Slides For Intermediate Accounting

Chapter 9
Receivables
© 2016 Pearson Education, Ltd.

Learning Objectives
1. Define and explain common

types of receivables and
journalize sales on credit,
credit card sales, and debit
card sales
2. Apply the direct write-off
method for uncollectibles
© 2016 Pearson Education, Ltd. 9-2

Learning Objectives
3. Apply the allowance

and estimate bad debts
expense based on the
percent-of-sales, percent-
of-receivables, and aging-
of-receivables methods

Learning Objectives
4. Account for notes
receivable including
computing interest and
recording honored and
dishonored notes
5. Use the acid-test ratio,
accounts receivable
turnover ratio, and days’
sales in receivables to
evaluate business
performance
Learning Objective 1
Define and explain common

types of receivables and
journalize sales on credit,
credit card sales, and debit
card sales

What Are Common Types of Receivables,
and How Are Credit Sales Recorded?
• A receivable occurs when a business sells

goods or services to another party on
account (on credit).
• A receivable is a monetary claim against a
business or an individual.
– A receivable is a right to receive cash in the
future from a current transaction.
– A creditor is the party who receives a
receivable.
– A debtor is the party to a credit transaction
who is obligated to pay later.

Accounts Receivable
• Accounts receivable, also called trade

receivables, represents the right to receive
cash in the future from customers for
goods or services performed.
– Generally collected within 30 to 60 days
– Reported as a current asset on the balance
sheet

Notes Receivable
• Notes receivable usually have longer

terms than accounts receivable.
• Notes receivable are sometimes called
promissory notes.
• A note receivable represents a promise to pay
a fixed amount of principle plus interest by a
certain due date.
• The maturity date is the date on which a note
receivable is due.

Other Receivables
• Any other type of receivable is considered

other receivables.
• Receivables are classified as either current
or long-term, depending on whether they
will be received in one year or less.
• Examples include:
• Dividends receivable
• Interest receivable
• Taxes receivable

Recording Sales on Credit
• Smart Touch Learning performs $5,000 in
services to Brown on account and sells
$10,000 (sales price) of merchandise
inventory to customer Smith on account on
August 8. Ignore Cost of Goods Sold.

• The control account, Accounts Receivable,
shows a balance of $15,000. The individual
customer accounts in the subsidiary ledger
(Accounts Receivable—Brown $5,000 +
Accounts Receivable—Smith $10,000) add up
to $15,000.

• When the business collects cash from both

customers on August 29—$4,000 from
Brown and $8,000 from Smith—Smart
Touch Learning makes the following entry:

Recording Credit Card and Debit
Card Sales
• Credit and debit card sales are recorded
the same as cash sales.
• A fee is usually charged by the card
company.
• There are two methods for recording
credit card sales:
– Net method
– Gross method

Card Sales
• Smart Touch Learning sells merchandise
inventory (ignore Cost of Goods Sold) to a
customer for $3,000. The customer pays with a
third-party credit card. The card processor
assesses a 4% fee. Use the net method.

Card Sales
• Smart Touch Learning sells merchandise
inventory (ignore Cost of Goods Sold) to a
customer for $3,000. The customer pays with
a third-party credit card. The card processor
assesses a 4% fee. Use the gross method.

Card Sales
• At the end of August, the process collects
the fee assessed for the month.

Apply the direct write-off


How Are Uncollectibles Accounted for
When Using the Direct Write-Off Method?
• Bad debts expense arises from failure to

collect from some customers who purchase
on account.
• There are two methods of accounting for
uncollectible receivables:
– Direct write-off method
– Allowance method (required by GAAP)

Recording and Writing Off Uncollectible
Accounts—Direct Write-off Method
• The direct write-off method of accounting
for uncollectible receivables is primarily
used by small, nonpublic companies.
– Accounts receivable are written off when the
business determines that it will never collect
from a specific customer.
– Bad debts expense is recorded.

• On August 9, Smart Touch Learning
determines that it will not be able to
collect $200 from customer Dan King for a
sale of merchandise inventory made on
May 5.

• Sometimes customers make payments
after the company writes off the account.
– To account for this recovery, the company
must reverse the earlier write-off.
– Then it records the receipt of the payment.

Apply the allowance method

for uncollectibles and
estimate bad debts expense
based on the percent-of-
sales, percent-of-receivables,
and aging-of-receivables
methods

How Are Uncollectibles Accounted for
When Using the Allowance Method?
• Most companies use the allowance method
to measure bad debts.
– The allowance method is based on the
matching principle.
– It records bad debts in the same period as the
sales revenue.
• A contra asset account called Allowance
for Bad Debts reduces the Accounts
Receivable to the net realizable value.

Recording Bad Debts Expense—
Allowance Method
• As of December 31, 2017, Smart Touch
Learning estimates that $80 of its $4,400
accounts receivable are uncollectible.

Recording Bad Debts Expense—
Allowance Method

Writing Off Uncollectible Accounts—
Allowance Method
• An allowance is established for the
estimated uncollectible accounts.
• Instead of recording a debit to Bad Debts
Expense, the company records a debit to
Allowance for Bad Debts.
• The entry to write off an account under
the allowance method has no effect on net
income at the time of entry.

Writing Off Uncollectible Accounts—
Allowance Method
• On January 10, 2018, Smart Touch
Learning determines that it cannot collect
a total of $25 from its customer Shawn
Clark.

Recovery of Accounts Previously
Written Off—Allowance Method
• Recall that Smart Touch Learning wrote off the $25
receivable from Shawn Clark on January 10, 2018.
It is now March 4, 2018, and Smart Touch Learning
unexpectedly receives $25 cash from Clark.

