Chapter 4 Section 1: Working Capital and Its Components Flashcards
Define working capital
Current assets - current liabilities
It measures solvency
Quick ratio
Cash+Net Receivables+Marketable Sec/Current liabilities
What is the relationship between the ratios and risk
As the ratio goes up, risk goes down
Can short term obligations expected to be refinanced be classified as a noncurrent liability?
GAAP: yes
IFRS: no
Define cash and cash equivalents
Short term highly liquid investments readily convertible to cash and with an original maturity of 90 days or less
How do you handle deposits in transit?
Add to bank
How do you handle outstanding checks?
Subtract from bank
How do you handle service charges?
Subtract from book
How do you handle bank collections?
Add to book
How do you handle NSF?
Subtract from book
How do you handle interest income?
Add to book
What is the true balance?
The adjusted book balance
Define net realizable value of accounts receivable
Balance of the A/R accounts adjusted for allowances for receivables that may be uncollectible, sales discounts, and sales returns and allowances.
What is the gross method of accounting for A/R?
It ignores discounts because it thinks they won’t take it. If they do take it, debit a sales discount account.
What is the net method of accounting for A/R?
It takes the discount right away because it believes customers will use it. If they don’t, credit a sales discount not taken account.
What are trade discounts and how are they applied?
They are quantity discounts. They are applied sequentially.
What are the two methods of accounting for uncollectible accounts receivable?
Which is GAAP?
Direct write-off and allowance
Allowance
Explain the direct write-off method
A/R is written off and the bad debt is recognized when the account becomes uncollectible.
Explain the allowance method
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.
What are the three estimates for the allowance method?
Percentage of Sales
Percentage of A/R at Year End
Aging
Define factoring
A company converts its receivables into cash by assigning them to a factor, either with or without recourse.
Define factoring without recourse
This is a true sale. The factor assumes the risk of loss on collections.
Define factoring with recourse
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.
How are notes receivable stated?
PV of FCF
What if the note receivable has no interest, or an interest rate below the market rate?
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
Define discounting a note receivable
The holder endorses the note with or without recourse to a third party and receives a sum of cash.
Define discounting without recourse
The holder assumes no further liability.
