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Giáo trình Financial accounting 3rd global edition by kemp part 1 Giáo trình Financial accounting 3rd global edition by kemp part 1 Giáo trình Financial accounting 3rd global edition by kemp part 1 Giáo trình Financial accounting 3rd global edition by kemp part 1 Giáo trình Financial accounting 3rd global edition by kemp part 1 Giáo trình Financial accounting 3rd global edition by kemp part 1
Financial Accounting For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization, and adaptation from the North American version Global edition Global edition Global edition Financial Accounting third edition Robert Kemp • Jeffrey Waybright third edition Kemp • Waybright This is a special edition of an established title widely used by colleges and universities throughout the world Pearson published this exclusive edition for the benefit of students outside the United States and Canada If you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author Pearson Global Edition KEMP_1292019549_mech.indd 07/03/14 2:15 PM Financial Accounting A01_KEMP9543_03_GE_FM.indd 03/04/14 1:22 PM A01_KEMP9543_03_GE_FM.indd 03/04/14 1:22 PM Financial Accounting Third Edition Global Edition Robert Kemp University of Virginia Jeffrey Waybright Spokane Community College Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo A01_KEMP9543_03_GE_FM.indd 03/04/14 1:22 PM Editor in Chief: Donna Battista Acquisitions Editor: Lacey Vitetta Senior Editorial Project Manager: Karen Kirincich Associate Editor, Global Edition: Toril Cooper Development Editor: Mignon Tucker, JD, Brava 360° Solutions Editorial Assistant: Christine Donovan Marketing Manager: Alison Haskins Managing Editor: Jeff Holcomb Senior Production Project Manager: Roberta Sherman Publisher, Global Edition: Angshuman Chakraborty Associate Print and Media Editor, Global Edition: M Vikram Kumar Publishing Administrator, Global Edition: Aditya Remy Shah Senior Project Editor, Global Edition: Vaijyanti Senior Manufacturing Controller, Production, Global Edition: Trudy Kimber Manufacturing Buyer: Carol Melville Art Director: Anthony Gemmellaro Cover Designer: PreMedia Global Cover Photo: isak55/Shutterstock Media Producer: James Bateman MyAccountingLab Content Project Manager: Martha LaChance Supplements Editor: Jill Kolongowski Associate Project Manager, Rights and Permissions: Samantha Graham Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on the appropriate page within text [or on page 757] Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsonglobaleditions.com © Pearson Education Limited 2015 The rights of Robert Kemp to be identified as the author of this work have been asserted by him in accordance with the Copyright, Designs and Patents Act 1988 Authorized adaptation from the United States edition, entitled Financial Accounting, 3rd edition, ISBN 978-0-13-342788-2, by Robert Kemp, published by Pearson Education © 2015 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 9 8 7 6 5 4 3 2 1 15 14 13 12 11 ISBN 13: 978-1-292-01954-3 ISBN 10: 1-292-01954-9 Typeset in 10/12 Meridian by Integra Printed by Ashford Colour Press Ltd, Gosport A01_KEMP9543_03_GE_FM.indd 03/04/14 1:22 PM Dedication I dedicate this book to my beloved children: Adam, Meg, and Sarah I also dedicate this book to their spouses and children They give meaning to my life and are my dream come true Robert Kemp I would like to dedicate this book to my colleagues in the Business Department at Spokane Community College Jeffrey Waybright A01_KEMP9543_03_GE_FM.indd 03/04/14 1:22 PM A01_KEMP9543_03_GE_FM.indd 03/04/14 1:22 PM About the Authors Robert S Kemp, DBA, CPA Professor Kemp is the Ramon W Breeden, Sr Research Professor at the McIntire School of Commerce, University of Virginia He is a certified public accountant and possesses a baccalaureate, master’s, and doctorate in business administration Professor Kemp is an accomplished scholar, conducting research and writing in the theory and practice of contemporary business He currently is conducting research in the funding of pensions, the management of financial institutions, and corporate finance His scholarly works include 70 completed projects, including monographs, articles, cases, research presentations, and working papers His work is published in, among other places, The Financial Review; The Journal of Financial Research; Advances in Accounting, A Research Journal; Benefits Quarterly; The Journal of Mathematics Applied in Business and Industry; The Journal of Accountancy; The Journal of Commercial Bank Lending; The Journal of Bank Accounting and Auditing; and The Journal of Business Economics Professor Kemp is likewise an accomplished teacher, to both University students and executives throughout the world During his 34 years at the University of Virginia, he has taught numerous undergraduate and graduate courses He has taught classes using lectures, case studies, discussion groups, and distance learning His consistently high evaluations by students reflect his devotion to the classroom This high quality is likewise seen in his teaching of business executives He has worked with and taught for organizations such as Bank of America, the FDIC, Navigant—Tucker Alan, the Siberian Banking Institute, the Barents Group, KPMG, Gerson Lehrman, Wellington Management, the Russian Bankers Association, the Central Asian American Enterprise Fund, the American Institute of Certified Public Accountants, and the Consumer Bankers Association Jeffrey Waybright teaches accounting at Spokane Community College, which is part of a multi-college district in eastern Washington He has been a full-time, tenured community college instructor for more than 21 years In addition to teaching at the community college level, he has also taught upper division courses for Linfield College Jeffrey is a co-recipient of the Washington Society of CPA’s Outstanding Educator Award Jeffrey received his BA in business administration (emphasis in accounting) and MBA from Eastern Washington University Before becoming a professor, Jeffrey spent eight years as a practicing CPA in Washington State and still holds his license During his teaching career, he has taught in many