Chapter 5
Short-Term Investments &
Receivables
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Learning Objectives
• Account for short-term investments
• Apply internal controls to receivables
• Use the allowance method for
uncollectible receivables
• Account for notes receivable
• Use 2 new ratios to evaluate financial
position
Key Terms
• Creditor
• Debtor
• Debt instrument
• Equity security
• Maturity
• Term
Short-Term Investments
• Marketable Securities
– investments
– company plans to hold one year or less
• Trading Investments – intent is to sell in
the short term to generate profits
• Trading securities are reported on the
balance sheet at current market value
• Unrealized gains and losses appear on
the income statement.
Entry for Unrealized Gain
Short-Term Investments 100,000
Cash 100,000
Purchased Investment
To record the purchase of short-term investments.
To record the receipt of a cash dividend from short-term
investments.
7 Cash 4,000
Dividend Revenue 4,000
Received cash dividend
Entry for Unrealized Gain
Dec 31 Short-Term Investments 2,
Unrealized Gain on Investments 2,
Adjust investment to market value
To record the $2,000 increase in market value of marketable
securities held as short-term investments.
Entry for Unrealized Loss
Dr: Unrealized loss on investments 5,000
Cr: Short-term Investments 5,000
To record the unrealized loss of $5,000 decreased in market
value of marketable securities held as short-term investmen
Reporting Short-Term Investments
• Balance Sheet
– Current Assets
– Trading investments reported at current
market value
• Income Statement
– Interest and dividend revenue reported under
Other Revenue.
– Gains and losses reported under Other
Revenue.
Reporting Short-Term Investments
Entry for Realized Gains and Losses
20x6
Dr: Cash 98,000
Loss on Sale of Investments 4,000
Cr: Short-term Investments 102,000
To record the realized Loss of $4,000 decreased in market
value of marketable securities held as short-term investmen
Lending Agreements and the Current Ratio
• Lending agreements often require the
borrower to maintain a current ratio at
some specified level, say or greater.
• There are several strategies of increasing
the current ratio.
Receivables
• Receivables are monetary claims against
others.
• Two major types:
– Accounts receivable (trade receivables) –
amounts collected from customers from the
sale of goods and services
– Notes receivable – written promise to pay
• secured
• unsecured
Issues When Extending Credit
• What are the benefits and cost of
extending credit to customers?
• Extend credit only to creditworthy
customers.
• Separate cash-handling and accounting
duties.
• Pursue collection from customers.
Issues in Accounting for Receivables
• Measure and report receivables at net
realizable value.
• Measure and report the expense
associated with failure to collect.
Accounting for uncollectible receivables
• Selling on credit creates both a benefit and
a cost:
– Benefit: Customers who cannot pay cash
immediately can buy on credit, so sales and
profits increase;
– Cost: The company cannot collect from some
customers. Accountants label this cost
uncollectible-account expense, doubtful-
account expense, or bad-debt expense
Uncollectible Receivables
• Allowance method
– record losses based on an estimate of
uncollectible accounts.
– Set up Allowance for uncollectible accounts,
Allowance for doubtful accounts and
Allowance for bad debts.
– This is a contra-account to Account Receivable
Uncollectible Receivables
Uncollectible Receivables
• Allowance method
– Percent-of-sales method
• computes expense as a percent of revenue
• income statement approach
– Aging-of-receivables method
• individual receivables are analyzed based on how
long they have been outstanding
• balance sheet approach
Percent-of-Sales
Total sales are $35,000. The credit department estimates
that uncollectible-account expense is 1% of total revenues.
Dec 31 Uncollectible-Account Expense
($35,000 x .001) 35
Allowance for Uncollectible Accounts 35
Recorded expense for the year
Accounts Receivable
3,789
Bal. 3,789
Allowance for
Uncollectible Accounts
29
35
Bal. 64
Net
Accounts Receivable
$3,789 – 64 = $3,725
Aging-of-Receivables
Aging-of-Receivables
• Current balance in allowance account is
$29.
• Calculate the adjustment needed to bring
the balance to $64.
• Expense: $64 – $29 = $35
Aging-of-Receivables
Dec 31 Uncollectible-Account Expense 35
Allowance for Uncollectible Accounts 35
Recorded expense for the year
Accounts Receivable
3,789
Bal. 3,789
Allowance for
Uncollectible Accounts
29
35
Bal. 64
Net
Accounts Receivable
$3,789 – 64 = $3,725
Writing off Uncollectible Accounts
• Decrease the Allowance account and
remove the account receivable.
Mar 31 Allowance for Uncollectible Accounts 12
Accounts Receivable – Fiesta 9
Accounts Receivable – Stop-N-Shop 3
Wrote off uncollectible receivables
Writing off Uncollectible Accounts
Writing off Uncollectible Accounts
Direct Write-Off Method
• No allowance is established and the expense is
recognized when accounts are written off.
