F4 - Working Capital and its Components

Question 1

Define working capital.

Answer 1

Current assets - Current liabilities

Question 2

How is the current ratio computed?

Answer 2

_ Current assets _
Current liabilities

Question 3

How is the quick ration computed?

Answer 3

Cash + Net receivables + Short-term investments
Current liabilities

Question 4

Current assets are defined as…

Answer 4

Those resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer.

Question 5

Current liabilities are defined as…

Answer 5

Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities.

Question 6

When can a short-term obligation be included in noncurrent liabilities?

Answer 6

If the enterprise intends to refinance the debt on a long-term basis and the intent is supported by the ability to do so as evidenced by:

• Actual refinancing prior to the issuance of the financial statements, or
• Existence of a noncancelable financing agreement from a lender having the financial resources to accomplish the refinancing.

Question 7

Define cash and cash equivalents.

Answer 7

• Cash includes both currency and demand deposits with banks and/or other financial institutions.
• Cash equivalents include short-term, highly liquid investments that are both readily convertible to cash and so near their maturity when acquired by the entity (90 days or less from the date of purchase) that they represent significant risk of changes in value.

Question 8

Name two methods of accounting for uncollectible accounts.

Answer 8

Direct Write-Off

Dr. Bad debt expense
Cr. Accounts receivable

Weaknesses: Bad debts are not matched to sales and accounts receivable are overstated. Not GAAP.

Allowance Method

Dr. Allowance for uncollectible accounts
Cr. Accounts receivable

Strengths: Matches bad debts with credit sales. Accounts receivable fairly stated. Required by GAAP.

Question 9

Name three methods for estimating uncollectible accounts.

Answer 9

• Percentage of credit sales
• Percentage of accounts receivable at year-end
• Aging of accounts receivable at year-end

Question 10

Using the allowance method, give the two journal entries to provide for and then to write off an uncollectible account.

Answer 10

Provide for

Dr. Bad debt expense
Cr. Allowance for uncollectible account

Write-off

Dr. Allowance for uncollectible accounts
Cr. Accounts receivable

Question 11

What is the difference between factoring with recourse and without recourse?

Answer 11

With Recourse

The factor may return the account to the company if it proves to be uncollectible. Potential liability and risk of loss remains with the company.

Without Recourse

The factor assumes the risk of loss if the account is uncollectible.

Question 12

State the three conditions that must exist for control of a financial asset to be considered surrendered.

Answer 12

• The transferred assets have been isolated from the transferor;
• The transferre has the right to pledge or exchange the assets; and
• The transferor does not maintain control over transferred assets under a repurchase agreement.

Question 13

If control of a financial asset is surrendered, what is the accounting treatment of the transfer?

Answer 13

No Continuing Involvement

Recorded as a sale with appropriate reduction in receivables and reconition of any gain or loss.

Continuing Involvement

• Asset for which there is no retained interest is recorded as a sale using the financial-components approach.
• Assets for which there is retained interest is carried on the books of transferor and allocated to a book value based on relative value of all transferred assets at the date of transfer.

Question 14

If control of a financial asset is not surrendered, what is the accounting treatment of the transfer?

Answer 14

• Account for transfer as a secured borrowing with pledged collateral.
• Recognize the appropriate asset/liability amounts and interest reveue/expense amounts.

Question 15

At what value should non-interest bearing promissory notes be recorded?

Answer 15

At the present value of all future payments required by the note. The payments should be discontinued at the market interest rate.

Question 16

Notes receivable may be discounted “with” or “without” recourse. What is the difference?

Answer 16

Discounting with Recourse

The holder remains contingently liable.

Discounting without Recourse

The holder assumes no further liability after discounting.

Question 17

Describe the computational steps required in “discounting a note”.

Answer 17

1. Compute maturity value (remember to include interest to maturity).
2. Compute the “discount” (remember to use maturity value).
3. Get the proceeds by subtracting discount from maturity value.
4. Compute interest income as difference between proceeds and face of note.