disciplines of accounting including financial, managerial, computerized, and payroll accounting as well as in the disciplines of economics, business math, and general business Jeffrey developed online courses in accounting, teaches online and traditional courses for financial and managerial accounting, and advises students Jeffrey is passionate about teaching students the subject of accounting A01_KEMP9543_03_GE_FM.indd 03/04/14 1:23 PM A01_KEMP9543_03_GE_FM.indd 03/04/14 1:23 PM Brief Contents Chapter Business, Accounting, and You 35 Chapter Analyzing and Recording Business Transactions 87 Chapter Adjusting and Closing Entries 136 Chapter Accounting for a Merchandising Business 193 Chapter Inventory 242 Chapter The Challenges of Accounting: Standards, Internal Control, Audits, Fraud, and Ethics 290 Chapter Cash and Receivables 322 Chapter Long-Term and Other Assets 387 Chapter Current Liabilities and Long-Term Debt 438 Chapter 10 Corporations: Paid-In Capital and Retained Earnings 486 Chapter 11 The Statement of Cash Flows 539 Chapter 12 Financial Statement Analysis 599 Appendix A Columbia Sportswear Company 2012 Annual Report to Shareholders 655 Appendix B Time Value of Money—Future and Present Value Concepts 723 Company Index 731 Glindex 739 Credits 757 A01_KEMP9543_03_GE_FM.indd 03/04/14 1:23 PM www.downloadslide.net Cash and Receivables 335 Internal Control over Accounts Receivable Write off Removing a customer’s receivable from the accounting records because it is considered uncollectible Most companies have a Credit Department to evaluate customers’ credit applications The extension of credit requires a balancing act The company wants to avoid receivables that will never be collected while at the same time granting credit to as many customers as possible Also, companies that sell on credit often receive the related payment by mail, so internal control over collections is important Remember, a critical element of internal control is the separation of cash-handling and cashaccounting duties Good internal control over Accounts Receivable dictates that the granting of credit, the receipt of cash, and the recording of Accounts Receivable transactions are done by different individuals, preferably from different departments For example, if the employee who handles the daily cash receipts also records the Accounts Receivable transactions, the company would have no separation of duties The employee could pocket money received from a customer He or she could then label the customer’s account as uncollectible, and the company would write off the account receivable, as discussed in the next section The company would stop billing that customer, and the employee would have covered his or her theft For this reason, separation of duties is important Accounting for Uncollectible Accounts Receivable Unfortunately, when a business chooses to sell goods or services on account, there will likely be customers who fail to pay the amount owed When this happens, the customer’s account is referred to as an uncollectible account or a bad debt Uncollectible accounts reflect a cost associated with selling goods and services on account Companies who make sales on account expect that the benefit of granting credit to customers outweighs the cost Bad debt expense Selling expense caused by uncollectible accounts; also called uncollectible accounts expense • The benefit: Increased revenues and profits from making sales to a wider range of customers • The cost: Some customers don’t pay, and that creates an expense called Bad Debt Expense Bad Debt Expense is also called Uncollectible Accounts Expense Both account names mean the same thing—a customer did not pay his or her account balance There are two methods of accounting for uncollectible accounts receivable: • The direct write-off method • The allowance method We will examine the direct write-off method first Direct write-off method The method of accounting for uncollectible accounts in which a customer’s account is written off as uncollectible when the business determines that the customer will not pay 4 Use the direct write-off and allowance methods to account for uncollectible accounts M07_KEMP9543_03_GE_C07.indd 335 How Do You Account for Uncollectible Accounts? The Direct Write-Off Method The simplest way to account for uncollectible accounts is to use the direct write-off method Under the direct write-off method, at the time it is determined the business will not collect from a specific customer, the business writes off that customer’s Account Receivable The Account Receivable is written off by debiting Bad Debt Expense and crediting the customer’s Account Receivable For example, on March 5, 2015, assume that Allied Enterprises determined that Bill Johnson’s $400 Account Receivable was 03/04/14 5:21 PM www.downloadslide.net 336 Chapter uncollectible The entry to write off Bill Johnson’s account under the direct write-off method would be: DATE Mar ACCOUNTS Bad Debt Expense Accounts Receivable—Bill Johnson Wrote off Bill Johnson’s account POST REF DR 400 CR 400 The direct write-off method is generally not allowed by GAAP because it does not always adhere to the matching principle that was discussed in Chapter For example, let’s assume Bill Johnson’s $400 account, which was written off, originated from a credit sale that occurred in 2014 In this instance, Allied Enterprises would have recorded sales revenue in 2014 However, Allied Enterprises wrote off the bad debt by recording the bad debt expense in 2015, a different year As a result, Allied Enterprises fails to correctly match expenses with related revenues The materiality principle, discussed in Chapter 5, allows companies who experience low amounts of bad debt expense to utilize the direct write-off method Direct Write-Off Method: Recovery of Accounts Previously Written Off Occasionally after a company has written off a customer’s account, the customer will unexpectedly pay part, or all, of the amount owed There is a two-step process used to record the receipt of cash from the customer when this happens First, the customer’s Account Receivable is reinstated This step is required as the customer’s account no longer exists within the company’s records