Advanced finance summary
Chapter 7, 8, 9, 10, 11, 12, 13 and 14
International Business and Management Studies
CHAPTER 7 SUMMARY
FINANCIAL ASSETS are a companies most liquid (or cashlike) resources. The three
financial asssets are:
(1) cash, (2) account receivables, (3) marketable securities or also called short-term
investments. All of these assets represent forms of money. Business people say that
companies should have “as little as necessary cash”.
The valuation of financial assets; on the balance sheet, cash and cash equivalents are
reported at their face amount. Short-term investments are reported at their fair market
value. Accounts receivable are reported at their net realizable value. Net realizable value
is the amount of the accounts receivable the business estimates it will actually collect,
(estimated collectible amount).
TheValuation of Financial Assets
B a s is fo r V a lu a t io n in
T y p e o f F in a n c ia l A s s e t s t h e B a la n c e S h e e t
C a s h ( a n d c a s h e q u iv a le n t s ) Face am ount
S h o r t - t e r m in v e s t m e n t s F a ir m a r k e t v a lu e
( m a r k e t a b le s e c u r it ie s )
R e c e iv a b le s N e t r e a liz a b le v a lu e
Estimated collectible amount
7-3
CASH
Accountant’s define cash as money on deposit in banks and any items that banks will
accept for deposit. Not only money but also check, money orders, travelers’ checks.
Consumers using bankcards (Visa and Mastercard) are considered cash sales, not credit
sales. Cash account in the general ledger is often a control account.
Reporting cash in the balance sheet
Cash is listed first in the BS, because it is the most liquid of all assets.
S.v.v.
,Cash equivalents; are short-term investments, usually with a maturity date of less than
three months, that have little risk of market value changes. For purposes of balance sheet
presentation, the balance in the Cash control account is combined with that of the control
account for cash equivalents.
Examples of cash equivalents include money market funds, U.S. Treasury bills, and high-
grade commercial paper (very short-term notes payable that are issued by large,
creditworthy corporations). Short-term investments that do not qualify as cash
equivalents are listed in the balance sheet as Marketable Securities.
Restricted cash; is cash that has been set aside for a particular use and is not available
for paying current liabilities. Restricted cash is not a current asset, rather it is classified
as an investment on the balance sheet. Restricted cash should be presented in the
balance sheet as part of the section entitled “Investments and Restricted Funds”.Line of
credit; is an agreement between a bank and a business where the bank agrees in
advance to lend a specific amount of money to the business. When the business borrows
from the line of credit, the business receives cash and incurs a liability. The business can
continue to borrow up to the limit on the line of credit. The business can also make a
payment to reduce the liability at any time. Any unused line of credit must be disclosed in
the notes to the financial statements. The unused portion of a line of credit is neither an
asset nor a liability.
Cash management
Comprehensive system that helps accurately account for cash, helps prevent theft of
cash and fraud, helps assure the availability of adequate amounts of cash, and helps
avoid having unnecessarily large amounts of idle cash on hand. Many businesses have
large departments that have the responsibility of properly managing the business’s cash
needs.
Internal control over cash
Is sometimes regarded merely as a means of preventing fraud and theft. The major steps
in achieving internal control over cash transactions and cash balances:
Segregation of duties such as authorization, custody, and recording of cash
transactions.
Preparing a cash budget.
Preparing a control listing of cash receipts.
Requiring daily deposits.
Making all payments by check.
Require that every expenditure be verified before payment, and
Promptly reconciling bank statements.
Cash over and short; when a cash drawer is over or short, the account Cash Over and
Short is used to record the difference. Management monitors the balance in the Cash
Over and Short account to determine if there is a problem with cash shortages or
overages. The account is debited for cash shortages and credited for cash overages. (P.
293) (debit balance = expense, credit balance = revenue).
Bank statements
Shows the account balance at the beginning of the month, the deposits, the checks paid,
any other additions and subtractions during the month, and the new balance at the end
of the month.
Reconciling the bank statement
Bank reconciliation is a schedule explaining any differences between the balance shown
in the bank statement and the balance shown in the depositors accounting records. The
bank and the depositor maintain independent records of the deposits, checks, and current
balance of the bank account.
Normal differences between bank records and accounting records; the balance shown in
the bank statement seldom equals the balance appearing in the depositors accounting
records. The most common examples are:
Outstanding checks; checks issued and recorded by the company but not yet
presented ito the bank for payment
S.v.v.
, Deposits in transit; cash receipts recorded by the depositor that reached the bank
too late to be included in the bank statement for the current month.
Certain transactions appearing in the bank statement may not have been recorded by the
depositor:
Service charges
Charges for depositing NSF (not sufficient funds) checks
Credits for interest earned
Miscellaneous bank charges and credits.
See PowerPoint page 9 till 12 or book page 293 till 297
SHORT-TERM INVESTMENTS (marketable securities)
Short-term investments are investments in bonds or stocks that are readily marketable.
They are classified as current assets on the balance sheet. Due to their liquidity,
investments in marketable securities are listed immediately after Cash in the balance
sheet and are most often classified as available for sale. They are almost as liquid as cash
itself.
