounted) notes Warranties

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Want to learn some accounting?

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Accounts and Notes Receivable ■

■

A/R are the expected future cash receipts of a company. They are typically small and are expected to be received within 30 days. N/R are used when longer credit terms are necessary. The promissory note specifies the maturity date, the rate of interest, and other credit terms.

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Value of Receivables ■

■

McGraw-Hill/Irwin

Receivables are reported at their face value less an allowance for accounts which are likely to be uncollectible. The amount which is actually expected to be collected is called the net realizable value (NRV). © The McGraw-Hill Companies, Inc., 2003

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Allowance Method vs. Direct Write-Off Method ■

■

GAAP requires that A/R be reported at NRV. (A/R minus Allowance) This is done using a valuation allowance: An ALLOWANCE METHOD. ❐ ❐

■

% of Sales (or “Income Statement”) approach. Aging (or “Balance Sheet”) approach.

With the ALLOWANCE METHOD, an estimate of the amount that will NOT be collected is recorded in the same period that the sales revenue is recorded. Thus, the MATCHING PRINCIPLE is being followed.

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Allowance Method vs. Direct Write-Off Method (continued) ■

■

■

The DIRECT WRITE-OFF method violates GAAP because it does NOT follow the MATCHING principle. With the Direct Write-off method, no estimate of bad debts is recorded at the time of the sale. Rather, only after a specific account is deemed “uncollectible” is a Bad Debt Expense recorded. Since GAAP is only required if the amounts are MATERIAL (significant), if the amount of uncollectible A/R is immaterial the Direct Write-off method may be used.

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Transaction Analysis: ■

Assume the following selected events occurred at Cell-It. For each event: ❐

❐

❐

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Determine how the accounting equation was affected and fill in the horizontal model. (Assume GAAP must be followed.) Determine the effect on the financial statements. Record the event in t-accounts. © The McGraw-Hill Companies, Inc., 2003

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Transaction Analysis: The following selected events occurred at Cell-It during 2004. 1. Provided services to customers for $10,000 on account. 2. Collected $7,000 on account receivables. 3. At year-end it was estimated that 2% of year’s credit sales will never be collected. 4. Jane Doe’s $50 account was written-off as “uncollectible”. 5A&B. $50 cash is unexpectedly received from Jane Doe. McGraw-Hill/Irwin

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Record the five transactions in this horizontal statements model. Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

1 2 3 4 5A 5B Bal.

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1.

Provided services to customers for $10,000 on account.

Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

1 2 3 4 5A 5B Bal.

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1.

Provided services to customers for $10,000 on account.

Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a.

2 3 4 5A 5B Bal.

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2. Collected $7,000 from account receivable. Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a.

2 3 4 5A 5B Bal.

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2. Collected $7,000 from account receivable. Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

3 4 5A 5B Bal.

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3. At year-end it was estimated that 2% of the year’s credit sales will not be collected. Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

200

3

Inc. Statement

(200)

200

(200)

n.a.

4 5A

2% x $10,000 = $200

5B Bal.

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for Doubtfulthat Accounts 3. At year-endAllowance it was estimated 2% ofis a CONTRA- ASSET account. This the year’s credit sales will not be collected. account balance is INCREASING by $200 causing TOTAL assets to Balance Sheet Inc. Statement Cashflow decrease.

Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

10000 10000

10000

n.a. 7000 OA

200

3

Rev. - Exp. = N. I. OA,IA,FA

(200)

200

(200)

n.a.

4 5A

2% x $10,000 = $200

5B Bal.

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4. Jane Doe’s $50 account was written-off as uncollectible.

Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

3

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

200

(200)

200

(200)

n.a.

4 5A 5B Bal.

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4. Jane Doe’s $50 account was written-off as uncollectible.

Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

3 4

(50)

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

200 (50)

(200)

200 (200) NO EXPENSE!

n.a.

5A 5B Bal.

Note: This is NOT the Direct Write-off method. Rather, it is a write-off under the ALLOWANCE Method.

