UNIT-9
Accounting for Receivable & Inventory
The term receivable refers to the amounts due from
individuals and companies. Receivables are claims that
are expected to be collected in cash. Receivable are
important because they represent one of a company's
most liquid assets. For many companies receivable are
also one of the largest assets.
Ques. What are the receivable?
Ans. Receivables are claims that are expected to be
collected in cash.
Ques. why are receivable important?
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Ans. Receivable are important because they represent
one of a company's most liquid assets.
Kinds of Receivable
Receivables are classified as –
1.Account Receivable
2. Note Receivable
3.Other Receivable
Account Receivable
Money which is owed to a company by a customer for
the products and services provided on credit. This is
often treated as a current asset on a balance sheet.
A specific sale is generally only treated as an accounting
receivable after the customer is sent an invoice.
In brief account receivable are amounts customers owe-
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On account. They result from the sale of goods and
services.
Ques. What are the different kinds of receivable?
Ans. There are three kinds of receivable namely1.Account Receivable
2. Note Receivable
3.Other Receivable
Ques. What is meant by account receivable?
Ans. Account Receivable is the amount customers owe on
account and that is the result from the sale of goods
and services.
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Note Receivable
A note receivable is a written promise to receive a
specific amount of cash from another party on one or
more future dates. This is treated as an asset by the
holder of the note. The payee is the party who
receives payment under the term of the note and the
maker is the party obliged to send funds to the payee.
Ques. What is note receivable?
Ans. A note receivable is a written promise to receive a
specific amount of cash from another party on one or
more future dates.
Ques. Is note receivable an asset or liability in the hand
of holder?
Ans. Note Receivable is an asset in the hand of holder.
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Ques. Is note receivable an asset or liability in hand of
maker ?
Ans. Note Receivable is a liability in the hand of maker.
Other Receivables
Other receivables include non-trade receivables such as
interest receivable ,loan to company's officers ,
advances to employees and income taxes refundable.
These do not generally result from the operation of the
business. Therefore, they are generally classified and
reported as separate items in the balance sheet.
Ques. What do you know about other receivables?
Ans. Various form of non- trade receivable are called
other receivable. For example interest receivable ,loan
to company's officers , advances to employees and
income taxes refundable etc.
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Accounting Issues Associated With Account Receivable
There are three accounting issues associated with
accounting receivable.
1.Recognising accounts receivable
2.Valuing accounts receivable
3.Disposing accounts receivable
Recognising accounts receivable
Recognising accounts receivable is relatively straight
forward. A service organisation records a receivable
when it performs service on account. A merchandiser
records account receivable at the time of sale of
merchandise on account. When goods are sold the
following entry is recorded.
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Customers a/c
Dr
To Sales a/c
(Being goods sold on credit)
The customers might find some of the goods unacceptable
And choose to return. The following entry is recorded.
Sales Return a/c
Dr
To Customers a/c
(Being goods returned by customer)
The seller may offer some discount for early payment.
If customers paid early the record maintained isCash a/c
Dr
Discount a/c
Dr
To Customers a/c
(Being payments received and discount allowed)
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Valuing Accounts Receivable
Some times amount due from customers are not receivable
due to different reasons. These uncollectible
amount is called bad-debts.
Two methods are used in accounting for uncollectible accounts
i.e. (1) the direct write - off method and
(2) the allowance method.
Direct write - off Method for Uncollectible Accounts
Under this method the uncollectible amount is transferred
To bad – debts account and write-off by following entry.
Bad-Debts a/c
Dr
To Customer’s a/c
( Being bad-debts provided for)
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Allowance Method for Uncollectible Accounts
Under the allowance method if a specific customer’s
account receivable is identified as uncollectible, it is
written-off by removing the amount from account
receivable/ debtors by passing the following entry.
Allowance for Bad-Debts a/c
Dr
To Customer’s a/c
Disposing of Accounts Receivable
The financial accounting term disposition of accounts
receivable is used to describe several approaches
company can take to accelerate the receipt of cash from
customers/receivables. The two most common methods
Include factoring and assignment, whereby the company
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transfer receivables to another party in exchange for cash.
The companies sell receivables for two major reasons. First
They may be the only reasonable sources of cash. When
money is tight, companies may not be able to borrow
money in the usual credit markets, or if money is
available, the cost of borrowing may be prohibitive.
