Chapter
Seven
Accounting
for
Receivables
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Accounts and Notes Receivable
• A/R are the expected future
cash receipts of a company.
They are typically small and are
expected to be received within
30 days.
• N/R are used when longer
credit terms are necessary.
The promissory note specifies
the maturity date, the rate of
interest, and other credit terms.
2
Value of Receivables
• Receivables are reported at
their face value less an
allowance for accounts
which are likely to be
uncollectible.
• The amount which is actually
expected to be collected is
called the net realizable value
(NRV).
3
Allowance Method vs. Direct
Write-Off Method
• GAAP requires that A/R be reported at
NRV. (A/R minus Allowance)
• This is done using a valuation allowance:
An ALLOWANCE METHOD.
– % of Sales (or “Income Statement”) approach.
– Aging (or “Balance Sheet”) approach.
• With the ALLOWANCE METHOD, an
estimate of the amount that will NOT be
collected is recorded in the same period
that the sales revenue is recorded. Thus,
the MATCHING PRINCIPLE is being followed.
4
Allowance Method vs. Direct
Write-Off Method (continued)
• The DIRECT WRITE-OFF method violates
GAAP because it does NOT follow the
MATCHING principle.
• With the Direct Write-off method, no estimate
of bad debts is recorded at the time of the
sale. Rather, only after a specific account is deemed
“uncollectible” is a Bad Debt Expense recorded.
• Since GAAP is only required if the amounts are
MATERIAL (significant), if the amount of uncollectible
A/R is immaterial the Direct Write-off method may be
used.
5
Transaction Analysis:
• Assume the following selected events
occurred at Cell-It. For each event:
– Determine how the accounting equation
was affected and fill in the horizontal
model. (Assume GAAP must be followed.)
– Determine the effect on the financial
statements.
– Record the event in t-accounts.
6
1. Provided services to customers for
$10,000 on account.
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
Inc. Statement
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
10000
n.a.
2
3
4
5A
5B
Bal.
10
2. Collected $7,000 from account
receivable.
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
Inc. Statement
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
10000
n.a.
7000 OA
3
4
5A
5B
Bal.
11
3. At year-end it was estimated that $200 of the
current accounts receivable balance will not be
collected.
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
3
Inc. Statement
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
10000
n.a.
7000 OA
200
(200)
200
(200)
n.a.
4
5A
5B
Bal.
12
3. At year-end
it wasfor
estimated
that 2%
Allowance
Doubtful Accounts
is
a CONTRAASSET will
account.
of the year’s
credit sales
not This
be
account balance is INCREASING by
collected.
$200 causing TOTAL assets to
Balance Sheet
decrease.
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
3
Inc. Statement
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
10000
n.a.
7000 OA
200
(200)
200
(200)
n.a.
4
5A
5B
Bal.
13
4. Jane Doe’s $50 account was written-off
as uncollectible.
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
3
4
(50)
Inc. Statement
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
10000
n.a.
7000 OA
200
(50)
(200)
200 (200)
NO EXPENSE!
n.a.
5A
5B
Bal.
Note: This is NOT the Direct Write-off method. Rather, it is a
write-off under the ALLOWANCE Method.
14
Effect of Transaction 4 on
Acct. Rec. Net Realizable
Value
Before Event 4
A/R
$3,000
Allow.
(200)
N.R.V.
$2,800
The check is
in the mail.
After Event 4
Acme Collection
Agency
15
Effect of Transaction 4 on
Acct. Rec. Net Realizable
Value
Before Event 4
A/R
$3,000
Allow.
(200)
N.R.V.
$2,800
After Event 4
A/R
$2,950
(150)
Allow.
N.R.V. $2,800
16
Effect of Transaction 4 on
Acct. Rec. Net Realizable
Value
Before Event 4
A/R
$3,000
Allow.
(200)
N.R.V.
$2,800
After Event 4
A/R
$2,950
Allow.
(150)
N.R.V. $2,800
When using an ALLOWANCE method, the
Net Realizable Value of accounts receivable
does not change as a result of the write-off.
