Chapter 5

Learning Objective
1. Account for short-term investments
5-1
Copyright 2015 Pearson Education Inc. All rights reserved.
ACCOUNT FOR SHORT-TERM

INVESTMENTS
Reasons to Invest in Other Companies
Companies invest in debt or equity securities for at least two
reasons:
1. Have excess cash
2. For strategic reasons, such as obtaining the ability to
influence another company
5-2
LO 1

To be classified as a current asset, an investment must
meet both of the following criteria:
Must be liquid (easily convertible to cash); and
Investor must intend to either
convert to cash within one year or current operating

cycle, whichever is longer, or
use it to pay a current liability
Otherwise, the investment is classified as a long-term asset
5-3
LO 1

Categories of Investments in Securities
Trading
5-4
Available-forSale
Held-toMaturity
Debt (bonds, notes, etc.) or equity (stock)
Expected to be sold within the near term through active

trading
Generate income or losses on a day-to-day basis through

changes in their prices
LO 1

Trading
5-5
Available-forSale
Held-toMaturity
Held with intent of selling some time in the future
Not classified as either trading or held-to-maturity
LO 1

Trading
5-6
Available-forSale
Held-toMaturity
Debt securities (bonds, notes, or other instruments with

established maturity dates)
Investor has intent and ability to hold until they mature
LO 1

Exhibit 5-1 | Categories of Investments in Securities
5-7
LO 1
Trading Securities
Suppose that, on June 18, 2014, Apple, Inc., purchases 5,000
shares of Intel stock as a trading security. For simplicity, suppose
that the Intel stock is Apple, Inc.s only short-term investment.
Apple, Inc., buys the Intel stock during 2014 for $20 per share,
paying $100,000 cash. Apple, Inc., records the purchase of the
investment at cost:
Account
June 18
Investment in Trading Securities

Cash
Debit
Credit
100,000
100,000
Purchase investment
5-8
LO 1
Trading Securities
Assume that, on June 30, Apple, Inc., receives a cash dividend of
$4,000 from Intel. Apple, Inc., records the dividend revenue as:
Account
June 30
Cash
Debit
Credit
4,000
Dividend Revenue
4,000
Received cash dividend
5-9
LO 1
Trading Securities
Unrealized Gains and Losses
Trading securities are reported on the balance sheet at current
fair (market) value
5-10
If fair value has

increased
Unrealized
gain
If fair value has

decreased
Unrealized
loss
LO 1
Unrealized Gains and Losses. Apple, Inc.s 2014 fiscal

year ends on September 27. On this date, the fair market value of
Intels stock is $110,000. Apple, Inc., adjusts the investment in Intel
securities to its current fair value with the following journal entry:
Account
Debit
Credit
10,000
10,000
Unrealized Gain on Trading Securities

Adjusted investment to fair value
Unrealized Gain on Trading

Securities (other income)
100,000
10,000
5-11
110,000
10,000
LO 1
Unrealized Gains and Losses. On September 26, 2015,

the end of Apple, Inc.s fiscal year, the fair value of Intel stock is
$105,000. In preparation for its 2015 balance sheet, Apple, Inc.,
makes the following adjusting entry:
Account
Debit
Unrealized Loss on Trading Securities
Credit
5,000
5,000

Adjusted investment to fair value

100,000
10,000
5-12
105,000
5,000
Unrealized Loss on Trading

Securities (other income)
5,000
LO 1
Trading Securities
Realized Gains and Losses
Occurs only when the investor sells an investment
5-13
Sales price >

carrying amount
Realized
gain
Sales price <

carrying amount
Realized
loss
LO 1
Realized Gains and Losses. Suppose Apple, Inc., sells its

Intel stock on June 19, 2016 for $107,000. Apple, Inc., makes the
following journal entry:
Account
Cash
Debit
Credit
107,000

Gain on Sale of Trading Securities
105,000
2,000
Sale of investments at a gain
5-14
LO 1
Available-for-Sale Securities
Same as Trading Securities
Recording initial purchase
Recording dividend revenue
Adjusting to fair value
Different from Trading Securities
Unrealized gains and losses reported as other

comprehensive income (loss) for each period
5-15
Accumulated and reported as accumulated other

comprehensive income (loss) in stockholders equity
LO 1
Reporting on the Balance Sheet and the