Mar 31 Uncollectible Account Expense 12
Accounts Receivable – Fiesta 9
Accounts Receivable – Stop-N-Shop 3
Wrote off bad accounts by direct write-off method
Direct Write-Off Method
• Assets are overstated on the balance
sheet because no allowance account is
used.
• Poor matching of uncollectible-account
expense against revenue. Net income is
overstated.
Notes Receivable
• Creditor has a note receivable.
• Debtor has a note payable.
• Interest is revenue to the lender and expense to the
borrower.
• Maturity date is on which the debtor must pay the note
• Maturity value is the sum of principal and interest on the
note
• Principal is the amount borrowed.
• Term is the length of time when the note was signed by
debtor to when the debtor must pay the note
A Promissory Note
Notes Receivable
Laura Holland signs a $1,000 note dated Aug. 31, 20X8 . To
record this on the bank’s books:
Aug 31 Notes Receivable – L. Holland 1,000
Cash 1,000
Made a loan
At , 20X8, the bank accrues 9% interest revenue for 4
as follows:
Dec 31 Interest Receivable (1,000 x .09 x 4/12) 30
Interest Revenue 30
Accrued interest revenue
Notes Receivable
To record collection of the note on Feb. 28, 20X9:
Feb 28 Cash 1,045
Interest Revenue (1,000×.09×2/12) 15
Collected note at maturity
Interest Receivable 30
Note Receivable – L. Holland 1,000
Speeding Up Cash Flow
• Credit Card or Bankcard Sales
• Selling Receivables
• Both methods result in financing expense.
Acid Test Ratio
• Measure of liquidity
• More stringent than the current ratio
Acid-test ratio Cash
Short-term
investments
Net current
receivables+ +
Total current liabilities
=
Days’ Sales in Receivables
• Compute one day’s sales
(net sales / 365 days)
• Compute days’ sales in receivables
– (average receivables / one day’s sales)
EXERCISE-TRUE/FALSE
• Marketable securities are investments that
a company is actively attempting to sell.
• False
• Short-term investments may be divided
into held-to-maturity securities, trading
securities, and available-for-sale-
investments.
• true
EXERCISE-TRUE/FALSE
• Trading securities are considered to be
current assets.
• True
• Trading securities are reported on the
balance sheet at their historical cost.
• false
EXERCISE-TRUE/FALSE
• Realized gains and losses are computed
by comparing cash received at the time of
sale to the original cost of the assets.
• False
• Unrealized gains and losses on trading
securities are reported as part of current
income.
• true
EXERCISE-TRUE/FALSE
• Notes receivable collected in installments
can appear on a balance sheet as both a
current asset and a long-term asset.
• True
• Trade receivables are amounts to be
collected from customers from the sale of
goods and services.
• true
EXERCISE-TRUE/FALSE
• Subsidiary records provide detailed
information about control accounts.
• True
• Under the allowance method, the entry to
record the estimated bad debts for the
period includes a credit to Accounts
Receivable.
• false
EXERCISE-TRUE/FALSE
• Allowance for Doubtful Accounts is used to
record the bad debts expense for the
period.
• False
• The allowance method of accounting for
bad debts records collection losses on the
basis of estimates rather than waiting to
determine which customers will not pay.
• true
EXERCISE-TRUE/FALSE
• Under the allowance method, the entry to
write off an account that has been deemed
uncollectible has no impact on the net
income of the firm.
• True
• When preparing financial statements, the
direct write-off method is preferred over
the allowance method because it is more
accurate.
• false
EXERCISE-TRUE/FALSE
• There are two basic ways to estimate
uncollectibles: the percent-of-sales
method and the aging-of-receivables
method.
• True
• The maturity value of a note is the sum of
the principal amount of a note plus the
interest due at maturity.
• true
EXERCISE-TRUE/FALSE
• The payee of the note records interest on
a note receivable as interest expense.
• False
• A note receivable is sold before its
maturity date for less than its original issue
value.
• false
EXERCISE-TRUE/FALSE
• Trade receivables can be sold to a factor
as a means of speeding cash flow.
• True
• In general, companies prefer a longer
collection period for receivables.
• false
EXERCISE-TRUE/FALSE
• Because it includes only cash and short-
term investments in the numerator, the
acid-test ratio is a more stringent measure
of a firm’s ability to pay current liabilities
than the current ratio.
