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Receivables and Short-TermInvestments Learning Objective 1Understand short-terminvestments.Short-Term InvestmentsShort-term investments are investments thata company plans to hold for one year or less. Held-to-maturity securities Trading investments Available-for-sale investmentsHeld-to-maturity and available-for-salesecurities could also be long-term.Short-Term InvestmentsHeld-to-maturity investments aresecurities that the investor expectsto hold until their maturity date.They earn interest revenue for the investor.Accounting for these securities is thesame as accounting for notes receivable.Short-Term InvestmentsSuppose that Oracle Corporation purchasesFord Motor Company stock on May 18,paying $100,000, with the intention ofselling the stock within a few months.Short-Term InvestmentsMay 18Short-Term Investment100,000Cash100,000Purchased investmentOn May 27, Oracle receives a cashdividend of $4,000 from Ford.Short-Term InvestmentsMay 27Cash 4,000Dividend Revenue 4,000Received cash dividendOracle fiscal year ends on May 31, andthe investment in Ford has a currentmarket value of $102,000 on this date.Short-Term InvestmentsMay 31Short-Term Investment2,000Unrealized Gain on Investments 2,000Adjusted investment to market valueShort-Term InvestmentsCost100,000Adjustment to market value 2,000Balance102,000Reporting on the Balance Sheetand the Income StatementBalance SheetCurrent Assets:$ XXXCash XXXShort-term investments at market value 102,000Accounts receivable XXXIncome StatementRevenues$ XXXExpenses XXXOther revenues, gains, and (losses):Interest revenue XXXDividend revenue 4,000Unrealized gain on investment 2,000Accounts and Notes ReceivableReceivables are the third most liquid asset after cash and short-term investments.Receivables are monetary claims against others.Accounts receivableTypes of ReceivablesNotes receivableOther receivables(miscellaneous)Accounts ReceivableGENERAL LEDGERAccounts ReceivableBal. 9,000ACCOUNTS RECEIVABLESUBSIDIARY RECORDAstonBal. 5,000HarrisSalazarBal. 1,000Bal. 3,000Learning Objective 3Use the allowance methodfor uncollectible receivables.Accounting forUncollectible AccountsSelling on credit creates both a benefit and a cost:The benefit:Customers who cannot pay cash immediatelycan buy on credit, so company profitsrise as sales increase.The cost:The company will be unable to collectfrom some credit customers.The Allowance MethodThe allowance method records collectionlosses on the basis of estimates, not waitingto see which customers will not pay.The Allowance for Uncollectible Accounts(Allowance for Doubtful Accounts) is acontra account to Accounts Receivable.The Allowance MethodBalance Sheet (partial)Accounts receivable$10,000Less: Allowance for uncollectible accounts 900Accounts receivable, net$ 9,100Income Statement (partial)Expenses:Uncollectible-account expense$ 900Methods for Estimating UncollectiblesPercent-of-salesAging-of-ReceivablesPercent-of-SalesIt computes uncollectible-accountexpense as a percentage of revenue.This method is also called theincome-statement approach.Percent-of-SalesThe credit department estimates thatuncollectible-account expense is 5% oftotal revenues, which were $11 billion for 20 x1.Dec 31 (in millions)Uncollectible-Account Expense($11,000 0.05)550Allowance for Uncollectible Accounts550Recorded expense for the yearPercent-of-SalesDecember 31, 20 x1 (in millions)After AdjustmentAccounts ReceivableBal. 11,000Allowance forUncollectible Accounts550Aging-of-ReceivablesThis method is a balance-sheet approachbecause it focuses on accounts receivable.Individual receivables from specificcustomers are analyzed based onhow long they have been outstanding.Aging-of-ReceivablesDecember 31, 20 x1 (in millions)Accounts ReceivableBal. 