Chapter 8 Accounting for Receivables

(1)

March.30, 2012 Page 1 Weygandt et al. (2010) . Accounting Principles (5^th ed.) John Wiley & Sons Canada, Ltd.

Chapter 8 – Accounting for Receivables

Accounts Receivable

Accounts Receivables are current assets. They are usually expected to be collected within 30 days.

Allowance Method and Bad Debt Expense 2 methods:

1. % of Accounts Receivable

Example: Dec.31, you have an A/R balance of $450,000. It is estimated that 5% of A/R will become uncollectible. The unadjusted balance in Allowance for Doubtful Accounts is $4000 credit.

450,000 x 0.05= 22500 Allowance for Doubtful Accounts Dec.31 Bal. 4000 18500

Dec.31 Bal. 22500

2. % of Net Sales

Example: Dec.31, you have an A/R balance of $450,000. It is estimated that 5% of Net Sales will become uncollectible. The Gross Sales for the period is $650,000. Sales Returns and Allowances is $100,000 and Sales Discounts is $23,000. The unadjusted balance in Allowance for Doubtful Accounts is $2000 debit.

Net Sales=Gross Sales – Sales Returns and Allowances – Sales Discounts Net Sales= 650,000 – 100,000-23,000

Net Sales= 527,000

Allowance for Doubtful Accounts 527000 x 0.05 = 26350 Dec.31. Bal. 2000 26350

Dec.31.Bal. 24350

(2)

[Note: Allowance for Doubtful Accounts may have a debit balance if the write off is larger than the amount of Bad Debts previously estimated.]

Net Realizable Value=Accounts Receivable – Ending/Adjusted Balance of AFDA

[AFDA stands for Allowance for Doubtful Accounts]

Notes Receivable

Notes Receivable usually requires debtors to pay interest.

Interest Expense per year = Face Value of the note x Annual interest rate Disposing of Notes Receivable

• Honouring of Notes Receivable

Cash XXX

Notes Receivable XXX Interest Revenue XXX Interest Receivable XXX

• Dishonouring of Notes Receivable If collection is expected:

Accounts Receivable XXX

Notes Receivable XXX Interest Revenue XXX Interest Receivable XXX If collection is not expected:

Allowance for Doubtful Accounts XXX

Notes Receivable XXX Interest Receivable XXX

(3)

Chapter 9 – Long-Lived Assets

Different Depreciation Methods 1. Straight-Line Method

Annual Depreciation Cost – Residual Value Expense Estimated Useful Life (in years)

2. Diminishing – balance method

Annual Depreciation Expense = Carrying amount x Depreciation Rate Carrying amount= Cost – Accumulated Depreciation

[Note: the carrying amount at the beginning of the first year would be the same as the asset’s cost because no depreciation was taken yet so you would have a zero balance for Accumulated Depreciation.]

Depreciation Rate is sometimes given in the question, otherwise you’ll have to calculate it.

Double declining rate is most commonly used. For example, if

equipment has an estimated useful life of 5 years what is the double declining rate?

Straight-line rate = 100% ÷ 5 = 20%

Double declining rate = 20% x 2= 40%

3. Units-of-production method

Annual Depreciation Cost – Residual Value units of production Expense Total estimated units of production of the year Revised Depreciation Calculations:

Annual (Old cost + New cost) – (Accumulated Depreciation) – (New Residual Value) Depre. Exp. New REMAINING number of periods or production units

(4)

Disposal of Property, Plant, and Equipment Carrying Amount > Proceeds = Loss

Carrying Amount < Proceeds = Gain Recording disposal

Dr. Cash or Accounts Receivable Dr. Accumulated Depreciation

Dr. Loss on Disposal or Cr. Gain on Disposal Cr. Property plant and equipment account

(5)

Chapter 10 – Current Liabilities and Payroll

Determinable (Certain) Current Liabilities Short-Term Notes Payable

Example: On October 1, Wonderkeys Corporation borrows a $15,000 five-

month note payable at an interest rate of 8%. Interest and principal are due on maturity. Assume Wonderkeys has a December 31 year end.