Income Statement
Exhibit 5-2
5-16
LO 1
Reporting on the Balance Sheet and the

Income Statement
Exhibit 5-2
5-17
LO 1
Illustration
Eastern Corporation, the investment banking company, often has extra
cash to invest. Suppose Eastern buys 1,000 shares of Dream, Inc.,
stock at $57 per share. Assume Eastern expects to hold the Dream
stock for one month and then sell it. The purchase occurs on
December 15, 2014. At December 31, the market price of a share of
Dream stock is $58 per share.
Requirements
1. What type of investment is this to Eastern? Give the reason for
your answer.
Trading
Eastern intends to sell the stock within a short time
5-18
LO 1
Illustration.
2. Record Easterns purchase of the Dream stock on
December 15 and the adjustment to market value on December 31.
Account
Dec. 15
Debit
Credit
57,000
57,000
Cash
(1,000 shares x $57)
Dec. 31

Unrealized Gain on Trading Securities
1,000
1,000
[(1,000 shares x $58) - $57,000]
5-19
LO 1
Illustration.
3. Show how Eastern would report this investment on
its balance sheet at December 31 and any gain or loss on its income
statement for the year ended December 31, 2014.
5-20
LO 4
Illustration.
4. Suppose Eastern did not intend to treat the Dream
stock as a trading security, but still intended to treat it as a short-term

investment. How do your answers for parts 1-3 change?
Requirements
1. What type of investment is this to Eastern? Give the reason for
your answer.
Available-for-Sale
Facts state it is not a trading security
5-21
LO 4
Illustration.
2. Record Easterns purchase of the Dream stock on
December 15 and the adjustment to market value on December 31.
Account
Dec. 15
Investment in AFSS
Debit
Credit
57,000
57,000
Cash
(1,000 shares x $57)
Dec. 31
Investment in AFSS Securities

Unrealized Gain on AFSS (OCI)
1,000
1,000
[(1,000 shares x $58) - $57,000]
5-22
LO 1
Illustration.
3. Show how Eastern would report this investment on
its balance sheet at December 31 and any gain or loss on its income
statement for the year ended December 31, 2014.
5-23
LO 4
Learning Objective
2. Apply GAAP for proper revenue recognition
5-24
APPLY GAAP FOR PROPER REVENUE

RECOGNITION
Revenue Recognition
5-25
When performance obligation satisfied
Goods transferred or services provided to customer
Price is fixed or determinable
Collection reasonably assured
Revenue is cash value of goods or services transferred
Impacted by shipping terms and payment incentives

offered
LO 2
APPLY GAAP FOR PROPER REVENUE

RECOGNITION
Assume Apple, Inc., delivers a truckload of iPhones to an AT&T
Wireless warehouse in Florida. On the truck are 30,000 iPhone 6s,
each of which Apple, Inc., sells to AT&T Wireless for $100 on
account. Apple, Inc., records the following:
Account
Accounts Receivable
Sales Revenue
Debit
Credit
3,000,000
3,000,000
(30,000 x $100)
5-26
LO 2
Shipping Terms
Ownership Changes Hands and
Shipping Terms Revenue Recognized
5-27
FOB
(free on board)
shipping point
At the point when the goods leave

the sellers shipping dock
FOB
(free on board)
destination
At the point of delivery to the

customer
LO 2
Sales Discounts
Discounts offered for early payment
Typical incentive
2/10, n/30
2% discount if
paid within 10
days
5-28
Full amount
due in 30 days
LO 2
Sales Discounts
Discounts offered for early payment
Typical incentive 2/10, n/30
If Apple, Inc. offered AT&T Wireless terms of 2/10, n/30 and AT&T
pays the invoice within 10 days, it is entitled to a $60,000 discount
($3,000,000 sale times 2%). The collection of this receivable is
recorded as follows:
Account
Cash
Credit
2,940,000
Sales Discount
Accounts Receivable
5-29
Debit
60,000
3,000,000
LO 2
Sales Returns and Allowances
Right to return unsatisfactory or damaged merchandise

to the retailer for a refund or exchange
Suppose that of the 30,000 iPhones Apple, Inc., sells to AT&T

Wireless, 100 are returned (or Apple, Inc., grants AT&T Wireless an
allowance) because they are damaged in shipment. Apple, Inc., would
record the following entry:
Account
Sales Returns and Allowances
Accounts Receivable
5-30
Debit
Credit
10,000
10,000
LO 2
Learning Objective
3. Account for and control accounts receivable
5-31
ACCOUNT FOR AND CONTROL ACCOUNTS