Estimating and Recording Bad Debts
Expense—Allowance Method
• Companies estimate bad debts expense
based upon:
• Past experience
• The industry in which they operate
• Other variables
• There are three methods to estimate
uncollectibles using the allowance method:
– Percent-of-sales
– Percent-of-receivables
– Aging-of-receivables
Percent-of-Sales Method
• The percent-of-sales method computes

bad debts expense as a percentage of net
credit sales.
• Some companies use all sales, not just
credit sales.
• This method is also called the income-
statement approach.

Percent-of-Sales Method
• Smart Touch Learning uses the percent-of-

sales method to account for uncollectibles.
Past experience suggests that 0.5% of
credit sales will be uncollectible, which
amounted to $60,000.

Percent-of-Receivables Method
• The percent-of-receivables method

computes bad debts expense as a
percentage of accounts receivable.

Percent-of-Receivables Method
• Assume on December 31, 2018, Smart Touch

Learning’s unadjusted Accounts Receivable
balance is $6,375, and 4% of the accounts
receivable is estimated to be uncollectible.
The Allowance for Bad Debts account
currently has a credit balance of $55, so the
adjustment in only $200.

Aging-of-Receivables Method
• The aging-of-receivables method is similar

to the percent-of-receivables method.
• In the aging method, businesses group
individual accounts based on how long the
receivable has been outstanding.
• Different percentages are applied to each
category.


• The target balance of the Allowance for

Bad Debts account is $185.


Comparison of Accounting for
Uncollectibles

Comparison of Accounting for
Uncollectibles

Account for notes

receivable including
computing interest and
recording honored and
dishonored notes

How Are Notes Receivable Accounted
For?
Notes receivable
Debtor
Interest
Interest
rate Maturity
Creditor Interest Maturity date Maturity value
period

For?

For?
• Smart Touch Learning lends Lauren
Holland $1,000 on September 30, 2017,
for one year, at an annual rate of 6%.

Computing Interest on a Note
• Interest is recorded based on the amount

of time that has passed:
• Interest rates are always annual.

• Time is always a fraction of a year.

Accruing Interest Revenue and
Recording Honored Notes Receivable
• December 31: The $1,000 loan to Lauren

Holland is not yet due, but interest must
be accrued at a rate of 6%.

Accruing Interest Revenue and
Recording Honored Notes Receivable
• Smart Touch Learning earns nine months

(January through September) of interest,
which is $1,000 × 0.06 × 9/12 = $45.

Recording Dishonored Notes Receivable
• When a maker dishonors a note, the

dishonored note and the unpaid interest
are transferred to Accounts Receivable.
• Later, the Accounts Receivable can be
written off under the direct write-off
method or the allowance method.

Recording Dishonored Notes Receivable
• Suppose Rubinstein Jewelers has a six-

month, 10% note receivable for $1,200
from Mark Adair that was signed on March
3, 2017, and Adair defaults.

Use the acid-test ratio,

accounts receivable
turnover ratio, and days’
sales in receivables to
evaluate business
performance

How Do We Use the Acid-Test Ratio, Accounts
Receivable Turnover Ratio, and Days’ Sales in
Receivables to Evaluate Business Performance?
• Balance-sheet data are useful because

they show the relationships among assets,
liabilities, and revenues.
• Ratios for analysis:
– Acid-test ratio
– Accounts receivable turnover ratio
– Days’ sales in receivables

Acid-Test (or Quick) Ratio
• The acid-test ratio is used to measure a

company’s ability to pay its current
liabilities.
• It is more stringent than the current ratio.
• Quick assets are cash, cash equivalents,
short-term investments, and net current
receivables.

Accounts Receivable Turnover Ratio
• The accounts receivable turnover ratio

measures the number of times the
company collects the average accounts
receivable balance in a year.
• The higher the ratio, the faster the cash
collections.

Days’ Sales in Receivables
• Days’ sales in receivables indicates how

many days it takes to collect the average
level of accounts receivable. It is also
called the collection period.

Chapter 10
Plant Assets,
Natural
Resources, and
Intangibles

Learning Objectives
1. Measure the cost of a plant

asset
2. Account for depreciation
using the straight-line,
units-of-production, and
double-declining-balance
methods
3. Journalize entries for the
disposal of plant assets

Learning Objectives
4. Account for natural

resources
5. Account for intangible
assets
6. Use the asset turnover ratio
to evaluate business
performance
7. Journalize entries for the
exchange of plant assets
(Appendix 10A)
Measure the cost of a

plant asset

How Does a Business Measure the
Cost of a Plant Asset?
• Plant assets are long-lived, tangible assets
used in the operations of a business.
• Examples:
– Land
– Buildings
– Equipment
– Furniture
– Fixtures
– Automobiles

• Plant assets are different from other
assets because plant assets are long-term
(lasting several years).
• The cost of a plant asset is allocated over
the years that the asset is expected to be
used.
• The allocation of a plant asset’s cost over
its useful life is called depreciation and
follows the matching principle.


• A plant asset is recorded at historical
cost—the amount paid for the asset.
• This follows the cost principle, which
states that acquired assets and services
should be recorded at their actual costs.
– The actual cost is the purchase price plus
taxes, commissions, and other amounts paid
to get the asset ready for its intended use.

Land and Land Improvements
• The cost of land includes the following

amounts paid by the purchaser:
Purchase Brokerage Survey and

price commission legal fees
Cost of
Delinquent Title transfer
clearing the
property taxes fees
land

• The cost of land does not include:

Sprinkler
Fencing Paving
systems
Lighting Signs
• These separate plant assets are called

land improvements and, unlike land, are
subject to depreciation.
• Smart Touch Learning purchases land on

August 1, 2015, for $50,000 with a note
payable. Other costs related to this
transaction include $4,000 in delinquent
property taxes, $2,000 in transfer taxes,
$5,000 to remove an old building, and a
$1,000 survey fee. The additional costs
are paid in cash.
• See Exhibit 10-2 on the next slide for the
total cost of the land.