Oct. 1 Cash 15,000

Notes Payable 15,000

Dec.31 Interest Expense 300

Interest Payable 300

[The above transaction is Wonderkeys’ year-end adjustment.

15,000 x 0.08 x

= 300]

Mar.1 Interest Expense 200 Interest Payable 300 Notes Payable 15,000

Cash 15,500

Sales Taxes

 HST Tax

Example: ABC Corporation made sales of $48,000. HST rate is 13%.

(a) Assume the $48,000 sales doesn’t include tax.

Cash 54,240

Sales 48,000 HST Payable 6240 [48,000 x 0.13=6240]

(6)

(b) Assume the $48,000 sales includes tax.

Cash 48,000

Sales 42,477.88 HST Payable 5522.12

[

= 42,477.88]

 GST + PST Tax

PST tax should be added on top of GST tax.

Example: ABC Corporation made sales of $48,000. GST rate is 5%. PST rate is 7%.

(a) Assume the $48,000 sales doesn’t include tax.

Cash 53,928

Sales 48,000 GST Payable 2400 PST Payable 3528 [GST Payable = 48,000 x 0.05=2400

PST Payable = (48,000 + 2400) x 0.07=3528]

(b) Assume the $48,000 sales includes tax.

Cash 48,000

Sales 42,723.63 GST Payable 2136.18 PST Payable 3140.19

[

Let sales be X.

X + 0.05X + 0.07(X+0.05X)=48,000 Solve for X.

Sales=X= 42,723.63

GST Payable = 0.05X = 2136.18

PST Payable = 0.07(X+0.05X)= 0.07(42,723.63+2136.18) =3140.19]

(7)

Property Taxes

Bills for property tax are usually issued in the spring. Property tax usually covers the full calendar year.

Example: DreamBig Ltd. received a property bill of $8000 on April 1, 2011 for the calendar year of 2011. The property bill is paid on July 31. Assume

DreamBig’s fiscal year is the same as the calendar year.

April 1 Property Tax Expense 2000

Property Tax Payable 2000 [8000 x

= 2000]

July 31 Property Tax Expense 2666.67 Property Tax Payable 2000 Prepaid Property Tax 3333.33

Cash 8000 [8000 x

= 2666.67

8000-2000-2666.67=3333.33]

Dec. 31 Property Tax Expense 3333.33

Prepaid Property Tax 3333.33

(8)

Uncertain Liabilities Product Warranties

Example: BestMusic Corporation sold 10,000 walkmans at $150 each in 2011.

The walkmans are covered for a one-year warranty. It is estimated that around 3% of the walkmans sold might become defective. It will cost $50 for fix each defective walkman. By the end of the year, 200 walkmans were fixed.

 Record the estimation of warranty costs.

Warranty Expenses 15,000

Warranty Liability 15,000

[Number of walkman that might become defective=10,000 x 0.03=300 Total estimated cost=50 x 300=15,000]

 Record the actual cost for fixing defective walkmans Warranty Liability 10,000

Repair Parts Inventory or Wages Payable 10,000 Customer Loyalty Programs

Example: Light Blue Corporation offers customers a redemption reward of

$0.01 for each dollar they purchase at Light Blue. On Feb.1, Light Blue made sales of $5600. On March 18, customers redeem $50 of rewards while making a purchase of $290.

Feb.1 Sales Discount for Redemption Rewards Issued 56 Redemption Rewards Liability 56 [5600 x 0.01=56]

Mar.18 Rewards Redemption Liability 50 Cash 240

Sales Revenue 290

(9)

Chapter 13 –Corporations: Organization and Share Capital

Transactions

Difference between Common and Preferred Shares

Common Shares Preferred Shares

Give the holder voting rights Doesn’t provide voting rights.

May receive any dividends that are left after dividends have been paid to

preferred shareholders.

Receive dividends before common shareholders do.

Get assets after Preferred shareholders

if the company is liquidated. Get assets before common

shareholders if company is liquidated.

Common Shares

·Issuing Shares for cash

Cash XXX

Common Shares XXX

·Issuing Shares for Services

Example: lawyer had provided legal services for the company for $2000. The company’s shares currently have a market price of $2 per share. Assume the lawyer agreed to accept 1200 shares for the service provided.

