Using Financial
Accounting Information:
The Alternative to Debits and Credits
Fifth Edition
Gary A. Porter and Curtis L. Norton
Chapter 7, Slide #1
Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo,
and South-Western are trademarks used herein under license.
Apple’s Consolidated Balance
Sheets (Partial)
ASSETS (in millions)
September 25, 2004 September 27, 2003
Current assets:
Cash and cash equivalents
$2,969
$3,396
Short-term investments
2,495
1,170
Accounts receivable, less
allowances of $47 and $49
774
766
Inventories
101
56
Deferred tax assets
231
190
Other current assets
485
309
Total current assets
$7,055
$5,887
Chapter 7, Slide #2
Apple’s Consolidated Balance
Sheets (Partial)
ASSETS (in millions)
Current assets:
Cash and cash equivalents
Short-term investments
Accounts receivable
Inventories
Deferred tax assets
Other current assets
Total current assets
Chapter 7, Slide #3
Highly
liquid
Less
liquid
Reasons Companies Invest in Other
Companies
 Short-term cash excesses
 Long-term investing for
future cash needs
 Exert influence over investee
 Obtain control of investee
Chapter 7, Slide #4
LO1
Accounting for Common-Stock
Investments
Fair
Value
Method
0%
Equity
Method
20%
No significant
influence
Our
focus
Appendix
Chapter in
7, Slide
#5
Significant
influence
Consolidated
Financial
Statements
100%
50%
Control
Credit Sales
 Slows inflow of cash
 Risk of uncollectible
accounts
Retail Customer
Receivables
Chapter 7, Slide #6
Trade Credit
Sales Invoice
Terms: 2/10,
net 30
LO2
Apple Corporation Sample Accounts
Receivable Subsidiary Ledger
Acme
Baxter
Jones
Martin
Smith
Gross Accounts
Receivable
Chapter 7, Slide #7
Total Due
$ 10,000
50,000
15,000
20,000
5,000
$100,000
Apple’s Consolidated Balance
Sheets (Partial)
(amounts in millions)
Accounts receivables, less
allowances of $47 and $49,
respectively
2004
2003
$774
$766
Net
Realizable
Value
Chapter 7, Slide #8
Accounting for Bad Debts:
Direct Write-off Method
Period of sale
Balance Sheet
Future period charged
with expense of bad debt
write-off
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Acct. RecBaxter (500)
Chapter 7, Slide #9
Bad Debt Expense
(500)
Accounting for Bad Debts:
Allowance Method
Estimated bad debt
expense (and allowance
account) recorded in the
same period
Period of sale
Chapter 7, Slide #10
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
Accounting for Bad Debts:
Allowance Method
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Allowance for
Doubtful Acct.
(6,000)
(1% X $600,000 = $6,000)
Chapter 7, Slide #11
Bad Debt Expense
(6,000)
Balance Sheet Presentation –
Allowance Method
Roberts Corp.
