1

Chapter 6

Investments

and Receivables

Financial Accounting, Alternate 4e by Porter and Norton

2

PepsiCo Inc. Consolidated Balance Sheet (partial)

ASSETS (in millions) Dec. 28 Dec. 29 2002 2001 .Current Assets:Cash and cash equivalents $1,638 $ 683Short-term investments, at cost 207 966

1,845 1,649Accounts & notes receivable 2,531 2,142Inventories 1,342 1,310Prepaid expenses & other assets 695 752

Total Current Assets $6,413 $5,853

selling on credit

highly liquid

3

PepsiCo Inc.Consolidated Balance Sheet (partial)

ASSETS (in millions)

Current Assets:Cash and cash equivalentsShort-term investments, at costAccounts and notes receivableInventoriesPrepaid expenses & other assets

Total Current Assets

LessLiquid

Highly Liquid

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

Investment in CD

Assets = Liab. + O/E + Rev. – Exp.Short-term Inv. – CD 100,000Cash (100,000)

Invest $100,000 in a 120-day CD. Principal plus interest @ 6% due upon investment maturity.

Example:

4

Year-end adjusting entry :Assets = Liab. + O/E + Rev. – Exp.Interest Rec. 1,500 Interest Inc. 1,500

Investment in CD

Interest = Principal x Rate x Time$1,500 = $100,000 x 6% x 90/360

5

October – 29 daysNovember – 30 daysDecember – 31 days

90 days

Upon investment maturity: Assets = Liab. + O/E + Rev. – Exp.Cash 102,000 Interest Inc. 500

Short-Term

Inv. – CD 100,000

Interest Rec. 1,500

Investment in CD

6

Interest earned in January:

$100,000 x 6% x 30/360 = $500

7

Reasons Companies Invest in Other Companies

Short-term cash excesses

Long-term investing for future cash needs

Exert influence over investee

Obtain control of investee

8

Accounting for Common-Stock Investments

No significantinfluence

0% 20%

FairValue

Method

Significantinfluence

50%

EquityMethod

Control

100%

ConsolidatedF/S

OurFocus

9

Investments Without Significant Influence

Held-to-Maturity Securities

Trading Securities

Available-for-Sale Securities

Use fair value method to

account for these investments

10

Held-to-Maturity Securities

Bonds of other companies Intent and ability to hold until maturity

$100,000 9% BondDue 2019

11

Held-to-Maturity Securities

On 1/1/04, Homer buys: $100,000; 10% bonds @ face value. Bonds mature December 31, 2013 Interest payable semiannually

.

Example:

Record the purchase of the bonds and receipt of the first interest payment

12

Recording Bond Purchase

Assets = Liab. + O/E + Rev. – Exp.Inv. in Bonds 100,000

Cash (100,000)

$100,000 10% BondDue 2014

13

Recording Receipt of Interest Payment

Assets = Liab. + O/E + Rev. – Exp.Cash 5,000 Interest Inc. 500

Interest forInvestor

Borrower

14

Recording Bond Sale

Assets = Liab. + O/E + Rev. – Exp.Cash 99,000 Loss on Sale of Bonds

1,000

Inv. in Bonds (100,000)

Interest forInvestor

Borrower

15

Trading Securities

Purchased to generate profit from short-term appreciation

Stocks Bonds

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

Intent to sell in near term (classified as current assets)

16

Trading Securities

IncomeStatement

Unrealized gain or loss recognized on income statement

At end of each period, security is “marked to market”

Stocks Bonds

17

Trading Securities

Dexter Corp. holds the following trading securities at 12/31/04:

Cost Market

Menlo preferred stock $25,000 $27,500

Canby common stock 40,000 39,000

Example:

Record the unrealized gain or loss at 12/31/04.

18

Recording Unrealized Gain or Loss on Trading Securities

Assets = Liab. + O/E + Rev. – Exp.Inv. in Menlo Unrealized Gain – Pref. Stock 2,500 Trading Sec.*

1,500

Inv. in Canby Pref. Stock (1,000)

* income statement account

19

Available-for-Sale Securities

Securities not classified as held-to-maturity or trading

Stocks

Bonds

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

Can be classified as short-term or long-term, depending on expected date of disposition

20

Available-for-Sale Securities

BalanceSheet

Unrealized gain or loss accumulated in stockholders’ equity account

Also “marked to market” at end of accounting period

StocksBonds

21

Available-for-Sale Securities

Lenox Corp. holds the following AFS securities at 12/31/04:

Cost Market

Adair preferred stock $15,000 $16,000

Casey common stock 35,000 32,500

Example:

Record the unrealized gain or loss at 12/31/04.

22

Recording Unrealized Gain or Loss on AFS Securities

Assets = Liab. + O/E + Rev. – Exp.Inv. in Adair Unrealized Gain/Loss Pref. Stock 1,000 – AFS Sec.* (1,500)

Inv. in Casey Com. Stock (2,500)

* part of Stockholders’ Equity

23

Accounting for Investments Without Significant Influence

Recognize Report Report FVCategories as income on BS at changes on

Held-to-maturity interest cost N/A

Trading interest, div. fair value Income stmt.