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Effect of Transaction 4 on Acct. Rec. Net Realizable Value

Before Event 4 A/R $ Allow. N.R.V. $

After Event 4 A/R $ Allow. N.R.V. $ Acme Collection Agency

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Effect of Transaction 4 on Acct. Rec. Net Realizable Value

Before Event 4 A/R $3,000 Allow. (200) N.R.V. $2,800 The check is in the mail.

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After Event 4

Acme Collection Agency

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Effect of Transaction 4 on Acct. Rec. Net Realizable Value

Before Event 4 A/R $3,000 Allow. (200) N.R.V. $2,800

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After Event 4 A/R $2,950 (150) Allow. N.R.V. $2,800

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Effect of Transaction 4 on Acct. Rec. Net Realizable Value

Before Event 4 A/R $3,000 Allow. (200) N.R.V. $2,800

After Event 4 A/R $2,950 Allow. (150) N.R.V. $2,800

When using an ALLOWANCE method, the Net Realizable Value of accounts receivable does not change as a result of the write-off. McGraw-Hill/Irwin

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Before recording Transaction #5: What happens when an account that has been written off later pays off his/her account? ①

②

Reinstate the account by recording an entry that undoes (reverses) the write-off: ❐ increase (debit) Accounts Receivable ❐ increase (credit) Allowance for Doubtful Accounts (a contra-asset) Record the entry to show the cash collection and A/Rec. reduction: ❐ increase (debit) Cash ❐ decrease (credit) Accounts Receivable

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5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

4

10000

n.a. 7000 OA

(50) 50

50

5A

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000 200 (50)

3

Inc. Statement

(200)

200 (200) NO EXPENSE!

n.a.

5B Bal.

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5. $50 cash was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

3 4

(50)

5A

50 (50)

5B Bal.

50

OA

McGraw-Hill/Irwin

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

200 (50)

(200)

200 (200) NO EXPENSE!

n.a.

50 50

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Calculate all ending balances. Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

3 4

(50)

5A

50 (50)

5B

50

OA

Bal. 7050

2950

McGraw-Hill/Irwin

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

200 (50)

(200)

200 (200) NO EXPENSE!

n.a.

50 50 200

9800 10000

200

9800 7050 bal.

© The McGraw-Hill Companies, Inc., 2003

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What’s the result?

After completing the horizontal model fill in below.

How did the previous transactions affect the financial statements?

20X1 How much Bad Debt Expense should appear on the income statement?…. What is the A/R: NRV at year end?…… How much A/R should be added to the other current assets on the year-end balance sheet?…………………………. McGraw-Hill/Irwin

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Final Account Balances Remember, the Bad Debt EXPENSE is accrued in the year of sale, NOT when the account is written off!

Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

4

(50)

5A

50 (50)

50

OA

Bal. 7050

2950

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

3

5B

Inc. Statement

10000

n.a. 7000 OA

200 (50)

(200)

200 (200) NO EXPENSE!

n.a.

50 50 200

9800 10000

200

9800 7050 bal.

MATCHING PRINCIPLE McGraw-Hill/Irwin

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What’s the result?

After completing the horizontal model fill in below.

How did the previous transactions affect the financial statements?

20X1 How much Bad Debt Expense should appear on the income statement?….

$

200

What is the A/R: NRV at year end?…… How much A/R should be added to the other current assets on the year-end balance sheet?…………………………. McGraw-Hill/Irwin

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Final Account Balances Net Realizable Value (NRV) = Acct.Rec. - Allowance Balance Sheet Assets = Liab.+ Stk. Equity Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E. 1

10000

2 7000

(7000)

3 4

(50)

5A

50 (50)

5B

50

OA

Bal. 7050

2950

McGraw-Hill/Irwin

Inc. Statement

Cashflow

Rev. - Exp. = N. I. OA,IA,FA

10000 10000

10000

n.a. 7000 OA

200 (50)

(200)

200 (200) NO EXPENSE!

n.a.

50 50 200

9800 10000

200

9800 7050 bal.

© The McGraw-Hill Companies, Inc., 2003

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What’s the result?

After completing the horizontal model fill in below.

