Chapter 7

Question 1

Cash

Answer 1

-Most liquid asset
-Standard medium of exchange
-Basis for measuring and accounting for all items
Current asset
-Examples: Coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts

Question 2

Cash Equivalents

Answer 2

Short-term, highly liquid investments that are both
(a) readily convertible to cash, and
(b) so near their maturity that they present insignificant risk of changes in value.
Examples: Treasury bills, Commercial paper, and Money market funds.

Question 3

Compensating Balance

Answer 3

Minimum cash balance on deposit as required by bank.
Compensating balances that result in legally restricted deposits must be separately classified in the balance sheet.
The nature of the borrowing arrangement determines whether the compensating balance is classified as a current asset or a noncurrent asset.

Question 4

Accounts Receivable

Answer 4

Receivables are claims held against customers and others for money, goods, or services. Receivables may generally be classified as trade or nontrade.

Question 5

Trade Receivables

Answer 5

Trade receivables (accounts receivable and notes receivable) are the most significant receivables an enterprise possesses. 
Accounts receivable are oral promises of the purchaser to pay for goods and services sold. Notes receivable are written promises to pay a certain sum of money on a specified future date.

Question 6

Non-trade Receivables

Answer 6

Nontrade receivables arise from a variety of transactions and can be written promises either to pay or to deliver. Non-trade receivables are generally classified and reported as separate items in the balance sheet.

Question 7

Two types of discounts that must be considered in determining the value of receivables

Answer 7

• Trade discounts represent reductions from the list or catalog prices of merchandise. They are often used to avoid frequent changes in catalogs or to quote different prices for different quantities purchased.
• Cash discounts (also called sales discounts) are offered as an inducement for prompt payment and are communicated in terms that read, for example, 2/10, n/30 (2% discount if paid within 10 days of the purchase or invoice date, otherwise the gross amount is due in 30 days).

Question 8

Two methods to account for uncollectible receivables

Answer 8

• Direct write-off method, the receivable account is reduced and an expense is recorded when a specific account is determined to be uncollectible.
• Allowance method requires a year-end estimate of expected uncollectible accounts based upon outstanding receivables. This ensures that companies state receivables on the balance sheet at their net realizable value (cash realizable value).

Question 9

Net realizable value (cash realizable value)

Answer 9

Net realizable value is the net amount the company expects to receive in cash.

Question 10

The percentage-of-receivables approach

Answer 10

Provides a reasonably accurate estimate of the net realizable value of receivables shown on the balance sheet.
This approach is commonly referred to as the balance sheet approach.

Question 11

Trade Notes Receivable

Answer 11

(a) notes represent a formal promise to pay and

(b) notes bear an interest element because of the time value of money.

Question 12

Reconciliation of Bank Balances

Answer 12

A basic cash control is preparation of a monthly bank reconciliation.
The bank reconciliation, when properly prepared, proves that the cash balance per bank and the cash balance per book are in agreement.

Question 13

Deposits in Transit

Answer 13

Deposits recorded in the cash account in one period, but not received by the bank until the next period.

Question 14

Outstanding Checks

Answer 14

Checks written by the depositor that have yet to be presented at the bank for collection.

Question 15

Bank Charges

Answer 15

Charges by the bank for services that are deducted from the account by the bank for which the company may not be aware until it receives the bank statement.

Question 16

Bank Credits

Answer 16

Collections or deposits in the company’s account for which the company may not be aware until it receives the bank statement.

Question 17

Bank or Depositor Errors

Answer 17

Errors made by the company or the bank that must be corrected for the reconciliation to balance.
Two forms of bank reconciliation may be prepared. -One form reconciles from the bank statement balance to the book balance or vice versa.
-The other form is described as the reconciliation of bank and book balances to corrected cash balance.

Question 18

Notes Receivable generally originate from

Answer 18

• Customers who need to extend payment period of an outstanding receivable
• High-risk or new customers
• Loans to employees and subsidiaries
• Sales of property, plant, and equipment
• Lending transactions (majority of notes)

Question 19

Recognition of Notes Receivable

Answer 19

Short-Term: Record at Face Value, less allowance

Long-Term: Record at Present Value of cash expected to be collected

Question 20

Valuation of Notes Receivable

Answer 20

Short-Term reported at net realizable value (same as accounting for accounts receivable).

Long-Term – F A S B requires companies disclose not only their cost but also their fair value in the notes to the financial statements.

Question 21

Sales of Receivables

Answer 21

Sale without Recourse:
-Purchaser assumes risk of collection 
-Transfer is outright sale of receivable
-Seller records loss on sale
Sale With Recourse
-Seller guarantees payment to purchaser
-Financial components approach used to record transfer

Question 22

Accounts Receivable Turnover

Answer 22

• Use to evaluate liquidity of accounts receivable

- Measures number of times, on average, a company collects receivables during the period

Question 23

Average Days to Collect Receivables

Answer 23

General rule is that the average collection period should not greatly exceed the credit term period

Question 24

Cash Controls

Answer 24

Management faces two problems in accounting for cash transactions:

• Establish proper controls to prevent any unauthorized transactions by officers or employees.
• Provide information necessary to properly manage cash on hand and cash transactions.

Question 25

Using Bank Accounts

Answer 25

To obtain desired control objectives, a company can vary the number and location of banks and the types of accounts.

• Collection float
• Lockbox accounts
• General checking account
• Imprest bank accounts

Question 26

Reconciliation of Bank Balances

Answer 26

Schedule explaining any differences between the bank’s and the company’s records of cash.
Reconciling Items:
-Deposits in transit.
-Outstanding checks.
-Bank charges and credits.
-Bank or Depositor errors.