• The entry to record the purchase of the

land on August 1, 2017, follows:

• Smart Touch Learning capitalizes the cost

of the land at $62,000.
• To capitalize an asset means to record the
acquisition of land, building, or other
assets by debiting (increasing) an asset
account.

Buildings
• When a building is constructed, the costs

to be capitalized include the following:
Architectural Building
fees permits
Payments for
Contractor
materials and
charges
labor

Buildings
• When a building is purchased, the costs to

be capitalized include:
Purchase price Brokerage fees
Delinquent Renovation
taxes costs

Machinery and Equipment
• The cost of machinery and equipment

includes:
– Purchase price (less any discounts)
– Transportation charges
– Insurance while in transit
– Sales tax and other taxes
– Purchase commission
– Installation costs
– Testing costs (prior to use of the asset)

Furniture and Fixtures
• Examples of furniture and fixtures include:

– Desks
– Chairs
– File cabinets
• The costs of furniture and fixtures include:
– Purchase price (less any discounts)
– All other costs to ready the asset for its
intended use

Lump-Sum Purchase
• A company may pay a single price for

several assets as a group; this is called a
lump-sum purchase.
• The company must identify the cost of
each asset purchased.
• The total cost paid is divided among the
assets according to their relative fair
market values. This is called the relative-
market-value method.

Lump-Sum Purchase
• Suppose Smart Touch Learning paid a
combined purchase price of $100,000 on
August 1, 2017, for the land and building.
An appraisal indicates the land’s market
value is $30,000, and the building’s
market value is $90,000.
• The total appraised value is $120,000:

Lump-Sum Purchase
• For Smart Touch Learning, the land is

assigned a cost of $25,000, and the
building is assigned a cost of $75,000,
calculated as follows:
Insert third exhibit on page 478

Lump-Sum Purchase
• Assume Smart Touch Learning purchased

the assets by signing a note payable. The
entry to record the purchase of the land
and building is as follows:

Capital and Revenue Expenditures
• Accountants divide spending on plant

assets after the acquisition into two
categories:
– Capital expenditures increase the asset’s
capacity or efficiency or extends the asset’s
useful life.
• Includes extraordinary repairs
– Revenue expenditures are expenses incurred
to maintain the asset in working order.

Capital and Revenue Expenditures

Account for depreciation

using the straight-line, units-
of-production, and double-
declining-balance methods

What Is Depreciation, and How Is It
Computed?
• Depreciation matches the expense
against the revenue generated from
using an asset.
• All assets, except land, wear out as
they are used.
• Some assets may become obsolete
before they wear out. An asset is
obsolete when a newer asset can
perform the job more efficiently.

Factors in Computing Depreciation
• Depreciation of a plant asset is based on

three main factors:
Capitalized Estimated
cost useful life
Estimated
residual value

Factors in Computing Depreciation
• Estimated residual value, also called

salvage value, is the amount the company
expects to receive upon disposition of the
asset.
• Cost minus estimated residual value is
called depreciable cost.

Depreciation Methods
• Three most commonly used depreciation
methods:
– Straight-line method
– Units-of-production method
– Double-declining-balance method

Straight-Line Method
• The straight-line method allocates an

equal amount of depreciation to each year
and is computed as follows:

• The adjusting entry to record the year’s

depreciation expense, assuming the
truck was placed in service on the first
day of the year, is as follows:

• Depreciation expense is reflected on the

income statement.
• The book value of the asset, cost minus
accumulated depreciation, is reflected on
the balance sheet.


Units-of-Production Method
• The units-of-production method allocates

a varying amount of depreciation each
year based on the asset’s usage.
• When a plant asset’s usage varies by year,
the units-of-production method better
matches expenses with revenues.

• Smart Touch Learning expects to drive a

truck 20,000 miles the first year, 30,000
miles the second, 25,000 the third, 15,000
the fourth, and 10,000 the fifth—for a
total of 100,000 miles.
• The units-of-production depreciation for
each period varies with the number of
units the asset is used.

• Units-of-production depreciation is


Double-Declining Balance Method
• An accelerated depreciation method

expenses more of the asset’s cost near the
start of an asset’s life and less at the end
of its useful life.
– The main accelerated method of depreciation is
the double-declining-balance method.
– The double-declining-balance method
multiplies an asset’s decreasing book value by
a constant percentage that is twice the
straight-line depreciation rate.

Double-Declining Balance Method

Comparing Depreciation Methods

Depreciation for Tax Purposes
• The Internal Revenue Service (IRS)

requires that companies use the Modified
Accelerated Cost Recovery System
(MACRS).
• MACRS is a depreciation method used for
tax purposes.
• Under MACRS, assets are divided into
specific classes such as 3-year, 5-year,
7-year, and 39-year property.

Reporting Plant Assets

Journalize entries for the

disposal of plant assets

How Are Disposals of Plant Assets
Recorded?
• Eventually, an asset wears out or becomes
obsolete. The business then has several
options:
– Discard the plant asset.
– Sell the plant asset.
– Exchange the plant asset for another asset.

Recorded?
• Regardless of the type of disposal, there
are four steps:
1. Bring the depreciation up to date.
2. Remove the old, disposed-of asset and
associated accumulated depreciation from
the books.
3. Record the value of any cash received (or
paid).
4. Determine the amount of any gain or loss.

Discarding Plant Assets
• Assume that on July 1, Smart Touch

Learning discards equipment with a cost of
$10,000 and accumulated depreciation of
$10,000.

• Suppose, instead, that on July 1, Smart

Touch Learning discarded the equipment,
which has a cost of $10,000 but is not
fully depreciated. Accumulated
depreciation is $8,000, and annual
depreciation is $1,000.
– The first step is to bring the asset up to date
on depreciation.
– The second step is to record the disposal.


Selling a Plant Asset at Book Value
• Smart Touch Learning sells the equipment

for $1,500.