How did the previous transactions affect the financial statements?

20X1 How much Bad Debt Expense should appear on the income statement?….

$

What is the A/R: NRV at year end?……

$ 2,750

How much A/R should be added to the other current assets on the year-end balance sheet?………………………….

$ 2,750

McGraw-Hill/Irwin

200

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Transactions Posted to T-accounts Post the five transactions to these Ledger accounts. Cash

Acct. Rec.

Allow. for D.A.

Service Revenue Bad Debt Exp.

McGraw-Hill/Irwin

Retain. Earn.

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Transaction Posted to T-accounts 1. Provided services to customers for $10,000 which will be collected at a later date. Cash

Acct. Rec.

Allow. for D.A.

Service Revenue Bad Debt Exp.

McGraw-Hill/Irwin

Retain. Earn.

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Transaction Posted to T-accounts 1. Provided services to customers for $10,000 which will be collected at a later date. Cash

Acct. Rec.

Allow. for D.A.

(1) 10,000

Service Revenue Bad Debt Exp. 10,000 (1)

McGraw-Hill/Irwin

Retain. Earn.

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Transaction Posted to T-accounts 2. Collected $7,000 of the Accounts Receivables. Cash

Acct. Rec.

Allow. for D.A.

(1) 10,000

Service Revenue Bad Debt Exp. 10,000 (1)

McGraw-Hill/Irwin

Retain. Earn.

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Transaction Posted to T-accounts 2. Collected $7,000 of the Accounts Receivables. Cash

(2) 7,000

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2)

Service Revenue Bad Debt Exp. 10,000 (1)

McGraw-Hill/Irwin

Retain. Earn.

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Transaction Posted to T-accounts

3. At Yr. end it was estimated that 2% of the year’s credit sales will never be collected. Cash Acct. Rec. Allow. for D.A. (2) 7,000

(1) 10,000 7,000 (2)

Service Revenue Bad Debt Exp. 10,000 (1)

McGraw-Hill/Irwin

Retain. Earn.

© The McGraw-Hill Companies, Inc., 2003

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Transaction Posted to T-accounts

3. At Yr. end it was estimated that 2% of the year’s credit sales will never be collected. Cash Acct. Rec. Allow. for D.A. (2) 7,000

(1) 10,000 7,000 (2)

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

200 (3)

Retain. Earn.

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Transaction Posted to T-accounts 4. Jane Doe’s $50 account was written-off as uncollectible. Cash

(2) 7,000

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2)

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

200 (3)

Retain. Earn.

© The McGraw-Hill Companies, Inc., 2003

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Transaction Posted to T-accounts 4. Jane Doe’s $50 account was written-off as uncollectible. Cash

(2) 7,000

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) 50 (4)

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

(4) 50

200 (3)

Retain. Earn.

© The McGraw-Hill Companies, Inc., 2003

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Effect of Transaction 4 on Acct. Rec. Net Realizable Value

Before Event 4 A/R $3,000 Allow. (200) N.R.V. $2,800

After Event 4 A/R $2,950 Allow. (150) N.R.V. $2,800

Net realizable value of accounts receivable did not change as a result of the write-off. McGraw-Hill/Irwin

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Transaction Posted to T-accounts 5a. Jane Doe’s account is reinstated. Cash

(2) 7,000

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) 50 (4)

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

(4) 50

200 (3)

Retain. Earn.

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Transaction Posted to T-accounts 5a. Jane Doe’s account is reinstated. Cash

(2) 7,000

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) 50 (4) 5a 50

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

(4) 50

200 (3) 50 (5a)

Retain. Earn.

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Transaction Posted to T-accounts 5b. Jane Doe’s account is collected. Cash

(2) 7,000

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) 50 (4) 5a 50

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

(4) 50

200 (3) 50 (5a)

Retain. Earn.

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Transaction Posted to T-accounts 5b. Jane Doe’s account is collected. Cash

(2) 7,000 5b

50

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) (4) 50 50 (4) 50 (5b) 5a 50

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

200 (3) 50 (5a)

Retain. Earn.

