FAR 4-1: Working Capital & 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 ratio 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 & 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 & cash equivalents

Answer 7

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

Question 8

Name 2 methods of accounting for uncollectible accounts

Answer 8

*Direct write-off: Dr. BDX, Cr. A/R
Weaknesses: Bad debts are not matched to sales & A/R are overstated. NOT GAAP.

*Allowance method: Dr. Allowance for uncollectible accounts, Cr. A/R

Question 9

Name 3 methods for estimating uncollectible accounts

Answer 9

• Percentage of credit sales
• Percentage of A/R at year-end
• Aging of A/R at year-end

Question 10

Using the allowance method, give the 2 journal entries to provide for & then to write off an uncollectible account

Answer 10

• Provide for: Dr. BDX, Cr. Allowance for uncollectible accounts
• Write-off: Dr. Allowance for uncollectible accounts, Cr. A/R

Question 11

What is the difference between factoring WITH recourse & WITHOUT recourse?

Answer 11

• With Recourse: The factor may return the account to the company if it proves to be uncollectible. Potential liability & 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 3 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 transferee has the right to pledge or exchange the assets, &
• 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 & recognition 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 & allocated 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 & interest revenue/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 discounted 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 proceeds by subtracting discount from maturity value
4. Compute interest income as difference between proceeds & face of note