Next, the payment on the account is recorded Let’s assume that on August 10, 2015, Bill Johnson unexpectedly sent Allied Enterprises a check for $250 as payment on his account, which had previously been written off Allied Enterprises would first reinstate the Account Receivable as follows: DATE Aug 10 ACCOUNTS Accounts Receivable—Bill Johnson Bad Debt Expense Reinstate Bill Johnson’s account POST REF DR 250 CR 250 Observe that only $250 of the account was reinstated If Allied Enterprises believes Mr Johnson will pay the remaining $150 owed on the account, the entire $400 could have been reinstated Also, notice that the accounts debited and credited in this entry are exactly opposite of those used in the entry to write off the account Now that the account has been reinstated, Allied Enterprises records the receipt of cash as follows: DATE Aug 10 ACCOUNTS Cash Accounts Receivable—Bill Johnson Collected cash on account POST REF DR 250 CR 250 Another method of accounting for uncollectible accounts that does adhere to the matching rule is the allowance method M07_KEMP9543_03_GE_C07.indd 336 03/04/14 5:21 PM www.downloadslide.net Cash and Receivables 337 The Allowance Method Allowance method A method of accounting for uncollectible accounts that utilizes estimates of the amount of Accounts Receivable that are not expected to be collected in the future Allowance for Uncollectible Accounts A contra-asset account that holds the estimated amount of uncollectible accounts receivable; also called Allowance for Doubtful Accounts Net realizable value The net amount that the business expects to collect; the net realizable value of receivables is calculated by subtracting Allowance for Uncollectible Accounts from Accounts Receivable Control account An account in the general ledger that summarizes the details of an account balance The allowance method is a method of accounting for bad debts in which bad debt expense is recorded in the same period as sales revenue For this reason, the allowance method adheres to the matching principle and is, therefore, required by GAAP Under the allowance method, a business will use an adjusting entry at the end of the period to record the bad debt expense for the period Because the business does not know which customers will eventually not pay it, it must estimate the amount of bad debt expense based on past experience The debit side of the adjusting entry will be to the Bad Debt Expense account This is the same account that was debited when an account was written off using the direct write-off method However, instead of crediting Accounts Receivable, a contra-account called Allowance for Uncollectible Accounts or Allowance for Doubtful Accounts will be credited The Allowance for Uncollectible Accounts is “tied” to the Accounts Receivable account and is subtracted from Accounts Receivable to arrive at the net realizable value of the Accounts Receivable The adjusting entry will look like this: DATE Dec 31 ACCOUNTS Bad Debt Expense Allowance for Uncollectible Accounts To record estimated bad debts POST REF DR XXX CR XXX The Allowance for Uncollectible Accounts is utilized because the specific customers who will ultimately not pay are unknown at the time the adjusting entry is made Remember from Chapter that, in addition to the Accounts Receivable control account in the general ledger, each customer also has an account in the Accounts Receivable subsidiary ledger In order to reduce Accounts Receivable, the specific customer would have to be known so that his or her Account Receivable could be reduced in the subsidiary ledger As we will demonstrate later in the chapter, once it is known that a specific customer’s account is uncollectible, his or her Account Receivable will be written off The offset to this entry will be to reduce the Allowance for Uncollectible Accounts by an equal amount Estimating the Amount of Uncollectible Accounts Percent of sales method The method of estimating uncollectible accounts that focuses on net credit sales; also called the income statement approach Net credit sales The total credit sales less sales discounts and sales returns and allowances related to the credit sales In order to estimate the amount of bad debt expense, a company will use its past bad debt experience to make an educated guess of how much will be uncollectible The state of the economy, the industry the business operates in, and other variables are also used in order to arrive at the best estimate possible There are two basic ways to estimate the amount of uncollectible accounts: • Percent of sales method • Aging method Percent of Sales Method The percent of sales method computes the estimated amount of uncollectible accounts as a percentage of net credit sales To demonstrate, let’s assume that Allied Enterprises has the following selected account balances as of December 31, 2014, prior to adjusting for bad debts: Accounts Receivable Allowance for Uncollectible Accounts 32,000 00 450 Bad Debt Expense M07_KEMP9543_03_GE_C07.indd 337 03/04/14 5:21 PM www.downloadslide.net 338 Chapter It is important to note that when using the allowance method, the Allowance for Uncollectible Accounts will almost always have a balance at the end of the period The balance in the account may have a debit or a credit balance depending on the amount of the adjusting entry from the prior period and the amount of uncollectible accounts that have been written off during the current period Also, note that the Bad Debt Expense account will always have a zero balance before the adjusting entry This is because, as an expense account, it was closed at the end of the prior period Now, let’s assume that Allied Enterprises estimates uncollectible accounts to be 1/2 of 1% of net credit sales, which totaled $300,000 during 2014 The estimated amount of uncollectible accounts is $1,500 ($300,000 × 0.005) Under the percent of sales method, once the estimated amount of uncollectible accounts has been determined, the adjusting entry is made for that amount The required journal entry at December 31, 2014, would be as follows: DATE Dec 31 ACCOUNTS Bad Debt Expense Allowance for Uncollectible Accounts To record estimated bad debts POST REF DR 1,500 CR 1,500 After posting