ACCT 200 1st Edition Exam 2 Study Guide Lectures 9 18 Chapter 6 Current Assets Receivables and Inventory Receivables are the amounts owed to the business by customers and others They are recorded as assets on the balance sheet The receivable is recorded as a current asset if the business expects to receive the amount within one year The receivable is recorded as a longterm asset if the business expects to receive the amount in longer than one year The three types of receivables we have studied are accounts receivables current asset notes receivables either current or long term asset and interest receivables current asset Account receivables are created when a business sells merchandise or services on account Normally the money is collected within a short period of 30 to 60 days However when selling on account businesses are taking the risk that customers will not pay them back In fact no business ever collects 100 on their account receivables This can be avoided by 1 never selling on account and becoming a cash only business which can turn off customers 2 transferring the collection risk to a credit card company which comes with monthly fees purchase of card reader and per transaction fees of five to ten cents on the dollar or 3 transferring the collection risk to a factor which is selling the right to future cash for getting cash now factors charge 2 10 of total account receivable If businesses decide to keep its own receivables GAAP principles require that businesses estimate and report each period how much of the receivables they will not collect Businesses do this by using historical bad debt rates to determine the amount they will not collect from the accounts receivable for the period This creates an allowance for doubtful account which is a contra asset that reduces accounts receivable on the balance sheet This also creates an uncollectible accounts expense that is incurred as a cost of selling on account The amount that is recorded on the balance sheet is called the net realizable value accounts receivable allowance for doubtful accounts which is the amount that the business will collect Because account receivables present such a risk companies usually convert account receivables into notes receivables after they have not received the money for a certain amount of time A note receivable or just a note is an unconditional promise legal contract that is generated when a business converts the account receivable to a formal note or when it lends money to another business Notes are often used for credit periods of more than 60 days and they have a stronger legal claim than accounts receivables A note will contain four things 1 the principal face amount 2 the stated due maturity date 3 the interest rate on the face amount for the term of the note and 4 the term of the note which is the length from issuance to maturity When an account receivable is converted to a note receivable the account receivable is decreased while the note receivable is increased Note receivables accumulate interest which is the revenue earned from another company using their money or other asset Interest can also be an expense when the business borrows money from another company Interest accumulates over time When accounting for interest the amount increases both interest receivable and interest revenue To find interest the equation is principal x rate x time Principal is the face value of the note Rate is the annual interest rate that is established when the note is first issued Time is the number of days that have passed divided by the number of days in a year which is simplified in accounting to 360 days When the note is paid off cash is increased notes receivable is decreased and interest receivable is decreased If any excess interest revenue is earned interest revenue is increased Businesses have physical inventory which are the goods or merchandise held for sale to customers When inventory is purchased the merchandise inventory account under assets is increased as well as the accounts payable account under liabilities Inventory is a current asset on the balance sheet until the goods are sold When this happens there is a cost of goods sold expense on the income statement When manufacturers and merchandisers sell goods they either can or cannot specifically identify the units that were sold If they can identify which units were sold the inventory cost is an expense on the income statement and if they can identify which units were not sold the inventory cost is an asset on the balance sheet More likely businesses cannot identify these and therefore have to use a cost flow method to do so The three methods are average cost FIFO first in first out and LIFO last in last out To help explain these concepts we will use the same example If you have 4 000 units that cost 8 unit from last year and then purchase more units in Purchase 1 1 500 units for 10 unit Purchase 2 2 000 units for 12 unit and Purchase 3 2 500 units for 15 unit you begin with 10 000 units available for sale 4 000 1 500 2 000 2 500 10 000 If you multiply each unit by the cost per unit and add those number up you get the total cost of good available as 108 500 4 000 x 8 1 500 x 10 2 000 x 12 2 500 x 15 108 500 At the end of the year 7 000 units were sold and 3 000 units were unsold The number of units sold and unsold should always equal the number of units available for sale 7 000 3 000 10 000 The average cost method is when the cost of the units sold and in ending inventory is an average of the purchase cost When using this method assumptions are made that each unit costs the same as every other unit and that the units sold were sold in no particular order This method is the easiest and most logical method however it is also the least used When using this method you must first find the cost per unit average cost You can find this by the equation total cost of goods available for sale total units available for sale For the example cost per unit average cost 108 500 10 000 units 10 85 unit Using this number you can find the cost of goods sold expense and the cost of ending inventory To find the cost of goods sold expense use the equation number of units sold x cost per unit average cost Cost of goods sold expense 7 000 units x 10 85 unit 75 950 This number goes on the income statement to match revenue To find cost of ending inventory use the equation number of units unsold x cost per unit average cost Cost of ending inventory 3 000 units x
View Full Document