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HELD TO MATURITY SECURITIES
INVESTMENTS IN BONDS: It was noted earlier that certain types of financial instruments have a
fixed maturity date; the most typical of such instruments are "bonds." The held to maturity
securitiesare to be accounted for by the amortized cost method.
To elaborate, if you or I wish to borrow money we would typically approach a bank or other lender
and they would likely be able to accommodate our request. But, a corporate giant's credit needs
may exceed the lending capacity of any single bank or lender. Therefore, the large corporate
borrower may instead issue "bonds," thereby splitting a large loan into many small units. For
example, a bond issuer may borrow $500,000,000 by issuing 500,000 individual bonds with a
face amount of $1,000 each (500,000 X $1,000 = $500,000,000). If you or I wished to loan some
money to that corporate giant, we could do so by simply buying ("investing in") one or more of
their bonds.
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s Receivable Turnover Ratio = Net Credit Sales/Average Net AccountsReceivable
To illustrate these calculations, assume Shoztic Corporation had annual net credit sales of
$3,000,000, beginning accounts receivable (net of uncollectibles) of $250,000, and ending
accounts receivable (net of uncollectibles) of $350,000. Shoztic's average net accounts
receivable is $300,000 (($250,000 + $350,000)/2), and the turnover ratio is "10":
10 = $3,000,000/$300,000
A closely related ratio is the "days outstanding" ratio. It reveals how many days sales are carried
in the receivables category:
Days Outstanding = 365 Days/Accounts Receivable Turnover Ratio
For Shoztic, the days outstanding calculation is:
36.5 = 365/10
By themselves, these numbers mean little. But, when compared to industry trends and prior
years, they will reveal important signals about how well receivables are being managed. In
addition, the calculations may provide an "early warning" sign of potential problems in receivables
management and rising bad debt risks. Analysts carefully monitor the days outstanding numbers
for signs of weakening business conditions. One of the first signs of a business downturn is a
delay in the payment cycle. These delays tend to have ripple effects; if a company has trouble
collecting its receivables, it won't be long before it may have trouble paying its own obligations.
NOTES RECEIVABLE
NOTES RECEIVABLE: A written promise from a client or customer to pay a definite amount of
money on a specific future date is called a note receivable. Such notes can arise from a variety of
circumstances, not the least of which is when credit is extended to a new customer with no formal
prior credit history. The lender uses the note to make the loan more formal and enforceable.
Such notes typically bear interest charges. The maker of the note is the party promising to make
payment, the payee is the party to whom payment will be made, the principal is the stated amount
of the note, and the maturity date is the day the note will be due.
Interest is the charge imposed on the borrower of funds for the use of money. The specific
amount of interest depends on the size, rate, and duration of the note. In mathematical form:
Interest = Principal X Rate X Time. For example, a $1,000, 60-day note, bearing interest at 12%
per year, would result in interest of $20 ($1,000 X 12% X 60/360). In this calculation, notice that
the "time" was 60 days out of a 360 day year. Obviously, a year normally has 365 days, so the
fraction could have been 60/365. But, for simplicity, it is not uncommon for the interest
calculation to be based on a presumed 360-day year or 30-day month. This presumption
probably has its roots in olden days before electronic calculators, as the resulting interest
calculations are much easier with this assumption in place. But, with today's technology, there is
little practical use for the 360 day year, except that it tends to benefit the creditor by producing a
little higher interest amount -- caveat emptor (Latin for "let the buyer beware")! The following
illustrations will preserve this archaic approach with the goal of producing nice round numbers
that are easy to follow.
