Chapter
Five
Accounting
for
Receivables
and
Inventory
Cost Flow
© 2015 McGraw-Hill Education.
LO 1
LO 1
Explain how the
allowance method of
accounting for
uncollectible
accounts affects
financial statements.
5-2
Net Realizable Value of Accounts
Receivable
Most companies do not expect to
collect the full amount (face value)
of their accounts receivable. Even
carefully screened credit customers
sometimes don’t pay their bills. The
net realizable value of accounts
receivable represents the amount
of receivables a company estimates
it will actually collect. The net
realizable value is the face value
less an allowance for doubtful
accounts.
5-3
Revenue Recognition
Event 1: Revenue Recognition
During 2014, Allen’s Tutoring Services
recognized $14,000 of service revenue earned
on account.
Assets
=
Accounts
Receivable =
14,000
=
Liab.
+
+
n/a
+
Stockholders' Equity
Common
Retained
Stock
+ Earnings
n/a
+
14,000
Revenue
-
Expenses
=
14,000
-
n/a
=
Net
Income
14,000
Cash Flow
n/a
5-4
Collection for Receivables
Event 2: Collection of Receivables
Allen’s Tutoring Services collected $12,500
cash from accounts receivable in 2014.
Assets
Cash +
12,500 +
=
Accts.
Rec.
=
(12,500) =
Liab.
Accts.
Pay
n/a
+
+
+
Stockholders' Equity
Com.
Retained
Stk.
+ Earnings
+
n/a
n/a
Net
Revenue - Expenses = Income
n/a
n/a
=
n/a
Cash Flow
12,500 OA
5-5
Recognizing Uncollectible Account
Expense
Event 3 Recognizing Uncollectible Accounts Expense
Allen’s Tutoring Services recognized uncollectible
accounts expense for accounts expected to be
uncollectible in the future.
Assets
=
Acct.
Rec. - Allow. =
n/a 75
=
Liab. +
Stockholders' Equity
+
+
Com. Retained
Stk. + Earnings
n/a +
(75)
n/a
Total accounts receivable
Cash collected on accounts receivable
Balance in accounts receivable
$
$
Net
Revenue
n/a
-
Expenses
75
=
=
Income
Cash Flow
n/a
(75)
14,000
(12,500)
26,500
Accounts receivable
Less: Allowance for Doubtful Accounts
Net Realizable Value of Receivables
$
$
1,500
(75)
1,575
5-6
Financial Statements
Statement of Cash Flows
Income Statement
Service Revenue
Uncollectible Accts Expense
Net income
$
$
14,000
(75)
13,925
Operating Activities
Inflow from Customers
Investing Activities
Financing Activities
Net Change in Cash
Beginning Cash Balance
Ending Cash Balance
$
$
12,500
12,500
12,500
Balance Sheet
Assets
Cash
Accounts receivable
Less: Allowance
Net Realizable Value
Total Assets
Stockholders' Equity
Retained Earnings
$ 12,500
$ 1,500
(75)
1,425
$ 13,925
$ 13,925
5-7
Subsequent Period
Event 1 Write-Off of an Uncollectible Account
Receivable
Allen’s Tutoring Services wrote off $70 of
uncollectible accounts receivable.
Assets
Acct.
Rec.
(70) -
=
Allow.
=
(70) =
Liab.
n/a
+
+
+
Stockholders' Equity
Com.
Retained
Stk.
+ Earnings
+
n/a
n/a
Accounts Receivable
Allowance for Doubtful Accounts
Net Realizable Value
Revenue - Expenses =
n/a
n/a
=
Before
Write-Off
$
1,500
(75)
$
1,425
Net
Income
n/a
Cash
Flow
n/a
After
Write-Off
$
1,430
(5)
$
1,425
5-8
Revenue Recognition
Event 2 Revenue Recognition
Allen’s Tutoring Services provided $10,000 of
tutoring services on account during 2015.
Assets
Accounts
Receivable
=
10,000
=
Liab.
=
+
+
n/a
+
Stockholders' Equity
Common
Retained
Stock
+ Earnings
n/a
+
10,000
Revenue
-
Expenses
=
10,000
-
n/a
=
Net
Income
10,000
Cash Flow
n/a
5-9
Collection of Accounts Receivable
Event 3 Collection of Accounts Receivable
Allen’s Tutoring Services collected $8,430 cash from
accounts receivable.
Assets
Cash +
8,430 +
=
Accts.
Rec.
=
(8,430) =
Liab.
n/a
+
+
+
Stockholders' Equity
Com.
Retained
Stk.