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Transaction Posted to T-accounts Closing entries at the end of Year 1. Cash

(2) 7,000 5b

50

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) (4) 50 50 (4) 50 (5b) 5a 50

Service Revenue Bad Debt Exp. 10,000 (1) (3) 200

McGraw-Hill/Irwin

200 (3) 50 (5a)

Retain. Earn.

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Transaction Posted to T-accounts Closing entries at the end of Year 1. Cash

(2) 7,000 5b

50

Acct. Rec.

Allow. for D.A.

(1) 10,000 7,000 (2) (4) 50 50 (4) 50 (5b) 5a 50

Service Revenue Bad Debt Exp. (c) 10,000 McGraw-Hill/Irwin

10,000 (1) (3) 200

200 (c)

200 (3) 50 (5a)

Retain. Earn. (c) 200 10,000 (c)

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Transaction Posted to T-accounts Balances of all accounts after Year 1 closings. Cash

Acct. Rec.

(1) 10,000 7,000 (2) (4) 50 50 (4) 50 (5b) 5a 50 bal 2,950

(2) 7,000 5b

Allow. for D.A.

50

bal. 7,050

Service Revenue Bad Debt Exp. (c) 10,000 McGraw-Hill/Irwin

10,000 (1) (3) 200 0 bal

bal. 0

200 (c)

200 (3) 50 (5a) 200 bal.

Retain. Earn. (c) 200 10,000 (c) 9,800 bal.

© The McGraw-Hill Companies, Inc., 2003

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Summary: Accounting for Bad Debts ■

Allowance method ❐ ❐

❐

❐

GAAP Required if company has a significant amount of bad debts. Matches bad debt expense (on the income statement) with the sale. Requires an adjusting journal entry before closing the books.

McGraw-Hill/Irwin

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Summary: Accounting for Bad Debts ■

Direct Write-off method ❐ ❐

❐

❐

Violates GAAP (Matching) No estimates of bad debts are made, so no allowance account is used. Used by small businesses with few account receivables or large business with few collection problems. No entry until time specific account is deemed “bad” (uncollectible).

McGraw-Hill/Irwin

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Direct Write-off Method for Accounting for Bad Debts ■

Direct Write-off method

Entry to write off J. Jones’ $100 account:

Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow

McGraw-Hill/Irwin

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Direct Write-off Method for Accounting for Bad Debts ■

Direct Write-off method

Entry to write off J. Jones’ $100 account: Bad Debt Expense Acct. Rec.-Jones

100 100

Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow

McGraw-Hill/Irwin

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Direct Write-off Method for Accounting for Bad Debts ■

Direct Write-off method

Entry to write off J. Jones’ $100 account: Bad Debt Expense

100

Acct. Rec.-Jones

100

Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow (100) McGraw-Hill/Irwin

(100)

+100 (100)

n.a.

© The McGraw-Hill Companies, Inc., 2003

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Accrued Liabilities: Warranty Costs ■ ■

Why give warranties? When should expense be recognized? We will repair or replace this item... Warranty

McGraw-Hill/Irwin

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Warranties…When to “expense”? General Principle According to GAAP, the entire estimated warranty expense must be recorded in the period the sale is made, NOT in the period when the actual warranty cost is paid. (Matching principle is being followed.) ■ A warranty liability is recorded along with the expense. This liability is REDUCED whenever cash is paid to service a product still under warranty. ■

McGraw-Hill/Irwin

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Transaction Analysis ■

The following selected warranty related events occurred at Cell-It. For each event: ❐

❐

Determine how the financial statements are affected and fill in the horizontal model. Record each event directly in LEDGER accounts.

McGraw-Hill/Irwin

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7- 57

Transaction Analysis The following selected events occurred at Cell-It. (Perpetual inventory method is used.) 1. On 1/1/04 sold merchandise for $5,000 cash that had originally cost $4,000. These goods were sold with a two-year warranty. 2. Estimated that $100 of warranty cost will be incurred over the next two years on the goods sold in #1. 3. During 2005 a customer returned for repair, goods still under warranty. The cost of the repair was $30 cash. ■

McGraw-Hill/Irwin

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Horizontal Model Transaction Analysis C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA

1a

McGraw-Hill/Irwin

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1a. Sold (on 1/1/04 with 2 yr. warranty) for $5,000 cash, 1b. merchandise that originally cost $4,000. (perpetual inventory method is used.)