the adjusting entry, Allied Enterprises’ accounts would look like this: Accounts Receivable Allowance for Uncollectible Accounts 32,000 450 1,500 1,950 Bad Debt Expense 1,500 1,500 Income statement approach The method of estimating uncollectible accounts that focuses on net credit sales; also called the percent of sales method Aging method The method of estimating uncollectible accounts that focuses on accounts receivable; the accountant calculates the end-ofperiod allowance balance based on an aging of the Accounts Receivable; also called the balance sheet approach The net realizable value of Allied Enterprises’ Accounts Receivable is $30,050 at December 31, 2014 ($32,000 Accounts Receivable less $1,950 Allowance for Uncollectible Accounts) Notice that Bad Debt Expense reflects the calculated amount of uncollectible accounts ($1,500), whereas Allowance for Uncollectible Accounts reflects a different amount ($1,950) This reflects why this method is also called the income statement approach This method focuses more on the income statement than on the balance sheet After the adjusting entry has been posted, the income statement account (Bad Debt Expense) reflects the calculated amount of uncollectible accounts rather than the balance sheet account (Allowance for Uncollectible Accounts) Aging Method The other method for estimating uncollectible accounts is the aging method Once again, let’s assume Allied Enterprises had the following account balances at December 31, 2014, prior to adjusting for bad debts Accounts Receivable Allowance for Uncollectible Accounts 32,000 00 450 Bad Debt Expense M07_KEMP9543_03_GE_C07.indd 338 03/04/14 5:21 PM www.downloadslide.net Cash and Receivables 339 When using the aging method, a schedule is created that reflects all of the company’s individual credit customers with their account balances broken down based on how long they’ve been outstanding This is known as an Accounts Receivable aging report Exhibit 7-7 reflects the Accounts Receivable aging report for Allied Enterprises at December 31, 2014 32 33 34 Customer B Ashford L Clark Balance $ 450 875 Current M Reynolds R Turlock K Wilson Total 575 225 950 $32,000 575 1–30 150 Days Past Due 31–60 61–90 91–180 > 181 300 875 225 26,850 2,800 125 325 475 825 1,250 300 Exhibit 7-7 Once the aging report has been prepared, an estimated percentage of uncollectible accounts is determined for each age category This percentage is then multiplied by the balance for each age category to determine the estimated uncollectible amount for that category These amounts are then added together to arrive at the total estimated amount of uncollectible accounts for the period The calculation for Allied Enterprises would look like this: Account Age Current 1–30 31–60 61–90 91–180 > 181 Total Balance $26,850 2,800 475 325 1,250 300 $32,000 Estimated Percent Uncollectible 2% 5% 20% 40% 50% 80% Estimated Uncollectible Amount $ 537 140 95 130 625 240 $1,767 Now that we know the total estimated amount of uncollectible accounts, $1,767, we are ready to make the adjusting entry Unlike when using the percent of sales method, we not simply take the calculated amount of uncollectible accounts and use this as the amount of the journal entry (this is the biggest difference between the two methods) Instead, we must look at the existing balance in Allowance for Uncollectible Accounts and perform a calculation to determine the amount to use in the adjusting entry When using the aging method, the goal is for Allowance for Uncollectible Accounts to reflect the calculated amount of uncollectible accounts after the adjusting entry has been recorded and posted The easiest way to determine the correct amount of the required adjusting entry is to a T-account analysis of Allowance for Uncollectible Accounts: Allowance for Uncollectible Accounts 450 ? 1,767 M07_KEMP9543_03_GE_C07.indd 339 03/04/14 5:21 PM www.downloadslide.net 340 Chapter The first step in the analysis is to enter the Allowance for Uncollectible Accounts balance that existed prior to making the adjusting entry Next, skip a line and enter the desired ending balance in the T-account This balance will be the calculated amount of the uncollectible accounts, $1,767 The question mark represents the adjusting entry amount that is required This amount is determined by calculating the credit needed to bring the ending balance up to the desired amount It is very important to pay attention to whether the Allowance for Uncollectible Accounts balance that existed prior to making the adjusting entry was a debit or a credit Also, remember that the ending balance in the account will always be a credit balance By looking at the T-account analysis, we can see that the required adjusting entry amount is $1,317 ($1,767 – $450) The required journal entry at December 31, 2014, would be: DATE Dec 31 ACCOUNTS Bad Debt Expense Allowance for Uncollectible Accounts To record estimated bad debts POST REF DR 1,317 CR 1,317 After posting the adjusting entry, Allied Enterprises’ accounts would look like this: Accounts Receivable Allowance for Uncollectible Accounts 32,000 450 1,317 1,767 Bad Debt Expense 1,317 1,317 Balance sheet approach The method of estimating uncollectible accounts that focuses on accounts receivable The accountant calculates the end-of-period allowance balance based on an aging of the Accounts Receivable; also called the aging method The net realizable value of Allied Enterprises’ Accounts Receivable is $30,233 at December 31, 2014 ($32,000 Accounts Receivable less $1,767 Allowance for Uncollectible Accounts) Notice that Allowance for Uncollectible Accounts reflects the calculated amount of uncollectible accounts ($1,767), whereas Bad Debt Expense reflects a different amount ($1,317) This reflects why this method is also called the balance sheet approach This method focuses more on the balance sheet than on the income statement After the adjusting entry has been posted, the balance sheet account (Allowance for Uncollectible Accounts) reflects the calculated amount of uncollectible accounts rather than the income statement account (Bad Debt Expense) Writing Off Uncollectible Accounts Under the Allowance Method The entry to write off a