Selling a Plant Asset Above Book Value
• If Smart Touch Learning sells the equipment

for $4,000, the company will record a gain
on the sale of the equipment.

Selling a Plant Asset Below Book Value
• If Smart Touch Learning sells the equipment

for $500, the company will record a loss on
the sale of the equipment.

Recorded?

Recorded?

Account for natural

resources

How Are Natural Resources
Accounted For?
• Natural resources are assets that come
from the earth that are consumed.
• Depletion is the process by which
businesses spread the allocation of a
natural resource’s cost to expense over its
usage.
• Depletion is computed by the units-of-
production method.

How Are Natural Resources
Accounted For?
• Assume an oil well cost $700,000 and is
estimated to hold 70,000 barrels of oil.
There is no residual value. If 3,000 barrels
are extracted during the year, the journal
entry to record depletion is as follows:

Account for intangible

assets

How Are Intangible Assets
Accounted For?
• Intangible assets are assets that have no
physical form.
• Examples of intangible assets include:
– Patents
– Copyrights
– Trademarks
– Other creative works

Accounting for Intangibles
• Intangible assets that are purchased are

recorded at cost.
• Most purchased intangibles are expensed
through amortization, the allocation of the
cost of an intangible asset to expense over
its useful life.
• Only intangibles with a definite life are
amortized.

Accounting for Intangibles
• Intangible assets with an indefinite life are

tested for impairment annually.
• Impairment occurs when the fair value of
an asset is less than the book value.
• A company records a loss when an
impairment occurs.

Patents
• A patent is an intangible asset that is a

federal grant conveying an exclusive
20-year right to produce and sell an
invention.
• The invention may be a process, product,
or formula.
• The acquisition cost of a patent is debited
to the Patent account.

Patents
• Assume Smart Touch Learning pays

$200,000 to acquire a patent on January
1. The useful life of the patent is
determined to be five years.
• Use the straight-line method to calculate
amortization.

Patents

Copyrights and Trademarks
• A copyright is the exclusive right to

reproduce and sell a book, a musical
composition, a film, another work of art,
or intellectual property.
• A trademark (also called a trade name) is
an asset that represents distinctive
identifications of products or services,
such as the Nike “swoosh” or the
McDonald’s “golden arches.”

Franchises and Licenses
• Franchises are privileges granted by a

business to sell goods or services under
specified conditions.
• McDonald’s and Subway are well-known
business franchises.
• Licenses are privileges granted by a
government to use public property in
performing services.

Goodwill
• Goodwill is the value paid above the net

worth of a company’s assets and liabilities.
• Special features of goodwill:
• It is recorded by an acquiring company when it
purchases another company for more than the
market value of the net assets acquired.
• Goodwill is not amortized.

Recording of Intangible Assets

Use the asset turnover

ratio to evaluate business
performance

How Do We Use the Asset Turnover Ratio
to Evaluate Business Performance?
• The asset turnover ratio measures the

amount of net sales generated for each
average dollar of total assets invested.
• To compute this ratio, we divide net sales
by average total assets.

Journalize entries for the

exchange of plant assets
(Appendix 10A)

How Are Exchanges of Plant Assets
Accounted For?
• A business may exchange a plant asset for
another plant asset.
• An exchange has commercial substance if
the future cash flows change as a result of
the transaction.
• Exchanges that have commercial
substance require any gain or loss on the
transaction to be recognized.

Exchange of Plant Assets—Gain
Situation
• On December 31, Smart Touch Learning
exchanges used equipment with a
historical cost of $10,000 and
accumulated depreciation of $9,000 for
new equipment. The company acquires
the new equipment with a market value of
$8,000 and pays $2,000 cash. Assuming
this exchange has commercial substance,
calculate the gain and record the journal
entry for this exchange.

Exchange of Plant Assets—Gain
Situation
The accounting clerk records the following entry:

Exchange of Plant Assets—Loss
Situation
• On December 31, Smart Touch Learning
exchanges used equipment with a
historical cost of $10,000 and
accumulated depreciation of $9,000 for
new equipment. The company acquires
the new equipment with a market value of
$3,000 and pays $2,500 cash. Assuming
this exchange has commercial substance,
calculate the loss and record the journal
entry for this exchange.

Exchange of Plant Assets—Loss
Situation
The accounting clerk records the following entry:

Chapter 11
Current
Liabilities and
Payroll

Learning Objectives
1. Account for current

liabilities of known
amount
2. Calculate and journalize
basic payroll transactions
3. Account for current
liabilities that must be
estimated

Learning Objectives
4. Account for contingent

liabilities
5. Use the times-interest-
earned ratio to evaluate
business performance

Account for current

liabilities of known
amount

How Are Current Liabilities of Known
Amounts Accounted For?
• Liabilities are debts that are owed to
creditors.
• Liabilities have three main characteristics:
1. They occur as a result of a past transaction or
event.
2. They create a present obligation for future
payments of cash or services.
3. They are an unavoidable obligation.

• Current liabilities must be paid either with
cash or with goods and services within one
year or within the entity’s operating cycle.
• Long-term liabilities do not need to be
paid within one year or within the entity’s
operating cycle.

Current Long-term
liabilities liabilities
Accounts Payable Notes Payable
Sales Tax Payable Mortgage Payable
Unearned
Bonds Payable
Revenue

Sales Tax Payable
• December’s taxable sales for Smart Touch

Learning totaled $10,000. The company
collected an additional 6% sales tax, which
would equal $600 ($10,000 × 0.06).

Sales Tax Payable
• Sales tax is not an expense of the

business. It is a current liability.
Companies collect the sales tax and then
forward it to the state at regular intervals.

Unearned Revenues
• Suppose Smart Touch Learning received

$900 in advance on May 21 for a month’s
work beginning on that date.