17
Before recording Transaction #5:
What happens when an account that has been
written off later pays off his/her account?
Reinstate the account by recording an
entry that undoes (reverses) the write-off:
– increase (debit) Accounts Receivable
– increase (credit) Allowance for
Doubtful Accounts (a contra-asset)
- Record the entry to show the cash
collection and A/Rec. reduction:
– increase (debit) Cash
– decrease (credit) Accounts
Receivable
18
5. $50 cash was unexpectedly received
from Jane Doe. (5A=Reinstate,
5B=Collect)
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
4
5A
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
10000
n.a.
7000 OA
(50)
200
(50)
50
50
3
Inc. Statement
(200)
200 (200)
NO EXPENSE!
n.a.
5B
Bal.
19
5. $50 cash was unexpectedly received
from Jane Doe. (5A=Reinstate,
5B=Collect)
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
4
5A
5B
50
10000
n.a.
7000 OA
(50)
50
50
(50)
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
200
(50)
3
Inc. Statement
(200)
200 (200)
NO EXPENSE!
n.a.
50 OA
Bal.
20
Calculate all ending balances.
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
4
5A
5B
50
Bal. 7050
10000
n.a.
7000 OA
(50)
50
50
(200)
200 (200)
NO EXPENSE!
(50)
2950
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
200
(50)
3
Inc. Statement
n.a.
50 OA
200
9800 10000
200
9800 7050 bal.
21
What’s the result?
After completing the horizontal model fill in
below.
How did the previous transactions affect the financial statements?
20X1
How much Bad Debt Expense should
appear on the income statement?….
What is the A/R: NRV at year end?……
How much A/R should be added to the
other current assets on the year-end
balance sheet?………………………….
22
Final Account Balances
Remember, the Bad Debt EXPENSE is accrued in the
year of sale, NOT when the account is written off!
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
5A
5B
50
Bal. 7050
10000
n.a.
7000 OA
(50)
200
(50)
50
50
(200)
200 (200)
NO EXPENSE!
(50)
2950
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
3
4
Inc. Statement
n.a.
50 OA
200
9800 10000
MATCHING PRINCIPLE
200
9800 7050 bal.
23
What’s the result?
After completing the horizontal model fill in
below.
How did the previous transactions affect the financial statements?
20X1
How much Bad Debt Expense should
appear on the income statement?….
$
200
What is the A/R: NRV at year end?……
How much A/R should be added to the
other current assets on the year-end
balance sheet?………………………….
24
Final Account Balances
Net Realizable Value (NRV) = Acct.Rec. - Allowance
Balance Sheet
Assets
= Liab.+ Stk. Equity
Cash+ A/Rec .- Allow. = A/P + C.Stk.+ R.E.
1
10000
2 7000
(7000)
4
5A
5B
50
Bal. 7050
10000
n.a.
7000 OA
(50)
50
50
(200)
200 (200)
NO EXPENSE!
(50)
2950
Cashflow
Rev. - Exp. = N. I. OA,IA,FA
10000 10000
200
(50)
3
Inc. Statement
n.a.
50 OA
200
9800 10000
200
9800 7050 bal.
25
What’s the result?
After completing the horizontal model fill in
below.
How did the previous transactions affect the financial statements?
20X1
How much Bad Debt Expense should
appear on the income statement?….
$
What is the A/R: NRV at year end?……
$ 2,750
How much A/R should be added to the
other current assets on the year-end
balance sheet?………………………….
$ 2,750
200
26
Transaction Posted to T-accounts
1. Provided services to customers for $10,000
which will be collected at a later date.
Cash
Acct. Rec.
Service Revenue Bad Debt Exp.
Allow. for D.A.
Retain. Earn.
27
Transaction Posted to T-accounts
1. Provided services to customers for $10,000
which will be collected at a later date.
Cash
Acct. Rec.
Allow. for D.A.
(1) 10,000
Service Revenue Bad Debt Exp.
10,000 (1)
Retain. Earn.
28
Transaction Posted to T-accounts
2. Collected $7,000 of the Accounts Receivables.
Cash
Acct. Rec.
