2.1 Flashcards
Cash equivalents
Highly liquid investments that are readily convertible into cash and have maturities of three months or less from the date of purchase by the entity. Common examples are Treasury bills, commercial paper, and money market funds
Post Dated Check
The postdated check is neither cash nor cash equivalent. The item should be treated as a receivable. It is not cash until the date written on the check.
On October 31, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15 payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance.
How should these accounts be reported in Dingo’s October 31 classified balance sheet?
The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
Items that affect Book Balance
NSF
Bank Service Fees
Adjustments
Items that affect Bank Balance
DIT
O/S Checks
On June 1, 2005, Pitt Corp. sold merchandise with a list price of $5,000 to Burr on account. Pitt allowed trade discounts of 30% and 20%.
Credit terms were 2/15, n/40 and the sale was made FOB shipping point. Pitt prepaid $200 of delivery costs for Burr as an accommodation.
On June 12, 2005, Pitt received from Burr a remittance in full payment amounting to
The answer $2,744 is incorrect only because the $200 shipping charges are omitted.
The goods were shipped FOB shipping point. Therefore, title transferred to Burr at the shipping point, meaning Burr bears the shipping charges. Because Pitt prepaid them as an accommodation, Burr must reimburse Pitt for the $200.
The final calculation is: $5,000(1 - .30)(1 - .20)(.98) + $200 = $2,944.
Alfisol, Inc. offers sales discounts of 2% on all credit sales paid within 15 days. For year 1, gross credit sales totaled $150,000 and 75% of Alfisol’s customers took advantage of the discount. Under the net method
For cash receipts after the discount period, discounts not taken must be credited for $750.
Under net method, everything is already calculated net of discounts. Discount not taken is recorded.
Red Co. had $3 million in accounts receivable recorded on its books. Red wanted to convert the $3 million in receivables to cash in a more timely manner than waiting the 45 days for payment as indicated on its invoices. Which of the following would alter the timing of Red’s cash flows for the $3 million in receivables already recorded on its books?
Factor the receivables outstanding.
Factoring is a sale of receivables. This allows Red Co. to sell the receivables and receive cash immediately upon sale.
After being held for 40 days, a 120-day, 12% interest-bearing note receivable was discounted at a bank at 15%. The proceeds received from the bank equal
e bank charges its discount (its fee) on the maturity value, which is the face value of the note plus 12% interest for 120 days. The bank charges 15% on this amount for the 80 remaining days in the note term. Thus, the proceeds equal the maturity value less its fee.
Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:
8% 3.992
9% 3.890
What should be the total interest revenue earned by King on this note?
Total interest over the life of the note equals the total amount paid by Ace over the life of the note less the proceeds to Ace. The proceeds equal the present value of the payments at the 9% yield rate. The annual payment is found using the 8% rate because that rate is contractually set and determines the annual payment.
The annual payment P is found as: $20,000 = P(3.992). P = $5,010
Total interest revenue = total payments by Ace - proceeds to Ace
= 5($5,010) − $5,010(3.89) = $5,560.
Roth, Inc. received from a customer a one-year, $500,000 note bearing annual interest of 8%. After holding the note for six months, Roth discounted the note at Regional Bank at an effective interest rate of 10%. What amount of cash did Roth receive from the bank?
This answer incorrectly computes the discount to the bank. The correct approach is:
Maturity value of the note: $500,000(1.08) $540,000
Less discount to the bank: $540,000(.10)(6/12) (27,000)
Equals proceeds to Roth $513,000
On July 1, 2005, Lee Co. sold goods in exchange for a $200,000, 8-month, noninterest-bearing note receivable. At the time of the sale, the note’s market rate of interest was 12%.
What amount did Lee receive when it discounted the note at 10% on September 1, 2005?
This answer uses an incorrect combination of interest rates and periods in computing the proceeds.
The correct analysis is:
Maturity value of note: $200,000
Less discount: $200,000(.10)(6/12) (10,000)
Equals proceeds on note $190,000
On November 1, 2004, Davis Co. discounted with recourse at 10%, a one-year, noninterest-bearing, $20,500 note receivable maturing on January 31, 2005.
What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, 2004?
The firm is contingent for the maturity amount, which for a noninterest-bearing note is the face value. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.
On November 1, 2004, Davis Co. discounted with recourse at 10%, a one-year, noninterest-bearing, $20,500 note receivable maturing on January 31, 2005.
What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, 2004?
Notes discounted with recourse create contingent liabilities. If the maker of the note fails to pay the bank or financial institution with whom Davis discounted the note, Davis would be called on to pay the entire maturity amount.
Milton Co. pledged some of its accounts receivable to Good Neighbor Financing Corporation in return for a loan. Which of the following statements is correct?
In a pledge or receivables, title to the receivables does not pass from the originator.
On April 1, Aloe, Inc. factored $80,000 of its accounts receivable without recourse. The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables. What amount of cash did Aloe receive from the factored receivables?
The net cash received when the receivables were factored was $80,000 × .85 (100% - 10% - 5%) = $68,000.