Unearned Revenue
• During May, Smart Touch Learning

delivered one-third of the work and
earned $300 ($900 × 1/3) of the revenue.
On May 31, the accounting clerk would
record the following entry:

Short-Term Notes Payable
• Assume on May 1, Smart Touch Learning

purchased merchandise inventory with a
10%, 90-day note payable, for $8,000.
The company uses the perpetual inventory
system.

Short-Term Notes Payable
• On July 30, when the note is due, Smart

Touch Learning will pay the note plus
interest.

Current Portion of Long-Term Notes
Payable
• Long-term notes payable are typically
reported in the long-term liability section
of the balance sheet.
• When the long-term debt is paid in
installments, the business reports the
current portion of notes payable as a
current liability.
• The remainder is classified as long-term.

Calculate and journalize

basic payroll transactions

How Do Companies Account for and
Record Payroll?
• Payroll, also called • There are
employee numerous ways to
compensation, label an
creates liabilities employee’s pay:
for a business. • Salary
• For service • Compensation
organizations, • Commission
payroll is the major • Bonus
expense. • Benefits

Gross Pay and Net (Take-Home) Pay
• Two pay amounts are important for

accounting purposes:
– Gross pay is the total amount of salary, wages,
commissions, and bonuses earned by the
employee during the pay period.
– Net pay is the amount the employee gets to
keep. Net pay is also called take-home pay.

Employee Payroll Withholding
Deductions
Required Deductions Optional Deductions
• Federal and state • Insurance

income tax premiums
• Social Security tax • Retirement plan
• Other deductions contributions
required by federal, • Charitable
state, or local law contributions

Withholding for Employee Income Tax
• The income tax deducted from gross pay

is called income tax withholding.
• The amount withheld depends on the
employee’s gross pay and the number of
withholding allowances claimed.
– Unmarried taxpayers usually claim one
allowance.
– A childless married couple usually claims two
allowances.

Withholding for Employee Income Tax

Withholding for Employee Social
Security Tax (FICA)
• The Federal Insurance Contributions Act
(FICA), also known as the Social Security
Act, created the Social Security tax.
• The law requires employers to withhold
Social Security (FICA) tax from
employees’ paychecks.
• FICA has two components:
– OASDI (old age, survivors, and disability
insurance)
– Medicare (medical benefits)
Payroll Register
• Many companies use a payroll register to

help summarize the earnings,
withholdings, and net pay for each
employee.

Journalizing Employee Payroll
• The payroll register is used to record the

payroll journal entry.

Employer Payroll Taxes
• Employers must pay at least three payroll

taxes, two of which are unemployment
compensation taxes.
• These taxes are not withheld from
employees’ gross earnings but instead are
paid by the employer:
– Employer FICA tax (OASDI and Medicare)
– State unemployment compensation tax (SUTA)
– Federal unemployment compensation tax
(FUTA)
Employer Payroll Taxes

Journalizing Employer Payroll Taxes
• Smart Touch Learning records the

employer’s payroll tax expense as a debit
to Payroll Tax Expense and a credit to the
various payable accounts.

Internal Control Over Payroll
• There are two main controls for payroll:

– Controls for efficiency:
• Payroll is usually automated rather than prepared by
hand.
– Controls to safeguard payroll disbursements:
• Employees sign for checks or present IDs.
• Hiring and firing is separated from payroll
preparation.
• Time clocks and direct deposit are also used.

Account for current

liabilities that must be
estimated

How Are Current Liabilities That Must
Be Estimated Accounted For?
• A business may • Common examples
know that a of estimated
liability exists but liabilities:
not know the exact • Bonus plans
amount. • Vacation pay
• It must estimate • Health and pension
the amount of the expense benefits
liability and report • Warranties
it on the balance
sheet.
Bonus Plans
• Assume Smart Touch Learning estimates

that it will pay a 5% bonus on annual net
income after deducting the bonus. The
company reports net income of $315,000
before the calculation of the bonus.

Vacation, Health, and Pension Benefits
• Businesses typically offer vacation, health,

and pension benefits to employees.
– A pension plan provides benefits to retired
employees.
• Smart Touch Learning estimates the cost
of providing vacation benefits is $1,000
per month.

Warranties
• Many corporations guarantee their

products against defects under warranty
agreements.
• The time period of warranties varies by
product and company.
• The matching principle requires
businesses to record Warranty Expense in
the same period that the company records
the revenue related to the warranty.

Warranties
• Assume that Smart Touch Learning made
sales on account of $50,000, costing
$35,000 subject to warranties on June 10,
and estimates warranties at 3% of sales.
• The journal entry to record this
transaction is shown on the next slide.

Warranties

Warranties
• Assume that some of Smart Touch
Learning’s customers make claims that
must be honored through the warranty
offered by the company. The warranty
costs total $800 and are made on June 27
as follows:

Account for contingent

liabilities

How Are Contingent Liabilities
Accounted For?
• A contingent • How businesses
liability is a record contingent
potential liability liabilities is based
that depends on a on the likelihood of
future event. events occurring in
• For a contingent the future:
liability to be paid, • Remote
some event must • Reasonably possible
happen in the • Probable
future.
How Are Contingent Liabilities
Accounted For?

Use the times-interest-

earned ratio to evaluate
business performance

How Do We Use the Times-Interest-
Earned Ratio to Evaluate Business
Performance?
• Investors can use the times-interest-
earned ratio to evaluate a business’s
ability to pay interest expense.
• A high interest coverage ratio indicates a
business’s ease in paying interest
expense.
• The formula is:

Chapter 12
Partnerships

Learning Objectives
1. Identify the
characteristics and
types of partnerships
2. Account for the start-up
of a partnership and
prepare partnership
financial statements
3. Allocate profits and
losses to the partners

Learning Objectives
4. Account for the

admission of a new
partner
5. Account for a partner's
withdrawal from the
partnership
6. Account for the
liquidation of a
partnership

Identify the characteristics

and types of partnerships

What are the Characteristics and Types
of Partnerships?
• A partnership is a business with two or
more owners that is not organized as a
corporation.
• Partnership characteristics include:
• A written agreement
• Limited life
• Mutual agency
• Unlimited liability
• Co-ownership of property
• No partnership income tax
• Partners’ capital accounts

The Written Agreement
• A partnership agreement:
• Is a contract between partners, also called the
articles of partnership.
• Is governed by contract law.
• Outlines the rules of the partnership.
• A partnership can exist even in the absence
of a written partnership agreement.

