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Fundamental Financial Accounting Concepts Third Edition by Edmonds, McNair, Milam, Olds

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Fundamental Financial Accounting Concepts Third Edition by Edmonds, McNair, Milam, Olds

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    1. Fundamental Financial Accounting Concepts Third Edition by Edmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin

    2. 7A- 2 Chapter 7- Part A Accounting for Accruals: Advanced Topics- Receivables and Payables

    3. 7A- 3 Advanced topics include: Accounting for bad debts Accounting for interest-bearing notes and noninterest bearing (discounted) notes Warranties

    4. 7A- 4 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.

    5. 7A- 5 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)

    6. 7A- 6 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,

    7. 7A- 7 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.

    8. 7A- 8 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.

    9. 7A- 9 Transaction Analysis: Assume the following selected events occurred at Cell-It. (1-5 in Yr. 1, 6-8 in Yr.2) In Year 1: 1. Provided services to customers for $9,000 on account. 2. Collected $6,000 on account receivables. 3. At year-end it was estimated that $200 of accounts receivables will never be collected. 4. Jane Doe’s $50 account was written-off as uncollectible. 5A&B. $50 cash is unexpectedly received from Jane Doe. Calculate all balances that will be carried forward to Yr. 2. In Year 2: 6. Provided services to clients for $8,050 on account. 7. Collected $5,000 on account receivables. 8. At year-end estimated that 5% of the A/R won’t be collected.

    10. 7A- 10 HORIZONTAL MODEL Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 2 3 4 5A 5B Bal. 6 7 8 Bal.

    11. 7A- 11 Record the eight transactions in this horizontal model. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1. 2 3 4 5A 5B 6 7 8

    12. 7A- 12 1. Provided services to customers for $9,000 on account. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 2 3 4 5A 5B 6 7 8 ..

    13. 7A- 13 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. 2. 3. 4. 5A. 5B. 6. 7. 8.

    14. 7A- 14 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect

    15. 7A- 15 2. Collected $6,000 from account receivable. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 3 4 5A 5B 6 7 8 ..

    16. 7A- 16 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA

    17. 7A- 17 3. At year-end it was estimated that $200 of accounts receivable will never be collected. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal.

    18. 7A- 18 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA 3. +Exp, so Decr. N.I. -Ret.Earn No effect

    19. 7A- 19 4. Jane Doe’s $50 account was written-off as uncollectible. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal.

    20. 7A- 20 4. Jane Doe’s $50 account was written-off as uncollectible. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    21. 7A- 21 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA 3. +Exp, so Decr. N.I. -Ret.Earn No effect 4. No effect No effect No effect

    22. 7A- 22 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $ A/R $ Allow. Allow. N.R.V. $ N.R.V. $

    23. 7A- 23 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 Allow. (200) N.R.V. $2,800

    24. 7A- 24 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 A/R $ Allow. (200) Allow. N.R.V. $2,800 N.R.V. $

    25. 7A- 25 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 A/R $2,950 Allow. (200) Allow. (150) N.R.V. $2,800 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.

    26. 7A- 26 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

    27. 7A- 27 5. Cash of $50 was unexpectedly received from Jane Doe. (5A=Reinstate, 5B=Collect) Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    28. 7A- 28 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA 3. +Exp, so Decr. N.I. -Ret.Earn No effect 4. No effect No effect No effect 5A. No effect No effect No effect 5B. No effect No effect +OA

    29. 7A- 29 Calculate all balances that will be carried forward to Year 2. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    30. 7A- 30 6. Provided services for clients for $8,050 on account. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    31. 7A- 31 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA 3. +Exp, so Decr. N.I. -Ret.Earn No effect 4. No effect No effect No effect 5A. No effect No effect No effect 5B. No effect No effect +OA 6. +Rev, so +N.I. +Ret.Earn No effect

    32. 7A- 32 7. Collected $5,000 on account receivables. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    33. 7A- 33 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA 3. +Exp, so Decr. N.I. -Ret.Earn No effect 4. No effect No effect No effect 5A. No effect No effect No effect 5B. No effect No effect +OA 6. +Rev, so +N.I. +Ret.Earn No effect 7. No effect No effect +OA

