Chapter

FINANCIAL Accounting:
7 BBA-IV, MBA-III
Spring 2019
Course Instructor
Sehrish Abro
sehrishabro@smiu.edu.pk

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 Marks Distribution
Marks Head Total Marks Total Marks
Frequency Frequency
Quiz 2 10 20
Assignments Multiple 1 20

Mid Term 1 20 20
Final Exam 1 40 40
Total 100

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 To Learn and Score good in
accounting, you need three things i.e.
B.B.C…………..

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 Financial Accounting defined:
• Financial accounting is the field of accounting concerned with
the summary, analysis and reporting of financial transactions
pertaining to a business.

• This involves the preparation of financial statements available for

public consumption.

• It communicates information regarding financial resources,

obligations and activities so that individuals can assess its financial
health and prospects.

• Financial Accounting provides information to investors and

creditors to assist them with their decisions

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 Have a look at financial position…

Chapter 07 through Chapter 11 of the text ©book

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 Chapter 12 through Chapter 14 of the text book
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 Financial Assets Defined:

All assets that are

easily and directly
convertible into

$
known amount of
cash

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 Financial Assets:

Financial
Assets

Cash Receivables

Short-term
Investments
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 Cash:
Coins and
paper
money
Cash is Checks

defined as
any deposit
Bank credit
card sales
banks will Money orders
accept.

Travelers’ checks

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 Reporting Cash in the Balance
Sheet
Combined
with cash on
balance sheet

Liquid short- Matures

Cash
term within 90 days
Equivalents
investments of acquisition

Stable
market
values

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E-g TBs,
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 Reporting Cash in the Balance
Sheet
Not available
for paying
current
liabilities

“Restricted”
Cash Listed as an
Not a current
investment &
asset
Funds

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 Reporting Cash in the Balance
Sheet
Bank agrees in
advance to lend
money.

Lines of
Credit

Liability is Unused line of

incurred when line credit is disclosed
of credit is used. in notes.
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 The Statement of Cash Flows

Statement of Cash Flows Summarizes cash

transactions for an
accounting period.

Includes cash and cash

equivalents.

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 Petty Cash Funds

Used for minor

expenditures.

Petty Cash
Funds

Has one Replenished

custodian. periodically.

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 Cash Over and Short
On May 5, XBAR, Inc.’s cash drawer was
counted and found to be $10 over.

Cash
Cash Over
Over and
and Short
Short is
is debited
debited for
for shortages
shortages
and
and credited
credited for
for overages.
overages.
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 Bank Statements
Shows the beginning bank balance,
deposits made, checks paid, other
debits and credits in the month, and
the ending bank balance.

Bank
Statement
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 Reconciling the Bank Statement
Explains the difference between cash
reported on bank statement and cash
balance in depositor’s accounting
records.

Provides information for

reconciling journal entries.

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 Reconciling the Bank Statement
Balance per Bank Balance per Depositor

+ Deposits by Bank
+ Deposits in Transit
(credit memos)

- Service Charge
- Outstanding Checks
- NSF Checks

± Bank Errors ± Book Errors

= Adjusted Balance = Adjusted Balance

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 Reconciling the Bank Statement
All reconciling Balance per Depositor

items on the + Deposits by Bank

book side (credit memos)

require an - Service Charge

adjusting - NSF Checks

entry to the ± Book Errors

cash account.
= Adjusted Balance

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 Reconciling the Bank Statement
Example
Prepare a July 31 bank reconciliation statement and the
resulting journal entries for the Simmons Company. The
July 31 bank statement indicated a cash balance of
$9,610, while the cash ledger account on that date shows
a balance of $7,430.

Additional information necessary for the reconciliation is

shown on the next page.

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 Outstanding
Outstanding checks
checks totaled
totaled $2,417.
$2,417.
A
A$500
$500 check
check mailed
mailed to
to the
the bank
bank for
for deposit
deposit had
had
not
not reached
reached the
the bank
bank at
at the
the statement
statement date.
date.
The
The bank
bank returned
returned aa customer’s
customer’s NSF NSF check
check for
for
$225
$225 received
received asas payment
payment of of an
an account
account
receivable.
receivable.
The
The bank
bank statement
statement showed
showed $30 $30 interest
interest earned
earned
on
on the
the bank
bank balance
balance for
for the
the month
month of of July.
July.
Check
Check 781781 for
for supplies
supplies cleared
cleared the
the bank
bank for
for $268
$268
but
but was
was erroneously
erroneously recorded
recorded in in our
our books
books asas
$240.
$240.
AA$486
$486 deposit
deposit bybyAcme
Acme Company
Company was was
erroneously
erroneously credited
credited to
to our
our account
account byby the
the bank.
bank.
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 Reconciling
Reconciling the
the Bank
Bank Statement
Statement
Example
Example

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 Reconciling the Bank Statement
Example
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Jul 31 Cash 30
Interest Revenue 30

31 Supplies Inventory 28
Accounts Receivable 225
Cash 253

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 Short-Term Investments
Capital
Bond
Stock
Investments
Investments
Marketable
Securities
Readily
Marketable
are . . . Current Assets

Almost As
Liquid As
Cash
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 Mark-to-Market: A New Principle of
Asset Valuation
Short-term investments
in marketable securities appear
on the balance sheet at
their current market value
as of
the balance sheet date.