C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b

McGraw-Hill/Irwin

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7- 60

Before recording Transaction #2: Warranties…When to “expense” According to GAAP, the entire estimated warranty expense must be recorded in the period the sale is made, NOT in the period when the actual warranty cost is paid. (Matching principle is being followed.) ■ A warranty liability is recorded along with the expense. This liability is REDUCED whenever cash is paid to service a product still under warranty. ■

McGraw-Hill/Irwin

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2. Estimated that $100 of warranty cost will be incurred over the next two years on the goods sold in #1.

C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a.

McGraw-Hill/Irwin

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3. During 2005 a customer returned for repair goods still under warranty. The cost of the repair was $30 cash.

C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3 (30) (30) n.a. n.a. n.a. n.a. (30) OA

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SUMMARY QUESTIONS C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

Questions:

2004

1. Warranty Expense for the year:

$100

2005

2. Warranty liability on year-end bal. sheet: 3. Cash outflow related to warranty work: McGraw-Hill/Irwin

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SUMMARY QUESTIONS C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

Questions:

2004

1. Warranty Expense for the year:

$100

2. Warranty liability on year-end bal. sheet:

$100

2005

3. Cash outflow related to warranty work: McGraw-Hill/Irwin

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SUMMARY QUESTIONS C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

Questions:

2004

1. Warranty Expense for the year:

$100

2. Warranty liability on year-end bal. sheet:

$100

3. Cash outflow related to warranty work:

$

McGraw-Hill/Irwin

2005

0

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SUMMARY QUESTIONS C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3. (30) (30) n.a. n.a. n.a. n.a. (30) OA

Questions:

2004

2005

1. Warranty Expense for the year:

$100

$ 0

2. Warranty liability on year-end bal. sheet:

$100

3. Cash outflow related to warranty work:

$

McGraw-Hill/Irwin

0

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SUMMARY QUESTIONS C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3. (30) (30) n.a. n.a. n.a. n.a. (30) OA 70 balance

Questions:

2004

2005

1. Warranty Expense for the year:

$100

$ 0

2. Warranty liability on year-end bal. sheet:

$100

$ 70

3. Cash outflow related to warranty work:

$

McGraw-Hill/Irwin

0

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SUMMARY QUESTIONS C=CofGS,W=War.exp. Balance Sheet Assets = Liab.+ Stk. Equity Inc. State. Cashflow Cash+ A/R + M.Inv. = W/P+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 5000 5000 5000 5000 5000 OA 1a (4000) (4000) C 4000 (4000) n.a. 1b 2 100 (100) w 100 (100) n.a. 3. (30) (30) n.a. n.a. n.a. n.a. (30) OA 70 balance

Questions:

2004

2005

1. Warranty Expense for the year:

$100

$ 0

2. Warranty liability on year-end bal. sheet:

$100

$ 70

3. Cash outflow related to warranty work:

$

($30)OA

McGraw-Hill/Irwin

0

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Transactions Posted to T-accounts 1. In 2004, sold for $5000 cash (1A), units costing $4000 (1B). 2. During 2004, estimated $100 warranty cost over two years. 3. During 2005, paid $30 cash to repair units sold in 2004. Warranty Payable

Cash Bal. X (1A) 5,000

30 (3)

(3)

30

Sales

100 (2)

5,000 (1A)

Inventory Bal. X

Cost of Goods Sold (1B) 4,000

4,000 (1B)

Entries (not shown here) to close Sales, Cost of Goods Sold, and Warranty Expense to Retained Earnings would have been made at the end of 2004. McGraw-Hill/Irwin

Warranty Expense (2) 100

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Notes Payable: Transaction Analysis ■Assume

the following selected events occurred at Cell-It. For each event: ❐Determine

how the financial statements are affected and fill in the horizontal statements model. ❐Record

the event in the Journal and Post to the Ledger.

