303 Exam 2- CH. 6

Question 1

cash equivalents are

Answer 1

short-term, highly liquid investments; Generally, only investments with original maturities of three months or less qualify

Question 2

Restricted cash is

Answer 2

held by a company for a specific purpose and is therefore not available for immediate general use. Petty cash, payroll, and dividend funds are examples of cash set aside for a particular purpose.

Question 3

Compensating balances against short-term borrowings should be reported in current assets as “cash and cash equivalents.”

Question 4

Compensating balances against long-term borrowings should be reported as noncurrent assets in either the investments or other assets sections, using a caption such as “Cash on deposit maintained as compensating balance.”

Question 5

Nontrade receivables rise from a variety of transactions outside the normal course of business. Some examples of nontrade receivables are as follows.

Answer 5

Advances to officers, employees, and subsidiaries.
Deposits paid to cover potential damages or losses, or as a guarantee of performance or payment.
Dividends and interest receivable.
Claims against insurance companies for casualties sustained, for tax refunds, or for damaged or lost goods.

Question 6

Transaction Price

Answer 6

is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods or services.

Question 7

Companies use such trade discounts to avoid frequent changes in catalogs, to alter prices for different quantities purchased, or to hide the true invoice price from competitors. Trade discounts are commonly quoted in percentages.

Question 8

Cash discounts are generally presented in terms such as 2/10, n/30 (2% discount if paid within 10 days, gross amount due in 30 days),

Question 9

The Sales Returns and Allowances account is a contra account to Sales Revenue. Sales Returns and Allowances will be deducted from Sales Revenue on the income statement to arrive at net sales. The Returned Inventory account is used to separate returned inventory from regular inventory.

Question 10

Two methods are used in accounting for uncollectible accounts: (1) the direct write-off method and (2) the allowance method. The direct write-off method, which records bad debt expense at the time a specific customer account is deemed uncollectible, is often used for tax purposes, but it is not allowed under GAAP unless the amount uncollectible is immaterial. The allowance method is acceptable under GAAP and is the method we will focus on in this section.

Answer 10

(1) the direct write-off method and (2) the allowance method.

Question 11

The direct write-off method,

Answer 11

which records bad debt expense at the time a specific customer account is deemed uncollectible, is often used for tax purposes, but it is not allowed under GAAP unless the amount uncollectible is immaterial

Question 12

The allowance method

Answer 12

is acceptable under GAAP and is the method we will focus on in this section.

Question 13

Supporters of the direct write-off-method contend that it records facts, not estimates. It assumes that a good account receivable resulted from each sale, and that later events revealed certain accounts to be uncollectible and worthless. From a practical standpoint, this method is simple and convenient to apply. However, the direct write-off method is theoretically deficient.

It usually fails to record expenses in the same period as associated revenues.
Receivables are not stated at the net amount expected to be collected on the balance sheet.

As a result, using the direct write-off method is not considered appropriate, except when the amount uncollectible is immaterial.

Question 14

The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period.

Answer 14

This ensures that companies state receivables on the balance sheet at the net amount expected to be collected, which is gross accounts receivable less estimated uncollectible accounts.
Companies estimate uncollectible accounts using information about past and current events as well as forecasts of future collectability.

Question 15

Restricted Cash

Answer 15

held by a company for a specific purpose and is therefore not available for immediate general use; petty cash, payroll, and dividend funds

Question 16

compensating balances against short term borrowings should be reported in current assets

Answer 16

as “cash and cash equivalents”

Question 17

compensating balances against long term borrowings should be reported in noncurrent assets

Answer 17

“cash on deposit maintained as compensating balance”

Question 18

Nontrade receivables

Answer 18

1. advances to officers, employees, and subsidiaries
2. Deposits paid to cover potential damages or loses, or as a guarantee of performance or payment
3. Dividends and interest receivable
4. Claims against insurance companies for casualties sustained, for tax refunds, or for damaged or lost goods

Question 19

transaction price

Answer 19

the amount of consideration that a company expects to receive from a customer in exchange for transferring goods or services

Question 20

trade discounts

Answer 20

used to avoid frequent changes in catalogs, alter prices for different quantities purchased, or hide the true invoice price from competitors

Question 21

sales discount

Answer 21

2/10, n/30 - 2% discount if paid within 10 days, gross amount due in 30

Question 22

Recording sales discount

Answer 22

under gross method, a company recognizes the receivable and related revenue at the invoice price

under net method, a company recognizes the accounts receivable and related revenue at the invoice price less the cash discount

Question 23

Sales Returns and Allowances

Answer 23

contra asset to sales revenue

Question 24

at the date of sale, both sales revenue and AR are recorded at their gross amounts without consideration of sales returns and allowances

