Post on 26-May-2015
Chapter 7
Current Assets- MBA 2006
Chapter 7 Mugan-Akman 2005 2-51
Economic Consequences of Accounting
• on wealth or behavior of– lenders and investors– reporting entities, their management and users of
financial statements– reporting entities and standard setters
• Sources of impact– Effect of financial results reported in the financial
statements– Effect of firm’s choice of accounting principles– Effect on reporting entities of standard setters’
decisions– Effect on standard setters of their decisions
Chapter 7 Mugan-Akman 2005 3-51
Quality of Earnings• Business: having stable and recurring basic revenue
generating activities• Accounting: 1) using consistent estimates and rules
High: same methods of estimation and rules 2) proximity of revenue recognition and cash
collectionHigh: when revenue recognition and cash collection are
close• High quality earnings are presumed to be fair
representations of the economic performance of the firm• Low quality earnings overstate fair earnings
Chapter 7 Mugan-Akman 2005 4-51
What will affect Quality of Earnings?
• Managers’ discretion in measuring and reporting earnings in:– Choosing among alternative accounting
principles
– Making estimates
– Timing transactions in order to control recognition
Chapter 7 Mugan-Akman 2005 5-51
Current assets
• assets that are expected to be converted into cash within one year or within the operating cycle of an entity
Chapter 7 Mugan-Akman 2005 6-51
Anadolu Efes
Chapter 7 Mugan-Akman 2005 7-51
Why is Current Asset Management Important?
• solvency
• profitability
• profitable but insolvent
• quality of receivables
• credit policies
• idle cash
Chapter 7 Mugan-Akman 2005 8-51
Cash and Cash Equivalents
• Cash– Coins, banknotes deposits at banks, checks received
from customers– Restricted Cash or Blocked Cash and the related
amounts should not be included in the cash amount – Petty Cash
• Cash Equivalents– Investments that are readily convertible to cash with
insignificant risk and with a maturity less than 90 days- e.g. Treasury Bills, term-deposits with less than 90 days maturity
Chapter 7 Mugan-Akman 2005 9-51
Checks Received From Customers
• by law, checks are payable at sight, so they are deemed as liquid and should be included as cash in the balance sheets of the entities
• although the concept of post dated checks is not within the context of the legislation, in practice checks with future payment dates are issued in Turkey
• due-dated checks should not be included as cash but treated as notes receivable in the balance sheet.
Chapter 7 Mugan-Akman 2005 10-51
Control Over Cash
• easily transportable • large number of transactions involving cash • Establish Responsibilities• Segregation of Duties• Documentation Controls• Physical Controls• Independent Internal Verification• Use of Bank Accounts
Chapter 7 Mugan-Akman 2005 11-51
Bank ReconciliationWhy are there differences between the Cash (bank balance of checking
account) per bank statement and ledger accounts ?
• Unknown items or forgotten items: - direct debits; - standing orders; - credit transfers;
• Bank charges or bank interest:
• Errors - calculations: - overs; - unders;
• Timing differences: - unpresented checks; - outstanding checks
All reconciling items on the book side require an adjusting entry to the cash account.
Chapter 7 Mugan-Akman 2005 12-51
BANK RECONCILIATIONHere are step-by-step instructions for preparing a bank reconciliation.
• Prepare a list of deposits in transit. Compare the deposits listed on your bank statement with the bank deposits shown in your cash receipts journal. On your bank reconciliation, list any deposits that have not yet cleared the bank statement. Also, take a look at the bank reconciliation you prepared last month. Did all of last month's deposits in transit clear on this month's bank statement? If not, you should find out what happened to them.
• Prepare a list of outstanding checks. In your cash disbursements journal, mark each check that cleared the bank statement this month. On your bank reconciliation, list all the checks from the cash disbursements journal that did not clear. Also, take a look at the bank reconciliation you prepared last month. Are there any checks that were outstanding last month that still have not cleared the bank? If so, be sure they are on your list of outstanding checks this month. If a check is several months old and still has not cleared the bank, you may want to investigate further.
• Record any bank charges or credits. Take a close look at your bank statement. Are there any special charges made by the bank that you have not recorded in your books? If so, record them now just as you would have if you had written a check for that amount. By the same token, if there are any credits made to your account by the bank, those should be recorded as well. Post the entries to your general ledger.
Chapter 7 Mugan-Akman 2005 13-51
BANK RECONCILIATION• Compute the cash balance per your books. Foot the general
ledger cash account to arrive at your ending cash balance.
• Enter bank balance on the reconciliation. At the top of the bank reconciliation, enter the ending balance from the bank statement.