Legal Fees Expense 2000

Common Shares 2000

[Note: The lawyer may agree to accept 1000 or more shares for the service provided because she can sell them in the market for $2000 or more. We record using the value of legal fees not the share’s market value.]

·Issuing Shares for Assets

Example: Issuing shares to acquire machine.

Machinery XXX

Common Shares XXX

(10)

[Note: If the fair value of the machine can be determined, we use this value. If not we may use the fair value of the common shares issued]

·Reacquisition at Average Cost

Example: Company’s common shares have an average cost of $1.50 per share.

2000 of common shares were reacquired for $3000.

Common Shares 3000

Cash 3000

·Reacquisition below Average Cost

Common Shares 3000

Contributed Capital-Reacquisition of Shares 500 Cash 2500

·Reacquisition above Average Cost

Common Shares 3000 Retained Earnings 700

Cash 3700

[Note: For reacquiring above average cost, if the company has Contributed Capital – Reacquisition of Shares, we have to deduct the amount ($700) from it first. If the amount in Contributed Capital – Reacquisition of Shares is lower than $700, we deduct the rest from Retain Earnings.]

Preferred Shares

Cumulative Preferred Shares – dividends must be paid for the current year as well as for any unpaid portion in previous years before dividends can be paid to Common Shareholders. Dividends that are not paid in the period are dividends in arrears.

(11)

Dividends in arrears is not a liability because the company doesn’t have the obligation to pay for it until it’s declared.

Noncumulative Preferred Shares – Dividends that are not paid in the current year are gone forever.

Convertible Preferred Shares – give preferred shareholders an option to convert their shares to Common Shares at a specified ratio.

Example: 200 Preferred Shares were converted to 400 Common Shares. These Preferred Shares have an average cost of $1 per share. The company’s common shares currently have a market value of $1.5 per share.

Preferred Shares 200

Common Shares 200

[Note: we used $1 per share instead of $1.5 because the total amount of

contributed capital was not changed so we should use the average cost value.]

Redeemable/Callable Preferred Shares – Give the company an option to purchase back the shares at specified dates and prices.

Retractable Preferred Shares – Give the shareholder an option to redeem their shares usually at an arranged price and date.

Balance Sheet – Shareholder’s equity section

The following chart is presented to help you clarify the order of shareholder’s equity.

Preferred Shares Contributed Capital Share Capital

S/E Common Shares

Contributed Capital – reacquisition of common shares Retained Earnings

Accumulated other comprehensive income

For the format of writing Shareholder’s equity section of the Balance Sheet please refer to your textbook on page737.

(12)

Chapter 14 – Corporations: Income and Equity Reporting

Cash Dividends

For a corporation to pay cash dividend it must meet all three of the following requirements:

 Enough Retained Earnings – because dividends are paid from Retained Earnings.

 Enough Cash

 A declaration of dividends by the board of directors – the corporation does not have the obligation to pay dividends even for cumulative preferred shares.

Dividend becomes the corporation’s liability when it is declared by the board of directors.

Journal Entries

Declaration of cash dividend

Cash Dividends XXX

Dividends Payable XXX Payment of cash dividend

Dividends Payable XXX

Cash XXX

Stock Dividends

Stock dividend is “paid” in shares. It does not change total shareholder’s equity. However, it results in a decrease of Retained Earnings and increase in Share Capital.

Declaration of stock dividend

Stock Dividends – Common XXX

Common Stock Dividends Distributable XXX

(13)

Issuing common shares for stock dividend

Common Stock Dividends Distributable XXX

Common Shares XXX Ratios

Earnings per share =

How to calculate the weighted average number of common shares:

Assume on Jan.1 the company has 2000 common shares. On March 31, the company issued 150,000 shares. On November 1, the company issued 5000 common shares. Company’s fiscal year is the same as the calendar year and it calculates for ratios at the end of each year.