Answer 24

at the end of the reporting period, adjusting entries are made, resulting in both sales revenues and AR being reported at net amounts, which reflect actual and estimated returns and allowances

Question 25

2 methods used in accounting for uncollectible accounts:

Answer 25

1. direct write-off method 2. allowance method

Question 26

direct write-off method

Answer 26

records bad debt expense at the time a specific customer account is deemed uncollectible, but is not allowed under GAAP; records fact not estimates

Question 27

allowance method

Answer 27

acceptable under GAAP and we focus on this one

Question 28

if an amount is uncollectible

Answer 28

company charges the loss to Bad Debt Expense

Question 29

direct write off deficiencies

Answer 29

usually fails to record expenses in the same period as associated revenues receivables are not stated at the net amount expected to be collected on the balance sheet only appropriate when amount uncollectible is immaterial

Question 30

allowance method

Answer 30

estimates uncollectible amounts at end of period

Question 31

net amount expected to be collected

Answer 31

gross accounts receivable less estimated uncollectible accounts

Question 32

FASB requires the allowance method for financial reporting when bad debts are material

Question 33

allowance method has 3 features

Answer 33

1. companies estimate uncollectible accounts receivable and compare the new estimate to the current balance in the allowance account 2. companies debt estimated increases in uncollectibles to Bad Debt Expense and credit them to Allowance for doubtful Accounts through an adjusting entry end of period 3. when companies write off a specific customer account they debit actual uncollectibles to allowance for doubtful accounts and credit that amount to accounts receivable

Question 34

reasons for using an allowance

Answer 34

Companies do not know which customers will not pay in the future; therefore, they cannot make a direct credit to Accounts Receivable for the estimate. The credit goes to the allowance account which is a contra account to Accounts Receivable. The credit balance in the allowance account will absorb the specific customer write-offs when they occur in the future.

Question 35

The entry to record the write-off of an uncollectible account reduces both Accounts Receivable and Allowance for Doubtful Accounts.

Question 36

The write-off of the account reduces both Accounts Receivable and Allowance for Doubtful Accounts. Cash realizable value in the balance sheet, therefore, remains the same

Question 37

Occasionally, a company collects from a customer after it has written off the account as uncollectible. The company makes two entries to record the recovery of a bad debt.

Answer 37

1. It reverses the entry made in writing off the account. This reinstates the customer’s account. 2. It journalizes the collection in the usual manner.

Question 38

Companies may apply the percentage-of-receivables approach using one composite rate, or percentage, that reflects an estimate of the uncollectible receivables.

Answer 38

Or, companies may set up an aging schedule of accounts receivable, which applies a different percentage based on past experience to the various age categories.

Question 39

the percentage-of-receivables basis provides an estimate of the cash realizable value of the receivables. It also provides a reasonable matching of expenses (bad debt) to revenue (sales). The FASB employs a current expected credit loss (CECL) model that requires companies to measure expected uncollectible accounts and record bad debt expense on all receivables.

Question 40

A note receivable is supported by a formal promissory note, a written promise to pay a certain sum of money at a specific future date.

Question 41

all notes contain an interest element because of the time value of money, companies classify them as interest-bearing or non-interest-bearing as follows. Interest-bearing notes have a stated rate of interest. Zero-interest-bearing notes (non-interest-bearing) include interest as part of their face amount.

Answer 41

Interest-bearing notes have a stated rate of interest. Zero-interest-bearing notes (non-interest-bearing) include interest as part of their face amount.

Question 42

 Notes receivable are considered fairly liquid, even if long-term, because companies may easily convert them to cash (although they might pay a fee to do so).

Question 43

the interest rates that are involved when determining the present value:

Answer 43

Stated (nominal or face) interest rate- The interest rate written into the notes receivable contract. The stated rate represents the cash rate of interest paid by the borrower. Effective-interest rate (market rate or effective yield)- The interest rate used in the market to determine the value of the note, also referred to as the discount rate used to determine present value.

Question 44

when the stated interest rate on an interest bearing note equals the effective interest rate

Answer 44

the note sells for face value

Question 45

When the two interest rates are not equal, the present value of the note will be different from the face value of the note.

Answer 45

Companies then record this difference, either a discount or a premium, and amortize it over the life of a note to approximate the effective (market) interest rate.

Question 46

Zero-interest-Bearing Notes

Answer 46

the cash received by the borrower when the note is first executed is less than face value, but the borrower must pay back the full face value on the maturity date

Question 47

if a company receives a zero-interest-bearing note

Answer 47

its present value is the cash paid to the borrower

Question 48

Discount on Notes Receivable

Answer 48

contra asset to notes receivable

Question 49

effective-interest method

Answer 49

carrying value of the note is multiplies by the implied interest rate to determine the amount of interest revenue for the period

Question 50

When the present value exceeds the face value, which means the stated rate is greater than the effective rate, the note is exchanged at a premium.

