302844 Flashcards
Select financial data for Alpha Corporation is shown below.
Alpha Corporation
SELECTED FINANCIAL DATA
As of December 31,
20X0 20X9 Cash $ 10,000 $ 80,000 Accounts receivable (net) 50,000 150,000 Merchandise inventory 90,000 150,000 Short-term marketable securities 30,000 10,000 Land and buildings (net) 340,000 360,000 Mortgage payable (no current portion) 270,000 280,000 Accounts payable (trade) 70,000 110,000 Short-term notes payable 20,000 40,000
Year Ended December 31,
20X0 20X9 Cash sales $1,800,000 $1,600,000 Credit sales 500,000 800,000 Cost of goods sold 1,000,000 1,400,000 Alpha’s current ratio at December 31, 20X0, is:
1.0 to 1.0.
0.7 to 1.0.
2.0 to 1.0.
0.5 to 1.0.
2.0 to 1.0.
The current ratio is computed as Current assets ÷ Current liabilities. There are no income statement components of the formula, so sales and cost of goods sold are not relevant here.
Of the assets presented, all but land and buildings are considered to be current assets. Of the liabilities presented, all but the noncurrent portion of the mortgage payable are considered to be current assets.
Therefore, the computation is as follows:
($10,000 + $50,000 + $90,000 + $30,000) Current Ratio = -----------------------------------------
($70,000 + $20,000)
$180,000 Current Ratio = ----------
$90,000
Current Ratio = 2.0:1.0
Accounts Payable
Accounts payable are obligations to suppliers of merchandise or of services purchased on open account, with payment usually due in 30 to 60 days.
Accounts Receivable
Accounts receivable are amounts the entity is entitled to receive that arise in the normal course of business (e.g., from the credit sales of goods or services). Receivables are claims against others for money, goods, or services, usually on “open” accounts after credit approval is granted. There is no formal written agreement, and they are usually classified as current assets. Normally, accounts receivable are expected to be received within 30 to 90 days. Accounts receivable are contrasted with notes receivable, which are of a longer term (e.g., 3 to 24 months) and accrue interest at a stated rate. Nontrade receivables are those that arise outside of the normal course of business (e.g., loans to employees or receivables from affiliated entities) and may be recorded net or gross. They are reported at net realizable value (i.e., the amount expected to be collected) and are offset by a valuation allowance account (a contra asset account).
Factors responsible for a net realizable value less than the amount billed are cash discounts, sales returns, and uncollectible amounts.
Current Ratio
The current ratio is a liquidity ratio that measures a firm’s ability to discharge currently maturing obligations from existing current assets that are expected to be converted into cash within the maturing period of the claims. Current ratio is a measure of short-term solvency; however, it is less precise than the quick ratio because a sizable amount of total current assets may be tied up in inventory, which is less liquid.
The computation is:
Current assets ÷ Current liabilities
Because balance sheet account totals are based on historical cost, which does not necessarily represent market value, the use of this ratio is limited.
Inventory
The aggregate of items of tangible personal property owned by the business (to which the firm has legal title) intended either for internal consumption in the production of goods for sale or for sale is considered inventory. The balance of costs applicable to goods on hand, including raw materials (for use in the production process), intermediate products and parts still in the production process (work-in-process), and finished goods is also considered inventory.
The major objective of accounting for inventories is to facilitate the determination of income. This is achieved through the proper valuation of inventories—the measurement of the value of the current assets and inventories, and the measurement of the related expense and cost of goods sold.
The basis of inventory accounting is cost. Inventories are valued at acquisition or production cost, which is generally held to be the sum of the purchase price plus indirect acquisition costs (freight, insurance, and handling) for purchased goods and the sum of direct materials, direct labor, and allocated factory overhead (i.e., the appropriate general and administrative costs that are clearly related to production) for manufactured goods. Selling, general, and administrative costs not directly related to production should be expensed rather than included in the valuation of inventory, which involves the use of judgment.
Standard costs may be used for inventory pricing so long as they are adjusted at reasonable intervals to reflect current conditions.
Valuation (pricing) of inventories involves:
determination of physical quantity (number of units) and
unit cost (in dollars).
Unit cost depends on the choice from among various alternative pricing (cost flow) assumptions:
last-in, first-out (LIFO),
first-in, first-out (FIFO),
weighted average, and
specific identification.
Consideration must also be given to the cost principle (i.e., the lower-of-cost-or-market rule (LCM)).
Inventories must be compiled periodically (physical count) and valued and compared to the amounts recorded in the accounts. Accounting records can be maintained under a periodic or perpetual system.
FASB ASC 330-10
SEE 2161.03
