Chapter 5: Accounting for and Presentation of Current Assets

Question 1

operating cycle

Answer 1

The average time needed for a firm to convert an amount invested in inventory back to cash. For most firms, the operating cycle is measured as the average number of days to produce and sell inventory, plus the average number of days to collect accounts receivable.

Question 2

cash

Answer 2

A company’s most liquid asset; includes money in change funds, petty cash, undeposited receipts such as currency, checks, bank drafts, and money orders, and funds immediately available in bank accounts.

Question 3

petty cash

Answer 3

A fund used for small payments for which writing a check is inconvenient.

Question 4

cash equivalents

Answer 4

Short-term, highly liquid investments that can be readily converted into cash with a minimal risk of price change due to interest rate movements; examples include U.S. Treasury securities, bank CDs, money market funds, and commercial paper.

Question 5

commercial paper

Answer 5

A short-term security usually issued by a large, creditworthy corporation.

Question 6

internal control system

Answer 6

Policies and procedures designed to provide reasonable assurance that objectives are achieved with respect to

1. The effectiveness and efficiency of the operations of the organization.
2. The reliability of the organization’s financial reporting.
3. The organization’s compliance with applicable laws and regulations.

Question 7

financial controls

Answer 7

Features of the internal control system that emphasize accuracy of bookkeeping and financial statements and protection of assets.

Question 8

administrative controls

Answer 8

Features of the internal control system that emphasize adherence to management’s policies and operating efficiency.

Question 9

bank reconciliation

Answer 9

The process of bringing into agreement the balance in the Cash account in the company’s ledger and the balance reported by the bank on the bank statement.

Question 10

deposit in transit

Answer 10

A bank deposit that has been recorded in the company’s cash account but that does not appear on the bank statement because the bank received the deposit after the date of the statement.

Question 11

outstanding check

Answer 11

A check that has been recorded as a cash disbursement by the company but that has not yet been processed by the bank.

Question 12

bank service charge

Answer 12

The fee charged by a bank for maintaining the company’s checking account.

Question 13

NSF (not sufficient funds) check

Answer 13

A check returned by the maker’s bank because there were not enough funds in the account to cover the check.

Question 14

short-term marketable securities

Answer 14

Investments made with cash not needed for current operations. [accrued as earned]

Question 15

net realizable value

Answer 15

The amount of funds expected to be received upon sale or liquidation of an asset. For accounts receivable, the amount expected to be collected from customers after allowing for bad debts and estimated cash discounts.

Question 16

bad debts expense (or uncollectible accounts expense)

Answer 16

An estimated expense, recognized in the fiscal period of the sale, representing accounts receivable that are not expected to be collected.

Question 17

valuation adjustment

Answer 17

An adjustment that results in an asset being reported at a net realizable value that is less than cost.

Question 18

carrying value

Answer 18

The balance of the ledger account (net of related contra accounts, if any) of an asset, liability, or stockholders’ equity account. Sometimes referred to as book value.

Question 19

Allowance for Uncollectible Accounts (or Allowance for Bad Debts)

Answer 19

The valuation allowance that results in accounts receivable being reduced by the amount not expected to be collected.

Question 20

contra asset

Answer 20

An account that normally has a credit balance that is subtracted from a related asset on the balance sheet.

Question 21

write-off

Answer 21

The process of removing from the Accounts Receivable account a specific account receivable that is not expected to be collected. Also used generically to describe the reduction of an asset and the related recognition of an expense or loss. [no effect on income statement]

Question 22

valuation account

Answer 22

A contra account that reduces the carrying value of an asset to a net realizable value that is less than cost.

Question 23

credit terms

Answer 23

A seller’s policy with respect to when payment of an invoice is due and what cash discount (if any) is allowed.

Question 24

cash discount

Answer 24

A discount offered for prompt payment.

Question 25

note receivable

Answer 25

A formal document (usually interest bearing) that supports the financial claim of one entity against another.

Question 26

collateral

Answer 26

Assets of a borrower that can be used to satisfy the obligation if payment is not made when due.

Question 27

cost flow assumption

Answer 27

An assumption made for accounting purposes that identifies how costs flow from the Inventory account to the Cost of Goods Sold account. Alternatives include specific identification; weighted average; first-in, first-out (FIFO); and last-in, first-out (LIFO).

Question 28

specific identification

Answer 28

The inventory cost flow assumption that matches cost flow with physical flow.

Question 29

weighted average

Answer 29

The inventory cost flow assumption that is based on an average of the cost of beginning inventory plus the cost of purchases during the year, weighted by the quantity of items at each cost.

Question 30

first-in, first-out (FIFO)

Answer 30

The inventory cost flow assumption that the first costs in to inventory are the first costs out to cost of goods sold.

Question 31

last-in, first-out (LIFO)

Answer 31

The inventory cost flow assumption that the last costs in to inventory are the first costs out to cost of goods sold.

Question 32

inventory (phantom) profits

Answer 32

Profits that result from using the FIFO cost flow assumption rather than LIFO during periods of inflation.

Question 33

inventory accounting system

Answer 33

The method used to account for the movement of items in to inventory and out to cost of goods sold. The alternatives are the periodic system and the perpetual system.

Question 34

perpetual inventory system

Answer 34

A system of accounting for the movement of items in to inventory and out to cost of goods sold that involves keeping a continuous record of items received, items sold, inventory on hand, and cost of goods sold.

Question 35

periodic inventory system

Answer 35

A system of accounting for the movement of items in to inventory and out to cost of goods sold that involves periodically making a physical count of the inventory on hand.

Question 36

physical inventory

Answer 36

The process of counting the inventory on hand and determining its cost based on the inventory cost flow assumption being used.

Question 37

cost of goods sold model

Answer 37

The way to calculate cost of goods sold when the periodic inventory system is used.

Question 38

merchandise inventory

Answer 38

Items held by an entity for sale to customers in the normal course of business.

Question 39

finished goods inventory

Answer 39

The term used primarily by manufacturing firms to describe inventory ready for sale to customers.

Question 40

raw materials inventory

Answer 40

An asset account that accumulates the costs of materials ready for the production process.

Question 41

work in process inventory

Answer 41

An asset account that accumulates the costs (raw materials, direct labor, and manufacturing overhead) of items that are in the process of being manufactured.

Question 42

prepaid expenses

Answer 42

Expenses that have been paid in the current fiscal period but that will not be subtracted from revenues until a subsequent fiscal period when the benefits are received. Usually a current asset. Another term for deferred charge.

Question 43

deferred charge

Answer 43

An expenditure made in one fiscal period that will be recognized as an expense in a future fiscal period. Another term for a prepaid expense.

Question 44

prepaid insurance

Answer 44

An asset account that represents an expenditure made in one fiscal period for insurance that will be recognized as an expense in a subsequent fiscal period to which the coverage applies.

Question 45

collect on delivery (COD)

Answer 45

A requirement that an item be paid for when it is delivered. Sometimes COD is defined as “cash” on delivery.

Question 46

imprest account

Answer 46

An asset account that has a constant balance in the ledger; cash on hand and vouchers (as receipts for payments) add up to the account balance. Used especially for petty cash funds.

Question 47

current assets

Answer 47

cash and other assets that are likely to be converted into cash or used to benefit the entity within one year of the balance sheet date