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Notes Payable: Transaction Analysis

Assume the following events occurred at Cell-It. 1. On Oct. 1, 2004 Cell-It borrowed $8,000 cash by issuing a note payable with a one-year term and an 8% stated interest rate. All interest will be paid at maturity. This is an “interest bearing” note. 2. On Oct. 1, 2004 Cell-It issued an $8,000 face value, discounted note payable with a one-year term and an 8% stated discount rate. This is called a “Discounted” or “Non-interest bearing” note. 3. On Dec. 31, 2004 recorded interest related to the 8% interestbearing note issued on Oct. 1st (see #1). 4. On Dec. 31, 2004 recorded interest related to the 8% discounted (non-interest bearing) note issued on Oct. 1st (see #2). 5. On Sept. 30, 2005 repaid the 8% non-discounted note payable (#1), plus all interest. 6. On Sept. 30, 2005 repaid the 8% discounted note payable (#2). McGraw-Hill/Irwin

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Horizontal Model Transaction Analysis Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1

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T1: On Oct. 1, 2004 Cell-it borrowed $8,000 at 8% for 1 year on an interest bearing note. All interest to be paid at maturity. Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000

McGraw-Hill/Irwin

8000

8000 FA

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T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.)

Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000 2 7360

8000 8000

640

8000 FA 7360 FA

The interest is INCLUDED in the Note Payable. The interest must be subtracted to calculate the amount of cash the borrower receives on the issue date. Note Payable $8000 Since no time Interest ($8000 x .08 x 12/12) (640) has past, the Cash to borrower $7360 $640 is NOT an EXPENSE yet. McGraw-Hill/Irwin

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T2: On Oct. 1, 2004 Cell-it issued an $8,000 face value, one year note payable discounted at 8%. (A noninterest bearing note.)

Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000 2 7360

8000 8000

8000 FA 7360 FA

640

Discount on Note Payable is a contra liability account. Its balance is SUBTRACTED from the Note Payable account to obtain the total liability for the Note. Note Payable 8000 Less: Discount on N/P (640) Total Note Liability 7360 McGraw-Hill/Irwin

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T3: On Dec. 31, 2004 recorded interest related to the note in #1. Oct. 1-Dec. 31 = 3 mo. (8000 x .08 x 3/12=160)

Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000 2 7360 3 160

McGraw-Hill/Irwin

8000 8000

640 (160)

8000 FA 7360 FA 160 (160) n.a.

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T4: On Dec. 31, 2004 recorded interest related to the discounted (noninterest bearing) note in #2. Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000 2 7360 3 160 4

McGraw-Hill/Irwin

8000 8000

640 (160)

(160) (160)

8000 FA 7360 FA 160 (160) n.a. 160 (160) n.a.

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T5: On Sept. 30, 2005 repaid the 8% note from Transaction #1 and all its interest. a= accrue the remaining interest. b= payment.

(Jan. 1-Sept. 30 = 9 mo. (8000 x .08 x 9/12= $480)

Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000 8000 2 7360 3 160 4 5a 480 b (8640) (640) (8000) OA

McGraw-Hill/Irwin

8000

640 (160)

(160) (160) (480)

8000 FA 7360 FA 160 (160) n.a. 160 (160) n.a. 480 (480) n.a (8000) FA (640)

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T6: On Sept. 30, 2005 repaid the 8% discounted note payable from Trans. #2. a= accrue the remaining interest. b= payment.