    34. 7A- 34 8. At the end of year 2 we estimated that 5% of the Acct. Receivables will not be collected. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    35. 7A- 35 How much Bad Debt Expense? (for Transaction #8) Allowance method, using the BALANCE SHEET approach. applied by aging Acct.Recs, or using % of ending A/R balance

    36. 7A- 36 How much Bad Debt Expense? (for Transaction #8) Allowance method, using the BALANCE SHEET approach. applied by aging Acct.Recs, or using % of ending A/R balance

    37. 7A- 37 How much Bad Debt Expense? (for Transaction #8) Allowance method, using the BALANCE SHEET approach. applied by aging Acct.Recs, or using % of ending A/R balance

    38. 7A- 38 How much Bad Debt Expense? (for Transaction #8)

    39. 7A- 39 How much Bad Debt Expense? (for Transaction #8)

    40. 7A- 40 8. At the end of year 2 we estimated that 5% of the Acct. Receivables will not be collected. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal.

    41. 7A- 41 Transaction Analysis: Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Rev, so +N.I. +Ret.Earn No effect 2. No effect No effect +OA 3. +Exp, so Decr. N.I. -Ret.Earn No effect 4. No effect No effect No effect 5A. No effect No effect No effect 5B. No effect No effect +OA 6. +Rev, so +N.I. +Ret.Earn No effect 7. No effect No effect +OA 8. +Exp, so Decr. N.I. -Ret.Earn No effect

    42. 7A- 42 Final Account Balances. Note that the ending balance of the Allowance account ($300) is 5% of the $6,000 A/R ending balance. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    43. 7A- 43 What’s the result? After completing the horizontal model fill in below.

    44. 7A- 44 Final Account Balances. Year 1 Remember, the Bad Debt Expense is accrued in the year of sale, NOT when the account is written off! Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    45. 7A- 45 Final Account Balances. Year 1 Remember, the N R V of A/R = Acct.Rec. - Allow. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 34 5A 5B Bal. 6 7 8 Bal.

    46. 7A- 46 What’s the result? After completing the horizontal model fill in below.

    47. 7A- 47 Final Account Balances. Year 2 Remember, the Bad Debt Expense is accrued in the year of sale, NOT when the account is written off! Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    48. 7A- 48 Final Account Balances. Year 2 Remember, the N R V of A/R = Acct.Rec. - Allow. Assets = Liab.+ C.C.+ R.E. Inc. State. Cashflow Cash + A/Rec .- Allow. = A/P + C.C.+ R.E. Rev. - Exp. = N. I. OA,IA,FA 1 9000 9000 9000 9000 n.a. 2 6000 (6000) 6000 OA 3 4 5A 5B Bal. 6 7 8 Bal. ..

    49. 7A- 49 What’s the result? After completing the horizontal model fill in below.

    50. 7A- 50

    51. 7A- 51

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    59. 7A- 59 Effect of Transaction 4 on Acct. Rec. Net Realizable Value Before Event 4 After Event 4 A/R $3,000 A/R $2,950 Allow. (200) Allow. (150) N.R.V. $2,800 N.R.V. $2,800 Net realizable value of accounts receivable did not change as a result of the write-off.

    60. 7A- 60

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    74. 7A- 74 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.

    75. 7A- 75 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).

    76. 7A- 76 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method

    77. 7A- 77 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method

    78. 7A- 78 Direct Write-off Method for Accounting for Bad Debts Direct Write-off method

    79. 7A- 79 Transaction Analysis: when Direct Write-off used Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1.

    80. 7A- 80 Transaction Analysis: when Direct Write-off used Effect on Financial Statements Inc. State. State. of Ch. in Eq CashFlow 1. +Exp., so Decr. N.I. Decr. R.E.,so decr.Eq. n.a.

    81. 7A- 81 Financial Statement Analysis Accounts Receivable Turnover

    82. 7A- 82 Accounts Receivable Ratios Accts. Rec. Turnover: (A measure of how fast receivables are collected. Higher is better.) Sales $50,000 Accounts. Receiv. $ 5,000

    83. 7A- 83 Chapter 7: Accounting for Accruals - Advanced Topics To be continued… Part B topics include: Warranties Notes Payable Interest bearing Non-interest bearing

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