Weighted Average = # of shares issued fraction of year outstanding Weighted Average = 2000

+ 150,000

+ 5000

= 115,334

Price-Earnings Ratio =

Payout Ratio =

(14)

Chapter 15 – Long-Term Liabilities

Bond Payable

Three Possible Cases:

Bond Contractual Interest Rate < Market Interest Rate  Discount Bond Contractual Interest Rate > Market Interest Rate  Premium Bond Contractual Interest Rate = Market Interest Rate  Face Value

Issuing Bond at Face Value

Example: Candyland Corporation issues 6-year, 4%, 1.8 million bonds on January 1, 2010, to yield a market interest rate of 4%. Interest is payable semi-annually on July 1 and January 1.

 Record the issue of the bond

Cash 1,800,000

Bond Payable 1,800,000

 Record interest payment on July 1,2010

Bond Interest Expense 36,000

Cash 36,000 [ 1,800,000 x 0.04 x = 36,000]

 Adjusting entry at year end for Bond Interest Payable Bond Interest Expense 36,000

Bond Interest Payable 36,000

(15)

Calculations when bond was issued at Premium or Discount

The Total Present Value of the bond

Total Present Value = Present Value of Face Value + Present Value of each Interest Paid

·Present value of face value = face value x PVIF (i%, n)

PVIF (Present Value Interest Factor) value may be found on the first table of your textbook on PV4 APPENDIX PV.

If the corresponding interest rate or period cannot be found in the table the following formula can be used:

PVIF =

·Present value of each interest paid = interest x PVIFA (i%, n) Interest per year = face value x bond contractual interest rate

PVIFA (Present Value Interest Factor Annuity) value may be found on the second table of your textbook on page PV6 APPENDIX PV.

If the corresponding interest rate or period cannot be found in the table the following formula can be used:

PVIFA =

The total present value of the bond is the issuing price of the bond.

 Calculate for interest for each period

- The amount of Cash paid or Bond Interest Payable is the same regardless whether the bond was issued at premium or discount.

Cash/Bond Interest Payable per year = Face Value x Contractual interest rate - The amount of Bond Interest Expense changes while bond was amortized.

Bond Interest Expense per year =Bond Amortized Cost x market interest rate

(16)

Bond Issued at Premium

Example: Candyland Corporation issues 6-year, 6%, 1.8 million bonds on January 1, 2010, to yield a market interest rate of 4%. Interest is payable semi- annually on July 1 and January 1.

Recording the sale of bonds at premium on January 1,2010.

PV of face value = 1800,000 x PVIF ( i=2%, n=6x2=12) PV of face value = 1800,000 x 0.78849 = $1,419,282

Interest payment = 1800,000 x 0.06 x = $54000 PV of interest payment = 54000 x PVIFA (i=2%, n=12) PV of interest payment = 54000 x 10.57534 = $571,068.36 Total Present Value = 1,419,282 + 571,068.36 = $1,990,350.36 Jan.1 Cash 1,990,350.36

Bond Payable 1,990,350.36

Recording semi-annual interest payment on July 1,2010.

July 1 Bond Interest Expense 39,807.01 Bonds Payable 14,192.99

Cash 54000 [1,990,350.36 x 0.04 x

=

39,807.01]

Record the adjusting entry at year end. Assume Candyland’s year end is December 31.

Dec.31 Bond Interest Expense 39,523.15 Bond Payable 14,476.85

Bond Interest Payable 54000

(17)

[ (1,990,350.36 – 14,192.99) x 0.04 x

= 39,523.15]

 Recording semi-annual interest payment on January 1, 2011 Jan.1 Bond Interest Payable 54000

Cash 54000

Bond Issued at Discount

Example: Candyland Corporation issues 6-year, 4%, 1.8 million bonds on January 1, 2010, to yield a market interest rate of 7%. Interest is payable semi- annually on July 1 and January 1.

Recording the sale of bonds at discount on January 1,2010.

PV of face value = 1800,000 x PVIF (i=3.5%, n=6x2=12) PVIF =

=

= 0.66178

PV of face value = 1800,000 x 0.66178 = $1,191,204

Interest payment = 1800,000 x 0.04 x = $36,000 PV of interest payment = 36000 x PVIFA (i=3.5%, n=12) PVIFA = =

= 9.66333

PV of interest payment = 36000 x 9.66333 = $347,879.88 Total Present Value = 1,191,204 + 347,879.88 = $1,539,083.88 Jan.1 Cash 1,539,083.88

Bond Payable 1,539,083.88

(18)

Recording semi-annual interest payment on July 1,2010.

