Chapter 7: Receivables and investments Flashcards
What is the distinction between an account receivable and a note receivable?
A note receivable arises from a written promise by someone to pay a specific amount of money in the future with interest. An account receivable arises from granting a customer an open line of credit and does not normally include interest.
Why does the discounting of a note receivable with recourse result in a contingent liability? Should the liability be reported on the balance sheet? Explain.
When a note receivable is discounted with recourse, it means that if the customer fails to pay the bank the total amount due on the maturity date, the company that sold the note to the bank is liable to the bank for the full amount. Therefore, during the time a discounted note is outstanding, the seller of the note is contingently liable. Accounting standards do not require the seller to recognize the contingency as a liability, but a note is required to alert the statement reader of the uncertainty.
On December 31, Stockton Inc. invests idle cash in two different certificates of deposit. The first is an 8%, 90-day CD, and the second has an interest rate of 9% and matures in 120 days. How is each of these CDs classified on the December 31 balance sheet?
The first CD should be classified as a cash equivalent because it has an original maturity of three months or less. The second CD is classified as a short-term investment. It is a current asset because it will be converted into cash within the next year, even though its original maturity of more than three months disqualifies it from classification as a cash equivalent.
Stanzel Corp. purchased 1,000 shares of Canby Company common stock. What will determine whether the shares are classified as current assets or noncurrent assets?
The intent of the company determines the proper classification. If Stanzel purchases the Canby Company shares with the intent of selling them in the near term, they should be classified as current assets. Otherwise, the shares should be classified as noncurrent assets.
How are purchases of investments classified and reported on the statement of cash flows?
Purchases of investments are classified on the statement of cash flows as Investing Activities and reported as an outflow of cash on the statement.
In what section of the statement of cash flows are changes in accounts receivable reported when the indirect method is used to prepare the statement?
Changes in accounts receivable are reported in the Operating Activities section of the statement.
Wildcat started the year with $25,000 in accounts receivable and ended the year with $40,000 in the account. Describe how information regarding the company’s accounts receivable should be reflected on its statement of cash flows, assuming the use of the indirect method.
The increase of $40,000 – $25,000, or $15,000, in accounts receivable should be deducted from net income under the indirect method of preparing the statement of cash flows. Sales increase net income. An increase in accounts receivable is an indication that sales exceeded cash collections; therefore, to arrive at cash from operations, a deduction is needed.
Why do accountants prefer the allowance method of accounting for bad debts?
The allowance method of accounting for bad debts tries to match one of the costs associated with granting credit, i.e., uncollectible accounts, with the revenue of the period. Under the matching principle, an estimate of bad debts is made on the basis of either the sales of the period or the accounts receivable at the end of the period. The allowance method properly matches the revenue for the period against an expense for the same period.
When bad debts are estimated, why is the balance in the Allowance for Doubtful Accounts considered when the percentage of receivables approach is used, but not when the percentage of sales approach is used?
When bad debts expense is estimated by using the percentage of receivables approach, the balance already in the allowance account must be considered. For example, if the estimate of the accounts receivable that will prove to be uncollectible is $20,000 and the allowance account has a credit balance of $3,000 before adjustment, only $17,000 has to be added to it. Under the percentage of sales approach, however, the emphasis is on the debit to Bad Debts Expense. The balance in the allowance account before adjustment is ignored.
When computing the accounts receivable turnover ratio, why is the average of accounts receivable for the period used in the denominator of the ratio?
The numerator of the ratio is net credit sales for the entire period, so an average of accounts receivable for that period is used in the denominator.