Allow. for D.A.
(1) 10,000
Service Revenue Bad Debt Exp.
10,000 (1)
Retain. Earn.
29
Transaction Posted to T-accounts
2. Collected $7,000 of the Accounts Receivables.
Cash
(2) 7,000
Acct. Rec.
Allow. for D.A.
(1) 10,000 7,000 (2)
Service Revenue Bad Debt Exp.
10,000 (1)
Retain. Earn.
30
Transaction Posted to T-accounts
3. At Yr. end it was estimated that 2% of the year’s
credit sales will never be collected.
Cash
(2) 7,000
Acct. Rec.
Allow. for D.A.
(1) 10,000 7,000 (2)
Service Revenue Bad Debt Exp.
10,000 (1)
Retain. Earn.
31
Transaction Posted to T-accounts
3. At Yr. end it was estimated that 2% of the year’s
credit sales will never be collected.
Cash
(2) 7,000
Acct. Rec.
(1) 10,000 7,000 (2)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
Allow. for D.A.
200 (3)
Retain. Earn.
32
Transaction Posted to T-accounts
4. Jane Doe’s $50 account was written-off as
uncollectible.
Cash
(2) 7,000
Acct. Rec.
(1) 10,000 7,000 (2)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
Allow. for D.A.
200 (3)
Retain. Earn.
33
Transaction Posted to T-accounts
4. Jane Doe’s $50 account was written-off as
uncollectible.
Cash
(2) 7,000
Acct. Rec.
(1) 10,000 7,000 (2)
50 (4)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
Allow. for D.A.
(4) 50
200 (3)
Retain. Earn.
34
Transaction Posted to T-accounts
5a. Jane Doe’s account is reinstated.
Cash
(2) 7,000
Acct. Rec.
(1) 10,000 7,000 (2)
50 (4)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
Allow. for D.A.
(4) 50
200 (3)
Retain. Earn.
35
Transaction Posted to T-accounts
5a. Jane Doe’s account is reinstated.
Cash
(2) 7,000
Acct. Rec.
(1) 10,000 7,000 (2)
50 (4)
5a
50
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
Allow. for D.A.
(4) 50
200 (3)
50 (5a)
Retain. Earn.
36
Transaction Posted to T-accounts
5b. Jane Doe’s account is collected.
Cash
(2) 7,000
Acct. Rec.
(1) 10,000 7,000 (2)
50 (4)
5a
50
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
Allow. for D.A.
(4) 50
200 (3)
50 (5a)
Retain. Earn.
37
Transaction Posted to T-accounts
5b. Jane Doe’s account is collected.
Cash
(2) 7,000
5b
50
Acct. Rec.
Allow. for D.A.
(1) 10,000 7,000 (2) (4) 50
50 (4)
5a
50
50 (5b)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
200 (3)
50 (5a)
Retain. Earn.
38
Transaction Posted to T-accounts
Closing entries at the end of Year 1.
Cash
(2) 7,000
5b
50
Acct. Rec.
Allow. for D.A.
(1) 10,000 7,000 (2) (4) 50
50 (4)
5a
50
50 (5b)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
200 (3)
50 (5a)
Retain. Earn.
39
Transaction Posted to T-accounts
Closing entries at the end of Year 1.
Cash
(2) 7,000
5b
50
Acct. Rec.
(1) 10,000 7,000 (2) (4) 50
50 (4)
5a
50
50 (5b)
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
(c) 10,000
Allow. for D.A.
200 (c)
200 (3)
50 (5a)
Retain. Earn.
(c) 200 10,000 (c)
40
Transaction Posted to T-accounts
Balances of all accounts after Year 1 closings.
Cash
Acct. Rec.
Allow. for D.A.
(1) 10,000 7,000 (2) (4) 50
50 (4)
5a
50
50 (5b)
bal 2,950
(2) 7,000
5b
50
bal. 7,050
Service Revenue Bad Debt Exp.
10,000 (1) (3) 200
(c) 10,000
0 bal
bal. 0
200 (c)
200 (3)
50 (5a)
200 bal.