+ Earnings
+
n/a
n/a
Revenue - Expenses =
n/a
n/a
=
Net
Income
n/a
Cash Flow
8,430 OA
5-10
Recovery of an Uncollectible Account
Event 4 Recovery of an Uncollectible account:
Reinstate Receivable
Allen’s Tutoring Services recovered a receivable that
it had previously written off.
Assets
Accts.
Rec. 10 -
=
Allow. =
10 =
Liab.
n/a
+
+
+
Stockholders' Equity
Com.
Retained
Stk.
+ Earnings
+
n/a
n/a
Net
Revenue - Expenses = Income
n/a
n/a
=
n/a
Cash Flow
n/a
5-11
Recovery of an Uncollectible Account
Event 5 Recovery of an Uncollectible Account:
Collection of Receivable
Allen’s Tutoring Services recorded collection of the
reinstated receivable.
Assets
=
Accts.
Cash + Rec. =
(10) =
10 +
Liab.
n/a
+
Stockholders' Equity
Com.
Retained
+ Stk. + Earnings
+ n/a +
n/a
Net
Revenue - Expenses = Income
n/a - n/a = n/a
Cash Flow
10 OA
5-12
LO 2
LO 1
Use the percent of
revenue method to
estimate the
uncollectible
accounts expense.
5-13
Year-End Adjusting Entries
Event 6 Adjustment for Recognition of Uncollectible
Accounts Expense
Using the percent of revenue method, Allen’s
Tutoring Services recognized uncollectible accounts
expense for 2015.
Sales for 2015
Uncollectible percent
Uncollectible amount
Assets
Accts.
Rec.
n/a
-
Allow.
135
=
=
=
Liab.
n/a
+
+
+
Stockholders' Equity
Com.
Retained
Stk.
+ Earnings
+
n/a
(135)
$ 10,000
1.35%
$
135
Revenue - Expenses =
n/a
135 =
Net
Income
(135)
Cash
Flow
n/a
5-14
Financial Statements
Balance Sheet
Income Statement
Service Revenue
$ 10,000
Uncollectible Accts. Expense
(135)
Net Income
$ 9,865
Assets
Cash
Accounts receivable
Less: Allowance
Net Realizable Value
Total Assets
Stockholders' Equity
Retained Earnings
$
$
20,940
$
2,850
23,790
$
23,790
3,000
(150)
Statement of Cash Flows
Operating Activities
Inflow from Customers
Investing Activities
Loan to other company
Financing Activities
Net Change in Cash
Beginning Cash Balance
Ending Cash Balance
$
8,440
$
0
0
8,440
12,500
20,940
5-15
LO 3
LO 1
Use the percent of
receivables method
to estimate the
uncollectible
accounts expense.
5-16
Percent of Receivables Method
• Alternative to percent of revenue method.
• Focuses on estimating the most accurate
amount for the balance sheet account,
Allowance for Doubtful Accounts and the
Net Realizable Value.
• The longer an account receivable is
outstanding, the less likely it is to be
collected.
• Aging of accounts classifies all receivables
by their due date.
5-17
Accounts Receivable Aging Schedule
5-18
Balance Required in Allowance
Account
The ending balance in the Allowance for Doubtful Accounts account should be
$3,760. If there is $500 in the allowance account before adjustment, $3,260
would need to be added. The effects on the financial statements would be:
Assets
=
Acct.
Rec. - Allow. =
n/a - 3,260 =
Liab. +
Stockholders' Equity
+
+
Com.
Retained
Stk. + Earnings
n/a + (3,260)
n/a
Net
Revenue
n/a
-
Expenses
= Income
3,260 = (3,260)
Cash Flow
n/a
5-19
Matching Revenues and Expenses Versus
Asset Measurement
The percent of revenue
method, with its focus
on determining the
uncollectible accounts
expense, is often called
the income statement
approach.
The percent of
receivables method,
focuses on determining
the best estimate of the
allowance balance, often
called the balance sheet
approach.
Either approach provides acceptable
results.
5-20
LO 4
LO 1
Explain how
accounting for notes
receivable and
accrued interest
affects financial
statements.
5-21
Promissory Note
5-22
Characteristics of Notes Receivable
• Legally documented with a promissory note
• Maker-borrower; responsible for paying note on
due date
• Payee-loans money to maker; expects payment of
principal and interest
• Principal-amount of money loaned
5-23
Characteristics of Notes Receivable
• Interest-economic benefit earned by the payee for
loaning the principal to the maker
• Maturity Date-date on which maker must repay
principal and interest
• Collateral-assets belonging to maker assigned as
security to ensure payment of note
5-24
Accounting for Notes Receivable
Event 1 Loan of money
During 2014, Allen's Tutoring Services decides to invest
some idle cash. On November 1, 2014, the company loans
$15,000 to Stanford Cummings. The note is due in one year
and bears interest at an annual rate of 6%.