• Total the deposits in transit. Add up the deposits in transit, and enter the total on the reconciliation. Add the total deposits in transit to the bank balance to arrive at a subtotal.
• Total the outstanding checks. Add up the outstanding checks, and enter the total on the reconciliation.
• Compute book balance per the reconciliation. Subtract the total outstanding checks from the subtotal in step 6 above. The result should equal the balance shown in your general ledger.
http://www.itssimple.biz/biz_tools/text/P06_1424.html
Chapter 7 Mugan-Akman 2005 14-51
Bank Reconciliation Example
• Prepare a 31 July 2005 bank reconciliation statement for Sinan A.S. The 31July bank statement indicated a cash balance of TL 9,610, while the cash ledger account on that date shows a balance of TL 7,430
Adapted from Williams, etal, 2003
Chapter 7 Mugan-Akman 2005 15-51
Bank Reconciliation Example
• Outstanding checks totaled TL 2,417.• A TL 500 check mailed to the bank for deposit had not
reached the bank at the statement date.• The bank returned a customer’s NSF check for TL 225
received as payment of an account receivable.• The bank statement showed TL30 interest earned on the
bank balance for the month of July.• Check #781 for supplies cleared the bank for TL 268 but
was erroneously recorded in our books as TL 240.• A TL 486 deposit by X A.S. was erroneously credited to
our account by the bank.
Chapter 7 Mugan-Akman 2005 16-51
Balance per bank statement,31 July 2005 9,610 TL
Add: NSF check 225 TL
Recording error 28
Deposit in transit 500
Additions 753 TL
Deduct Outstanding checks 2,417
Interest 30
Bank error 486
Deductions 2,933 TL
Balance per company's records,31 July 2005 7,430 TL
Reconciling the Bank StatementExample
Reconciling the Bank StatementExample
Chapter 7 Mugan-Akman 2005 17-51
Reconciling the Bank Statement Example
Reconciling the Bank Statement Example
Reconciling the Bank StatementExample
Reconciling the Bank StatementExample
Balance per bank statement, 31 July 9,610 TLAdditions: Deposit in transit 500 Deductions: Bank error 486 TL Outstanding checks 2,417 2,903 Adjusted cash balance 7,207 TL
Balance per company's records, 31 July 7,430 TLAdditions: Interest 30 Deductions: Recording error 28 TL NSF check 225 253 Adjusted cash balance in the balance sheet 7,207 TL
Chapter 7 Mugan-Akman 2005 18-51
Receivables
• Accounts Receivable
• Notes Receivable
• Other Receivables
Chapter 7 Mugan-Akman 2005 19-51
Chapter 7 Mugan-Akman 2005 20-51
Anadolu Efes
Chapter 7 Mugan-Akman 2005 21-51
Recognition of Accounts Receivable
• accrual basis of accounting- sales revenue is recognized at the time a sale is made and the title of ownership of the items under the sale passes to the buyer regardless of the cash payment date
• when sales are made on credit the accounts receivable is recognized and recorded at the invoice amount when a sale is realized
Chapter 7 Mugan-Akman 2005 22-51
Valuation of Receivables-IFRS• Receivables are carried at amortized cost (financial assets)
– Amortised cost = approximate the original invoice amount for short-term receivables with no stated interest rate if the impact of discounting would not be significant
• a risk that a customer will not pay or will not be able to pay its debt
• IFRS -accounts receivable should be valued at their net realizable value (or net recoverable amount)
• Net Realizable Value (amortized cost) represents the amount of cash expected to be collected from the receivables
Net Realizable Value =Invoice amount (original amount)
- cash received at the time of sale - collections from customers (during the period) - Unamortized discounts- impairment
• net recoverable amount of accounts receivable (or trade receivables) is equal to their original values unless there is an indication of impairment
• Entities should assess at each balance sheet date whether there is objective evidence that an account receivable may be impaired, and determine the amount of allowance that should be estimated based on the net realizable value or the discounted cash flow from such receivable
• TAX- when it is certain that a customer is not going to pay write-off the account *i.e. erase from the accounts and record it as a loss
Chapter 7 Mugan-Akman 2005 23-51
Receivables are Carried at Amortized Cost
• When sales are made on credit, the interest imputed in the transaction is not recognized as sales revenue but as INTEREST INCOME
• By using the Effective Interest Method
Chapter 7 Mugan-Akman 2005 24-51
Illustration• The sales price of TL 58.000 was charged to customer
for a sale on credit (n/90) on 1 November. If the same goods were sold at cash, the price would have been TL 50.000
• The effective interest rate for the transaction is:
1/FV
i = 1PV
Future value
PV = Present Value
n = days to maturity
i = effective interest rate
n
FV
1(90/360)58,000
i = 1 = %81.0650,000
Chapter 7 Mugan-Akman 2005 25-51
At 31 of December30/360
58,000PV = 55,200 TL
(1+0,8106)
Account Name Debit CreditAccounts Receivable 58000