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 Accounting for Marketable
Securities:
• Purchase of Marketable Securities:
• Fine company purchases 5,000 shares of Eastern
company for short-term investment at the rate of $45.50
per share on December 1, 2015. It also pays a brokerage
commission of $100 for the purchase of these shares.

Purchases of Marketable Securities

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 Recognition of Investment Revenue

• If the marketable securities are equity securities, they

generate dividend revenue for the investor and if the
marketable securities are debt securities, they generate
interest revenue for the investor

• Fine company has a short term investment of 5,000

shares in Eastern company. It receives a dividend of
$0.45 per share on this investment.

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 Sales Of Investment:
• At a gain:

• Fast company sells 1,000 shares on December 20, 2015

at the rate of $46 per share and pays a $25 brokerage
commission.

• At a loss:
• Refer to example above and suppose the Fast company
sells an additional 2,000 shares of Eastern company on
December 26 at a rate of $44.50 per share and pays a
$35 brokerage commission.

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 The Mark-To-Market Adjustment
• Journal entries for adjusting marketable securities to market
value:

• A) When market value of securities is higher than their cost

• Ex: On December 31, 2015, Fine company holds 2,000 shares of Eastern
company at a cost of $45.52. On the same date, the market value of a
share of Eastern company is $46 per share.

• B) When market value of securities is less than their cost

• Refer to example 1 and suppose the market value of securities is $44.50
per share on December 31 2015

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 Unrealized holding gain in Balance
Sheet

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 Let’s turn our
attention to accounts
receivable.

The term receivables refers to

amounts due from individuals
and companies.
Receivables are claims that are
expected to be collected in
cash.

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 Uncollectible Accounts

IfIf aacompany
companymakes
makescredit
creditsales
salesto
to
customers,
customers, some
someaccounts
accounts
inevitably
inevitablywill
willturn
turnout
outto
to be
be
uncollectible.
uncollectible.

Therefore,
Therefore,Account
Accountreceivables
receivablesare
are
shown
shownin inBalance
BalanceSheet
Sheet on
on PAST DUE
Net
NetRealizable
RealizableValue.
Value.

The net realizable value is the amount of accounts

receivable that the business expects to collect.
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 Reflecting Uncollectible Accounts in the
Financial Statements
At
Atthe
theend
endofof each
each period,
period, record
record an
an
estimate
estimate of
ofthe
theuncollectible
uncollectible accounts.
accounts.

Selling
Sellingexpense
expense Contra-asset
Contra-assetaccount
account
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Balance Sheet Illustration
Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable

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 Writing Off an Uncollectible Account
Receivable
When
Whenananaccount
accountisisdetermined
determinedto
tobe
be uncollectible,
uncollectible, itit no
no
longer
longer qualifies
qualifiesas
as an
anasset
assetand
andshould
shouldbe
be written
writtenoff.off.
To
Towrite
writeoff
offmeans
meansreducing
reducingcustomer’s
customer’saccount
accountto
toZERO
ZERO

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 Writing Off an Uncollectible Account
Receivable
Assume that on January 5, K-Max determined that Jason
Clark would not pay the $500 he owes.
K-Max would make the following entry.

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 Writing Off an Uncollectible Account
Receivable
Assume that before this entry, the Accounts Receivable
balance was $10,000 and the Allowance for Doubtful
Accounts balance was $2,500.

Let’s see what effect the write-off had on these accounts.

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 Writing Off an Uncollectible Account
Receivable
Before After
Write-Off Write-Off
Accounts receivable $ 10,000 $ 9,500
Less: Allow. for doubtful accts. 2,500 2,000
Net realizable value $ 7,500 $ 7,500

Notice that the $500 write-off did not change the net
realizable value nor did it affect any income
statement accounts.

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 Recovery of an Account Receivable
Previously Written Off
Subsequent
Subsequent collections
collectionsrequire
requirethat
thatthe
theoriginal
originalwrite-off
write-off
entry
entrybe
bereversed
reversedbefore
beforethe
thecash
cashcollection
collectionis
isrecorded.
recorded.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Accounts Receivable (X Customer) $$$$
Allowance for Doubtful Accounts $$$$

Cash $$$$
Accounts Receivable (X Customer) $$$$

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 Monthly Estimates of Credit Losses

At
At the
the end
end of
of each
each
month,
month, management
management
should
should estimate
estimate the
the
probable
probable amount
amount ofof
uncollectible
uncollectible accounts
accounts
and
and adjust
adjust the
theAllowance
Allowance
for
for Doubtful
DoubtfulAccounts
Accounts toto
this
this new
new estimate.
estimate.