The Written Agreement
• The articles of partnership should specify:

– Name, location, and nature of the business
– Name, capital contribution, and duties of each
partner
– Procedures for admitting a new partner
– Method of sharing profits and losses among the
partners
– Procedure for withdrawal of assets by the partners
– Procedures for withdrawal of a partner from the
partnership
– Procedures for liquidating the partnership

Limited Life
• A partnership has a limited life.

• A dissolution is the ending of a partnership.
• Examples of dissolutions include:
– Changes in the existing partners
– The withdrawal of a partner
– The death of a partner
– Adding a new partner (Note: This dissolves the old
partnership, but creates a new one.)

Mutual Agency
• Mutual agency means that every partner is a

mutual agent of the firm.
• Any partner can bind the business to a contract.
• Partners cannot bind the business to contracts
associated with personal matters.

Unlimited Liability
• Each partner has unlimited personal liability for

the debts of the business.
• Partners must pay the debts of the business with
personal assets when the partnership cannot pay
its debts.
– This is known as unlimited liability.

Co-Ownership of Property
• Any asset contributed by a partner becomes

property of the partnership.
• The partner who contributed the property is no
longer the sole owner.
• Any new assets purchased by the partnership are
owned by the partners.

No Partnership Income Tax
• The partnership entity does not pay tax.

• The net income (or net loss) flows through to the
individual partners.
• Partners pay personal income tax on their share
of partnership income.

Partnership Characteristics

Types of Partnerships
General Limited
Partnership Partnership
All partners are At least 1

general partner is a
partners general partner
Partners are Limited

co-owners and partners are
participants in similar to
the business investors
Limited liability partnerships (LLP) are a variation of a limited partnership.

Other Forms of Business
Limited Liability Company (LLC)

• Combines the advantages of both the
partnership and corporate forms.
S Corporation
• A type of corporation, limited to 100
shareholders.
Other Forms of Business

Account for the start-up of

a partnership and prepare
partnership financial
statements

How Are Partnerships Organized?
• It is easy to form a partnership.

• No permissions are required from the
government.
• It is wise to enlist the assistance of an
attorney.
• The partners contribute assets and
abilities to the partnership.

The Start-up of a Partnership
• Sheena Bright and Martin Gonzales form a
partnership to sell computer software on June 1,
2017. The partners agree on the following:

The Start-up of a Partnership

Partnership Financial Statements
• The asset and liability sections for a

partnership balance sheet do not differ
from other forms of business.
• A partnership equity statement is called
the statement of partners’ equity.
• The equity section of a partnership
balance sheet reports a separate capital
balance for each partner.

Partnership Financial Statements

Allocate profits and losses

to the partners

How Are Partnership Profits and Losses
Allocated?
• The allocation of income is usually based
on the terms in the partnership
agreement.
• Typical arrangements include:
– Sharing of profits and losses based on a stated
ratio for each partner
– Sharing based on each partner's capital
balances
– Sharing based on each partner's service
– Sharing based on a combination of stated
ratios, capital balances, and service
Allocation Based on a Stated Ratio
• Bright and Gonzalez allocate 2/3 of the profits

and losses to Bright and 1/3 of the profits and
losses to Gonzalez. If the net income for the
year was $60,000, Bright and Gonzalez would
share the net income as follows:

• The entry to close net income, would include

a debit to Income Summary and credits to
the partner's capital accounts, as follows:

• If, instead, the partnership had a net loss of

$18,000, the Income Summary account
would have a debit balance of $18,000. The
partner's capital accounts would be reduced
by the allocation of the loss.

Allocation Based on Capital Balances
• The allocation of profits and losses may be

based on the partner's capital balances
instead of a stated ratio. Assume Bright
contributed $30,000 in capital and Gonzalez
contributed $20,000. The allocation of profits
would be as follows:

Allocation Based on Services, Capital
Balances, and Stated Ratios
• Net income can be allocated using a
combination of services, capital balances,
and stated ratios.
• Suppose Bright and Gonzalez agree to
share profits and losses as follows:
– The first allocation is a salary allowance with
Bright receiving $16,000 and Gonzalez
$24,000.
– The next allocation is based on 10% of the
partners’ capital balances.
– Any remaining profit or loss is allocated
equally.


Partner Withdrawal of Cash and Other
Assets
• Sheena Bright and Martin Gonzalez each
made withdrawals of $3,000. The partnership
records the December 31 withdrawals as
follows:

Partner Withdrawal of Cash and Other
Assets
• The withdrawal accounts are closed at the
end of the period, exactly as they are for a
sole proprietorship. The entry for Bright &
Gonzalez would be as follows:

Statement of Partners’ Equity

Account for the admission

of a new partner

How Is the Admission of A Partner
Accounted For?
• Admitting a new partner dissolves the old
partnership and begins a new one.
• The two main ways a partner joins a
partnership are:
– Admission by purchasing an existing partner's
interest
– Admission by contributing to the partnership

Admission by Purchasing an Existing
Partner's Interest
• Suppose Bright wants to sell Cheryl Kaska
half of her partnership interest ($53,500 x
½ = $26,750) on January 1, 2018. The
partnership records:

Admission by Contributing to the
Partnership
• A person enters the partnership by
contributing directly to the business.
• The new partner contributes assets, such as
land or equipment.
• There are several ways to add a new partner:
– Admission by contributing to the partnership at
book value and no bonus to any partner
– Admission by contributing to the partnership with a
bonus to existing partners
– Admission by contributing to the partnership with a
bonus to the new partner

Partnership at Book Value – No Bonus
to Any Partner
• Cheryl Kaska wants to join the Bright & Gonzalez
partnership on January 1, 2018. Bright and
Gonzalez agree to dissolve their partnership and
start a new one, giving Kaska a 1/3 interest in
the new partnership for her $52,000 contribution.