Unearned financial income 8000Sales Revenue 50000
Account Name Debit CreditUnearned financial income 5200
Interest Income 5200
Chapter 7 Mugan-Akman 2005 26-51
Impairment of Accounts Receivable-IFRS
• Matching principle and losses estimated from selling on credit
• Some possible indications of impairment are as follows: – If there is a sign that the customer has financial difficulty,– If there is a high probability of bankruptcy of the customer,– If the customer delays its payments,– If the customer asks for extension of the payment period, and– If the economy in general or the industry the customer operates
in suffers from financial difficulties
• under IAS 39, general provisions are not permitted and all impairment of trade receivables must be measured using a discounted cash flow methodology
Chapter 7 Mugan-Akman 2005 27-51
Impairment Loss
• measured as the difference between the original or the carrying value of the receivable and the present value of estimated cash flows discounted at the original effective interest rate of the receivable
• effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected collection date of the receivable to the net carrying amount of the receivable
• Allowance for Uncollectible Accounts account accumulates the estimated losses – a contra-asset account – deducted from Accounts Receivable in order to determine the
net realizable value of receivables
Chapter 7 Mugan-Akman 2005 28-51
Adjusting Entry-IFRS
Date Account Title and Description Debit Credit
Impairment Loss on Accounts Receivable
Allowance for Uncollectible Accounts 10.000To record impairment loss on accounts receivable
31-Dec-03 10.000
Dekorasyon A.Ş. has outstanding receivables of TL120.000 as of 31 December 2003, and its management estimated that
there is impairment of TL10.000
Cash and Cash Equivalents TL 11.000
Accounts Receivable TL 120.000
Less: Allowance for Uncollectible Accounts
-10.000 110.000
Inventories 129.000
Total Current Assets TL 250.000
Dekorasyon A.Ş.
Partial Balance Sheet
31-Dec-03
Chapter 7 Mugan-Akman 2005 29-51
Determining the Impairment Loss
• examine each receivable or customer carefully and assess whether there is an indication of impairment
• prepare a chart showing all trade receivables and whether there is an indication of impairment
Chapter 7 Mugan-Akman 2005 30-51
Illustration of Impairment-IFRSSağlam Yapı Market is in the process of preparing the financial statements for the
year 2004. The credit department examined all outstanding receivables and determined that the following accounts may be impaired as of 31 December 2004. Total accounts receivable as of 31 December 2004 is TL 59.750
Invoice Net
Recoverable Amount Amount
Altay A.Ş. TL 5.000 TL 4.800
Güçlü A.Ş. 4.000 3.820
Mir A.Ş. 9.800 9.322
Risk A.Ş. 5.450 2.905
OTM A.Ş. 9.000 8.220
TL 33.250 TL 29.067
Customer
Difference= impairment loss of TL 4.183
Chapter 7 Mugan-Akman 2005 31-51
How much is the expense?
• difference between total of net recoverable amount of accounts receivable and the total invoice amount represents the targeted balance for the Allowance for Uncollectible Accounts
• adjusting entry to record the impairment loss on accounts receivable should bring the balance of the Allowance for Uncollectible Accounts to the amount estimated from the impairment of accounts receivable
Chapter 7 Mugan-Akman 2005 32-51
Adjusting Entries – target impairment loss known- Case 1
Allowance for Uncollectible Account Balance is a credit of TL 2.950Estimated (target) Allowance for Uncollectible Accounts TL 4.183CR
Balance of Allowance for Uncollectible Accounts Before Adjustment 2.950CR
Estimated Impairment Loss TL 1.233
Date Account Title and Description Debit Credit
Impairment Loss on Accounts Receivable Allowance for Uncollectible Accounts 1.233To record impairment loss of accounts receivable
31-Dec-04 1.233
Balance Sheet RepresentationAccounts Receivable TL 59.750Allowance for Uncollectible Accounts 4.183Net Realizable Value of Accounts Receivable TL 55.567
Chapter 7 Mugan-Akman 2005 33-51
Adjusting Entries – target impairment loss known- Case 2
Allowance for Uncollectible Account Balance is credit of TL 6.283 Balance of Allowance for Uncollectible Account Before Adjustment TL 6.283CREstimated Allowance for Uncollectible Accounts 4.183CRRecovery of Impairment Loss TL 2.100
Date Account Title and Description Debit Credit
Allowance for Uncollectible Accounts 2.100 Recovery of Impairment Loss 2.100To record the recovery of impairment loss
31-Dec-04
Balance Sheet RepresentationAccounts Receivable TL 59.750Allowance for Uncollectible Accounts 4.183Net Realizable Value of Accounts Receivable TL 55.567
Chapter 7 Mugan-Akman 2005 34-51
Write Off of Accounts Receivable
• a specific customer is not able to pay its debt
Risk A.Ş. declared bankruptcy on 20 March 2005 Date Account Title and Description Debit Credit
Bad Debt Expense Accounts Receivable-Risk A. Ş 5.450To write off the receivable from Risk A.Ş.