A second reason for selling receivable is that billing and
Collection are often time consuming and costly. It is often
easier for a businessman to sell the receivables to another
party with expertise in billing and collection matter.
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Note Receivables
The basic issues in an accounting for notes receivable are
the same as those for accounts receivable:
1. Recognising Notes Receivable
2. Valuing Notes Receivable
3. Disposing of Notes Receivable
Recognising Notes Receivable
The company records the note receivable at its face value,
the amount shown on the face of the note. No interest
is reported when the note is accepted, because the
revenue recognition principles does not recognise
revenue untill the performance obligation is satisfied.
Interest is earned(accrued) as time passes. If a company11
Lends money using a note, the following entry is recorded.
Note Receivable a/c
Dr
To Cash a/c
(Being loan given by issuing a note receivable)
Valuing Notes Receivable
Companies have two methods available to them for
valuing notes receivable i.e. allowance method and
direct write off method. These are explained belowThe Allowance Method
This method establishes a contra asset account allowance
for doubt full debt account or bad debts provision that has
the effect of reducing the balance for account receivable.
The amount for bad debt provision can be computed in12
two ways1. By receiving each individual debt and deciding whether
it is doubtful(a specific provision)
2. By providing for a fixed percentage of total debts.
The Direct Write off Method
This method is simpler than allowance method, in that it
allows for one simple entry to reduce account receivable
to its net realisable value
The entry would consistsBad Debts a/c
Dr
To A/R (customers) a/c
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Disposing of Notes Receivable
Notes may held to their maturity date, at which time the
face value plus accrued interest is due. In some situation
the maker of note defaults and the payee must make an
Appropriate adjustment.
Honour of Account/ Notes Receivable
When the payment is made on due date is called the
honour of account/notes receivable. On the collection
of money the following record is maintained.
Cash a/c
Dr
To Note Receivable a/c
To Interest a/c
(Being note receivable honour with interest)
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Dishonour of Account/ Notes Receivable
When the payment is not made on due date, is called the
dishonour. A dishonoured note receivable is no longer
negotiable. However the payee still has a claim against
the maker of the note for both the note and the interest.
Ques. What is honour of receivable?
Ans. When amount of account receivable/notes
receivable is paid on due date is called honour of
accounts or honour of notes receivable .
Ques. What is dishonour of account?
Ans. When amount of account receivable/notes
receivable is not paid on due date is called dihonour of
accounts or dihonour of notes receivable .
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Ques. Select the right alternative from the following.
Receivables are frequently classified as:
1.Account receivable, company receivable and other
receivable.
2.Account receivable, notes receivable and employees
receivable.
3.Account receivable, and general receivable.
4.Account receivable, notes receivable and other
receivable.
Ans.Account receivable, notes receivable and other
receivable.
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Determining the Maturity Date
When the life of note is expressed in terms of months, one
Can find the date when it matures by counting the months
from the date of issue. For example, the maturity date of a
three-month note dated May 1 is August 1. A note drawn
on the last day of a month matures on the last day of a
Subsequent month. This is, a July 31 note due in two months
matures on September 30.
When the due date is stated in terms of days, one need to
Count the exact number of days to determine the maturity
date. In counting, omit the date the note is issued but
Include the due date. For example, the maturity date of a 17
60-day note dated July 17 is September15, computed as
follows.
Term of note
60 days
July(31-17)
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August
31
45
-------Maturity date: September
15
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Accounting for Inventory
The raw materials, work-in-process goods and completely
finished goods that are considered to be the portion of a
business's assets that are ready or will be ready for sale.
Inventory represents one of the most important assets
that most businesses possess, because the turnover of
inventory represents one of the primary sources of
revenue generation and subsequent earnings for the
company's shareholders/owners.
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Possessing a high amount of inventory for long
periods of time is not usually good for a business
because of inventory storage, obsolescence and
spoilage costs. However, possessing too little
inventory isn't good either, because the business
runs the risk of share losing out on potential
sales and potential market as well.
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Purpose of Inventory
The purpose of an inventory system is to keep track
of what you have in your small store, large office
or product development factory. If you know
what you have available for sale or to build
products, you can easily satisfy the needs of your
customers when they contact you to buy your
products. The inventory system informs you
when you need to purchase more products or
supplies.