RECEIVABLE
Types of Receivables
5-32
Third most liquid asset
Monetary claims against others
Acquired mainly by:
Selling goods and services (accounts receivable)
Lending money (notes receivable)
LO 3

RECEIVABLE
Entries to
record
receivables
5-33
LO 3

RECEIVABLE
Accounts Receivable
5-34
Amounts collectible from customers from the sale of

goods and services
Sometimes called trade receivables
The Accounts Receivable account serves as a control
Summarizes total receivables from all customers
Subsidiary ledger kept with a separate account for

each customer
LO 3

RECEIVABLE
Bal.
GENERAL LEDGER
ACCOUNTS RECEIVABLE
SUBSIDIARY LEDGER
Accounts Receivable
Brown
9,000
Bal.
5,000
FedEx
Total
$9,000
Bal.
1,000
Moodys
Bal.
5-35
3,000
LO 3

RECEIVABLE
Notes Receivable
5-36
Borrower signs a written promise to pay the lender
A definite sum plus interest
At the maturity date
May require the borrower to pledge security
LO 3

RECEIVABLE
Other Receivables
5-37
Miscellaneous category for all receivables other than

accounts receivable and notes receivable
Examples
Interest receivable
Advances to employees
LO 3
Internal Controls Over Cash Collections

on Account
5-38
Separate cash-handling and cash accounting duties
Bookkeeper should
Not handle cash
Record amounts from remittance advices
Separate employee should open incoming mail and

make deposit
Lockbox system
LO 3
Learning Objective
4. Evaluate collectibility using the allowance for
uncollectible accounts
5-39
EVALUATE COLLECTIBILITY USING THE

ALLOWANCE FOR UNCOLLECTIBLE
ACCOUNTS
Benefits of Selling
on Credit
5-40
Customers can buy on

credit, so sales and profits
increase
Cost of Selling
on Credit
Company cannot collect

from some customers
Recorded as uncollectibleaccount expense
LO 4
Allowance Method
5-41
Records collection losses based on companys

collection experience
Records Uncollectible-Account Expense (Income

Statement)
Sets up Allowance for Uncollectible Accounts
Contra-account to Accounts Receivable
Amount of receivables business expects to not collect
LO 4
Allowance Method
5-42
LO 4
Allowance Method
5-43
Alternate
Presentation
LO 4
Allowance Method
Two basic ways to estimate uncollectibles:
5-44
Percent-of-Sales
Method
Income
Statement
Approach
Aging-ofReceivables
Method
Balance
Sheet
Approach
LO 4
Allowance Method
Income
Statement
Approach
Percent-of-Sales
Method
Estimate %
Uncollectible
5-45
Sales
Revenue
UncollectibleAccount
Expense
LO 4
Percent-of-Sales. Assume it is September 29, 2012, and

Apple, Inc.s accounts have these balances before the year-end
adjustments (amounts in millions):
Accounts Receivable
11,028
Allowance for
Uncollectible Accounts
10
Suppose Apple, Inc.s credit department estimates that uncollectibleaccount expense is 0.0005 (1/20 of 1%) of total revenues, which are
$156,508 million. The entry that records uncollectible-account
expense for the year also updates the allowance as follows (using
Apple, Inc., figures).
5-46
LO 4
Percent-of-Sales. Suppose Apple, Inc.s credit department

estimates that uncollectible-account expense is 0.0005 (1/20 of
1%) of total revenues, which are $156,508 million. The entry that
records uncollectible-account expense for the year also updates
the allowance as follows (using Apple, Inc., figures).
Uncollectible-Account Expense =
$156,508 x .0005 = $78
Account
Sep. 29 Uncollectible-Account Expense
Allowance for Uncollectible Accounts
5-47
Debit
Credit
78
78
LO 4
Percent-of-Sales.
Allowance for
Accounts Receivable
11,028
10
Adj
Bal
78
Net accounts receivable, $10,940
Employs the expense

recognition (matching) concept
88
UncollectibleAccount Expense
78
5-48
LO 4
Allowance Method
Aging-ofReceivables
Method
Estimate %
Uncollectible
5-49
Balance
Sheet
Approach
Accounts
Receivable
Allowance for
Uncollectible
Accounts
LO 4
Aging-of-Receivables. Assume it is September 29, 2012,