ACCOUNTING FOR MARKETABLE SECURITIES
There are four e events related to marketable securities: (1) the purchase of investments,
(2) the receipt of dividends or interest revenue, (3) the sale of investments, and (4) end-
of-period adjustments.
(1) The purchase of marketable securities (MS)
They are recorded as cost, which includes any brokerage commissions. MS is a control
account used to report all of a companies short-term investments.
Purchase of Marketable
Securities
Foster Corporation purchases as a short-term
investment 4,000 shares of The Coca-Cola
Company on December 1. Foster paid $48.98
per share, plus a brokerage commission of $80.
G ENERAL J O URNAL
D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
D ec 1 M a r k e t a b le S e c u r it ie s 1 9 6 ,0 0 0
C ash 1 9 6 ,0 0 0
Total Cost: (4,000 × $48.98) + $80 = $196,000
Cost per Share: $196,000 ÷ 4,000 = $49.00
7-15
(2) Recognition of investment revenue
Entries to recognize interest and dividend revenue typically involve a debit to cash and a
credit to either interest revenue or dividend revenue.
Recognition of Investment
Revenue
On December 15, Foster Corporation
receives a $0.30 per share dividend on its
4,000 shares of Coca-Cola.
G ENERAL J O URNAL
D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
D ec 15 C as h 1 ,2 0 0
D iv id e n d R e v e n u e 1,2 0 0
4,000 × $0.30 = $1,200
7-16
S.v.v.
,(3) Sale of investments (at a gain)
When an investment is sold for more than its cost basis a gain is recorded. This increases
the company’s net income. This account (gain of sale investment) is closed to the income
summary account.
Sales of Investments at a Gain
On December 18, Foster Corporation sells 500
shares of its Coca-Cola stock for $50.04 per
share, less a $20 brokerage commission.
G ENERAL J O URNAL
D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
D ec 18 C as h 2 5 ,0 0 0
M a r k e t a b le S e c u r it ie s 2 4 ,5 0 0
G a in o n S a le o f In v e s t m e n t 500
Sales Proceeds: (500 ×$50.04) - $20 =$25,000
Cost Basis: 500 ×$49 =$24,500
Gain on Sale: $25,000 - $24,500 =$500
7-17
(3) Sale of investment (at a loss)
Selling an investment for an amount less than its cost basis a loss is recorded. This loss
reduces the net income and this account (loss on sale of investments) is closed to the
income summary account.
Sales of Investments at a Loss
On December 27, Foster Corporation sells an
additional 2,500 shares of its Coca-Cola stock
for $48.01 per share, less a $25 brokerage fees.
D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
D ec 27 C ash 1 2 0 ,0 0 0
L o s s o n S a le o f In v e s t m e n t 2 ,5 0 0
M a r k e t a b le S e c u r it ie s 1 2 2 ,5 0 0
Sales Proceeds: (2,500 ×$48.01) - $25 =$120,000
Cost Basis: 2,500 × $49 = $122,500
Loss on Sale: $120,000 - $122,500 =$2,500
7-18
(4) Adjusting marketable securities
Securities classified as available for sale are presented in the balance sheet at their
current market value (fair value accounting). The adjustment of MS to their current
market value requires the use of an account entitled “unrealized holding (gain or loss) on
investments”. This account appears as a stockholders’ equity item in the balance sheet.
Adjusting Marketable Securities
to Market Value
On December 31, Foster Corporation’ s remaining shares
of Coca-Cola capital stock have a current market value
of $47,000. Prior to any adjustment, the company’ s
Marketable Securities account has a balance of $49,000
(1,000 ×$49 per share).
G ENERAL J O URNAL
D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
D ec 3 1 U n r e a liz e d H o ld in g L o s s o n In v e s t m e n t s 2 ,0 0 0
M a r k e t a b le S e c u r it ie s 2 ,0 0 0
Unrealized Loss: $47,000 - $49,000 =($2,000)
7-19
S.v.v.
, Presentation of Marketable Securities
in the Balance Sheet
7-20 LOSS is negative; GAIN is positive
(equity).
Unrealized holding gains and losses are not subject to income taxes. Incomes taxes are
levied only upon realized gains and losses recognized when investments are sold.
ACCOUNTS RECEIVABLE
Accounts receivable comprise the largest financial asset of many merchandising
companies. They are relatively liquid, usually converting into cash within a period of 30 to
60 days. In the BS they appear immediately after cash and short-term marketable
securities. Current assets are typically received within one year. All account receivables
arising from normal sales activity are generally classified as current assets, even if the
credit terms extend beyond one year.
Uncollectible accounts
Accounts receivable are shown in the balance sheet at the estimated collectible amount
(net realizable value).
Reflecting uncollectible accounts in the financial statements
An account receivable that has been determined to be uncollectible is no longer an asset.
The loss is represented as an expense (uncollectible account expense). In measuring
business income, one of the most fundamental principles of accounting is that revenue
should be matched with (offset by) the expenses incurred in generating that revenue.