customer’s account under the allowance method is similar to the entry used under the direct write-off method At the time a company determines a customer’s account is uncollectible, the Accounts Receivable will be credited to remove it from the company’s books However, the offsetting debit will not be made to Bad Debt Expense as it was under the direct write-off method Instead, it will be made to Allowance for Uncollectible Accounts Assume that on March 5, 2015, Allied Enterprises determined that Bill Johnson’s $400 Account Receivable was uncollectible M07_KEMP9543_03_GE_C07.indd 340 03/04/14 5:21 PM www.downloadslide.net Cash and Receivables 341 The entry to write off Bill Johnson’s account under the allowance method would be as follows: DATE Mar ACCOUNTS Allowance for Uncollectible Accounts Accounts Receivable—Bill Johnson Wrote off Bill Johnson’s account POST REF DR 400 CR 400 Remember that the expense related to writing off Bill Johnson’s account was recognized in 2014 when Allied Enterprises made the adjusting entry to record the estimated bad debts Allowance Method: Recovery of Accounts Previously Written Off The entries required to record the receipt of cash from a customer whose account was previously written off are similar under the allowance method to those used under the direct write-off method First, the customer’s Account Receivable is reinstated Then the payment on the account is recorded Let’s assume once again that on August 10, 2015, Bill Johnson unexpectedly sent Allied Enterprises a check for $250 as payment on his previously written-off account Allied Enterprises would first reinstate the Account Receivable: DATE Aug 10 ACCOUNTS Accounts Receivable—Bill Johnson Allowance for Uncollectible Accounts Reinstated Bill Johnson’s account POST REF DR 250 CR 250 Notice again that the accounts debited and credited in this entry are exactly opposite of those used in the entry to write off the account Allied Enterprises now records the receipt of cash in the same manner as was done under the direct write-off method as: DATE Aug 10 ACCOUNTS Cash Accounts Receivable—Bill Johnson Collected cash on account POST REF DR 250 CR 250 Exhibit 7-8 summarizes the differences between the entries required when using the direct write-off method and those required when using the allowance method Event Direct Write-off Method Allowance Method Period-end adjusting entry None required Bad Debt Expense Allowance for Uncollectible Accounts Entry to write off customer account Bad Debt Expense XXXX Accounts Receivable—customer name XXXX Allowance for Uncollectible Accounts XXXX Accounts Receivable—customer name XXXX Entries to record receipt of payment on an account previously written off Accounts Receivable—customer name XXXX Bad Debt Expense XXXX Cash XXXX Accounts Receivable—customer name XXXX Accounts Receivable—customer name XXXX Allowance for Uncollectible Accounts XXXX Cash XXXX Accounts Receivable—customer name XXXX XXXX XXXX Exhibit 7-8 M07_KEMP9543_03_GE_C07.indd 341 03/04/14 5:22 PM www.downloadslide.net 342 Chapter Try It… Will writing off Bill Johnson’s $400 account reduce the net realizable value of Allied Enterprises’ Accounts Receivable? Answer No, under the allowance method, the write-off of uncollectible receivables has no impact on the net realizable value of Accounts Receivable Remember that the net realizable value of Accounts Receivable equals the balance in the Accounts Receivable account less the balance in the related contra account, Allowance for Uncollectible Accounts When Bill Johnson’s account was written off, the asset account, Accounts Receivable, was reduced by $400 However, the Allowance for Uncollectible Accounts was also reduced by $400, so the total change in the net realizable value of the Accounts Receivable is zero How Are Accounts Receivable Reported on the Balance Sheet? Report accounts receivable on the balance sheet Accounts receivable are reported at “net realizable value” in the current assets section of the balance sheet There are two ways to show Accounts Receivable at net realizable value For example, assume that at December 31, 2014, Allied Enterprises’ Accounts Receivable balance is $32,000 and its Allowance for Uncollectible Accounts balance is $1,767 Allied Enterprises could report its accounts receivable in either of the two ways shown here: Allied Enterprises Balance Sheet (partial): December 31, 2014 Accounts Receivable Less: Allowance for Uncollectible Accounts Accounts Receivable, Net $32,000 1,767 $30,233 Allied Enterprises Balance Sheet (partial): December 31, 2014 Accounts Receivable, Net of Allowance for Uncollectible Accounts of $1,767 $30,233 Most companies use the second method, but either is acceptable The key is to show Accounts Receivable at net realizable value M07_KEMP9543_03_GE_C07.indd 342 03/04/14 5:22 PM www.downloadslide.net Cash and Receivables 343 How Do You Account for Notes Receivable? Account for notes receivable Promissory note A written promise to pay a specified amount of money at a particular future date Maker of a note The entity that promises future payment; also called the debtor Payee of a note The entity to whom the debtor promises future payment; also called the creditor Principal The amount loaned out by the payee and borrowed by the maker of the note Interest The fee for using money; revenue to the creditor for loaning money; expense to the debtor for borrowing money Interest rate The percentage rate of interest specified by the note; almost always stated for a period of one year Maturity date The date when final payment of a note is due; also called the due date Maturity value The sum of the principal of a note plus interest due at maturity Note term The time span of the note during which interest is computed; it extends from the original date of the note to the maturity date Principal Notes receivable are more formal than accounts receivable The debtor signs a promissory note as evidence of the transaction Before launching into the accounting, let’s define the terms related to notes receivable • Promissory note: A written promise to pay a specified amount of money on a particular future date • Maker of a note: The entity that signs the note and promises to pay