Assets
=
Liab. +
Net
Notes
Rec.
Cash +
+ Int. Rec. =
(15,000)+ 15,000 + n/a =
Equity
n/a
+
+
Ret. Earn.
n/a
Rev. n/a -
Exp.
n/a
= Income
= n/a
Cash Flow
(15,000) IA
5-25
Accrual of Interest Revenue
Event 2 Recognition of Interest Revenue
At the end of 2014, Allen's Tutoring Services must
accrue interest on its note receivable.
$15,000 × 6% × 2/12 = $150 interest revenue
Assets
=
Liab. +
Net
Notes
Cash + Rec.
n/a
+
+ Int. Rec. =
n/a + 150 =
Equity
n/a
+
+
Ret. Earn.
150
Revenue
150 -
Expenses
n/a
=
=
Income
150
Cash Flow
n/a
5-26
Collecting principal & interest
at maturity date
Event 3 Collection of principal and interest on
the maturity date, October 31, 2015.
$15,000 × 6% × 10/12 = $750 interest revenue
Assets
=
Notes
Cash + Rec. + Int. Rec. =
750 =
n/a + n/a +
Liab. +
Equity
Net
n/a
+
+
Ret. Earn.
750
Revenue
750 -
Expenses
n/a
=
=
Income
750
Cash Flow
n/a
Now, record payment of principal and interest receivable.
Cash
Assets
=
Notes
+
+ Int. Rec. =
Rec.
15,900 +
(15,000) +
(900)
=
Liab.
+
Equity
+ Ret. Earn.
n/a
+
n/a
Revenue - Expenses =
n/a
-
n/a
=
Net
Income
n/a
Cash
Flow
15,000
IA
900 OA
5-27
Notes Receivable & Financial
Statements
Accrual accounting calls for recognizing revenue in the
period earned regardless of when cash is collected.
Interest Revenue Recognized
Operating Activities Cash Inflow
2014
$ 150
0
2015 Total
$ 750 $ 900
900
900
Remember cash received from interest is shown as an
operating activity on the Statement of Cash Flows,
but interest revenue is often reported as a nonoperating item on the Income Statement.
5-28
Typical Balance Sheet Presentation
of Receivables
5-29
LO 5
LO 1
Explain how
accounting for credit
card sales affects
financial statements.
5-30
Credit Card Sales
Rather than maintaining a credit granting department,
many companies find it cost beneficial to accept credit
cards. The credit card company deducts a fee, usually
between 2% and 8%, from the gross amount of the
sales, and pays the merchant the net balance (gross sales
less credit card fee).
5-31
Credit Card Sales
Event 1 Recording a Credit Card Sale
Allen's Tutoring Services accepts a credit card in payment for
services of $1,000. The credit card company charges a fee of
5% of the gross sale.
Assets
=
Accounts
Receivable =
950
=
Liab.
+
+
n/a
+
Stockholders' Equity
Common
Retained
Stock
+ Earnings
n/a
+
950
Revenue
-
Expenses
=
1,000
-
50
=
Net
Income
950
Cash Flow
n/a
5-32
Credit Card Sales
Event 2 Collection of a Credit Card Receivable
Allen's Tutoring Services collects the full amount due from the
credit card company.
Assets
Cash +
950 +
=
Accts.
Rec.
=
(950) =
Liab.
n/a
+
+
+
Stockholders' Equity
Com.
Retained
Stk. + Earnings
+
n/a
n/a
Net
Revenue - Expenses = Income
n/a n/a
=
n/a
Cash Flow
950 OA
5-33
LO 6
LO 1
Explain how different
inventory cost flow
methods (specific
identification, FIFO,
LIFO, and weighted
average) affect
financial statements.
5-34
Inventory Cost Flow Methods
Specific
Identification
First-in, FirstOut (FIFO)
Four
Common
Inventory
Cost Flow
Methods
Last-in, FirstOut (LIFO)
Weighted
Average
5-35
Specific Identification
When a company’s
inventory consists of
many high-priced,
low-turnover goods
the record keeping
necessary to use
specific identification
is more practical.
5-36
Specific Identification
Assume TMBC Company
purchased two identical
inventory items: the first for
$100 and the second for $110.
Alert!
Using specific identification,
when the first item is sold,
cost of goods sold would be
$100. When the second item
is sold, cost of goods sold
would be $110.