July 1 Bond Interest Expense 53,867.94

Bonds Payable 17,867.94 Cash 36000 [1,539,083.88x 0.07 x

=

53,867.94]

Record the adjusting entry at year end. Assume Candyland’s year end is December 31.

Dec.31 Bond Interest Expense 54,493.33

Bond Payable 18,493.31 Bond Interest Payable 36000 [ (1,539,083.88 + 17,867.94) x 0.07 x

= 54,493.33]

 Recording semi-annual interest payment on January 1, 2011 Jan.1 Bond Interest Payable 36000

Cash 36000

Notes Payable

Fixed Principal Payments

The amount of principle you are reducing stays the same.

Interest Expense XXX

Notes Payable XXX This number stays the same Cash XXX

(19)

Blended Payments

The amount of total cash payment stays the same Interest Expense XXX

Notes Payable XXX

Cash XXX This number stays the same

(20)

Chapter 17 – Cash Flow Statement

Cash Flow Statements are usually prepared using cash and cash equivalents as its basis rather than just cash.

3 Types of Activities:

 Operating Activities include cash effects that create revenues and expenses.

ie. Inventory, salaries, tax, interests, dividends, revenues and expenses

 Investing Activities include investments, long-lived assets, lending and collecting loans, short-term investments and long-term asset accounts.

ie. Property Plant and Equipment, debt or equity investments, loans, intangibles

 Financing Activities include short-term notes payable, long-term liability and shareholder’s equity accounts.

ie. Preferred Shares, Common Shares, dividends, notes, bonds, redeem long-term debt and reacquire shares.

Operating Activities

Two methods that can be used for operating activities are indirect method and direct method.

Indirect Method

Net earnings adjustments = net cash provided(used) by operating activities

Adjustments: (All adjustments have to be non-cash items!) Add back non-cash expenses. [eg. Depreciation Expense]

Add back losses These loss and gains should be from Deduct gains investing and financing activities Add ↓ in current asset, ↑ in current liabilities

Deduct ↑ in current asset, ↓ in current liabilities

(21)

Explanations for the adjustments:

Selling property plant and equipment is not part of a company’s primary activities. It should not be included in the operating activities. Therefore, to eliminate the loss, we have to add it back.

 Inventory • Inventory will increase if we Jan.1 20,000 purchase and decrease if we Purchase 6000 COGS 5000 sell it out.

Bal. 21,000

• In Net Earnings, we have already accounted for Cost of Goods Sold(COGS). So in this case we don’t have to worry about the $5000.

• However, in total we have purchased $6000. We have not accounted for the additional $1000. Therefore, increase in inventory should be deducted.

 Cost of Goods Sold + Increase in Inventory = Cost of Goods Purchased − Increase in Accounts Payable = Cash Payments to Suppliers Presentation Format:

Operating activities

Net Earnings $XXX Adjustments to reconcile net earnings to net cash

provided(used) by operating activities:

Depreciation Expense $XXX

Accounts Receivable XXX XXX Net cash provided by operating activities XXX

(22)

Direct Method

Cash receipts – cash payments = Net cash provided(used) by operating activities.

• Cash Receipts

Revenue + increase in A/R – decrease in A/R

Interest Revenue + decrease in interest receivable – increase in interest receivable

• Cash Payments

+ increase in inventory + decrease in A/P COGS

decrease in inventory increase in A/P

[eg. Cost of Goods Sold+ increase in inventory – increase in Accounts Payable]

+ increase in Prepaid Expense + decrease in Expense Payable Operating Expenses

decrease in Prepaid Expense – increase in Expense Payable

+ decrease in Interest Payable Interest Expense

increase in Interest Payable + decrease in Tax Payable Income Tax Expense

increase in Tax Payable Investing and Financing Activities

Regardless of whether direct or indirect method is used, investing and financing activities are measured and reported in the same way.