20-Mar-05 5.450
Chapter 7 Mugan-Akman 2005 35-51
Recovery of Receivables Written Off
Risk A.Ş. informed Sağlam Yapı Market that it will pay TL 3.000 of its
total debt on 3 April 2005 and the remaining amount later
Date Account Title and Description Debit Credit
Accounts Receivable- Risk A.Ş. Other Income 5.450To recover the written off receivable from Risk A.Ş.Cash 3.000 Accounts Receivable- Risk A.Ş. 3.000To record collection from Risk A.Ş.
3-Apr-05 5.450
3-Apr-05
Chapter 7 Mugan-Akman 2005 36-51
Direct Write-off Dekorasyon A.Ş. sold furniture at TL1.000 to Mr. Aksoy in December 2004
with terms n/60. However, Mr. Aksoy was in financial difficulty and informed Dekorasyon A.Ş. that he bankrupted in May 2005. Since it became evident that this receivable cannot be collected, Dekorasyon A.Ş. decided to write off the receivable.
Date Account Title and Description Debit CreditUncollectible Account Expense Accounts Receivable-Mr. Aksoy 1,000To record receivable from Mr. Aksoy as Uncollectible Account Expense
May 31 2005 1,000
Chapter 7 Mugan-Akman 2005 37-51
Financing with Accounts Receivable
• Pledge of Accounts Receivable - used as a guarantee in credit arrangements with financial institutions to receive loans-IFRS requires that pledge agreements should be disclosed in the notes to the financial statements
• Factoring Accounts Receivable- selling receivables to get cash before the maturity (due date) of the receivables
• Credit Card Sales
Chapter 7 Mugan-Akman 2005 38-51
Factoring Accounts Receivable
• With recourse - factor can collect the receivable from the seller if the customer does not pay the receivable – risk with lies with the company
• Without recourse -risk of non-payment of the customer lies with the factor
• Based on the risks involved rates differ• In the case of with recourse factoring the entity
may become liable to the factor - this contingent liability should be disclosed in the notes to the financial statements
Chapter 7 Mugan-Akman 2005 39-51
Factoring Example-without recourse
Fashion Giyim Sanayi sold its receivables of TL 3.500 to Firm Factoring on 3 March 2005 without recourse and agreed to pay 5% factoring expense- financing expense plus TL 150 for recourse liabilities and TL 50 for possible sales discounts
Date Account Title and Description Debit Credit
Cash 3.125Financing Expense* 325Due from Firm Factoring 50 Accounts Receivable 3.500To record the sale of accounts receivable to Firm Factoring
3-Mar-05
* TL 3.500 x 5% = TL 175 plus TL 150 for recourse liability
Fashion Giyim Sanayi –without recourse
Chapter 7 Mugan-Akman 2005 40-51
Factoring Example-with recourseIf Fashion Giyim Sanayi had sold its accounts receivable with recourse; Firm
Factoring keeps TL 50 for possible sales discounts and TL 150 for recourse liabilities.