the required amount; the maker of the note is the debtor • Payee of a note: The entity to whom the maker promises future payment; the payee of the note is the creditor • Principal: The amount loaned out by the payee and borrowed by the maker of the note • Interest: The amount charged for loaning money Interest is expense to the debtor and revenue to the creditor • Interest rate: The percentage rate of interest specified by the note Interest rates are almost always stated for a period of one year A 10% note means that the amount of interest for one year is 10% of the note’s principal • Maturity date: This is the date when final payment of the note is due Also called the due date • Maturity value: The sum of the principal plus interest due at maturity • Note term: The period of time during which interest is earned It extends from the original date of the note to the maturity date Exhibit 7-9 illustrates a promissory note As you study the promissory note, look for the items mentioned previously Identifying the Maturity Date Some notes specify the maturity date For example, March 31, 2015, is the maturity date of the note shown in Exhibit 7-9 Other notes state the period of the note in days or months When the period is given in months, the note’s maturity date falls on the same PROMISSORY NOTE $1,000 March 31, 2014 Date Amount Interest period starts For value received, I promise to pay to the order of Allied Enterprises Principal One thousand and no/100 on March 31, 2015 plus interest at the annual rate of 10 percent Payee Dollars Interest period ends on the maturity date Interest rate Maker Exhibit 7-9 M07_KEMP9543_03_GE_C07.indd 343 03/04/14 5:22 PM www.downloadslide.net 344 Chapter day of the month as the date the note was issued For example, a three-month note dated March 1, 2014, would mature on June 1, 2014 When the period is given in days, the maturity date is determined by counting the actual days from the date of issue A 180-day note dated March 16, 2014, matures on September 12, 2014 When counting the days for a note term, remember to: • Count the maturity date • Omit the date the note was issued Origination of Notes Receivable Notes receivable typically originate from a company doing one of the following: • Lending money • Providing goods or services in exchange for a promissory note • Accepting a promissory note as payment on an account receivable Assume that, on August 1, 2014, Allied Enterprises lent $800 to Kim Simmons on a sixmonth, 8% promissory note The journal entry to record the note would be: DATE Aug ACCOUNTS Note Receivable—K Simmons Cash POST REF DR 800 CR 800 Next, assume that on September 5, Allied Enterprises sells goods for $2,500 to Don Hammond Hammond signs a nine-month promissory note at 10% annual interest Allied Enterprises’ entry to record the sale (ignore cost of goods sold) is: DATE Sep ACCOUNTS Note Receivable—D Hammond Sales POST REF DR 2,500 CR 2,500 A company may also accept a note receivable from a credit customer who is unable to pay his or her account receivable on time The customer signs a promissory note and gives it to the creditor Assume that on November 18, 2014, Sandra Fisher cannot pay her $1,200 account when it comes due and that Allied Enterprises accepts a 60-day, 12% note receivable in lieu of payment Allied Enterprises would record this as follows: DATE Nov 18 ACCOUNTS Note Receivable—S Fisher Accounts Receivable—S Fisher POST REF DR 1,200 CR 1,200 Computing Interest on a Note The formula for computing the interest is: Amount of interest ϭ Principal ϫ Interest rate ϫ Time M07_KEMP9543_03_GE_C07.indd 344 03/04/14 5:22 PM www.downloadslide.net Cash and Receivables 345 In the formula, multiplying by “Time” adjusts for the fact that the interest rate represents a year’s worth of interest The “Time,” or time period, represents the portion of a year for which interest has accrued on the note It may be expressed as a fraction of a year in months (x/12) or a fraction of a year in days (x/360 or x/365) When the interest period is stated in days, interest may be computed based on either a 360-day year or a 365-day year Using the data in Exhibit 7-9, Allied Enterprises computes interest revenue for one year: Amount of interest ϭ Principal ϫ Interest rate ϫ Time $100 ϭ $1,000 ϫ 0.10 ϫ 12/12 The maturity value of the note is $1,100 ($1,000 principal + $100 interest) The time element is 12/12 or because the note’s term is year Interest on a $2,000 note at 6% for nine months is computed as: Amount of interest ϭ Principal ϫ Interest rate ϫ Time $90 ϭ $2,000 ϫ 0.06 ϫ 9/12 Interest on a $4,000 note at 8% for 90 days (assuming a 360 day year) is computed as: Amount of interest ϭ Principal ϫ Interest rate ϫ Time $80 ϭ $4,000 ϫ 0.08 ϫ 90/360 Accruing Interest Revenue Notes receivable are often outstanding at the end of an accounting period The interest revenue earned on the notes up to year-end should be recorded as part of that year’s earnings Recall that interest revenue is earned over time, not just when cash is received Because of the matching principle, we want to record the interest revenue from notes in the year in which it was earned Let’s continue with the Allied Enterprises’ note receivable from Exhibit 7-9 Allied Enterprises’ accounting period ends December 31 • How much of the total interest revenue does Allied Enterprises earn in 2014 (from March 31 through December 31, 2014)? Amount of interest ϭ Principal ϫ Interest rate ϫ Time $75 ϭ $1,000 ϫ 0.10 ϫ 9/12 Allied Enterprises makes the following adjusting entry at December 31, 2014: DATE Dec 31 M07_KEMP9543_03_GE_C07.indd 345 ACCOUNTS Interest Receivable Interest Revenue Accrue interest revenue POST REF DR CR 75 75 03/04/14 5:22 PM www.downloadslide.net 346 Chapter • How much interest revenue does Allied Enterprises earn in 2015 (from January through March 31, 2015)? Amount of interest ϭ Principal ϫ Interest rate ϫ Time $25 ϭ $1,000 ϫ 0.10 ϫ 3/12 On the note’s maturity date, Allied Enterprises makes the following entry: DATE Mar 31 ACCOUNTS Cash (Maturity Value) Note Receivable—B Anderson Interest Receivable Interest Revenue Record repayment of note at maturity POST REF DR 1,100 CR 1,000 75 25 Earlier we determined that total interest on the note was $100 ($1,000 × 0.10 × 12/12) These entries assign the correct amount of interest to each year 2014 ϭ $ 75 2015 ϭ $ 25 Total Interest ϭ $100 Focus on Decision Making “Can a Business Pay Its Bills?” 