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Inventory System
Inventory systems are tracking systems that inform you of
the amount of raw materials, supplies or final products
you have readily available. The inventory system is
updated each time you sell an item or use raw materials
to create a product, so you know what you have
available for the following day or week. This type of
system also allows you to order products in advance, so
you have everything you need at all times.
There are basically two inventory systems followed by
business concerns.
1. Periodic Inventory System
2. Perpetual Inventory System
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Periodic Inventory System
It is a system of inventory in which updates are made on
a periodic basis.
In a periodic inventory system no effort is made to keep
up-to-date records of either the inventory or the cost
of goods sold. Instead, these amounts are determined
only periodically - usually at the end of each year. This
physical count determines the amount of inventory
appearing in the balance sheet. The cost of goods sold
for the entire year then is determined by a short
computation.
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Perpetual Inventory System
System of inventory control in which the number of units of
any inventory item (and the total value of inventory) on
any day can be obtained from the stock records. In
this method (1) all additions (purchases) and withdrawals
(sales or consumption) are recorded in inventory cards as
they occur to provide a
running balance of quantity and cost of items, (2) a certain
number of items are counted every day (or week or month)
so that, by the year end, every item has been actually
(physically) counted at least once. If there is any mismatch
(due to human error, leakage, pilferage, loss) between the
physical quantity and the quantity shown in inventory
cards, the records are adjusted accordingly. It is also called
the continuous inventory method.
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Classifying Inventory
Classification of inventory depends on whether the firm is a
merchandiser or a manufacturer. On this basis inventory
can be classify as –
1. Merchandising Company Inventory
2.Manufacturing Company Inventory
Merchandising Company Inventory
Merchandising Company merchandisers need only one
Inventory classification i.e. merchandising inventory.
(Different items make up the total inventory)
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Manufacturing Company Inventory
Manufacturers usually classify inventory into three
categories1.Finished goods inventory
2.Work in progress
3. Raw materials.
Determining Inventory Quantities
No matter whether they are using periodic or perpetual
inventory system, all companies need to determine inventory quantities at the end of the accounting period. If using
a perpetual system, companies take a physical inventory
for the following reasons:
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1. To check the accuracy of their perpetual inventory
records.
2. To determine the amount of inventory lost due to
wasted raw materials, shoplifting, or employee theft.
Companies using a periodic inventory
system take a physical inventory for two different
purposes: to determine the inventory on hand at the
balance sheet date, and to determine the cost of
goods sold for the period.
Ques. Why do the companies determine the inventory?
Ans. The companies determine the inventory due to the
following reasons:
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1. To check the accuracy of their perpetual inventory
records.
2. To determine the amount of inventory lost due to
wasted raw materials, shoplifting, or employee
theft.
Inventory Costing
Inventory is accounted for at cost. Cost includes all
Expenditures necessary to acquire goods and place
them in a condition ready for sale. After a company has
determined the quantity of units of inventory, it applies
unit costs to the quantities to compute the total cost of
the inventory and the cost of the goods sold. There are
three methods for the inventory costing.
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1. First in, first – out (FIFO)
2. Last in, first- out (LIFO)
3. Average- cost
First in, first – out (FIFO)
The first in, first – out (FIFO) method assumes that the
earlier goods purchased are first to be sold. FIFO often
parallels the actual physical flow of merchandise. That is,
it generally is good business practice to sell the oldest unit
first. Under the FIFO method, therefore , the costs of the
earliest goods purchased are the first to be recognised in
determining cost of goods sold.
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Ques. Explain FIFO.
Ans. The first in, first – out (FIFO) method assumes that the
earlier goods purchased are first to be sold. FIFO often
parallels the actual physical flow of merchandise. That is,
it generally is good business practice to sell the oldest unit
first. Under the FIFO method, therefore , the costs of the
earliest goods purchased are the first to be recognised in
determining cost of goods sold.