Retain. Earn.
(c) 200 10,000 (c)
9,800 bal.
41
Summary:
Accounting for Bad Debts
• Allowance method
– GAAP
– Required if company has a
significant amount of bad
debts.
– Matches bad debt expense (on
the income statement) with the
sale.
– Requires an adjusting journal
entry before closing the books.
42
Summary:
Accounting for Bad Debts
• Direct Write-off method
– Violates GAAP (Matching)
– No estimates of bad debts are made,
so no allowance account is used.
– Used by small businesses with few
account receivables or large
business with few collection
problems.
– No entry until time specific account is
deemed “bad” (uncollectible).
43
Direct Write-off Method for
Accounting for Bad Debts
• Direct Write-off method
Entry to write off J. Jones’ $100
account:
Bad Debt Expense
100
Acct. Rec.-Jones
100
Cash+Acct.Rec. = A/P +C. Stk.+Ret.E. Rev.- Exp. = N.I. Cashflow
(100)
(100)
+100 (100)
n.a.
44
Notes Receivable
Event 1 Loan of Money
On November 1, 2013, ATS loans $15,000 cash to
Stanford Cummings. Cummings issues ATS a note
promising to repay the loan, with interest, in one
year.
Event No.
1
7-45
Assets
Cash
+ Notes Rec.
(15,000)
15,000
= Liab.
+ Equity
Rev.
– Exp.
= Net Inc.
= NA
+ NA
NA
– NA
= NA
Cash Flow
(15,000) IA
Calculating and recording
interest earned on the Note…
Let’s review how to calculate interest. The basic formula is:
BALANCE
SHEET (and Accounting
Principal
X RateEquation)
X Time
ASSETS
=
LIABILITIES
+
EQUITY
Accts
Int.
Accts
Int.
Note
Com.
Ret.
Cash + CD + Receiv. + Rec. + Land = Pay. + Pay. + Pay. + Stk. + Earn.
BB
$ borrowed or invested
1,650
1,500
1
ANNUAL1,000
rate
2,000
2,000
2
1,200
INCOME STATEMENT
STATEMENT
Net
Rev. - Exp. = Inc.
Time since interest
150
was2,000
last recorded.
2,000
2,000
(1,200)
CASHFLOW
1,200
OA,IA,FA
$ amt
1,650 bal.
(1,200)
On
Nov. 1, 2013
3 1,500
(1,500)ATS loans $15,000 cash to Cummings at 6% for 1 year.
1,500
4 (1,000)
(1,000)be accrued on December 31, 2013? (1,000)
How much interest should
5
(500)
500
Principal
6
7
$15,000
8
EB
+
+
+
+
X
Rate
X
Time
=
Interest
OA
OA
(500) IA
X .06 X 2/12 = $150.00
rate =for 12+mo. +
+
November
through
+
= December
bal.
Interest Revenue
Event 2 Recognition of Interest Revenue
At the end of 2011, ATS must accrue interest on its
note receivable.
$15,000 × 6% × 2/12 = $150 interest revenue
Event No.
2
Assets = Liab. + Equity
150
= NA
Interest Receivable
7-47
+
150
Rev.
150
– Exp. = Net Inc.
– NA
=
150
Cash Flow
NA
Collection of a Note Receivable
Event 3 Collection of Principal and Interest
On November 1, 2012, ATS collects the principal
and interest due on the note receivable. ATS first
recognizes interest revenue for the 10 months of
2012.
$15,000 × 6% × 10/12 = $750 interest revenue
Event No.
3a
Assets = Liab. + Equity
750
= NA
Interest Receivable
7-48
+
750
Rev.
750
– Exp. = Net Inc.
– NA
=
750
Cash Flow
NA
Collection of a Note Receivable
Event 3 Collection of Principal and Interest
Now that the entire $900 of interest receivable has
been accrued, ATS records the collection of $15,900
in principal and interest on the note.
Account Title
Cash
Notes receivable
Interest receivable
Event No.