and Apple, Inc.s receivables accounts show the following before
the year-end adjustment (amounts in millions):
Accounts Receivable
11,028
Allowance for
10
Apple, Inc.s accounts receivable aging schedule shows that the

company will not collect $98.
5-50
LO 4
Aging-of-Receivables.
Exhibit 5-3 | Aging Accounts Receivable of Apple, Inc.
* Computations are rounded
LO 4
5-51
Aging-of-Receivables. The aging method will bring the

balance of the allowance account ($10) to the needed amount as
determined by the aging schedule ($98). To update the allowance,
Apple, Inc., would make the following adjusting entry at year-end:
Allowance for
$98 - $10 = $88
Account
Sep. 29 Uncollectible-Account Expense
Allowance for Uncollectible Accounts
5-52
Debit
Credit
88
88
LO 4
Aging-of-Receivables.
Allowance for
Accounts Receivable
11,028
10
Adj
Bal
88
Net accounts receivable, $10,930
98
UncollectibleAccount Expense
88
5-53
LO 4
Write Off Uncollectible Accounts. Assume that at the

beginning of fiscal 2013, Apple, Inc., had these accounts receivable
(amounts in millions):
Accounts ReceivableRS
Allowance for
98
Accounts ReceivableTM
Total Accounts Receivable =
$11,028
3
Accounts ReceivableOther
11,016
Accounts Receivable, Net = $10,930

5-54
LO 4
Write Off Uncollectible Accounts. Early in fiscal 2013,

Apple, Inc.s credit department determines that Apple, Inc., cannot
collect from RS. Apple, Inc., then writes off this receivable with the
following entry:
Account
Jan. 31 Allowance for Uncollectible Accounts
Debit
Credit
9
9
+9
-9
5-55
LO 4
Write Off Uncollectible Accounts. Early in fiscal 2013,

Apple, Inc.s credit department determines that Apple, Inc., cannot
collect from RS. Apple, Inc., then writes off this receivable with the
following entry:
Account
Debit
Jan. 31 Allowance for Uncollectible Accounts
Credit
9
9
Allowance for
9
0
5-56
98
89
LO 4
Write Off Uncollectible Accounts. After the write-off,

Apple, Inc.s accounts show these amounts:
Allowance for
9
98
Accounts ReceivableTM
89
Total Accounts Receivable =
$11,019
3
Accounts ReceivableOther
11,016
Accounts Receivable, Net = $10,930

5-57
LO 4
Impact of Write-Off
5-58
LO 4
Allowance Method
Exhibit 5-4 | Comparing the Percent-of-Sales and Aging Methods for
Estimating Uncollectible Accounts
5-59
LO 4
Direct Write-Off Method
Record expense when specific customers account

proves to be uncollectible
Not GAAP
1. No allowance for uncollectibles
2. Receivables (assets) may be overstated
3. Fails to recognize expense in same period in which
sales revenue is earned
5-60
Required method for federal income tax purposes
LO 4
Direct Write-Off Method

The journal entry to record the write off of the RS receivable
using the direct write-off method is as follows:
Account
Jan. 31 Uncollectible-Account Expense
5-61
Debit
Credit
9
9
LO 4
Learning Objective
5. Account for notes receivable
5-62
ACCOUNT FOR NOTES RECEIVABLE

Terms
Creditor
Party to whom money is owed; lender
Debtor
Party that borrowed and owes money; maker, borrower
Interest
Cost of borrowing money; stated as annual percentage

rate
Maturity date
Date when debtor must pay note
Maturity value
Sum of principal and interest
Principal
Amount borrowed by debtor
Term
Length of time from when note was signed to when

payment must be made
Classified as current or long-term

5-63
LO 5
Accounting for Notes Receivable

Consider the promissory note in Exhibit 5-5. After Lauren
Holland signs the note, Continental Bank gives her $1,000 cash.
The bank makes the following entry to record the loan.
Account
Aug 31
Notes ReceivableL.Holland
Cash
Debit
Credit
1,000
1,000
Made a loan
LO 5
5-64

Continental Bank earns interest revenue during September,
October, November, and December. At December 31, 2014, the
bank accrues 9% interest revenue for four months:
Account
Dec 31
Debit
Interest Receivable
Credit
30
30
Interest Revenue
Accrued interest
Calculation of Accrued Interest:

$1,000
Principal
5-65
.09 Rate
Interest
4/12
Time
Amount$30
of Interest
LO 5

Continental Bank reports these amounts in its financial
statements at December 31, 2014:
5-66
LO 5