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Illustration given below shows the allocation of cost
of goods available for sale at Houston Electronics under
FIFO
Date-2014 Explanation
Units
Unit Cost Total Cost
Jan. 01
Beginning inventory
100
10 (SR)
1,000 (SR)
Apr.15
Purchase
200
11
2,200
Aug.24
Purchase
300
12
3,600
Nov.27
Purchase
400
13
5,200
Total
1,000
SR-12,000
Closing inventory 450 units only on31 Dec.2014
Date -2014
Units
Nov.27
400
Aug.24
50
Total
450
Unit Cost
13 SR
12
Total Cost
5,200 SR
600
5,800 SR
Cost of goods available for sale = 12,000 SR
Less- Ending inventory
5,800 SR
----------------Cost of goods sold
=
6,200 SR
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Last-In, First-Out (LIFO) Method
Last-In, First-Out is one of the common techniques used in
the valuation of inventory on hand at the end of a period
and the cost of goods sold during the period. LIFO assumes
that goods which made their way to inventory (after
purchase, manufacture etc.) later are sold first and those
which are manufactured or acquired early are sold last.
Thus LIFO assigns the cost of newer inventory to cost of
goods sold and cost of older inventory to ending inventory
account. This method is exactly opposite to first-in, firstout method.
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Ques. Explain LIFO.
Ans.
Last-In, First-Out is one of the common techniques used in
the valuation of inventory on hand at the end of a period
and the cost of goods sold during the period. LIFO assumes
that goods which made their way to inventory (after
purchase, manufacture etc.) later are sold first and those
which are manufactured or acquired early are sold last.
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Illustration given below shows the allocation of cost
of goods available for sale at Houston Electronics under LIFO
Date-2014
Explanation
Units
Unit Cost
Total Cost
Jan. 01
Beginning inventory
100
10 (SR)
1,000 (SR)
Apr.15
Purchase
200
11
2,200
Aug.24
Purchase
300
12
3,600
Nov.27
Purchase
400
13
5,200
Total
1,000
SR-12,000
Closing inventory 450 units only on31 Dec.2014
Date -2014
Units
Unit Cost
Total Cost
Jan.01
100
10 SR
1,000 SR
Apr.15
200
11
2,200
Aug.24
150
12
1,800
Total.
450
5,000 SR
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Practical Problems
From the following information calculate cost of goods
Sold under FIFO and LIFO methods.
Date- 2014
Particulars
Units
Cost per unit (SR)
Jan.01
Opening inventory NOKIA XI
250
170
Feb.15
Purchased
500
165
Apr. 25
Purchased
300
180
May.18
Purchased
800
155
June.15
Purchased
200
175
Closing inventory on 30th June 2014.180 units.
Ans. Cost of goods sold under –FIFO SR- 3,06,500
LIFO SR- 3,07,400
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2. Calculate cost of inventory sold during six months
Under FIFO and LIFO methods.
Date2014
Particulars
Units
Cost per unit (SR)
Jan.01
Opening inventory (Radio)
150
170
Mar.15
Purchased
300
165
Apr. 20
Purchased
400
180
May.12
Purchased
600
155
June.22
Purchased
900
150
Radios sold during six months are 1,700 units.
Ans Cost of goods sold under FIFO method SR- 2,77,500
LIFO method SR -2,64,000
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3.Find out cost of goods sold under FIFO and LIFO
methods.
Date- 2014 Particulars
Units
Cost per unit (SR)
Jan.01
Opening inventory NOKIA Camera
200
100
Mar.15
Purchased
300
105
Apr. 20
Purchased
400
110
May.12
Purchased
600
115
June.22
Purchased
800
120
Sep.15
Purchased
500
125
Dec.08
Purchased
1000
130
Stock on 31Dec.2014. 500 units
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4.Find out cost of goods sold under FIFO method.
Date- 2014
Particulars
Units
Cost per unit (SR)
Jan.01
Opening inventory Galaxy Grand 2
200
800
Mar.15
Purchased
300
810
Apr. 20
Purchased
400
805
May.12
Purchased
600
815
June.22
Purchased
800
820
Sep.15
Purchased
500
815
Dec.08
Purchased
1000
830
Closing inventory on 31 Dec.2014. 600 units
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5.Find out cost of goods sold under LIFO method.
Date- 2014 Particulars
Units
Cost per unit (SR)
Jan.01
Opening inventory Galaxy Grand 2
200
800
Mar.15
Purchased
300
810
Apr. 20
Purchased
400
805
May.12
Purchased
600
815
June.22
Purchased
800
820
Sep.15
Purchased
500
800
Dec.08
Purchased
1000
830
Closing inventory on 31 Dec.2014. 400 units
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