ACCOUNTING FOR NOTES RECEIVABLE: To illustrate the accounting for a note receivable,
assume that Butchko initially sold $10,000 of merchandise on account to Hewlett. Hewlett later
requested more time to pay, and agreed to give a formal three-month note bearing interest at
12% per year. The entry to record the conversion of the account receivable to a formal note is as
follows:
6-1-X8 Notes Receivable 10,000
Accounts Receivable 10,000
To record conversion of an account receivable to a note receivable
When the note matures, Butchko's entry to record collection of the maturity value would appear
as follows:
8-31-X8 Cash 10,300
Interest Income 300
Notes Receivable 10,000
To record collection of note receivable
plus accrued interest of $300 ($10,000 X
12% X 90/360)
A DISHONORED NOTE: If Hewlett dishonored the note at maturity (i.e., refused to pay), then
Butchko would prepare the following entry:
8-31-X8 Accounts Receivable 10,300
Interest Income 300
Notes Receivable 10,000
To record dishonor of note receivable plus
accrued interest of $300 ($10,000 X 12%
X 90/360)
The debit to Accounts Receivable in the above entry reflects the hope of eventually collecting all
amounts due, including the interest, from the dishonoring party. If Butchko anticipated some
difficulty in collecting the receivable, appropriate allowances would be established in a fashion
similar to those illustrated earlier in the chapter.
NOTES AND ADJUSTING ENTRIES: In the above illustrations for Butchko, all of the activity
occurred within the same accounting year. However, if Butchko had a June 30 accounting year
end, then an adjustment would be needed to reflect accrued interest at year-end. The
appropriate entries illustrate this important accrual concept:
Entry to set up note receivable:
6-1-X8 Notes Receivable 10,000
Accounts Receivable 10,000
To record conversion of an account receivable to a note receivable
Entry to accrue interest at June 30 year end:
6-30-X8 Interest Receivable 100
Interest Income 100
To record accrued interest at June 30 ($10,000 X 12% X 30/360 = $100)
Entry to record collection of note (including amounts previously accrued at June 30):
8-31-X8 Cash 10,300
Interest Income 200
Interest Receivable 100
Notes Receivable 10,000
To record collection of note receivable
plus interest of $300 ($10,000 X 12% X
90/360); $100 of the total interest had
been previously accrued
The following drawing should aid your understanding of these entries:
introduction chapters
chapter 8
Inventory
goals discussion goals achievement fill in the blanks multiple choice problems check list and key terms
GOALS
Your goals for this "inventory" chapter are to learn about:
The correct components to include in inventory.
Inventory costing methods, including specific identification, FIFO, LIFO, and weighted-
average techniques.
The perpetual system for valuing inventory.
Lower-of-cost-or-market inventory valuation adjustments.
Two inventory estimation techniques: the gross profit and retail methods.
Inventory management and monitoring methods, including the inventory turnover ratio.
The impact of inventory errors.
DISCUSSION
THE COMPONENTS OF INVENTORY
CATEGORIES OF INVENTORY: You have already seen that inventory for a merchandising
business consists of the goods available for resale to customers. However, retailers are not the
only businesses that maintain inventory. Manufacturers also have inventories related to the
goods they produce. Goods completed and awaiting sale are termed "finished goods" inventory.
A manufacturer may also have "work in process" inventory consisting of goods being
manufactured but not yet completed. And, a third category of inventory is "raw material,"
consisting of goods to be used in the manufacture of products. Inventories are typically classified
as current assets on the balance sheet. A substantial portion of the managerial accounting
chapters of this book deal with issues relating to accounting for costs of manufactured inventory.
For now, we will focus on general principles of inventory accounting that are applicable to most all
enterprises.
DETERMINING WHICH GOODS TO INCLUDE IN INVENTORY: Recall from the merchandising
chapter the discussion of freight charges. In that chapter, F.O.B. terms were introduced, and the
focus was on which party would bear the cost of freight. But, F.O.B. terms also determine when
goods are (or are not) included in inventory. Technically, goods in transit belong to the party
holding legal ownership. Ownership depends on the F.O.B. terms. Goods sold F.O.B.
destination do not belong to the purchaser until they arrive at their final destination. Goods sold
F.O.B. shipping point become property of the purchaser once shipped by the seller. Therefore,
when determining the amount of inventory owned at year end, goods in transit must be
considered in light of the F.O.B. terms. In the case of F.O.B. shipping point, for instance, a buyer
would need to include as inventory the goods that are being transported but not yet received.
The diagram at right is meant to show who includes goods in transit, with
ownership shifting at the F.O.B. point noted with a "flag."
Another problem area pertains to goods on consignment. Consigned
goods describe products that are in the custody of one party, but belong to another. Thus, the
party holding physical possession is not the legal owner. The person with physical po...
