MODULE 5
Primary Current Assets
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Cash
Accounts Receivable*
Inventory*
Prepaid Expenses
*Focus in this module.
ASSETS ON THE BALANCE SHEET
Assets = Liabilities + Owners’ Equity
Reminder:
Assets appear on
the Balance Sheet.
Asset Categories
 Current Assets - Expected to be realized in cash, sold,
or used up within one year.
 Investments - Securities or property held longer than
one year for the purpose of enhancing income.
 Fixed Assets - Property, plant and equipment used in
business.
 Intangibles - Lack physical existence.
 Other assets – do not fit in above categories
Assets
2
ACCOUNTS RECEIVABLE
Example Transactions
Sale on Account: During December of 20X1, the company
sold $1,000,000 of goods “on account.” Entry:
Accounts Receivable (BS) $1,000,000
Sales Revenues (IS)
$1,000,000
Collection: During December 20X1, $500,000 was collected.
Cash (BS)
$500,000
Accounts Receivable (BS)
$500,000
Estimate Bad Debt: At year end, there is $500,000 of
receivables outstanding. Two percent are expected to be
uncollectible. (2% of $500,000 = $10,000)
Bad Debt Expense (IS)
$10,000
Allowance for Bad Debt
$10,000
= Net Receivables
= Gross Receivables – Allowance for Bad Debt
= $500,000 – $10,000
= $490,000
Write Off: $5,000 was deemed uncollectible.
Allowance for Bad Debt
Accounts Receivable
$5,000
$5,000
In real life, this is not pleasant. It is usually
the result of bankruptcy or heated argument
in which a business relationship is ended.
Assets
3
ACCOUNTS RECEIVABLE
Determining the Allowance Amount
Bad debt allowance is estimated by aging receivables currently
outstanding.
Assumption: Older receivables are less likely to be collected.
The accounts receivable are aged as follows:
< 30 days
30-59 days
60-90 days
> 90 days
Total
Gross
Amount
Probability
Not Collected
$80,000
$15,000
$4,000
$1,000
$100,000
2%
5%
15%
40%
Considered
Uncollectible
$1,600
$750
$600
$400
$3,350
In statistics, this is known
as probability analysis.
Unlike fine wines and
cheese, receivables do not
improve with age.
Assets
4
ACCOUNTS RECEIVABLE
Disclosures Related to Receivables
Ingersoll-Rand Company
ON THE BALANCE SHEET
ASSETS (in millions)
Current assets:
2005
$880.6
156.5
2004
$1,703.1
0.6
1,679.0
1,128.8
403.3
$4,248.2
1,498.4
1,058.8
348.8
$4,609.7
December 31,
Cash and cash equivalents
Marketable securities
Accounts receivable, less allowance
of $47.6 in 2005 and $70.1 in 2004
Inventories
Prepaid expenses
Total current assets
Gross receivables for 2005 is
$1,726.6 ($1,679.0 + $47.6)
IN THE NOTES (back of the annual report)
Receivables Reserves (in millions)
Years Ended December 31,
2005
Balance at beginning of year
$70.1
Additions – Bad Debt Expense
0.8
Deductions – Write-offs
-21.0
Currency Translation
-2.3
Balance at end of year
$47.6
2004
$58.7
21.0
-13.1
3.5
$70.1
2003
$58.1
24.4
-26.5
2.7
$58.7
Is IR good at estimating bad debt? Over a three year period, they
wrote off $60.6 million and expensed $46.2 million.
Assets
5
INVENTORY
Inventory Relationships
Purchases
Inventory
Goods Sold
Increase Inventory
(Stored in Warehouse)
Decrease Inventory
Inventory processed during the period is accounted for in
the following way:
Beginning Inventory
+ Purchases
Goods Available for Sale
- Ending Inventory
Cost of Goods Sold
On the
balance sheet
On the
income
statement
Remember:
 Ending inventory is on the balance sheet as a current asset.
 Cost of goods sold appears on the income statement.
 This year’s ending inventory is next year’s beginning inventory.
Assets
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INVENTORY
Cost Flow Assumptions
Specific Identification – directly matches cost to the
physical flow of inventory.
Methods in which the cost method may not match
the physical flow of inventory:
First-In, First-Out (FIFO) – first items acquired are
assumed to be the first items sold.
Last-In, First-Out (LIFO) – most recent items acquired
are assumed to be the first items sold.
Average Cost – inventory and cost of goods sold are
determined by averaging costs of goods available for
sale and ending inventory.
Purchases
Cost of
Goods Sold
Ending
Inventory
 IFRS standards do not allow LIFO.
Assets
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INVENTORY
Cost Flow Assumptions
Bought six items in inventory in the following order:
$4
$4
$5
$5
$6
$6
SALES
Sold four items for $10 each during the period (Sales = 4 X $10
= $40).
Sold
Not Sold
FIFO COST OF GOODS SOLD
Under FIFO, Cost of Goods Sold = $4 + $4 + $5 + $5 = $18
$4
$4
$5
$5
$6
$6
Inventory = $6 + $6 = $12
Sales
- CoGS
Income
$40
- $18
$22
LIFO COST OF GOODS SOLD
Under LIFO, Cost of Goods Sold = $6 + $6 + $5 + $5 = $22
$4
$4
$5
$5
Inventory = $4 + $4 = $8
$6
$6
Sales
- CoGS
Income
$40
- $22
$18
During inflationary times, which method yields higher income?
Why might companies use LIFO?
Assets
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INVENTORY
Inventory Disclosure
DEERE & CO.
Inventory Note
Most inventories owned by Deere & Company and its United States
equipment subsidiaries are valued at cost, on the “last-in, first-out”
(LIFO) basis. Remaining inventories are generally valued at the lower of
cost, on the “first-in, first-out” (FIFO) basis, or market. The value of
gross inventories on the LIFO basis represented 60 percent and 61
percent of worldwide gross inventories at FIFO value on October 31,
2006 and 2005, respectively.
If all inventories had been valued on a FIFO basis, estimated inventories
by major classification at October 31 in millions of dollars would have
been as follows:
Raw materials and supplies
Work-in-process
Finished machines and parts
Total FIFO value
Less adjustment to LIFO value
Inventories
2006
$712
372
2,013
3,097
1,140
$1,957
2005
$716
425
2,126
3,267
1,132
$2,135
The LIFO Reserve
Amount on the balance
sheet (at LIFO)
Assets
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