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 Monthly Estimates of Credit Losses
Example
At
At December
December 31,
31, 2015,
2015, MusicLand’s
MusicLand’s accounting
accounting
records
records indicate
indicate the
the following:
following:
Accounts
Accounts Receivable
Receivable == $50,000
$50,000
Allowance
Allowance for
for Doubtful
DoubtfulAccounts
Accounts == $200
$200 (credit)
(credit)
Past
Past experience
experience suggests
suggests that
that 5%
5% of
of receivables
receivables
are
are uncollectible.
uncollectible.
What
What is
is MusicLand’s
MusicLand’s Uncollectible
UncollectibleAccounts
Accounts
Expense
Expense for
for 2015?
2015?

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 Monthly Estimates of Credit Losses
Example
Desired balance in Allowance
for Doubtful Accounts.

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 Let’s
Let’s look
look at
at
another
another way
way
to
to estimate
estimate
the
the
uncollectible
uncollectible
accounts!
accounts!
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Estimating Credit Losses — The
“Balance Sheet” Approach
At December 31, 2016, the receivables for
EastCo, Inc. were categorized as follows:

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 Estimating Credit Losses — The
“Balance Sheet” Approach
At December 31, 2016, the receivables for
EastCo, Inc. were categorized as follows:

 

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 Estimating Credit Losses — The
“Balance Sheet” Approach
At December 31, 2016, the receivables for
EastCo, Inc. were categorized as follows:

  

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 Estimating Credit Losses — The
“Balance Sheet” Approach
continue……
EastCo’s
EastCo’sunadjusted
unadjustedbalance
balance
in
in the
theallowance
allowanceaccount
account is
is
$500.
$500.
Per
Perthe
theprevious
previouscomputation,
computation,
the
thedesired
desiredbalance
balanceis
is$1,350.
$1,350.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Guess
Guess What!
What!
There
There is
is
another
another
alternative
alternative to
to
estimate
estimate the
the
uncollectible
uncollectible
accounts!
accounts!
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 An Alternative Approach to Estimating
Credit Losses
Uncollectible accounts’
percentage is based on actual
uncollectible accounts from
prior years’ credit sales.

Focus is on determining the amount to

record on the income statement as
Uncollectible Accounts Expense.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 An Alternative Approach to Estimating
Credit Losses

Net
Net Credit
Credit Sales
Sales
 %
% Estimated
Estimated Uncollectible
Uncollectible
Amount
Amount of
of Journal
Journal Entry
Entry

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 An Alternative Approach to Estimating
Credit Losses
In 2017, EastCo had credit sales of $60,000.

Historically, 1% of EastCo’s accounts have been

uncollectible.

For 2017, the estimate of uncollectible accounts

expense is ……………?

Now, prepare the adjusting entry for December

31, 2017.

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 An Alternative Approach to Estimating
Credit Losses

No aging schedule required and no

consideration given to existing
amount of allowance for doubtful
accounts
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 Direct Write-Off Method

This method makes no attempt to

match revenue with the expense of
uncollectible accounts.

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 Evaluating the Quality of Accounts
Receivable
Accounts
AccountsReceivable
ReceivableTurnover
TurnoverRatio
Ratio
This
Thisratio
ratio provides
provides useful
useful information
informationfor
for evaluating
evaluating how
how
efficient
efficientmanagement
managementhas hasbeen
beeniningranting
grantingcredit
creditto
to
produce
producerevenue.
revenue.

Net Sales
Average Accounts Receivable

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Evaluating the Quality of Accounts
Receivable
Avg.
Avg.Number
Numberof of Days
DaystotoCollect
CollectA/R
A/R
This
Thisratio
ratiohelps
helpsjudge
judgethe
the liquidity
liquidityof
of aa company’s
company’saccounts
accounts
receivable.
receivable.

Days in Year
Accounts Receivable Turnover Ratio

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Notes Receivable and Interest
Revenue
Customers
Customersfrequently
frequentlysign
signpromissory
promissorynotes
notestotosettle
settle
overdue
overdueaccounts
accountsreceivable
receivablebalances.
balances.ForForexample,
example,ififaa
customer
customernamed
namedD. D.Brown
Brownsigns
signsaathree
three‐‐month,
month,10%,
10%,
$2,500
$2,500promissory
promissorynote
noteon onDec
Dec1,after
1,afterfalling
falling90
90days
dayspast
past
due
dueon
onher
heraccount,
account,how
howshould
shouldthe
thethe
thebusiness
businessrecord
record
this
thisevent?
event?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Interest Revenue =Principal x
Interest rate x Time period
• Notes Receivable and Interest Revenue

• The company adjusts its accounts on the year end only on

Dec 31 each year. Record accrued interest for the month
of Dec.

• On march 1, when the note matures, record the collection

of notes receivable.

• What if the maker of the note defaults?

• Class Ex: problem 7.11
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The Valuation of Financial Assets
Basis for Valuation in
Type of Financial Asset the Balance Sheet
Cash (and cash equivalents) Face amount
Short-term investments Current market value
(marketable securities)
Receivables Net realizable value

Estimated
Estimated collectible
collectible amount
amount

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 End of Chapter 7

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