3b
Credit
15,000
900
Assets = Liab. + Equity
Rev.
– Exp. = Net Inc.
Cash Flow
NA
NA
– NA
15,000 IA
900 OA
= NA
+ NA
Asset Exchange Transaction
7-49
Debit
15,900
= NA
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).
50
Credit Card Sales
Event 1 Recording a Credit Card Sale
Matrix, Inc. accepts a credit card in payment for services
of $10,000. The credit card company charges a fee of 2%
of the gross sale.
Event No.
1
Assets
= Liab.
9,800 = NA
+ Equity
+
9,800
Account Title
Accounts Receivable
Credit Card Expense
Service Revenue
Rev.
– Exp.
10,000 –
Debit
9,800
200
= Net Inc.
200 =
9,800
Cash Flow
NA
Credit
10,000
51
Credit Card Sales
Event 2 Collection of a Credit Card Receivable
Matrix, Inc. collects the full amount due from the
credit card company.
Event No.
2
Assets
= Liab.
Cash
+ Acct. Rec.
9,800
(9,800) = NA
+ Equity
Rev.
– Exp.
= Net Inc.
+ NA
NA
– NA
= NA
Account Title
Cash
Accounts Receivable
Debit
9,800
Cash Flow
9,800 OA
Credit
9,800
52
Financial Statement Analysis
• Accounts Receivable Turnover
Sales
Accts/Rec. =
Turnover
$ Accounts Receivable*
Often the AVERAGE Accts. Rec. is used as the denominator.
Ave. A/R =
Beginning Accts/Rec. + Ending Accts/Rec.
2
This ratio is a measure of how
quickly receivables are collected.
53
Accounts Receivable Ratios
Accts. Rec. Turnover: (A measure of how fast
receivables are collected. Higher is better.)
Sales
$50,000
=
= 10.0 times
Accounts. Receiv.
$ 5,000
Average Days to collect A/R: (How many days
go by between a credit sale and the time it is collected?)
365
365
Accts. Rec. Turnover = 10.0 = 36.5 days
Generally, lower means better.
54
Length of Operating Cycle
Remember from Chapter 6 that a
company’s operating cycle is the time it
takes to convert inventory to cash by
selling it plus the time it takes to convert
accounts receivable back into cash.
So, the Operating Cycle is:
Ave. days to sell inventory
+ Ave. days to collect receivables
Length of Operating Cycle
60.8 days
36.5 days
97.3 days
55
Chapter 7
The End
56
Notes Payable: Transaction
Analysis - Appendix
nAssume
the following selected
events occurred at Cell-It. For
each event:
pDetermine
how the financial statements
are affected and fill in the horizontal
statements model.
pRecord
the event in the Journal and
Post to the Ledger.
57
Notes Payable: Transaction
Analysis
Assume the following events occurred at Cell-It.
1. On Oct. 1, 2004 Cell-It borrowed $8,000 cash by issuing a note
payable with a one-year term and an 8% stated interest rate. All
interest will be paid at maturity. This is an “interest bearing” note.
2. On Oct. 1, 2004 Cell-It issued an $8,000 face value, discounted note
payable with a one-year term and an 8% stated discount rate. This
is called a “Discounted” or “Non-interest bearing” note.
3. On Dec. 31, 2004 recorded interest related to the 8% interestbearing note issued on Oct. 1st (see #1).
4. On Dec. 31, 2004 recorded interest related to the 8% discounted
(non-interest bearing) note issued on Oct. 1st (see #2).
5. On Sept. 30, 2005 repaid the 8% non-discounted note payable (#1),
plus all interest.
6. On Sept. 30, 2005 repaid the 8% discounted note payable (#2).
58
Horizontal Model Transaction Analysis
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1
59
T1: On Oct. 1, 2004 Cell-it borrowed $8,000
at 8% for 1 year on an interest bearing
note. All interest to be paid at maturity.
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
8000
8000 FA
60
T2: On Oct. 1, 2004 Cell-it issued an $8,000 face
value, one year note payable discounted at
8%. (A noninterest bearing note.)