2,835Allowance forUncollectible Accounts120Accounts before the year-end adjustment:Aging-of-ReceivablesDaysOverdue 1-30 days31-60 days61-90 days91 + daysAccountsReceivable$1,555 750 311 219$2,835Estimated %Uncollectible 6102079Allowance forUncollectibleAccounts$ 93 75 62 173$403Aging the Accounts ReceivableAging-of-ReceivablesAccounts after the year-end adjustment:Uncollectible-Account Expense283Allowance for Uncollectible Accounts ($403 $120)283Recorded expense for the yearDecember 31, 20 x1 (in millions)Accounts ReceivableBal. 2,835Allowance forUncollectible Accounts120Adj.283403Writing OffUncollectible AccountsSuppose that early in 20 x2, the creditdepartment determines that the companycannot collect from two customers.These accounts must be written off.Writing OffUncollectible AccountsAllowance for Uncollectible Accounts100Accounts Receivable Customer A61Accounts Receivable Customer B39Wrote off uncollectible receivablesDirect Write-Off MethodAn account is written offonly when it is decided that a specificcustomers receivable is uncollectible.January 2, 20 x4Uncollectible-Account Expense2,000Accounts Receivable Jones2,000Wrote off a bad accountDirect Write-Off MethodThis method is defective for two reasons:Since no allowance for uncollectiblesis established, assets are overstatedon the balance sheet.It causes a poor matching of uncollectible-account expense against revenueand overstates net income.Learning Objective 4Account for notes receivable.Notes ReceivableNotes receivable are more formalthan accounts receivable.The creditor has a note receivable.The debtor has a note payable.NoteNotes ReceivableThe principal amount of the note isthe amount borrowed by the debtor.The maker pays the payee the maturity value.The maturity value includes principal plus interest.Notes Receivable PROMISSORY NOTE $1,000 August 31, 20 x5AmountFor value received, I promise to pay to the order ofContinental bankChicago, IllinoisOne thousand and no/100Dollarson February 28, 20 x6plus interest at the annual rate of 9 percentPrincipalInterest period startsPayee(creditor)InterestrateInterest period endson the maturity dateMaker (Debtor)Accounting for Notes ReceivableContinental Bank entry is as follows:August 31, 20 x5Note Receivable1,000Cash1,000Made a loanHow much interest revenueis accrued at December 31?Interest = Principal Rate TimeAccounting for Notes ReceivableDecember 31, 20 x5Interest Receivable30Interest Revenue30Accrued interest revenue$1,000 9% 4/12 = $30Accounting for Notes ReceivableFebruary 28, 20 x6Cash1,045Note Receivable1,000Interest Receivable 30Interest Revenue ($1,000 9% 2/12) 15Collected note at maturityThe bank collects the note on February 28, 20 x6.Learning Objective 5Use the acid-test ratio andthe days sales in receivablesto evaluate financial position.Reporting Assets inOrder of LiquidityCURRENT ASSETS 2001 2000Cash and cash equivalents$ 4,449$ 7,429Short-term investments 1,438 333Trade receivables, net 2,432 2,534Prepaid expenses 644 587Total current assets$ 8,963$10,883Long-term investments 110Property, net 975 935Other assets 1,092 1,149Total assets$11,030$13,077CURRENT LIABILITIESTotal current liabilities 3,916 5,892Long-term debt and liabilities 836 753Stockholders equity 6,278 6,462Total liabilities and stockholders equity$11,030$13,077One days sales = Net sales 365 days= 10,860 365 = 29.75 per dayDays sales in average accounts receivable =Average net accounts receivable One days sales= (2,534 + 2,432) 2 29.75 = 83 daysDays Sales in ReceivablesA smaller number indicatesa quick conversion to cash.Acid-test ratio = (Cash + Short-term investments+ Net current receivables) Total current liabilities= (4,449 + 1,438 + 2,432) 3,916 = 2.12Acid-Test RatioThis is a stringent test of liquidity whichmeasures the entitys ability to pay itscurrent liabilities immediately.This ratio value is extremely high andindicates great liquidity for this company.