Incomplete Data from the Income Statement - PowerPoint by hko20175


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   Hoskin • Fizzell • Davidson
    Second Canadian Edition
    Cash, Temporary
Investments, and Accounts
   & Notes Receivable
      Chapter Six
• Asset with probable future value
• Purchasing power
  – Ability to be exchanged for goods
    and services in the future
• Medium of exchange
• Difficult to control
  – Need for internal control procedures
    Cash Valuation Methods
• Record at face value
  – Value is assumed not to change
• Unit-of-measure assumption
  – Canadian practise
  – Results of a company’s activities
    can be measured by a monetary
    unit - the Canadian dollar
     Internal Control Systems

• Control to prevent loss or theft
• Safeguarding of all assets
• Policies and procedures established
  – cash      - supplies    - buildings
  – inventory - equipment
     Internal Control Systems

• Effective systems should include:
  – Physical measures to guard against
    theft and vandalism
  – Separation of duties
  – An effective record-keeping system
   Internal Control Systems
• Bank reconciliation
  – Ensures that the accounting records
    agree with the bank records
  – Differences may be due to timing,
    incomplete data, and errors
  – Normally made every month
     Bank Reconciliation
    For the Month of March
Balance per bank statement    $ 9,043.92
Add: Outstanding deposit        1,035.62
Deduct: Outstanding cheques       528.67
Adjusted cash balance         $ 9,550.87
Balance per cash account      $ 9,763.42
Deduct: Bank charges               25.75
        NSF cheque               186.80
Adjusted cash balance         $ 9,550.87
      Bank Reconciliation
• The appropriate cash balance is
• Journal entry to adjust the cash
  SE-Bank charge expense 25.75
  A-Accounts receivable  186.80
    A-Cash                     212.55
      Bank Reconciliation
• Reconciling items include:
  – Outstanding cheques
  – Outstanding deposits
  – Bank service charges
  – Errors in recording items
  – Any other item that affects cash
       Control Measures
• The person who reconciles the
  bank account should not be the
  person who is responsible for the
  bank account or the accounting
• Sufficient cash should be readily
  accessible to pay expenses
    Temporary Investments
• Cash may be invested in
  marketable securities:
  – Debt or equity interest in another
  – Two sources of future value
    • Periodic payments
    • Value when sold in the future
       Valuation Methods
• Historical cost
  – Changes in market value have no
  – A realized gain or loss is
    recognized when the securities are
       Valuation Methods
• Market cost
  – Changes in market value are
    recognized as unrealized gains or
  – Other income is recognized when
    interest or a dividend is received
       Valuation Methods
• Canadian practice:
  – Lower of cost and market (LCM)
    • Temporary investments shown at
    • If market value has declined below
      cost, then shown at market value
       Initial Acquisition
• Each investment is recorded in its
  own subsidiary account
    A-Investment in HTMS     10,000
    A-Investment in ATS      20,000
    A-Investment in LFS      30,000
         A-Short-term Investments 60,000
• Control account: Short-term
         Initial Acquisition
   ACCOUNTS             ACCOUNT