Partnership at Book Value – No Bonus
to Any Partner
• Cheryl Kaska contributes land with a market
value of $52,000 for a 1/3 interest in the new
partnership. The partnership records:

Partnership – Bonus to the Existing
Partners
• Bright and Gonzalez admit Cheryl Kaska to a
¼ interest in the new partnership for a cash
contribution of $100,000. Kaska's capital
balance on the new partnership books would
only be $51,000.

Partners
• The new partnership's total capital is now
$204,000, but Kaska's ¼ share is only
$51,000. The remaining $49,000 ($100,000 -
$51,000) is allocated to the original partners
as a bonus.

Partners
• The journal entry for the partnership would
be:

Admission of a New Partner—Bonus to
the New Partner
• On January 1, 2018, Kaska gives Bright and
Gonzalez $98,000 and gets a 60% interest in
the new partnership.

Admission of a New Partner—Bonus to
the New Partner
• The new partnership's total capital is now
$202,000, but Kaska's 60% share is
$121,200, which is $23,200 more than her
contribution. The “bonus” will be allocated
from the original partners to Kaska.

Account for a partner's

withdrawal from the
partnership

How is the Withdrawal of A Partner
Accounted For?
• Partners leave the business for many
reasons, such as:
– Retirement
– Death
– Dispute
• The partnership agreement specifies the
procedures to follow.
• The old partnership ceases to exist, but a
new partnership might begin.

Withdrawal from the Partnership at
Book Value – No Bonus to Any Partner
• On January 2, 2018, Bright withdraws from
the partnership by receiving cash for the book
value of her capital account. The journal entry
would be:

Withdrawal from the Partnership—
Bonus to Existing Partners
• Bright withdraws from the business and
agrees to receive cash of $47,200. This
settlement is $6,300 less than Bright's
$53,500 capital balance. The entry is as
follows:

Withdrawal from the Partnership—
Bonus to the Withdrawing Partner
• Bright is given cash of $57,200 which is
$3,700 more than Bright's capital account of
$53,500. The remaining partners share this
$3,700 as a capital reduction. The journal
entry is:

Account for the liquidation

of a partnership

How is the Liquidation of a Partnership
Accounted For?
• A liquidation is the process of going out of
business by selling the entity's assets,
paying its liabilities, and distributing any
remaining cash to the owners based on
their equity balances.
• Partnership liquidations follow three steps:
1. Sell the assets
2. Pay all partnership liabilities
3. Pay the remaining cash to the partners based
on their capital balances

Sale of Assets at a Gain

• Step 1: The partnership sells the non-cash

assets for $150,000.

• Step 2: The partnership pays off its

liabilities.

• Step 3: After paying the liabilities, the

partnership has the following balances in
its accounts:

• Because there is cash left in the partnership,

the final liquidation pays all remaining cash to
the partners according to their capital
balances.


Sale of Assets at a Loss with Capital
Deficiency
• Step 1: Assume Bright, Gonzalez, and Kasha
decide to liquidate on November 30 and sell
the non-cash assets for $60,000. The partnership
realizes a loss of $30,000 ($60,000 - $90,000).

Deficiency

Deficiency
• Step 2: Bright, Gonzalez, and Kaska then use
the remaining cash of $70,000 ($10,000 +
$60,000) to pay the liabilities.
• The partnership records the following entry:

Deficiency
• Step 3: After the liabilities are paid, Kaska's
capital account has a debit balance. This
represents a capital deficiency and is the
partnership's claim against the partners.

Deficiency
• Revised capital account balances are:

Deficiency
• The partners divide the remaining cash
according to their capital balances.

Sale of Assets at a Loss with
Capital Deficiency
• The liquidation of a partnership at a loss with
a capital deficiency is summarized below:

Chapter 16
The Statement of
Cash Flows

Learning Objectives
1. Identify the purposes of

the statement of cash
flows and distinguish
among operating,
investing, and financing
cash flows
2. Prepare the statement of
cash flows by the indirect
method

Learning Objectives
3. Use free cash flow to

evaluate business
performance
cash flows by the direct
method (Appendix 16A)
method using a
spreadsheet (Appendix
16B)

Identify the purposes of the

statement of cash flows and
distinguish among operating,
investing, and financing cash
flows

What Is the Statement of Cash Flows?
• The statement of cash flows reports on a

business’s cash receipts and cash
payments for a specific period.
• This statement does the following:
– Reports on the cash flows of a business.
– Reports why cash increased or decreased
during the period.
– Covers a span of time and is dated the same
as the income statement .

Purpose of the Statement of Cash
Flows
• The statement of cash flows explains why
net income as reported on the income
statement does not equal the change in
the cash balance.
• The statement of cash flows helps:
– Predict future cash flows.
– Evaluate management.
– Predict ability to pay debts and dividends.

Classification of Cash Flows
• There are three basic types of cash flows,

and the statement of cash flows has a
section for each:
– Operating activities
– Investing activities
– Financing activities

Operating Activities
• Operating activities is the first section on

the statement of cash flows.
• This section reports on activities that
create revenue or expense in the entity’s
business.
• This is often the most important category.

Investing Activities
• Investing activities is the second category

listed on the statement of cash flows.
• This section reports cash receipts and
cash payments that increase or decrease
long-term assets.
• It includes the cash inflow from selling and
the cash outflow from purchasing long-
term assets.