Avail.-for-Sale interest, div. fair value Balance sheet

24

Credit Sales

Slows inflow of cash Risk of uncollectible

accounts

Trade Credit

Retail Customer Receivables Terms: 2/10,

net 30

Sales Invoice

25

Menkhaus Corporation Sample Accts. Rec. Subsidiary Ledger

Total Due

ABC Distributors $ 25

HIJ Distributors 336

: :

: :

XYZ Distributors 108

$ 1,105 Gross AccountsReceivable

In 000s

26

Winnebago Industries, Inc.Consolidated Balance Sheet (partial)

2002 2001

Receivables, less allowance

for doubtful accounts ($120

and $244, respectively) $28,616 $21,571

Net Realizable

Value

Estimated

Uncolle

ctible

Accounts

27

Accounting for Bad Debts:Direct Write-off Method

Adjustment to write off uncollectible account:Assets = Liab. + O/E + Rev. – Exp.Accts. Rec. Bad Debts – Dexter (500) Exp. (500)

Period of Sale Future Period charged with expense of bad debt write-off

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

28

Accounting for Bad Debts: Allowance Method

Period of Sale Estimated bad debt

expense (and allowance account) recorded in

same period

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

29

Roberts Corp.Partial Balance Sheet

Current assets:Accounts receivable $ 250,000 Less: Allowance for doubtful accounts ( 6,000)Net accounts receivable $ 244,000

Balance Sheet Presentation - Allowance Method

30

Accounting for Bad Debts:Allowance Method

Adjustment for estimated bad debt expense :

Assets = Liab. + O/E + Rev. – Exp.Allow. for Bad Debts Doubtful Exp. (6,000) Accts (6,000)

I estimate...

31

Accounting for Bad Debts:Allowance Method

Adjustment to write off uncollectible account:

Assets = Liab. + O/E + Rev. – Exp.Allow. forDoubtful Accts 500

Accts. Rec. – Dexter (500)

Bankrupt

32

Approaches to Allowance Method

% of Net Credit Sales

% of Accounts Receivable » Aging Method

Income Statement Approach

Balance Sheet

Approach

33

Example:

Percentage of Net Credit Sales Method

Assume prior years’ net credit sales and bad debt expense are as follows:

Year Net credit sales Bad debts1999 $1,250,000 $ 26,4002000 1,340,000 29,3502001 1,200,000 23,1002002 1,650,000 32,1502003 2,120,000 42,700

$7,560,000 $153,700

34

Example:

Percentage of Net Credit Sales Method

Develop bad debt percentage:

$153,700$7,560,000

use 2%

= 0.02033

35

Percentage of Net Credit Sales Method

2004 Net credit sales (given) $2,340,000

Bad debt percentage 2%

Bad debts expense 46,800

Example:

Assets = Liab. + O/E + Rev. – Exp.Allow. for Bad Debts Doubtful Exp. (46,800) Accts (46,800)

36

Est. Percent Est. AmountCategory Amount Uncollectible

UncollectibleCurrent $ 85,600 1% $ 856Past due: 1-30 days 31,200 4% 1,248 31-60 days 24,500 10% 2,450 61-90 days 18,000 30% 5,400 90+ days 9,200 50% 4,600 Totals $168,500 $14,554

Aging Method

37

Aging Method

To determine the amount recognized as bad debts:

Bal. required in allow. acct. after adj. $14,554

Less: Bal. in allow. acct. before adj. 1,230

Amount of adjustment $13,324

38

Aging Method Example

Adjustment for estimated bad debt expense :

Assets = Liab. + O/E + Rev. – Exp.Allow. for Bad Debts Doubtful Exp.

(13,324) Accts (13,324)

39

Comparison of Methods

% of Net Sales

Computes bad debt expense

Aging Computes ending

balance in the allowance account

40

Accounts Receivable Turnover

Net Credit Sales

Average Accounts Receivable

Indicates how quickly a company is collecting (i.e.,

turning over) its receivables

41

Accounts Receivable Turnover

Too fast

credit policies too stringent; may be losing sales

Too slow

credit department notoperating effectively; dissatisfied customers

42

Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on March 13, 2005.

Date: December 13, 2004

Signed:_________

Interest-Bearing Promissory Note

Baker Corporation

MaturityDate

Principal

Interest

43

In exchange for $9,000 applied toward my purchase today, I promise to pay $9,900 in six months.

Date: November 1, 2004

Signed:_________J.E. Privett

Non-Interest-Bearing Promissory Note

Effective interest rate on note = 20%

$900 12 $9,000 x 6

44

12/31/04 4/30/05

Notes receivable $ 9,900 $ 9,900

Less: Discount on

notes receivable ( 600) - 0 -

$ 9,300 $ 9,900

Balance Sheet Presentation of Discounted Notes

Discount transferred to interest revenue

over life of note

Upon Maturity

45

Accelerating Cash Inflow From Sales

Sales Discounts Credit Card Sales Discounting Notes Receivable

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

46

Credit Card Sales

Competitive necessity Credit card company:

» Charges fee» Assumes risk of nonpayment

47

Discounting Notes Receivable

Sell note prior to maturity date for cash Receive less than face value (i.e.,

discounted amount) Can be sold with or without recourse

Baker Corporation promises to pay HighTec, Inc. $15,000 plus 12% annual interest on December 31, 1998.

Date: January 1, 1998

Signed:_________Baker Corporation

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

Operating Activities Net income xxxx Increase in accounts receivable - Decrease in accounts receivable + Increase in notes receivable - Decrease in notes receivable +Investing Activities Purchases of held-to-maturity and available-for-sale securities -

Sales/maturities of held-to-maturity and

available-for-sale securities +

Financing Activities

Liquid Assets and the Statement of Cash Flows - Indirect Method

48

49

End of Chapter 6