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
2 7360
8000
8000
640
8000 FA
7360 FA
The interest is INCLUDED in the Note Payable. The
interest must be subtracted to calculate the amount of
cash the borrower receives on the issue date.
Note Payable (Face Value)
$8000
Interest ($8000 x .08 x 12/12)
(640)
Cash to borrower
$7360 (Carrying value)
61
T2: On Oct. 1, 2004 Cell-it issued an $8,000 face
value, one year note payable discounted at
8%. (A noninterest bearing note.)
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
2 7360
8000
8000
640
8000 FA
7360 FA
The interest is INCLUDED in the Note Payable. The
interest must be subtracted to calculate the amount of
Since no time
cash the borrower receives on the issue date.
has past, the
Note Payable (Face Value)
$8000
$640 is NOT an
12
Interest ($8000 x .08 x /12)
(640)
EXPENSE yet.
Cash to borrower
$7360 (Carrying value)
62
T2: On Oct. 1, 2004 Cell-it issued an $8,000 face
value, one year note payable discounted at
8%. (A noninterest bearing note.)
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
2 7360
8000
8000
640
8000 FA
7360 FA
Discount on Note Payable is a contra liability account.
Its balance is SUBTRACTED from the Note Payable
account to obtain the total liability for the Note.
Note Payable
8000
Less: Discount on N/P
(640)
Total Note Liability
7360
63
T3: On Dec. 31, 2004 recorded interest
related to the note in #1.
Oct. 1-Dec. 31 = 3 mo. (8000 x .08 x 3/12=160)
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
2 7360
3
160
8000
8000
640
(160)
8000 FA
7360 FA
160 (160) n.a.
64
T4: On Dec. 31, 2004 recorded interest related to
the discounted (noninterest bearing) note in #2.
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
2 7360
3
160
4
8000
8000
640
(160)
(160)
(160)
8000 FA
7360 FA
160 (160) n.a.
160 (160) n.a.
65
T4: On Dec. 31, 2004 recorded interest related to
the discounted (noninterest bearing) note in #2.
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
2 7360
3
160
4
8000
8000
640
(160)
(160)
(160)
8000 FA
7360 FA
160 (160) n.a.
160 (160) n.a.
Discount on Note Payable is a contra liability account.
Its balance is SUBTRACTED from the Note Payable
account to calculate the current liability for the Note.
Note Payable
8000
Less: Discount on N/P
(480) (640 – 160)
Current Note Liability 7520
66
T5: On Sept. 30, 2005 repaid the 8% note from
Transaction #1 and all its interest.
a= accrue the remaining interest. b= payment.
(Jan. 1-Sept. 30 = 9 mo. (8000 x .08 x 9/12= $480)
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
8000
2 7360
3
160
4
5a
480
b (8640) (640) (8000)
8000
640
(160)
(160)
(160)
(480)
8000 FA
7360 FA
160 (160) n.a.
160 (160) n.a.
480 (480)
n.a
(8000) FA
(640) OA
67
T6: On Sept. 30, 2005 repaid the 8%
discounted note payable from Trans. #2. a=
accrue the remaining interest. b= payment.
Balance Sheet
Assets =
Liabilities
+ Equity
Inc. State.
Cashflow
Cash = I/P + N/P(1) + N/P(2) - Disc.+C.Stk+R.E. Rev.- Exp.= N. I. OA,IA,FA
1 8000
8000
2 7360
3
160
4
5a
480
b (8640) (640) (8000)
8000
6a
b (8000)
(8000)
640
(160)
(160)
(160)
(480)
160
160
480
(480)
(480)
480
8000 FA
7360 FA
(160) n.a.
(160) n.a.
(480)
n.a
(8000) FA
(640) OA
(480)
n.a.
(7360) FA
(640) OA
68
Comparison of Journal Entries for
Interest Bearing and Discounted Notes
Contra-liabilities are increased by debiting.
