FAR 4 Flashcards
Working Capital: what is working capital and what does it measure
working capital = current assets - current liabilities
measures: solvency
Working Capital: what is the formula for the Quick Ratio
(cash + NET A/R + marketable securities) / current liabilities
Note: NOT inventory
Working Capital: List the 9 common current assets
- cash
- trading securities
- other short-term investments (if liquidiation is anticipated within the operating cycle or one year, whichever is longer)
- trade installment receivables
- inventories
- A/R and N/R
- prepaid expenses
- cash surrender value of life insurance (if policy owner intends to surrender policy for cash during the normal operating cycle)
Note: CSV can be non-current
Working Capital: how are premium payments that do not add to an insurance policy’s cash surrender value recorded
expensed
Working Capital: define a current asset
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
Working Capital: define a current liability
obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities
Note: includes estimates or accrued amounts expected to be required to cover expenditures within the year for known obligations (1) when the amount can be determined only approximately or (2) where specific persons to whom payment will be made is unascertainable
Working Capital: what are the main sources of current liabilities
- operating liabilities
- borrowings from banks
Note: short-term notes payable are not always an operating liability (see F7)
Working Capital: list the 7 main types of current liabilities
- trade accounts and notes payable
- current portions of LT debt
- cash dividends payable (declared but not paid)
- accrued liabilities
- payroll liabilities
- taxes payable
- advances from customers (unearned revenue expected to be recognized within one year)
Working Capital: what are the GAAP and IFRS requirements for reclassifying current liabilities to non-current liabilities
- GAAP: company intends to refinance the debt on a LT basis and intent is support by ability to do so as evidenced by either:
(a) actual refinancing prior to the issuance of the financial statements or
(b) existence of a non-cancelable financing agreement from a lender having the financial resources to accomplish the refinancing - IFRS: short-term liabilities must be ACTUALLY refinanced at the balance sheet date
Working Capital: what is the journal entry to record the refinancing of short-term liabilities
Dr. Short-term Liability Cr. Long-term Liability --OR-- Dr. Short-term Liability Cr. Common Stock Cr. APIC
Working Capital: define cash and cash equivalent
- cash: currency, demand deposits, and similar (that can be added to or withdrawn at any time without penalty)
- cash equivalent: short-term, highly liquid investments that are both readily convertible to cash and so near maturity when acquired by the entity (ORIGINAL maturity of 90 days or less from date of purchase) that they present insignificant risk of changes in value
Working Capital: give 6 examples of cash and cash equivalents
- coin and currency on hand (including petty cash)
- checking accounts
- savings accounts
- money market funds
- deposits held as compensating balances against borrowing arrangements with a lending institution that are NOT legally restricted
- Negotiable paper:
- bank checks, money orders, traveler’s checks, bank drafts, and cashier’s checks
- commercial paper and T-Bills
- certificates of deposits (with original maturities of 90 days or less)
Note: NOT INCLUDED -
- time certificates of deposit (if original maturity >90 days)
- LEGALLY restricted deposits held as compensating balances against borrowings with a lending institution
Working Capital: define restricted cash and how it is recorded
Restricted Cash: cash that has been set aside for a specific use or purpose (disclose nature, timing, amount in footnotes)
If associated with a current asset/liability = current asset but separate from unrestricted cash.
If associated with a non-current asset/liability = non-current asset separate from either the Investments or Other Assets section.
Working Capital: what are the 2 general forms of bank reconciliations
- Simple Reconciliation
2. Reconciliation of Cash Receipts and Disbursements (4-Column Approach)
Working Capital: list the treatment of components in a Simple Bank Reconciliation
- Deposits in Transit = add to bank balance
- Outstanding Checks = subtract from bank balance
- Service Charges = subtract from books
- Bank Collections = add to books
- Errors = fix it (either bank or books)
- Nonsufficient Funds (NSF) = subtract from books if not redeposited
- Interest Income = add to books
Working Capital: what are the procedures for calculating the True Balance in a Simple Bank Reconciliation
Step #1: Book balance is adjusted to reflect any corrections reported by bank
Step #2: Adjusted Book Balance = True Balance
Step #3: bank balance per the bank statement is reconciled to the “true balance” determined above
Working Capital: how are accounts receivable
A/R: oral promises to pay debts and generally classified as current assets
N/R: written promises to pay that can be current or non-current (depending on when collection will occur)
Working Capital: what are the 2 types of A/R
- trade (from purchasers of company goods and services)
2. non-trade (from persons other than customers)
Working Capital: how are A/R recorded
@ net realizable value
NRV = A/R - allowances for uncollectibles, - sales discounts - sales returns and allowances
Working Capital: what are the 2 types of discounts considered when reporting A/R
- Sales or Cash Discounts
- Gross Method: if taken, DEBIT “Sales Discounts Taken” (contra-revenue) account
- Net Method: if not taken, CREDIT “Sales Discounts Not Taken” (revenue account) - Trade Discounts (quantity)
- apply SEQUENTIALLY
Working Capital: how are Sales Returns and Allowances recorded when recognizing A/R
General Rule: wait until actual return
If past experience shows a material % of A/R are returned, estimate and accrue “Allowances for Sales Returns” (if reasonably estimable)
Sales Returns and Allowances account is a contra-sales account
Working Capital: what are the 3 GAAP allowance methods for estimating uncollectible A/R accounts
- Percentage of Sales (I/S, emphasizes matching)
- Percentage of A/R @ yr-end (B/S) = amount calculated is the ending balance that should be in the Allowance for Doubtful Accounts account
- Aging of A/R (B/S, emphasizes asset valuation NRV) = the sum of the product for each aging category is the desired ending balance in the allowance account
Note: Tax method = direct write-off (no matching)
Working Capital: what is the journal entry for subsequent collection of A/R previously written off under the (1) allowance method and (2) direct write-off method
1. Allowance method Dr. A/R Cr. Allowance for Uncollectible Accounts - and- Dr. Cash Cr. A/R
- Direct write-off method
Dr. Cash
Cr. Uncollectible accounts recovered (revenue account)
Working Capital: define Pledging (Assignment) of Accounts Receivable
Pledging: company uses existing A/R as collateral for a loan
- company maintains title to the A/R
- company pledges to use proceeds from the A/R to repay the loan
- A/R is not adjusted
Dr. Cash
Cr. Note Payable