• false
Exercise-Choice
• Trading securities:
be debt securities
be equity securities
be debt securities or equity securities
Accounts Receivable and Notes
Receivable on the balance sheet
• C
• All trading securities are classified as:
• a. available-for-sale securities
• b. current assets
• c. long-term assets
• d. equity securities
• b
• Trading securities are reported on the
balance sheet at:
• a. amortized cost
• b. original purchase price
• c. current market value
• d. historical cost adjusted for investment
income
• c
• Unrealized gains or losses on trading
securities are reported on the:
• a. balance sheet
• b. income statement
• c. statement of cash flows
• d. are not reported on any financial
statement
• b
• An unrealized loss on a marketable security
means that:
• a. the value of the security at the time of sale
exceeded the historical cost of the security
• b. the current market value of the security
exceeds its original cost
• c. the original purchase price of the security
exceeded the historical cost
• d. the historical cost of the security exceeds its
current market value
• d
• Trading securities purchased for $200,000
were valued at $206,000 at the end of the
year. The adjusting entry to record this
difference included a credit to:
• a. Retained Earnings
• b. Unrealized Gain on Investments
• c. Short-term Investments
• d. No adjusting entry is required.
• b
• Trading securities purchased in 2006 for
$100,000 were valued at $95,000 on December
31, 2006. The securities were sold at the
beginning of 2007 for $98,000. The 2007
income statement should report a:
• a. realized loss of $2,000
• b. realized gain of $3,000
• c. unrealized loss of $5,000 and a realized gain
of $3,000
• d. unrealized gain recovered of $3,000
• b
• On December 31, 2005, installment notes receivable
totaled $20,000. Of this amount $6,000 will be collected
in 2006. The remainder will be collected in 2007. How
should these notes be classified on the balance sheet?
• a. Current assets are $6,000 and long-term assets are
$14,000.
• b. Current assets are $20,000 and long-term assets
are $0.
• c. Current assets are $0 and long-term assets are
$20,000.
• d. Current assets are $6,000 and long-term assets are
$20,000.
• (a)
• The two accepted methods of recording bad
debts are the:
• a. allowance method and the aging method
• b. receivables method and the aging method
• c. allowance method and the direct write-off
method
• d. direct write-off method and the percentage-of
-sales method
• (c)
• The two methods of estimating uncollectible
receivables are the:
• a. allowance method and the direct write-off
method
• b. percent of sales method and the aging-of-
receivables method
• c. percent of sales method and the direct write-
off method
• d. aging-of-receivables method and direct write
-off method
• (b)
• The net realizable value of accounts receivable
is the:
• a. amount remaining after uncollectible
accounts are written off
• b. amount owed by customers after sales
returns and allowances and sales discounts are
posted
• c. amount the company expects to collect from
customers
• d. amount the company can collect from a
factor when the receivables are sold
• (c)
• Under the allowance method for
estimating uncollectible accounts, the
entry to write off an account:
• a. reduces total assets
• b. reduces net income
• c. has no effect on total assets or net
income
• d. increases net income
• (c)
• Under the percentage-of-sales method,
the estimate of bad debts for the period:
• a. is based on the balance in the
Accounts Receivable account
• b. is based on aging accounts receivable
• c. is based on a percentage of net credit
sales
• d. is based on a percentage of net
accounts receivable
• (c)
A year-end review of accounts receivable and estimated
uncollectible percentages revealed the following:
• 1-30 days $24,000 2%
• 31-60 days $800 10%
• 61-90 days $500 20%
• Amounts over 90 days past due are written off. The
normal balance in Allowance for Uncollectible Accounts
was $300. The uncollectible accounts expense for the
year was:
• a. $300
• b. $360
• c. $660
• d. $960
• (b)
• An aging-of-accounts-receivable method
indicates that amount of uncollectible accounts
is $5, Allowance for Uncollectible
Accounts prior to adjustment has a debit balance
of $1,100. The amount of the adjusting entry
should be:
• a. $6,900
• b. $5,800
• c. $4,700
• d. $1,100
• (a)
• Using the percentage-of-sales method, you
estimate that total uncollectible accounts is
$4,500. The Allowance for Uncollectible
Accounts prior to adjustment has a debit balance
of $1,400. The amount of the adjusting entry is:
• a. $1,400
• b. $3,100
• c. $4,500
• d. $5,900
• (c)
• Triclinium Company signed an 18-month,
$20,000, 8% note on June 1, 2006. The
amount of interest to be accrued on
December 31, 2006, is:
• a. $1,600
• b. $933
• c. $800
• d. $519
• (b)
• The maturity value of a $50,000 note at
9% for 4 months is:
• a. $51,500
• b. $51,125
• c. $54,500
• d. $68,000
• (a)
• A company with net sales of $850,000, a
beginning balance of net receivables of
$190,000, and an ending balance of net
receivables of $230,000 has a days’ sales in
receivables of:
• a. 99 days
• b. 92 days
• c. 90 days
• d. 82 days
• (c)
• A company with net sales of $850,000, a
beginning balance of net receivables of
$190,000, and an ending balance of net
receivables of $230,000 has a days’ sales
in receivables of:
• a. 99 days
• b. 92 days
• c. 90 days
• d. 82 days
• (c)
End of Chapter 5