The bank collects the
note on February 28,
2015, and records
the following:
Account
Feb 28
Debit
Cash
1,045
Notes ReceivableL.Holland
5-67
Credit
1,000
Interest Receivable
30
Interest Revenue
15
Interest Revenue for January and February
= $1,000 x .09 x 2/12 = $15
LO 5

Interest
5-68
Rates usually expressed as an annual percent
Fraction used for time periods less than an year
Months/12
Days/365
LO 5
Learning Objective
6. Show how to speed up cash flow from
receivables
5-69
SHOW HOW TO SPEED UP CASH FLOW

FROM RECEIVABLES
Strategies to shorten credit cycle:
5-70
Sales discounts
Interest on past due customer accounts
Effective credit and collection procedures
Emphasize credit card and bankcard sales
LO 6
Credit Card or Bankcard Sales

Apple, Inc., sells a computer and peripheral devices for $5,000
at one of its stores, and the customer pays with a VISA card.
VISA charges companies a 2% processing fee.
Credit card fee =
$5,000 x 2% = $100
Account
Cash
Credit
4,900
Credit Card Discount Expense

Sales Revenue
5-71
Debit
100
5,000
LO 6
Selling (Factoring) Receivables
5-72
Company sells receivables to a factor
Factor pays discounted price
Benefits company with immediate receipt of cash
Expensive and loss of control over collection process
Used by companies with
Weak or insufficient credit history
Significant amount of debt
LO 6
Selling (Factoring) Receivables

To illustrate, suppose a company wishes to speed up cash flow
and therefore sells $100,000 of accounts receivable, receiving
cash of $95,000. The company would record the sale of the
receivables:
Account
Cash
Credit
95,000
Financing Expense
Accounts Receivable
5-73
Debit
5,000
100,000
LO 6

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Learning Objective

1. Account for short-term investments

Copyright 2015 Pearson Education Inc. All rights reserved.

ACCOUNT FOR SHORT-TERM

Copyright 2015 Pearson Education Inc. All rights reserved.

Reasons to Invest in Other Companies

Must be liquid (easily convertible to cash); and

Investor must intend to either

convert to cash within one year or current operating

use it to pay a current liability

Otherwise, the investment is classified as a long-term asset

Copyright 2015 Pearson Education Inc. All rights reserved.

Reasons to Invest in Other Companies

Debt (bonds, notes, etc.) or equity (stock)

Expected to be sold within the near term through active

Generate income or losses on a day-to-day basis through

Reasons to Invest in Other Companies

Held with intent of selling some time in the future

Not classified as either trading or held-to-maturity

Copyright 2015 Pearson Education Inc. All rights reserved.

Reasons to Invest in Other Companies

Debt securities (bonds, notes, or other instruments with

Investor has intent and ability to hold until they mature

Copyright 2015 Pearson Education Inc. All rights reserved.

Reasons to Invest in Other Companies

Copyright 2015 Pearson Education Inc. All rights reserved.

Investment in Trading Securities

Copyright 2015 Pearson Education Inc. All rights reserved.

Received cash dividend

Copyright 2015 Pearson Education Inc. All rights reserved.

If fair value has

If fair value has

Copyright 2015 Pearson Education Inc. All rights reserved.

Unrealized Gains and Losses. Apple, Inc.s 2014 fiscal

Investment in Trading Securities

Unrealized Gain on Trading Securities

Investment in Trading Securities

Unrealized Gain on Trading

Unrealized Gains and Losses. On September 26, 2015,

Unrealized Loss on Trading Securities

Investment in Trading Securities

Investment in Trading Securities

Unrealized Loss on Trading

Copyright 2015 Pearson Education Inc. All rights reserved.

Sales price >

Sales price <

Copyright 2015 Pearson Education Inc. All rights reserved.

Realized Gains and Losses. Suppose Apple, Inc., sells its

Investment in Trading Securities

Sale of investments at a gain

Copyright 2015 Pearson Education Inc. All rights reserved.

Recording initial purchase

Recording dividend revenue

Adjusting to fair value

Different from Trading Securities

Unrealized gains and losses reported as other

Accumulated and reported as accumulated other

Copyright 2015 Pearson Education Inc. All rights reserved.

Reporting on the Balance Sheet and the

Copyright 2015 Pearson Education Inc. All rights reserved.

Reporting on the Balance Sheet and the

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.