Partial Balance Sheet
Accounts receivable
Less: Allowance for
doubtful accounts
Net accounts receivable
Chapter 7, Slide #12
$250,000
6,000
$244,000
Accounting for Bad Debts:
Allowance Method
To write-off of account determined uncollectible:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Allowance for
Doubtful Acct
500
Acct. Rec. – Dexter
(500)
Chapter 7, Slide #13
Approaches to Allowance Method
% of Net Credit Sales
Income
Statement
Approach
% of Accounts Receivable
– Aging Method
Chapter 7, Slide #14
Balance
Sheet
Approach
Percentage of Net Credit Sales
Method
Example:
Assume prior years’ net credit sales and bad debt
expense is as follows:
Year
2002
2003
2004
2005
2006
Chapter 7, Slide #15
Net Credit Sales
$1,250,000
1,340,000
1,200,000
1,650,000
2,120,000
$7,560,000
Bad Debts
$ 26,400
29,350
23,100
32,150
42,700
$153,700
Percentage of Net Credit Sales
Method
Example:
Develop bad debt percentage:
$153,700
$7,560,000
= 0.02033
use 2%
Chapter 7, Slide #16
Percentage of Net Credit Sales
Method
Example:
2007 Net credit sales
Bad debt percentage
Bad debts expense
Balance Sheet
$2,340,000 (given)
2%
$ 46,800
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Allowance for
Doubt Acct
(46,800)
Chapter 7, Slide #17
Bad Debt Expense
(46,800)
Aging Method
Category
Amount
Current
$ 85,600
Past due:
1–30 days
31,200
31–60 days
24,500
61–90 days
18,000
90+ days
9,200
Totals
$168,500
Estimated Percent Estimated Amount
Uncollectible
Uncollectible
1%
$ 856
4%
10%
30%
50%
1,248
2,450
5,400
4,600
$14,554
Aging Method
Assume the Allowance for Doubtful Accounts
has a beginning credit balance of $1,230:
Credit balance required in allowance
account after adjustment
Less: Credit balance in allowance
account before adjustment
Amount for bad debt expense entry
Chapter 7, Slide #19
$14,554
1,230
$13,324
Aging Method
Assume the Allowance for Doubtful Accounts has
a beginning balance of $1,230:
Balance Sheet
Assets =
Income Statement
Liabilities + Stockholders’ + Revenues – Expense
Equity
Allowance for
Doubt Accts
(13,324)
Chapter 7, Slide #20
Bad Debts Expense
(13,324)
Aging Method
The net realizable value of accounts receivable
would be determined as follows:
Accounts receivable
$168,500
Less: Allowance for doubtful accounts
14,554
Net realizable value
$153,946
Chapter 7, Slide #21
Accounts Receivable Turnover
Net Credit Sales
Average Accounts Receivable
Indicates how quickly a
company is collecting (i.e.,
turning over) its receivables
Chapter 7, Slide #22
LO3
Accounts Receivable Turnover
 Too fast
 Too slow
credit policies too
stringent; may be
losing sales
credit department
not operating effectively;
dissatisfied customers
Chapter 7, Slide #23
Interest-Bearing Promissory Note
Principal
Baker Corporation promises to pay HighTec,
Inc. $15,000 plus 12% annual interest on
March 13, 2008.
Interest
Date: December 13, 2007
Signed:_________
Baker Corporation
Chapter 7, Slide #24
Maturity
Date
LO4
Interest-Bearing
Promissory Note
To record the receipt of the note on December 13
Balance Sheet
Assets = Liabilities + Stockholders’ +
Equity
Notes
Receivable
15,000
Chapter 7, Slide #25
Income Statement
Revenues - Expenses
Sales Revenue
15,000
Interest-Bearing
Promissory Note
To record interest:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Interest
Receivable
90 *
*Interest = $15,000 × 12% × 18/360
Chapter 7, Slide #26
Interest
Revenue 90
Interest-Bearing
Promissory Note
To record the collection of the note on March 13, 2008:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Cash 15,450
Notes
Receivable (15,000)
Interest
Receivable (90)
*15,000 × 12% × 72/360
Chapter 7, Slide #27
Interest Revenue
360
Accelerating the Cash Inflow from
Sales
 Credit card sales
 Discounting notes receivable
Chapter 7, Slide #28
LO5
Credit Card Sales
 Competitive necessity
 Credit card company:
• Charges fee
• Assumes risk of nonpayment
Chapter 7, Slide #29
Discounting Notes Receivable
 Sell note prior to maturity date for cash
 Receive less than face value (i.e.,
discounted amount)
 Can be sold with or without recourse
Baker Corporation promises to pay
HighTec, Inc. $15,000 plus 12% annual
interest on December 31, 2007.