7 Calculate the current ratio, quick ratio, accounts receivable turnover, and receivable collection period Liquidity management The management of cash, specifically the amount and timing of cash receipts and payments Current ratio The ratio of current assets to current liabilities Current assets Cash, short-term investments, accounts receivable, inventory, and prepaid expenses How much cash, and assets that can be quickly turned into cash, should a business have? A business needs enough cash to pay its bills in normal times It also needs enough cash to face unexpected challenges and opportunities Just because a business is profitable does not mean that it can pay its bills Remember, accrual accounting does not wait to recognize revenue or expense until the cash is received or paid Thus, net income is not the same as cash Likewise, an unprofitable business may be able to pay its bills in the short term Like any asset, a business can have too little or too much cash A business wants enough cash to pay its bills But unneeded cash does not help the business’s profitability So how can you tell when a business has the right amount of cash and assets that quickly turn into cash? The term often used to describe this issue is “liquidity management.” Liquidity management examines how a business manages its cash so it can pay its bills Current Ratio and Quick Ratio Two ratios often used to measure a business’s liquidity are the current ratio and the quick ratio The current ratio is the ratio of current assets to current liabilities Current assets are cash and assets that are expected to turn into cash or be sold or consumed within the next year Current assets include cash, short-term investments, accounts receivable, inventory, and prepaid expenses Current liabilities are liabilities that must be paid in one year Current liabilities include accounts payable, accrued liabilities, and other debts due in the next year The formula for the current ratio is: Current Ratio ϭ M07_KEMP9543_03_GE_C07.indd 346 Current Assets Current Liabilities 03/04/14 5:22 PM www.downloadslide.net Cash and Receivables Quick ratio Ratio that reveals how well the entity can pay its current liabilities; also called the acid-test ratio Quick assets Cash, short-term investments, and accounts receivable 347 A more stringent measure of a company’s ability to pay current liabilities is the quick ratio The quick ratio, also called the acid-test ratio, compares a company’s quick assets to its current liabilities Quick assets include cash, short-term investments, and accounts receivable The quick ratio reveals whether the entity could pay all of its current liabilities with quick assets if they were to become due in the near future The formula for the quick ratio is: Quick Ratio ϭ Quick Assets Current Liabilities Let’s assume that Mackay Industries has the following current assets as of December 31, 2013: cash, $3,100; net current receivables, $2,500; inventory, $6,300; and shortterm investments, $1,600 Current liabilities are $4,300 The current ratio for Mackay Industries is calculated as: Current Ratio = $3,100 + $2,500 + $1,600 + $6,300 = 3.14 $4,300 The quick ratio for Mackay Industries is calculated as: Quick Ratio ϭ ($3,100 ϩ $2,500 ϩ $1,600) $7,200 ϭ ϭ 1.67 $4,300 $4,300 Notice the $6,300 of inventory was not considered in the calculation of the quick ratio This is because, although inventory is a current asset, it is not considered to be a “quick” asset The higher the current and quick ratios, the more able the business is to pay its current liabilities Mackay Industries has a very strong current ratio and quick ratio Mackay Industries’ current ratio of 3.14 means that it has $3.14 of current assets to pay each $1.00 of current liabilities Mackay Industries’ quick ratio of 1.67 means that it has $1.67 of quick assets to pay each $1.00 of current liabilities Accounts Receivable Turnover and Receivable Collection Period Accounts receivable turnover Net Credit Sales divided by average Net Accounts Receivable; it measures a company’s ability to collect cash from its credit customers Why would a business have accounts receivable? Every business would prefer to receive cash from a sale The answer is competition Businesses have accounts receivable to attract customers Accounts receivable are a way customers finance their purchases Would you shop at Best Buy if it did not accept credit cards? Credit cards are a form of accounts receivable So how much accounts receivable should a business have? It’s a balancing act A business wants enough accounts receivable to attract customers and have sales However, businesses not want unnecessary accounts receivable The money to finance accounts receivable is expensive The business must also work to collect the accounts receivable and worry about bad debts To help manage accounts receivable, a business often looks at two measures, the accounts receivable turnover and the receivable collection period The accounts receivable turnover measures the ability to collect cash from customers who buy on credit The higher the turnover, the more successful the business is in collecting cash However, an accounts receivable turnover that is too high may indicate that a company is not extending credit freely enough to make sales to all potentially good customers The accounts receivable turnover is calculated as: Accounts Receivable Turnover ϭ M07_KEMP9543_03_GE_C07.indd 347 Net Credit Sales Net Credit Sales ϭ Average Net Accounts Receivable (Beginning Net Accounts Receivable ϩ Ending Net Accounts Receivable)/2 03/04/14 5:22 PM www.downloadslide.net 348 Chapter Receivable collection period Average Net Accounts Receivable divided by daily credit sales It measures how many days it takes to collect accounts receivable The accounts receivable turnover is usually computed for an annual period, so the sales figure is the amount for the entire year Average accounts receivable is computed by adding the beginning balance and ending balance of net accounts receivable