Fashion Giyim Sanayi –with recourse: Date Account Title and Description Debit Credit
Cash 3.125Financing Expense 175Due from Firm Factoring 200 Accounts Receivable 3.500To record the sale of accounts receivable to Firm Factoring
3-Mar-05
Yagmur Mensucat defaulted its payment of TL 100 on 5 September 2005 to Firm Factoring
Date Account Title and Description Debit Credit
Accounts Receivable- Yagmur Men.Due from Firm Factoring 100
To record the default of an accounts receivable
5-Sep-05 100
Chapter 7 Mugan-Akman 2005 41-51
Factoring-without recourse-Factor company entries
Firm Factoring–without recourse:
Date Account Title and Description Debit Credit
Accounts Receivable 3.500 Financing Revenue 325 Due to Fashion Giyim Sanayi 50 Cash 3.125To record the sale of accounts receivable to Firm Factoring
3-Mar-05
Chapter 7 Mugan-Akman 2005 42-51
Factoring-with recourse-Factor entries
Date Account Title and Description Debit CreditAccounts Receivable 3.500 Financing Revenue 175 Due to Fashion Giyim Sanayi 200 Cash 3.125To record the sale of accounts receivable to Firm Factoring
3-Mar-05
Firm Factoring-a customer defaulted:
Date Account Title and Description Debit Credit
Due to Fashion Giyim Sanayi Accounts Receivable- Yagmur Men. 100
To record the default of an accounts receivable
5-Sep-05 100
Chapter 7 Mugan-Akman 2005 43-51
Factoring with recourse-payment date• Assume none of the customers take sales discount and by 15 December 2005 Firm Factoring
collects all accounts receivable and pays Fashion Giyim Sanayi the remaining amount.
Fashion Giyim Sanayi will make the following entry
Date Account Title and Description Debit Credit
Cash Due from Firm Factoring 100To record receipt of amount withheld by the factor.
15-Dec-05 100
Firm Factoring
Date Account Title and Description Debit Credit
Due to Fashion Giyim Sanayi Cash 100T o record payment of the amount withheld by the factor.
15-Dec-05 100
Chapter 7 Mugan-Akman 2005 44-51
Credit Card SalesGourmet Restaurant served dinner to various customers on 11 May 2005 and
collected TL 750 with the credit cards. Gourmet Restaurant’s agreement with INVO Bank to collect the credit card slips is 21 days with 5% interest rate
Date Account Title and Description Debit Credit
Receivable from INVO Bank 712,5Commission Expense 37,5 Revenues 750To record the dinner served on 11 May 2005Cash Receivable from INVO Bank 712,5To record the collection from INVO Bank
11-May-05
1-Jun-05 712,5
Chapter 7 Mugan-Akman 2005 45-51
Notes Receivable
• A promissory note is an unconditional promise to pay a certain amount of money in the future. – To borrow money – To settle an accounts receivable
• notes with maturity dates less than or equal to 12 months are classified as short-term
Chapter 7 Mugan-Akman 2005 46-51
Amount Date
OnPlus
Animal Co. Ankara Turkey
the amount of Eight thousand three hundred Turkish Lira
120 days after dateinterest at an annual rate of 25%.
For value received, I promise to pay to the order of Health Pharmacy Ankara Turkey
PROMISSORY NOTETL 8.300 2-Jun-05
Promissory Note-(IOU)
Chapter 7 Mugan-Akman 2005 47-51
Accounting Entries Illustrated for Notes Receivable-1
When the Note Received
Date Account Title and Description Debit Credit
Notes Receivable 8.300 Accounts Receivable 8.300To record the notes received from Animal Co.
2-Jun-05
At the end of the Fiscal Year
Date Account Title and Description Debit Credit
Interest Receivable 518,75 Interest Income(*) 518,75To accrue for the interest on notes receivable
31-Aug-05
(*) Interest: 8.300*25%*90 days/360 days = TL 518,75)
Chapter 7 Mugan-Akman 2005 48-51
Accounting Entries Illustrated for Notes Receivable-2
When the Note is Paid
Date Account Title and Description Debit Credit
Cash 8.991,67 Notes Receivable 8.300,00 Interest Income 172,92 Interest Receivable 518,75To record the collection of the note
30 Sept. 2005
If the Note is Dishonored
Date Account Title and Description Debit Credit
Accounts Receivables 8.991,67 Notes Receivable 8.300,00 Interest Income 172,92 Interest Receivable 518,75To record the dishonored note
30 Sept. 2005
Chapter 7 Mugan-Akman 2005 49-51
Other Current Assets
• Value Added Taxes Deductible and Carried Forward
• Advances Given
• Prepaid Taxes
• Prepaid Expenses
Chapter 7 Mugan-Akman 2005 50-51
Common Financial Ratios Used in Management of Current Assets
Current AssetsCurrent Ratio =
Current Liabilities
sLiabilitieCurrent
sInvestmentSecurity Short term Rec. Notes and Accounts Eqvt Cash and(Cash RatioQuick
Net SalesAccounts Receivable Turnover =
Average Accounts Receivable
365Collection Period=
Accounts Receivable Turnover
Chapter 7 Mugan-Akman 2005 51-51
BREAK- How about coffee?