Financing Activities
• Financing activities is the last category

listed on the statement of cash flows.
• Financing activities include cash inflows
and outflows involved in long-term
liabilities and equity.
• Financing activities include:
– Issuing stock.
– Paying dividends.
– Buying and selling treasury stock.

Classification of Cash Flows

Non-cash Investing and Financing
Activities
• Companies make investments that do not
require cash.
• Such transactions are called non-cash
investing and financing activities.
• These activities appear as a separate
schedule at the bottom of the statement
of cash flows or in the notes to the
financial statements.

Activities

Two Formats for Operating Activities
Indirect Direct
method method
Starts with
Restates the
accrual income
income in terms
and adjusts to
of cash
net cash
Uses account
Shows actual
relationships to
cash receipts and
determine
cash payments
changes in cash

Prepare the statement of

method

How Is the Statement of Cash Flows
Prepared Using the Indirect Method?
• Items needed:
– Income statement for the current year.
– Balance sheet for current year.
– Balance sheet from prior year.
– Additional information based on review of
transactions.

Prepared Using the Indirect Method?
• Prepare in five steps:
1. Complete the cash flows from operating
activities.
2. Complete the cash flows from investing
section.
3. Complete the cash flows from financing
section.
4. Compute the change in cash.
5. Prepare a schedule for non-cash activities.

How Is the
Statement of
Cash Flows
Prepared
Using the
Indirect
Method?

How Is the
Statement of
Cash Flows
Prepared Using
the Indirect
Method?

How Is the
Statement of
Cash Flows
Prepared Using
the Indirect
Method?

Cash Flows from Operating Activities
• When using the indirect method, the

operating activities section begins with
accrual-basis net income or loss, which
needs to be adjusted to a cash number.
• For example:
– Sales on account generate revenues that
increase net income, but the company has not
yet collected cash from those sales.
– Accrued expenses decrease net income, but
the company has not yet paid cash.

Depreciation, Depletion, and
Amortization Expenses
• Depreciation, depletion, and amortization
expenses are added back to net income to
reconcile net income to net cash flow from
operating activities.

Gains and Losses on the Disposal of
Long-Term Assets
• Disposals from long-term assets create a
gain or loss that must be removed from
net income, which is in the operating
activities section.

Changes in Current Assets and Current
Liabilities
• Most current assets and current liabilities
result from operating activities.

Evaluating Cash Flows from Operating
Activities
• The operating activities section starts with
accrual net income, and then adjustments are
made to reconcile net income to net cash.

Evaluating Cash Flows from Operating
Activities

Cash Flows from Investing Activities
• Investing activities affect long-term

assets, such as:
– Plant assets
– Investments
– Notes receivable
• It is helpful to evaluate the T-accounts for
each long-term asset to determine if there
was an acquisition or disposal.

• Use the information available to determine

the cash received from an asset disposal:


Cash Flows from Financing Activities
• Financing activities affect the long-term

liability and equity accounts:
– Long-Term Notes Payable
– Bonds Payable
– Common Stock
– Retained Earnings

• If the amount of cash dividend payments

is not readily available, the Retained
Earnings account can be used to
determine dividend payments.


Net Change in Cash and Cash Balances

Activities
• The last step is to prepare the non-cash
investing and financing activities section.

Use free cash flow to

evaluate business
performance

How Do We Use Free Cash Flow to
Evaluate Business Performance?
• Investors want to know how much cash a
company can “free up” for new
opportunities.
• Free cash flow is the amount of cash
available from operating activities after
paying for planned investments in long-
term assets and after paying dividends.

How Do We Use Free Cash Flow to
Evaluate Business Performance?
• ShopMart expects net cash provided by
operations of $200,000. It plans to spend
$160,000 to modernize its retail facilities
and pays $15,000 in cash dividends.
• ShopMart’s free cash flow is $25,000:

($200,000 ‒ $160,000 ‒ $15,000)

Prepare the statement of

cash flows by the direct
method (Appendix 16A)

Prepared Using the Direct Method?
• The Financial Accounting Standards Board
(FASB) prefers the direct method of
reporting cash flows from operating
activities.
• This method provides clearer information
about the sources and uses of cash than
the indirect method.
• Only the operating section differs between
the two methods.

Cash Flows from Operating Activities
• Cash collections from customers:

Payments to Suppliers
• Cash paid for inventory is calculated as

follows:
• Cash paid for operating expenses is


Payments to Suppliers

Net Cash Provided by Operating
Activities
• To calculate net cash provided by
operating activities using the direct
method, we add all the cash receipts and
cash payments.
• Net cash provided by operating activities
is $70,000, which is the same amount
found under the indirect method.

Net Cash
Provided by
Operating
Activities

Preparing the Indirect

Statement of Cash Flows
Using a Spreadsheet
(Appendix 16B)

How Is the Statement of Cash Flows Prepared
Using the Indirect Method and a Spreadsheet?
• Most companies use a spreadsheet to

prepare the statement of cash flows.
• This statement starts with the beginning
balance sheet and concludes with the
ending balance sheet.
• Columns labeled “Transaction Analysis”
hold the data for the statement of cash
flows.



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Chapter 9

© 2016 Pearson Education, Ltd.

1. Define and explain common

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3. Apply the allowance

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Define and explain common

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• A receivable occurs when a business sells

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• Accounts receivable, also called trade

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• Notes receivable usually have longer

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• Any other type of receivable is considered

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• When the business collects cash from both

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Apply the direct write-off

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• Bad debts expense arises from failure to

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Apply the allowance method

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• The percent-of-sales method computes

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• Smart Touch Learning uses the percent-of-

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• The percent-of-receivables method

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• Assume on December 31, 2018, Smart Touch

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• The aging-of-receivables method is similar

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• The target balance of the Allowance for

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Account for notes

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• Interest is recorded based on the amount

• Interest rates are always annual.

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