Date: January 1, 2007
Baker Corporation
Signed:_________
Chapter 7, Slide #30
$$$
Liquid Assets and the Statement of
Cash Flows – Indirect Method
Operating Activities
Net income
Increase in accounts receivable
Decrease in accounts receivable
Increase in notes receivable
Decrease in notes receivable
xxx
–
+
–
+
Investing Activities
Purchases of held-to-maturity and
available-for-sale securities
Sales/maturities of held-to-maturity and
available-for-sale securities
–
+
Financing Activities
LO6
Appendix
Accounting for Investments in
Stocks and Bonds
Chapter 7, Slide #32
Security Investment Categories
 Held-to-maturity securities
 Trading securities
 Available-for-sale
securities
Chapter 7, Slide #33
Use fair value
method to account
for these
investments
LO7
Held-to-Maturity Securities
 Bonds of other companies
 Intent and ability to hold until maturity
Example:
$100,000, 9% bond
due 2019
Chapter 7, Slide #34
Held-to-Maturity Securities
Example:
On 1/1/07, Atlantic buys:
 $100,000, 10% bonds @ face value
 Bonds mature in ten years
 Interest payable semiannually
Record the purchase of the bonds and
receipt of the first interest payment
Chapter 7, Slide #35
Recording Bond Purchase
To record purchase of ABC bonds:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Investment
in Bonds 100,000
Cash (100,000)
$100,000, 10% bond
due 2017
Chapter 7, Slide #36
Recording Receipt of Interest
Payment
To record interest income on ABC bonds:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Cash 5,000
Chapter 7, Slide #37
Interest Revenue 5,000
Recording Bond Sale
To record sale of Investment in ABC bonds:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Cash 99,000
Investment
in Bonds (100,000)
Chapter 7, Slide #38
Loss on Sale of Bonds
(1,000)
Trading Securities
Stocks
Bonds
 Purchased to generate profit from
short-term appreciation
 Intend to sell in near term
(classified as current assets)
Chapter 7, Slide #39
Trading Securities
Stocks
 At end of each period, security
is “marked to market”
 Unrealized gain or loss
recognized on income
Income
statement
Statement
Chapter 7, Slide #40
Bonds
Trading Securities
Example:
Dexter Corp. holds the following trading securities at
12/31/07:
Total Fair Value
On Security
Total Cost
Menlo preferred stock $25,000
Canby common stock 40,000
December 31, 2007
$27,500
39,000
Record the unrealized gain or loss at 12/31/07
Chapter 7, Slide #41
Recording Unrealized Gain/ Loss on
Trading Securities
To adjust trading securities to fair value:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Investment
Trading
*Unrealized Gain
Menlo 1,500
Securities 2,500
Investment
Canby (1,000)
Chapter 7, Slide #42
*income statement account
Available-for-Sale Securities
 Securities not classified as either
held-to-maturity or trading
Stocks
Bonds
 Unrealized gain or loss
accumulated in stockholders’
equity account
Chapter 7, Slide #43
Balance
Sheet
Available-for-Sale Securities
Example:
Lenox Corp. holds the following available-for-sale
securities at 12/31/07:
Total Fair Value on
Security
Total Cost December 31, 2007
Adair preferred stock
$15,000
$16,000
Casey common stock
35,000
32,500
Record the unrealized gain or loss at 12/31/07
Chapter 7, Slide #44
Recording Unrealized Gain/ Loss on
Available-for-Sale Securities
To adjust available-for-sale securities to fair value:
Balance Sheet
Income Statement
Assets = Liabilities + Stockholders’ + Revenues - Expenses
Equity
Investment
in Adair 1,000
Investment
in Casey (2,500)
*Unrealized Loss
Avail for Sale
Securities (1,500)
*part of Stockholders’ Equity
Chapter 7, Slide #45
Accounting for Investments without
Significant Influence
Recognize
Categories
as Income
Held-to-maturity Interest
Trading
Interest, dividends
Available-for-Sale Interest, dividends
Chapter 7, Slide #46
Report
on Balance
Sheet at
Cost
Fair value
Fair value
Report
Changes in
Fair Value on
N/A
Income statement
Balance sheet
End of Chapter 7
Chapter 7, Slide #47