A disadvantage of the
specific identification
method is the opportunity
for managers to
manipulate the income
statement.
5-37
First-in, First-out
The first-in, first-out
cost flow method
requires that the cost
of the items
purchased first be
assigned to Cost of
Goods Sold.
5-38
First-in, First-out
Assume TMBC Company
purchased two identical
inventory items: the first for
$100 and the second for $110.
Using first-in, first-out, the
cost assigned to the first item
sold would be $100 (the first
cost in). The cost of goods sold
assigned to the second item
sold would be $110.
5-39
Last-in, First-out
The last-in, first-out
cost flow method
requires that the cost
of the items
purchased last be
assigned to Cost of
Goods Sold.
5-40
Last-in, First-out
Assume TMBC Company
purchased two identical
inventory items: the first for
$100 and the second for $110.
Using last-in, first-out, the
cost assigned to the first item
sold would be $110 (the last
cost in). The cost of goods
sold assigned to the second
item sold would be $100.
5-41
Weighted Average
The weighted average
cost flow method
assigns the average
cost of the items
available to Cost of
Goods Sold.
5-42
Weighted Average
Assume TMBC Company
purchased two identical
inventory items: the first for
$100 and the second for $110.
Using weighted average, the
cost assigned to both items
sold would be $105 (the
average cost).
Total Cost
$210
=
= $105
Total Number
2
5-43
Physical Flow
Our discussions about
inventory cost flow
methods pertain to the
flow of costs through the
accounting records, not
the actual physical flow
of goods.
Cost flows can be done on
a different basis than
physical flow.
5-44
Effect of Cost Flow on
Income Statement
The cost flow method a company uses can
significantly affect the gross margin
reported in the income statement.
Sales
Cost of Goods Sold
Gross Margin
Weighted
FIFO
LIFO
Average
$
120 $
120 $
120
(100)
(110)
(105)
$
20 $
10 $
15
5-45
Effect of Cost Flow on
Balance Sheet
Since total product costs are allocated
between costs of goods sold and ending
inventory, the cost flow method used affects
its balance sheet as well as its income
statement.
Ending Inventory
Weighted
FIFO
LIFO
Average
$ 110 $ 100 $
105
5-46
Multiple Layers with
Multiple Quantities
The following information relates to TMBC’s Eraser bike.
Jan. 1
Mar. 18
Aug. 21
Beginning Inventory 10 units @ $200 = $ 2,000
First purchase
20 units @ $220 =
4,400
Second purchase
25 units @ $250 =
6,250
Total cost of the 55 bikes available for sale
$ 12,650
TMBC sold 43 bikes at a cash price of $350 each
First-in, FirstOut (FIFO)
Last-in, FirstOut (LIFO)
Weighted
Average
5-47
First-in, First-out Inventory
Cost Flow
FIFO Cost of Goods Sold
Jan. 1
Beginning inventory 10 units @ $ 200 = $ 2,000
Mar. 18 First purchase
20 units @ $ 220 = 4,400
Aug. 21 Second purchase
13 units @ $ 250 = 3,250
Total cost of the 43 bikes sold
$ 9,650
Cost of goods sold is an expense
and, thus, decreases net income.
5-48
Allocation of Cost of Goods
Available for Sale
FIFO
Cost of Goods Sold
$9,650 (43 bikes)
Cost of Goods
Available for Sale
$12,650 (55 bikes)
Ending Inventory
Balance $3,000
(12 bikes)
5-49
Last-in, First-out Inventory
Cost Flow
LIFO Cost of Goods Sold
Aug. 21 Second purchase
25 units @ $ 250 = $ 6,250
Mar. 18 First purchase
18 units @ $ 220 =
3,960
Total cost of the 43 bikes sold
$ 10,210
5-50
Allocation of Cost of Goods
Available for Sale
LIFO
Cost of Goods
Available for Sale
$12,650 (55 bikes)
Cost of Goods Sold
$10,210 (43 bikes)
Ending Inventory
Balance $2,440
(12 bikes)
5-51
Weighted Average Inventory
Cost Flow
Weighted Average Cost of Goods Sold
Total cost of the 43 bikes sold 43 units @ $ 230 = $ 9,890
Total Cost
$12,650
=
= $230
Total Number
55
5-52
Allocation of Cost of Goods
Available for Sale
WeightedAverage
Cost of Goods Sold
$9,890 (43 bikes)
Cost of Goods
Available for Sale
$12,650 (55 bikes)
Ending Inventory
Balance $2,760
(12 bikes)
5-53
Effect of Cost Flow on
Financial Statements
5-54
End of Chapter Five
5-55