and dividing the total by two Remember that balance sheet accounts, such as accounts receivable, carry their balances from one period to the next The ending accounts receivable for one year becomes the beginning accounts receivable for the next year The receivable collection period looks at the same issue with a slightly different measure The receivable collection period measures how many days it takes to collect the average balance of accounts receivable The receivable collection period is computed as follows: Receivable Collection Period ϭ Average Net Accounts Receivable (Net Credit Sales/365 Days) To demonstrate the accounts receivable turnover and receivable collection period, assume that Mackay Industries has net credit sales for the year of $486,000; beginning net accounts receivable of $64,000; and ending net accounts receivable of $52,000 Mackay Industries would calculate the accounts receivable turnover and receivable collection period for the year as: Accounts Receivable Turnover ϭ Receivable Collection Period ϭ $486,000 $486,000 ϭ ϭ 8.38 (($64,000 ϩ $52,000)/2) $58,000 ($64,000 ϩ $52,000)/2 $58,000 ϭ ϭ 44 Days ($486,000/365 Days) $1,331.51 The determination of whether a company’s accounts receivable turnover is good or bad depends on the company’s credit terms If Mackay Industries grants 30-day credit terms, its 8.38 accounts receivable turnover and 44 day receivable collection period would be viewed as poor With 30-day credit terms, you would expect a turnover of closer to 12 (365 days divided by 30 days) If Mackay Industries grants 45-day credit terms, its 8.38 accounts receivable turnover and 44 day receivable collection period would be viewed as good With 45-day credit terms, you would expect an accounts receivable turnover of closer to (365 days divided by 45 days) How They Do It: A Look at Business So, what are acceptable current and quick ratios? What are a good accounts receivable turnover and receivable collection period? It depends on the business Let’s look at Hershey and Walmart First, let’s look at Hershey Hershey makes and sells candy to wholesalers and retailers When the economy is doing well, customers buy a lot of Hershey’s products When the economy is not doing well, customers not buy as much Hershey candy Making and selling these products is a volatile and thus risky business To make sure it can pay its bills, Hershey has a considerable amount of cash On December 31, 2012, Hershey’s had $728 million in cash and cash equivalents But Hershey also had a current ratio of 1.4 and a quick ratio of 0.8.The management of Hershey has significant liquidity to make sure it can pay its bills in good and bad times A part of Hershey’s liquidity is the management of accounts receivable Hershey sells to wholesalers and retailers, allowing them to pay later Hershey has accounts receivable Hershey’s accounts receivable turnover for its 2012 fiscal year was 15.4 times a year It takes Hershey an average of 23.6 days to collect its average level of accounts receivable Now, let’s look at Walmart Walmart buys and resells clothing and household products Walmart is a discount retailer that sells the basic goods that people need to live in good and bad times Its sales and costs are very predictable Its business is risky, but M07_KEMP9543_03_GE_C07.indd 348 03/04/14 5:22 PM www.downloadslide.net Cash and Receivables 349 not as risky as Hershey’s To make sure it can pay its bills, Hershey has a lot of cash On January 31, 2013, Walmart had $7.8 billion in cash But Walmart also had a current ratio of 0.8 and a quick ratio of 0.2 at the end of the 2012 fiscal year Walmart is a business that has less risk than Hershey Because of the higher certainty of Walmart’s sales and operations, the management of Walmart does not believe Walmart needs as much liquidity as Hershey A part of Walmart’s liquidity is the management of accounts receivable, particularly its credit card receivables Walmart doesn’t loan money to its customers directly However, Walmart accepts credit cards issued by banks When Walmart accepts a credit card for payment, it takes several days for the bank to pay Walmart Until the bank pays Walmart, credit card transactions are receivables Walmart’s accounts receivable turnover for the fiscal year ending January 31, 2013, was 73.4 times a year In other words, it takes Walmart an average of days to collect its credit card receivables Now think about and compare Hershey and Walmart Each have accounts receivables Accounts receivable are important in how each does business However, Hershey and Walmart use accounts receivables differently and thus have different accounts receivable turnovers and collect periods Summary MyAccountingLab Discuss internal controls for cash and prepare a bank reconciliation Here is what you should know after reading this chapter The Study Plan in MyAccountingLab will help you identify what you know and where to go when you need practice Key Points Key Accounting Terms Maintaining internal controls over cash is critical: Bank balance (p 328) Bank collection (p 329) • Cash receipts should be deposited promptly Bank reconciliation (p 328) • A payment process that ensures separation of duties is very important Book balance (p 328) • Bank reconciliations should be prepared regularly Bank statement (p 328) Controller (p 327) Deposits in transit (p 329) Electronic data interchange (EDI) (p 327) Electronic funds transfer (EFT) (p 328) Lock-box system (p 329) Nonsufficient funds (NSF) check (p 329) Outstanding checks (p 329) Purchase order (p 327) Purchasing agent (p 327) Receiving report (p 327) Treasurer (p 327) M07_KEMP9543_03_GE_C07.indd 349 03/04/14 5:22 PM .. .Financial Accounting A 01 _KEMP9 543_03_GE_FM.indd 03/04 /14 1: 22 PM A 01 _KEMP9 543_03_GE_FM.indd 03/04 /14 1: 22 PM Financial Accounting Third Edition Global Edition Robert Kemp University... 757 A 01 _KEMP9 543_03_GE_FM.indd 15 03/04 /14 1: 23 PM A 01 _KEMP9 543_03_GE_FM.indd 16 03/04 /14 1: 23 PM Preface Changes to this Edition Chapter 1 Business, Accounting, and You • Added Real World Accounting. .. by such owners British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 9 8 7 6 5 4 3 2 1 15 14 13 12 11 ISBN 13 : 978 -1- 292- 019 54-3