Balance Sheet Assets = Liabilities + Equity Inc. State. Cashflow Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA 1 8000 8000 2 7360 3 160 4 5a 480 b (8640) (640) (8000)

8000

OA 6a

b (8000)

(8000)

640 (160)

(160) (160) (480)

160 160 480

(480)

(480)

480

8000 FA 7360 FA (160) n.a. (160) n.a. (480) n.a (8000) FA (640) (480) n.a. (7360) FA (640) OA

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Comparison of Journal Entries for Interest Bearing and Discounted Notes Contra-liabilities are increased by debiting. Date 2004 Oct. 1

NOTE PAYABLE (Interest bearing) Accounts Debit Credit Cash Note Payable

8000 8000

Borrowed $8000 at 8% for one year

Date 2004 Oct. 1

DISCOUNTED NOTE PAYABLE Accounts Debit Credit Cash Discount on Note Payable Note Payable

7360 640 8000

Borrowed $8000 discounted at 8% for one year

Dec. 31 Interest Expense Interest Payable

160 160

Accrued 3 mo. interest (8000x.08x3/12)

2005 Sept. 30 Interest Expense Interest Payable

160 160

Amortized 3 mo. interest from Discount to Int. Exp.

480 480

Accrued 9 mo. interest (8000x.08x9/12)

Sept. 30 Interest Payable Note Payable Cash

Dec. 31 Interest Expense Discont on Note Payable

2005 Sept. 30 Interest Expense Discont on Note Payable

480 480

Amortized 9 mo. interest from Discount to Int. Exp.

640 8000

Sept. 30 Note Payable Cash 8640

8000 8000

Paid note (which already includes iall nterest)

Paid note and all interest

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Comparison of Ledger Accounts for Interest Bearing and Discounted Notes INTEREST BEARING NOTE PAYABLE Cash X Beg. Bal. 10/01/04 8000 8640 9/30/05

Note Payable 10/01/04 8000 9/30/05 8000

2004 Exp. Interest Expense 160 12/31/04 480 09/30/05

0 2005 Exp. Interest Payable 160 12/31/04 480 09/30/05 640 9/30/05 0

NON-INTEREST BEARING (DISCOUNTED) NOTE PAYABLE Cash X Beg. Bal. 10/01/04 7360 8000 9/30/05

Note Payable 10/01/04 8000 9/30/05 8000

2004 Exp. Interest Expense 160 12/31/04 480 09/30/05

0 2005 Exp. Discount on Note Pay. 160 12/31/04 480 09/30/05 640 9/30/05 0

McGraw-Hill/Irwin

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Which loan was the better deal for Cell-It?

Transaction Analysis:

Calculate the EFFECTIVE INTEREST % of each. Interest bearing note:

Effect on Financial Statements With note #2 Cell-It only

Eff. Int. %State. = $ Annual Interest ÷ $7,360 Cash received from the Inc. State. of Ch. in Eq Rec’d. CashFlow lender, but had+8,000 to payFA 1. No effect No effect = $640 ÷ still $8,000 $640 interest for the year.FA 2. No effect No effect +7,360 = 8.0% That’s why theEq, effective 3. +Int. Exp, so - N.I. Decr. R/E, so Dec. n.a. interest higher for 4. +Int. Exp, sobearing - N.I. Decr. R/E, sorate Dec.isEq. n.a. Non-Interest note (Discounted note): Note 5. +Int. Exp, so - N.I. Decr. R/E,#2. so Dec. Eq. -8000FA,-640 OA Eff. Int. % = $ Annual Interest ÷ Cash Rec’d. Note #1 (Interest bearing) is = $640 $7,360 a “better÷deal” in this case. McGraw-Hill/Irwin

=

8.7%

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Financial Statement Analysis ■

Accounts Receivable Turnover Sales

Accts/Rec. = Turnover $ Accounts Receivable* Often the AVERAGE Accts. Rec. is used as the denominator.

Ave. A/R =

Beginning Accts/Rec. + Ending Accts/Rec. 2

This ratio is a measure of how quickly receivables are collected.

McGraw-Hill/Irwin

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Accounts Receivable Ratios Accts. Rec. Turnover: (A measure of how fast receivables are collected. Higher is better.) Sales $50,000 = = 10.0 times Accounts. Receiv. $ 5,000 Average Days to collect A/R: (How many days go by between a credit sale and the time it is collected?) 365 365 Accts. Rec. Turnover = 10.0 = 36.5 days Generally, lower means better. McGraw-Hill/Irwin

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Chapter 7

The End McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2003