Chapter 4 Section 1: Working Capital and Its Components

Question 1

Define working capital

Answer 1

Current assets - current liabilities

It measures solvency

Question 2

Quick ratio

Answer 2

Cash+Net Receivables+Marketable Sec/Current liabilities

Question 3

What is the relationship between the ratios and risk

Answer 3

As the ratio goes up, risk goes down

Question 4

Can short term obligations expected to be refinanced be classified as a noncurrent liability?

Answer 4

GAAP: yes
IFRS: no

Question 5

Define cash and cash equivalents

Answer 5

Short term highly liquid investments readily convertible to cash and with an original maturity of 90 days or less

Question 6

How do you handle deposits in transit?

Answer 6

Add to bank

Question 7

How do you handle outstanding checks?

Answer 7

Subtract from bank

Question 8

How do you handle service charges?

Answer 8

Subtract from book

Question 9

How do you handle bank collections?

Answer 9

Add to book

Question 10

How do you handle NSF?

Answer 10

Subtract from book

Question 11

How do you handle interest income?

Answer 11

Add to book

Question 12

What is the true balance?

Answer 12

The adjusted book balance

Question 13

Define net realizable value of accounts receivable

Answer 13

Balance of the A/R accounts adjusted for allowances for receivables that may be uncollectible, sales discounts, and sales returns and allowances.

Question 14

What is the gross method of accounting for A/R?

Answer 14

It ignores discounts because it thinks they won’t take it. If they do take it, debit a sales discount account.

Question 15

What is the net method of accounting for A/R?

Answer 15

It takes the discount right away because it believes customers will use it. If they don’t, credit a sales discount not taken account.

Question 16

What are trade discounts and how are they applied?

Answer 16

They are quantity discounts. They are applied sequentially.

Question 17

What are the two methods of accounting for uncollectible accounts receivable?
Which is GAAP?

Answer 17

Direct write-off and allowance

Allowance

Question 18

Explain the direct write-off method

Answer 18

A/R is written off and the bad debt is recognized when the account becomes uncollectible.

Question 19

Explain the allowance method

Answer 19

It is based on past experience. The amount uncollectible is expensed and put in an allowance account, and when the specific account is written off you take it out of the allowance account and lower A/R.

Question 20

What are the three estimates for the allowance method?

Answer 20

Percentage of Sales
Percentage of A/R at Year End
Aging

Question 21

Define factoring

Answer 21

A company converts its receivables into cash by assigning them to a factor, either with or without recourse.

Question 22

Define factoring without recourse

Answer 22

This is a true sale. The factor assumes the risk of loss on collections.

Question 23

Define factoring with recourse

Answer 23

This can be a sale or a loan. The factor has an option to re-sell any uncollectible receivables back to the seller.
If a sale, make the JE
If a loan, disclose in footnotes.

Question 24

How are notes receivable stated?

Answer 24

PV of FCF

Question 25

What if the note receivable has no interest, or an interest rate below the market rate?

Answer 25

The value of the note should be determined by imputing the market rate of interest and determining the value of the promissory note by using the effective interest method

Question 26

Define discounting a note receivable

Answer 26

The holder endorses the note with or without recourse to a third party and receives a sum of cash.

Question 27

Define discounting without recourse

Answer 27

The holder assumes no further liability.