Uncollectible accounts expense is caused by selling goods on credit to customers who fail
to pay their bills. Therefore, this expense is estimated and recorded in the time period in
which the related sales are made, even though specific accounts receivable may not be
determined to be uncollectible until a later accounting period. Thus an account receivable
that originates from a credit sale in January and is determined to be uncollectible in June
represents an expense in January (the matching process).
Reflecting Uncollectible Accounts in the
Financial Statements
At the end of each period, record an
estimate of the uncollectible accounts.
G ENERAL J O URNAL
D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
J a n 3 1 U n c o lle c t ib le A c c o u n t s E x p e n s e 1 0 ,0 0 0
A llo w a n c e fo r D o u b t fu l A c c o u n t s 1 0 ,0 0 0
Selling expense Contra-asset account
7-22
S.v.v.
,The expense account is closed to the income summary, just like any other expense
account
Accounts receivable – allowance for doubtful accounts = net realizable value of accounts
receivable.
The allowance for doubtful accounts is the account with the amount estimated to be
uncollectible. It is described as a contra-asset or valuation account. This account has a
credit balance. It is just estimation, not a precise calculation, so professional judgment
play a considerable role in determining the size of the value.
The allowance for doubtful account
The net realizable value is the amount of AR that the business expects to collect.
Calculation: AR – allowance for doubtful accounts = net realizable value.
Writing off an uncollectible account receivable
Allowance for doubtful accounts
To: AR
Monthly estimate of credit losses
At the end of each month management should estimate the probable amount of
uncollectible accounts and adjust allowance for doubtful accounts. Two approaches are
possible:
1. Balance sheet approach
2. Income statement approach
Balance sheet approach
1. Classify the account receivable by age
2. For each group determine the likelihood of being uncollectible
3. Calculate a separate allowance amount for each group
Estimating Credit Losses — The Estimating Credit Losses — The
Balance Sheet Approach Balance Sheet Approach
At December 31, the receivables for Valley Valley Ranch’s unadjusted A llo w a n c e fo r
Ranch Supply were categorized as follows: balance in the allowance D o u b t fu l A c c o u n t s
account is $4,000. 4 ,0 0 0
Per the previous 1 ,6 8 0
computation, the desired
5 ,6 8 0
balance is $5,680.
G ENERAL JO URNAL
Œ Ž D a te A c c o u n t T it le s a n d E x p la n a t io n D e b it C r e d it
D e c . 3 1 U n c o lle c t ib le A c c o u n t s E x p e n s e 1 ,6 8 0
A llo w a n c e fo r D o u b t fu l A c c o u n t s 1 ,6 8 0
7-28 7-29
The income statement approach
Uncollectible accounts percentage is based on actual uncollectible accounts form prior
years credit sales. Calculation: Net credit sales x % estimated uncollectible = the amount
of journal entry.
Recovery of an AR previously written off
Sometimes after an AR has been written off, a customer will send a payment. This is
referred to as recoveries of bad debts. Two entries are necessary:
AR
To: allowance for doubtful account
Cash
To: AR
The original write-off debited allowance for doubtful accounts and credited AR.
Direct write-off method
S.v.v.
, When using this method, AR are written off to uncollectible account expense at the time
the company becomes aware that the customer will not be able to pay. The allowance
method provides a much better matching of expenses in the period in which they help
generate revenues. The direct write off method is required when preparing tax returns.
Uncollectible account expense
To: AR
Management of AR
When managing accounts receivable, keep in mind that while extending credit
encourages purchases, it also ties up resources in accounts receivable. Managers need to
balance the leniency of their credit terms with the need to minimize accounts receivable.
Two ways to get cash more quickly from credit sales is to factor AR and accept credit
cards. Factoring: selling AR to another company, the other company charges a fee for this
service and the customer pays for This service when the AR is due.
Notes receivable and interest
A note receivable is a written promise to pay a specific amount at a future date. The
maker: the person who signs the note and thereby promises to pay. The payee: the
person to whom payment is to be made. Notes include: the term, payee, maker, principal,
interest rate, and due date.
The interest rate formula
Calculation: interest = principal x interest rate x time
Time: when computing interest for one year time equals 1, when the period is less than
one year time is a fraction. Example: if you need to compute interest for 3 months “time”
would be 3/12 = 0,25.
Entry to record interest
Interest receivable
To: interest revenue
Entry on the maturity date:
Notes Receivable and Interest
Revenue
What entry would Valley Ranch Supply
make on March 1, the maturity date?
$60,0006% 2/12 =$600
D a te D e s c r ip t io n D e b it C r e d it
M a r. 1 C a s h 6 0 ,9 0 0
In te r e s t R e c e iv a b le 300
In te r e s t R e v e n u e 600
N o te s R e c e i v a b l e 6 0 ,0 0 0
7-38
CHAPTER 8 SUMMARY
When you buy inventory
Inventory
To: accounts payable (or cash)
Calculation: Net sales – costs of goods sold = gross profit
Four ways to determine how cost of inventory sold
1. Specific identification (low sales volume, high dollar items. E.g. cars)
2. FIFO
S.v.v.
