Chapter 5

Question 1

What are short term investments called?

Answer 1

Marketable Securities

Question 2

How long can companies hold short term investment and what does it allow companies to do?

Answer 2

These are investments that a company plans to hold for one year or less. They allow the company to invest cash for a short period of time and earn a return until the cash is needed

Question 3

When do companies report short term investments and why?

Answer 3

Short-term investments are the next-most-liquid asset after cash. This is why companies report short-term investments immediately after cash and before receivables on the balance sheet

Question 4

Name 3 categories of short term investments

Answer 4

A short-term investment falls into one of three categories: (1) trading investments (2) available-for-sale investments (covered in chapter 10) (3) held-to-maturity investments.

Question 5

What is the purpose of trading investment? & what form can a T.I. be ?

Answer 5

The purpose of owning a trading investment is to hold it for a short time and then sell it for more than its cost. Trading investments can be the stock of another company.

Question 6

Example of trading investment

Answer 6

Suppose a company purchases stock, intending to sell the stock within a few months. If the market value of the stock increases, the company will have a gain; if the stock price drops, the company will have a loss. The company may also receive dividend revenue from its investment.

Question 7

What is an unrealized gain or loss?

Answer 7

The difference between an investment’s market value and cost is an unrealized gain or loss.

Question 8

What is a trading investment?

Answer 8

Selling price > cost = Gain

Selling price < cost = Lost

Question 9

What is the difference between realized and unrealized?

Answer 9

(Realized) Investment sold to third party
Gain or loss = difference between selling price and cost
Word “realized” usually dropped from title

(Unrealized)
Company still owns investment
Gain or loss = difference between market value and cost
Word “unrealized” is kept in account title

Question 10

How is a Trading Investment reported on balance sheets?

Answer 10

Trading Investment
Reported at current market value
Listed directly under “cash” in the current asset section

On the balance sheet, trading investments at their current market value. They appear on the balance sheet in the current asset section immediately after cash because short-term investments are almost as liquid as cash.

Question 11

How is a Trading investment reported on Income statement?

Answer 11

Gains and losses
From sales of investments

Investment revenue
From dividends or interest earned

Unrealized gain or loss
From entry to adjust to market value

Question 12

Information about Trading Investments on Income Statements

Answer 12

On the income statement, there can be up to three accounts related to trading investments. If trading investments are sold during the period, a gain or loss will be incurred. Investments also can earn interest revenue and dividend revenue. If the company has any trading investment at the end of the period, the entry to adjust to market will result in an unrealized gain or loss. For trading investments these three items are reported on the income statement as Other revenue, gains, and (losses) section.

Question 13

Two facts about Receivables

Answer 13

Monetary claims against others

Third most liquid asset

Question 14

Difference between Accounts and Notes Receivables

Answer 14

Accounts Receivable
Amounts owed by customers for selling goods or services
Notes Receivable
Lending money to outsiders
More formal than accounts receivable

Question 15

How do you account for uncollectible receivables?

Why is extending credit to customers a risk?

Answer 15

Risk: Some customers do not pay the amount owed

Cost: Uncollectible accounts

Question 16

What is the best way to measure bad debts? And describe the method.

Answer 16

Allowance method

This method records collection losses based on estimates based upon the company’s collection experience. Companies don’t wait to see which customers will not pay. Instead, they record the estimated amount as Uncollectible-Account Expense and also sets up Allowance for Uncollectible Accounts.

Question 17

What are other titles for bad debt?

Answer 17

Other titles for this account are Allowance for Doubtful Accounts and Allowance for Bad Debts.

This is a contra account to Accounts Receivable. The allowance shows the amount of the receivables the business expects not to collect.

Question 18

What is a contra asset? And what is it always paired with?

Answer 18

A contra-asset is recorded that reduces accounts receivable on the balance sheet

A contra-asset is always paired
with an asset and reduces
its balance

Question 19

What is the allowance method?

Answer 19

Amount of uncollectible accounts is estimated

An expense is recorded as part of the adjusting process

Question 20

What are the two methods to estimate uncollectibles?

Answer 20

The best way to estimate uncollectibles uses the company’s history of collections from customers.

There are two basic ways to estimate uncollectibles: (1) Percent-of-sales-method (2) Aging-of-receivables method.

Question 21

What is Percent of Sales ? And what approach do you take?

Answer 21

Expense is estimated based on credit sales

Income Statement approach

Question 22

What is aging-of-receivables? And what approach do you take?

Answer 22

Accounts receivable analyzed based on how long outstanding

Balance Sheet approach

Question 23

Describe the percent of sales method and why it takes the income statement approach?

Answer 23

The percent-of-sales method computes uncollectible-account expense as a percent of revenue. This method takes an income statement approach because it focuses on the amount of expense to be reported on the income statement.

Question 24

Describe aging of receivables and why it takes the balance-sheet approach?

Answer 24

The other popular method for estimating uncollectibles is called aging-of-receivable. This method is a balance-sheet approach because it focuses on accounts receivable. In the aging method, individual receivables from specific customers are analyzed based on how long they have been outstanding.

Question 25

What are the differences between the two uncollectible account methods?

Answer 25

The percent-of-sales method computes uncollectible accounts expense without regard to the balance in the allowance for uncollectible accounts. The aging method, on the other hand, focuses on the amount of receivables that are not likely to be collected. Then, adjusts the allowance to equal that amount.

Question 26

What does management do when they decide that a specific amounts receivable is uncollectible?

What is the purpose of the Allowance for Uncollectible Accounts?

When do you adjust the allowance?

Describe the entry to record the write off.

Answer 26

When management decides that a specific accounts receivable is uncollectible, the account is “written off”.

The purpose of the Allowance for Uncollectible Accounts is to absorb these write offs.

The Allowance is adjusted at the end of one year, so it can be used the following year for actual accounts receivable that are uncollectible.

The entry to record the write off has a debit to the Allowance and a credit to the customer’s accounts receivable.

Question 27

What is the direct write-off method?

What happens under the direct write-off method?

What doesn’t this method use?

Answer 27

Away to account for uncollectible receivables.

Under the direct write-off method, the company waits until a specific customer’s receivable proves uncollectible. Then the accountant writes off the customer’s account and records Uncollectible-Account Expense.

Question 28

What doesn’t a direct write off use? And what happens as a result?

Answer 28

The direct write-off method uses no allowance for uncollectibles.

As a result, receivables are always reported at their full amount, which is more than the business expects to collect. Assets on the balance sheet are overstated.

Question 29

Creditor

Answer 29

Party to whom money is owed, lender

Question 30

Debtor

Answer 30

Party that owes money, borrower

Question 31

Interest

Answer 31

Interest is the cost of borrowing money. The interest is started in an annual percentage rate.

Question 32

Maturity date

Answer 32

The date on which the debtor must pay the note

Question 33

Principal

Answer 33

The amount of money borrowed by the debtor

Question 34

Term

Answer 34

The length of time for which the note was signed by the debtor

Question 35

How do you record for notes receivables?

Answer 35

Notes Receivable has $ under Debit

Cash has $ under credit