Answer 50

Companies record the premium on a note receivable as a debit and amortize it using the effective-interest method over the life of the note as annual reductions in the amount of interest revenue recognized. Therefore, in a premium situation, the recorded interest revenue will always be less than the cash interest received.

Question 51

When a note is received in exchange for property, goods, or services in a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless:

Answer 51

1. No interest rate is stated, or 2. The stated interest rate is unreasonable, or 3. The face amount of the note is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument. In these circumstances, the company measures the present value of the note by the fair value of the property, goods, or services or by an amount that reasonably approximates the fair value of the note.

Question 52

to estimate the present value if company cannot determine fair value

Answer 52

Approximate an applicable interest rate that may differ from the stated interest rate. This process of interest-rate approximation is called imputation and results in an imputed interest rate. Determine the imputed interest rate when it receives the note. The company ignores any subsequent changes in prevailing interest rates.

Question 53

Factors

Answer 53

companies that buy receivables for a fee and then collect the payments directly from customers

Question 54

sale of receivables can be arranged in 2 ways

Answer 54

Sale without recourse. This means that the factor assumes the credit-risk of some customers not paying their accounts receivable balance. Sale with recourse. This means that if a receivable becomes uncollectible, you will be responsible. It follows that a factor will charge you more for the without recourse approach, because the factor is taking on more risk by being responsible for any bad debts.

Question 55

In nonrecourse transactions

Answer 55

1. Debits Cash for the proceeds and credits Accounts Receivable for the face value of the receivables. 2. Recognizes the difference, reduced by any provision for probable adjustments (discounts, returns, allowances, etc.), as Loss on Sale of Receivables. 3. Uses a Receivable from Factor account (reported as a receivable) to account for the proceeds retained by the factor to cover probable sales discounts, sales returns, and sales allowances.

Question 56

The with recourse basis means that EBC will have to guarantee payment to Blue Line if any of the accounts receivable sold become uncollectible.

Answer 56

In other words, you are going to have to recognize a liability related to possible losses on uncollectible accounts

Question 57

other reasons to sell receivables

Answer 57

For competitive reasons, providing sales financing for customers is virtually mandatory in many industries. In the sale of durable goods, such as automobiles, trucks, industrial and farm equipment, computers, and appliances, most sales are on an installment contract basis. Many major companies in these industries have created wholly owned subsidiaries specializing in receivables financing. For example, Ford has Ford Motor Credit, and John Deere has John Deere Credit. The holder may sell receivables because money is tight and access to normal credit is unavailable or too expensive. A company may sell its receivables, instead of borrowing, to avoid violating existing lending agreements. Billing and collection of receivables are often time-consuming and costly. Credit card companies such as MasterCard, Visa, American Express, Diners Club, Discover, and others take over the collection process and provide merchants with immediate cash

Question 58

for a sale to occur,

Answer 58

1. The receivables have been isolated from EBC (put beyond the reach of EBC and its creditors). 2. Blue Line has the right to pledge or exchange either the receivables or beneficial interest in the receivables. 3. EBC does not maintain effective control over the receivables through an agreement to repurchase or redeem them before maturity.

Question 59

The general rules in classifying receivables are as follows.

Answer 59

1. Separate the different types of receivables that a company possesses, if material. 2. Appropriately offset the valuation accounts against the proper receivable accounts. 3. Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer. 4. Disclose any loss contingencies that exist on the receivables. 5. Disclose any receivables designated or pledged as collateral. 6. Disclose the nature of credit risk inherent in the receivables, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses.

Question 60

companies must provide the following disclosures about receivables on a disaggregated basis.

Answer 60

1. A roll-forward schedule of the allowance for doubtful accounts from the beginning of the reporting period to the end of the reporting period. 2. The nonaccrual status of receivables by class of receivables. Lenders classify loans as nonaccrual loans when payment is 90 days or more overdue. Because of the overdue status of the receivable, interest is no longer accruing on the outstanding balance. 3. Impaired receivables by type of receivable.

Question 61

companies should disclose credit quality indicators and the aging of past due receivables

Question 62

Companies must disclose concentrations of credit risk for all financial instruments (including receivables). Concentrations of credit risk exist when receivables have common characteristics that may affect their collection. These common characteristics might be companies in the same industry or same region of the country. Financial statement users want to know if a substantial amount of receivables from such sales are to customers facing uncertain economic conditions (see Global View). No numerical guidelines are provided as to what is meant by a “concentration of credit risk."

Question 63

The accounts receivable turnover measures the number of times, on average, a company collects receivables during the period.

Answer 63

The ratio is computed by dividing net sales by average (net) accounts receivable outstanding during the year.