Week 4 Key Concepts

Question 1

Receivables

Answer 1

claims that are expected to be collected in cash.

Question 2

Accounts Receivable

Answer 2

: the proceeds which the company will receive from its customers who have purchased its goods & services on credit.

Also called sales on account or sales on
credit. It usually involves oral promise and has no interest.

Question 3

Notes Receivable

Answer 3

a written promise to receive money at a future date. The money is
usually made up of interest and principal.

Question 4

Installment Receivables

Answer 4

: a contract that allows buyers to pay by installments, which usually
involves a series of payments of fixed amount over a certain period time. The installment
consists payment of principle and interest charge.

Question 5

NRV
Net Realizable Value

Answer 5

net realizable value of accounts receivable, equal to the balance of accounts receivable
minus the balance of the allowance for doubtful or uncollectible accounts.

Question 6

“Near Cash” Assets

Answer 6

assets that can be easily converted into cash

▪ Mostly money market instruments
▪ Commercial paper
▪ Stocks & bonds

Question 7

Temporary Investments

Answer 7

: investments that are intended to be held for a short-term. They are
easier to be converted into cash as compared to long-term investments.

Question 8

Liquidity

Answer 8

: the ability of firm to covert current assets into cash. The higher the liquidity, the
easier of such conversion.

Question 9

Direct write-off method

Answer 9

The less preferable method for recognizing losses from uncollectible
accounts. The bad debt expense is recognized when the bad debt actually occurs.

Question 10

Allowance Method

Answer 10

the preferable method for recognizing losses from uncollectible accounts.
The bad debt expense is recognized when the bad debt is anticipated to occur.

Question 11

Aging method

Answer 11

: One of the two ways to estimate bad debt when the allowance method is used.
The bad debt expenses are decided based on the age of outstanding account receivables.

The aging method is a straightforward way to estimate bad debts. It involves categorizing accounts receivable by the length of time they have been outstanding (aging), and then applying different estimated bad debt percentages to each category based on historical experience. This helps companies predict and prepare for potential uncollectible debts.

Question 12

% of sales method

Answer 12

One of the two ways to estimate bad debt when the allowance method is
used. The bad debt expenses are decided based on the percentage of credit sales.

The percentage of sales method is a simple way to estimate bad debts. It involves applying a fixed percentage to total sales to estimate the amount of bad debts expected. This method provides a straightforward way for companies to account for potential losses from uncollectible accounts.

Question 13

Cash

Answer 13

paper money, coins, cheques, and money orders - all items that are acceptable for deposit in a bank - as well as money already on deposit with a bank. Cryptocurrencies are not cash.

Question 14

Cash on hand

Answer 14

receipts from customers which have not yet been deposited in the bank

Question 15

Petty cash

Answer 15

small amounts of currency retained in a firm used for small disbursements, to save
clerical preparation time, supply cost, mailing, bank charges and executive review time.

Question 16

IOU

Answer 16

an IOU is a document that acknowledges a debt owed. In business, accounts receivable
may be informally called IOUs, standing for “I-owe-you”.

Question 17

Segregation of duties

Answer 17

the separation of the custody of cash and the recording of cash, to
minimize the chance of misappropriations of cash.

Question 18

Bank reconciliation

Answer 18

A reconciliation to reconcile the cash balance shown on bank statement
with the cash balance shown on the firm’s General ledger. The differences of cash balances may
arise from withdrawal/deposit made by the bank but not yet reflected on firm account, or
withdrawal/deposit made by the firm but not yet reflected on bank account.

Question 19

• 3 Major Sources of Cash for Business

Answer 19

–Operations (selling product)
–Financing
– Selling assets other than
product

Question 20

Business spends cash on 4 major activities
(cash outflows)

Answer 20

–Operations (e.g., inventory)
–Reduce debt
–Money paid back to owners
–Purchasing assets

Question 21

Bank reconciliation
Balance per bank statement

Answer 21

• outstanding cheques
  + deposits in transit
  + - bank errors
  = Adjusted Cash Balance

Question 22

Bank reconciliation

Balance per G/L

Answer 22

• bank service charges
  + interest earned
  + - recording errors
• NSF cheques returned
• preauthorized amounts removed
  = Adjusted Cash Balance

Question 23

The Liquid Assets

Answer 23

Cash
Receivables
Temporary Investments

Question 24

Definition of Receivables

Answer 24

Claim to Cash
➢ Must be at NRV
➢ Segregated into Current &
Non-current
➢ Three principal types:
▪ Trade (A/R)
▪ Notes
▪ Other

Question 25

Miscellaneous Receivables

Answer 25

• Interest
• From Employees & Officers
• From Government
• Other

Question 26

Valuation of the Liquid Assets
Are they valued at their face value?

Answer 26

NO

Question 27

Why do receivables become uncollectible?

Answer 27

1. Customers unable to pay
2. Customers unwilling to pay

Question 28

Minimizing credit losses:

Answer 28

1. Formal credit and collection policies
2. Receivables manager to monitor and enforce
3. Regular review of accounts
4. Sales discount inducements
5. Using collection agencies and legal strong arms

Question 29

Estimating Uncollectible Account Losses:

Answer 29

1. After the fact
   * The Direct Write Off Method
2. In advance
   * The Allowance Method

Question 30

Direct Write Off Method

Answer 30

The direct write-off method is a simple way to account for bad debts. When a specific customer’s debt becomes uncollectible, the company writes off that amount as an expense. This method is straightforward but doesn’t match revenues with expenses as per standard accounting principles.

Assume an Account of $200 is to be written off
Dr Bad Debts Expense 200
Cr Accounts Receivable 200

Main Problem (besides not being conservative)
* Often violates matching
*The sale & the expense end up in different income statements

Question 31

The Allowance Method

Answer 31

2 methods
1. Aging
2. Percentage of sales

The allowance method predicts and records potential bad debts before they occur. It involves estimating bad debts and creating an allowance for them on the balance sheet, ensuring a more accurate reflection of the company’s financial position.

Question 32

Steps in Aging Method

Answer 32

1. Construct aged T/B
2. Determine likely loss in each age category
3. Compute the expected loss
4. Adjust the allowance to the expected loss

Question 33

Simple Interest Formula
I = Prt

Answer 33

Example:
What is the interest on a 90 day note for $20,000 bearing interest at
12% per annum
I = $20,000 x 0.12 x (90/365) = $592
Nuances:
*A note for $1000 was issued October 5 and Matures Jan 12 at 12%
annually
* the 360 day year

Key is that r and t must be in same time frame
Compare with compound interest