Chapter 5 Short Term Investments Receivables For many companies acct receivables are the largest current asset Short term investments are listed immediately after cash on the balance sheet Account for Short Term Investment Short term investments marketable securities investments in marketable securities that can be easily converted to cash that a company plans to hold for one year or less o Next most liquid asset after cash Investments in marketable securities o Trading securities Purpose is to hold for short time then sell for more than it cost Current asset If the market value of the stock we purchased increases we gain If market value decreases we have a loss We earn dividend revenue o Available for sale securities o Held to maturity securities Usually long term unless they mature during that period Usually long term unless they mature during that period Unrealized gains losses o Say stock increases by 2 000 Gain because the fair value is greater than the cost Gain has same effect as revenue Unrealized gain because we have not sold the securities yet Loss has the same result as an expense o Trading securities are reported on balance sheet with current fair value because that is the price the investor can earn by selling o o o o Reporting on the Balance Sheet and Income Statement Balance sheet Short term investments are current assets Trading securities are reported at current fair market value Income statement Investments on debt and equity securities earn interest revenue and dividend revenue Investments create losses and gains Reported as Other revenue gains losses Realized gains losses o Realized gain loss happens after investor sells investment Realized gain sale price is greater than investment carrying amount Realized loss sale price is less than investment carrying amount o Most accountants don t use the word realized its just loss gain Ethics and the Current Ratio Lending agreements may require company to maintain a specific current ratio Current ratio total assets total liabilities Ways to increase current ratio o o Launch major sales effort to increase cash This offsets liabilities Pay off some liabilities Current asset and current liabilities will decrease by the same amount Increases ratio when current ratio is already about 1 o Reclassify long term investments as current assets which increases ratio Unethical if you will keep them for more than a year GAAP For Revenue Recognition Revenue is recognized when it is earned Seller has done everything required Price is fixed and collection is reasonable assured Timing and amount of revenue recognized depends on shipping terms and payment incentives offered to buyer Shipping terms sales discounts sales returns Shipping Proper time to recognize sales revenue is when ownership of goods changes hands between buyer and seller Determined by shipping terms in sales contract FOB free on board shipping ownership happens when goods leave sellers shipping doc FOB destination ownership changes at point of delivery to customer o o o o o Sale Discounts Sales discount for early payment to speed up cash flow Ex 2 10 n 30 Seller will discount order by 2 if buyer pays invoice within 10 days Buyer must pay within 30 days Sales Returns and Allowances Buyer can return damaged or unsatisfactory merchandise Retailers keep track to make sure they are not excessive Returned merchandise is a loss Retailers usually disclose sales revenue at net amount after discounts and returns are subtracted o o o o Account for and Control Receivable Receivables are 3rd most liquid asset Types of receivables Receivables monetary claims o Acquired by services acct receivable or lending money notes receivable o Acct receivable trade receivable Current asset Control account that summarizes total amount receivable from customers Companies keep subsidiary record off all acct receivable accounts by customer o Notes receivable Formal contracts Borrower agrees to pay sum at maturity date plus interest Note may require borrower to pledge security in form of collateral Internal Controls over Cash Collections on Account Bookkeeper cannot handle cash How Do We Manage the Risk of Not Collecting By selling credit companies run risk of not collecting some receivables Evaluate Collectability Using Allowance for Uncollectible Accounts Companies rarely collect all accounts receivable Benefit of credit sales and profit increase Cost of credit cannot collect from everyone o This is uncollectable account expense doubtful account expense bad debt expense Acct notes receivable net o Net means some has been taken out amount they don t expect to collect Called net realizable value because they expect to collect all those cash receipts Uncollectable account expense is listed as operating expense in selling general category Allowance Method Allowance method records collection losses based on estimates developed from company s collection experience Records estimated amount as uncollectible account expense and sets up Allowance for uncollectable accounts o Allowance for uncollectable doubtful accounts is contra account to accounts receivable Like accumulated depreciation for depreciation expense o Allowance shows amount they don t expect to collect Income statement reports uncollectable account expense 2 ways to estimate uncollectable o Percent of sales method Computes uncollectable account expense as a percent of revenue Takes income statement approach because it focuses on amount of expense on income statement Employees expense recognition concept to estimate the amount of cost incurred to earn certain amount of revenue and to recognize both in same period Net realized is amount expected to be collected o Aging of receivables method Balance sheet approach because it focuses on what is the best representation of acct Individual receivables from customers are analyzed based on how long they are receivable outstanding 100 dollars should be in allowance but there is only 25 so make new entry Writing off uncollectable accounts o Write off has no effect on total assets or net acct receivable or net income No effect on net income because the write off doesn t affect expense account Combining percent of sales and aging method Interim statements monthly quarterly companies use percent of sales because its easier End of year use aging method to make sure acct receivable is reported at net realized value o o o Using both shows expense and assets best Direct Write Off Method Company waits until