Date
2004
Oct. 1
NOTE PAYABLE (Interest bearing)
Accounts
Debit Credit
Cash
Note Payable
8000
8000
Borrowed $8000 at 8% for one year
Date
2004
Oct. 1
DISCOUNTED NOTE PAYABLE
Accounts
Debit Credit
Cash
Discount on Note Payable
Note Payable
7360
640
8000
Borrowed $8000 discounted at 8% for one year
Dec. 31 Interest Expense
Interest Payable
160
160
Accrued 3 mo. interest (8000x.08x3/12)
2005
Sept. 30 Interest Expense
Interest Payable
Paid note and all interest
160
160
Amortized 3 mo. interest from Discount to Int. Exp.
480
480
Accrued 9 mo. interest (8000x.08x9/12)
Sept. 30 Interest Payable
Note Payable
Cash
Dec. 31 Interest Expense
Discount on Note Payable
2005
Sept. 30 Interest Expense
Discount on Note Payable
480
480
Amortized 9 mo. interest from Discount to Int. Exp.
640
8000
Sept. 30 Note Payable
Cash
8640
8000
8000
Paid note (which already includes iall nterest)
69
Comparison of Ledger Accounts for
Interest Bearing and Discounted Notes
INTEREST BEARING NOTE PAYABLE
Cash
Beg. Bal.
X
10/01/04 8000
8640 9/30/05
Note Payable
10/01/04 8000
9/30/05 8000
2004 Exp.
Interest Expense
12/31/04
160
09/30/05
480
0
2005 Exp.
Interest Payable
160 12/31/04
480 09/30/05
9/30/05
640
0
NON-INTEREST BEARING (DISCOUNTED) NOTE PAYABLE
Cash
Beg. Bal.
X
10/01/04 7360
8000 9/30/05
Note Payable
10/01/04 8000
9/30/05 8000
2004 Exp.
Interest Expense
12/31/04
160
09/30/05
480
0
2005 Exp.
Discount on Note Pay.
160 12/31/04
480 09/30/05
9/30/05
640
0
70
Which loan was the better deal for Cell-It?
Transaction Analysis:
Calculate the EFFECTIVE INTEREST % of each.
Interest bearing note:
Effect on Financial Statements
Eff. Int.
%State.
= $ Annual
Interest
÷ Cash
Inc.
State.
of Ch.
in Eq Rec’d.
CashFlow
1.
No effect
No effect
= $640
÷ $8,000+8,000 FA
2.
No effect
No effect
+7,360 FA
= 8.0%
3. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq,
n.a.
Non-Interest
note
(Discounted
4.
+Int. Exp, sobearing
- N.I. Decr.
R/E,
so Dec. Eq. note):
n.a.
5. +Int. Exp, so - N.I. Decr. R/E, so Dec. Eq. -8000FA,-640 OA
Eff. Int. % = $ Annual Interest ÷ Cash Rec’d.
=
$640
=
8.7%
÷
$7,360
71
Which loan was the better deal for Cell-It?
Transaction Analysis:
Calculate the EFFECTIVE INTEREST % of each.
Interest bearing note:
Effect on Financial
Statements
With note
#2 Cell-It only
Eff. Int.
%State.
= $ Annual
Interest
÷ $7,360
Cash
received
from
the
Inc.
State.
of Ch.
in Eq Rec’d.
CashFlow
lender,
but
had+8,000
to payFA
1.
No effect
No effect
= $640
÷ still
$8,000
$640
interest for the
year.FA
2.
No effect
No effect
+7,360
= 8.0%
That’s
why
the
effective
3. +Int. Exp, so - N.I. Decr.
R/E, so
Dec.
Eq,
n.a.
interest
higher
for
Non-Interest
note
(Discounted
note):
4.
+Int. Exp, sobearing
- N.I. Decr.
R/E,
sorate
Dec.isEq.
n.a.
Note
5. +Int. Exp, so - N.I. Decr.
R/E,#2.
so Dec. Eq. -8000FA,-640 OA
Eff. Int. % = $ Annual Interest ÷ Cash Rec’d.
Note #1 (Interest bearing) is
= $640
$7,360
a “better÷deal”
in this case.
72
= 8.7%