A-Investment in HTMS
A-Investment in ATS     Investments
      20,000              60,000
A-Investment in LFS
 Dividend/Interest Recognition
• Recognized each period, as
• Could be accrued, resulting in a
    A-Cash                      1,200
         SE-Dividend/interest income    1,200
         (income statement account)
Unrealized Losses/Recoveries
• LCM Rule:
 – Compare the market value of the
   investments to their original cost
 – Determine the lower of the two
 – Carry the investment at this lower
 – Apply to entire portfolio or to
   individual securities
 Unrealized Losses/Recoveries
• Cost: $60,000
• Market value of portfolio: $57,000
   SE-Unrealized loss on valuation
   of temporary investments        3,000
          XA-Valuation allowance
          for temporary investments      3,000
• Affects both the income statement
  and the balance sheet
 Unrealized Losses/Recoveries
• If the market value has increased
  – Companies can recover unrealized
  – But can never recognize unrealized
    gains above the original cost
 Unrealized Losses/Recoveries
• Market value of portfolio has
  increased: $62,000
   XA-Valuation allowance for
   temporary investments           3,000
          SE-Recovery of unrealized
          loss on valuation of
          temporary investments          3,000
• The additional $2,000 cannot be
   Realized Gains and Losses
• Investment HTMS was sold for
  $12,000 (Cost had been $10,000)
    A-Cash                         12,000
        A-Investment in HTMS            10,000
        SE-Realized gain on sale
        of temporary investment             2,000
      Disclosure of Temporary
                        December 31   December 31
                           1998          1997
Marketable securities
[Market value
$379,542 (1997-
$233,794)]               300,593       219,292
      Accounts Receivable
• Amounts owed from customers
  as a result of selling goods and
  services on credit
• Uncertainty of bad debts
Accounts Receivable Valuation
• Gross payment method
  – Ignores the effects of bad debts
• Time value of money to be
• Possibility that the receivable will
  not be paid
• Factoring:A/R can be sold
Accounts Receivable Valuation
• Canadian practice:
  – Show receivable at gross less
    allowances for bad debts and
       Allowance Method
• Matching concept:
  – When revenues from a sale are
    recognized, also recognize all
    expenses relating to that sale
• Bad debts are reductions in
• Companies must estimate
  uncollectible amounts
        Allowance Method
• Allowance for doubtful accounts
  – Contra account to accounts receivable
    SE-Bad debt expense         325
         XA-Allowance for
         doubtful accounts            325
• Reduces
  – Net carrying value of A/R
  – Net income
       Allowance Method
• Write-off of an account receivable
    XA-Allowance for
    doubtful accounts        300
       A-Accounts receivable       300
       Allowance Method
• Recovery of a previous written off
  account receivable
    A-Accounts receivable     50
      XA-Allowance for
          doubtful accounts        50

    A-Cash                    50
      A-Accounts receivable        50
 Estimating Doubtful Accounts

• Percentage of credit sales method
• Aging of accounts receivable
   Percentage of Credit Sales
• Assumes that the bad debt expense
  is based on credit sales
• Multiply credit sales by an
  appropriate percentage
• Percentage is based on collection
    Direct Write-Off Method
• Recognizes the loss from the
  uncollectible account in the period
  in which the company decides that
  the account is uncollectible
• Violates the matching concept
    SE-Bad debt expense          300
         A-Accounts receivable         300
         Notes Receivable
• Promissory note
  – Written contract between the maker
    and the payee
  – Interest is calculated on the principal
    amount of the note
• Collateral
  – Asset that the payee has the right to
    receive if the note is defaulted
 Interest on Notes Receivable
• Implied interest
  – Interest is included in the amount
    stated in the note
• Explicit
  – Interest is calculated based on the
    amount stated in the note
 Interest on Notes Receivable
• Short-term notes receivable
  – Simple-interest calculations
• Long-term notes receivable
  – Compound interest calculations
       Simple-Interest Formula

Interest = Principal x Interest Rate x Time

      Principal - amount borrowed
 Interest Rate - stated as a yearly amount
    Time - stated as a fraction of year
• Nov.30: Acceptance of a 12% note,
  with a maturity of 60 days
    A-Notes receivable        1,000
      A-Accounts receivable       1,000
• Dec.31: One month’s interest (year end)
   Interest = $1,000 x 12% x 30/360
    A-Interest receivable         10
       SE-Interest revenue           10
• Jan.31: Accrue interest for January
    A-Interest receivable       10
      SE-Interest revenue            10
• Jan.31: Cash payment
    A-Cash                    1,020
      A-Notes receivable           1,000
      A-Interest receivable           20
     Short-Term Liquidity
• Liquidity
  – The ability of a company to convert
    assets into cash to pay liabilities
  – Quantitative measures
    • Current ratio
    • Quick ratio
         Current Ratio

                  Current Assets
Current Ratio =
                  Current Liabilities

Current Ratio =            =       1.79
             Quick Ratio
                Current Assets - Inventory -
                    Prepaid Expenses
Quick Ratio =
                   Current Liabilities

              $4,115,116 - 2,050,703 -
Quick Ratio =         433,785
                                     = .71
 Accounts Receivable Turnover

A/R Turnover =     Total Sales Revenue
                     Average A/R
A/R Turnover    26,466,241
for 1999   =                      = 18.57
A/R Turnover
for 1998                          = 19.52

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