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Chapter 6
Cash and Accounts Receivable
37
Accounting
Undergraduate 2
02/19/2013

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Term
Current Asset
Definition
Any asset that is intended to be converted into cash within one year or the company’s operating cycle, whichever is longer
Term
Operating Cycle
Definition
The time required for a company to go through all of the required phases of the production and sales process
Term
What accounts are included in current assets?
Definition
o Cash, short-term investments, short-term accounts and notes receivable, inventories, and prepaid expenses
Term
Working Capital
Definition
Current Assets minus current liabilities
Term
Current Ratio
Definition
= current assets / current liabilities
Term
Quick Ratio
Definition
(cash + Short investments + short receivables) / current liabilities
Term
What does working capital indicate?
Definition
Whether a company has enough current assets to support its sales volume
Term
If a company does not keep a certain debt covenant, what can the creditor do?
Definition
Call for the immediate payment of the entire loan principal
Term
What is the main limitation of working capital, current ratio and quick ratio
Definition
The fundamental fact that current assets and current liabilities fail to accurately reflect future cash inflows and outflows
Term
Window Dressing
Definition
Choosing accounting methods or making operating decisions designed solely to make the financial statements appear more attractive
Term
Which financial statement are investors beginning to rely on more heavily?
Definition
Statement of cash flows
Term
What does the cash account consist of?
Definition
coin, currency, and checking accounts, as well as money orders, certified checks, cashiers checks, personal checks, and bank drafts received by a company
Term
3 issues concerning cash that are important to managers
Definition
(1) restrictions on the use of cash, (2) proper management of cash, and (3) control of cash
Term
Who imposes restrictions on cash?
Definition
Creditors to help ensure future interest and principal payments
Term
Escrow
Definition
Cash is controlled by a trustee (third party) until the debtor’s existing liability is discharged
Term
Compensating balances
Definition
Minimum required cash balances be maintained on deposit in the accounts of customers to whom they lend money or extend credit
Term
2 aspect of the control of cash
Definition
(1) record control and (2) physical control
Term
Record Control
Definition
The procedures designed to ensure that the cash account on the balance sheet reflects the actual amount of cash in the company’s possession
Term
Physical control
Definition
The procedures designed to safeguard cash from loss or theft
Term
Accounts Receivable
Definition
Arise from selling goods or services to customers who do not immediately pay cash
Term
Open Accounts
Definition
Credit trade agreements which represent short-term extensions of credit normally collected within 30 to 60 days
Term
When do accounts receivable appear on the balance sheet
Definition
During the time between revenue recognition and the receipt of the related cash payment
Term
Net Realizable Value for A/R
Definition
Face Value – Adjustments for (1) Cash discounts, (2) Bad debts, and (3) Sales returns
Term
Benefits associated with cash discounts for those who pay within a specific period of time
Definition
Collected cash can earn a return and eliminating receivables quickly reduces the costs of maintaining records for collecting outstanding receivables
Term
Quantity Discount
Definition
A reduction in the per-unit price of an item if a certain quantity is purchased
Term
Markdown
Definition
A common trade discount and is a sales price reduction due to decreased demand
Term
Two ways to account for cash discounts
Definition
gross method and net method
Term
Gross method
Definition
Records the transaction at the original value (assuming the buyer will not receive the discount)
• If the buyer pays within the period for a discount, a cash discount account appears on the income statement (serves as a contra account to the credit balance in the sales account) which gives rise to an income statement number called net sales
Term
How can companies monitor collection of debts
Definition
create and maintain collection departments, hire collection agencies, and pursue legal proceedings to control bad debts
Term
2 basic adjustments for bad debts
Definition
(1) an adjustment to reduce the value of accounts receivable and (2) an adjustment to reduce net income
Term
Allowance Method
Definition
Used to account for bad debts
1. The dollar amount of bad debts is estimated at the end of the accounting period
2. An adjusting journal entry, which recognizes a bad debt expense on the income statement and reduces the net balance in accounts receivable (and is recorded in the books)
3. A write-off journal entry is recorded when a bad debt naturally occurs
Term
Percentage-of-credit-sales approach
Definition
The most common method of estimating bad debts
• This method simply multiplies a percentage by the total credit sales for the year – based primarily on past experience
Term
Aging Schedule
Definition
A method which categorizes individual accounts in terms of length of time each has been outstanding and applies a different bad debt rate to each category
Term
Details of Aging Schedules
Definition
o Can identify slow-moving accounts, thus directing collection efforts and defining maximum costs that should be incurred by those efforts
o Can be helpful in estimating how much money a company is losing in potential interest charges (useful in deciding whether to offer cash discounts)
o However, these can be costly to establish and maintain
Term
How to account for sales returns
Definition
• At the end of each period, an estimate of expected sales returns is made which, in turn, determines the dollar value of an adjusting journal entry that reduces income and establishes an allowance account
• The account is disclosed on the balance sheet as a contra to accounts receivable – actual returns are debited against the allowance and credited against accounts receivable
Term
2 general questions that are of significant economic importance regarding short-term receivables
Definition
o When should a receivable be recorded in the books?
o At what dollar amount should a receivable be valued on the balance sheet?
Term
Hedging
Definition
A strategy used by management to reduce the risk of associated with holding receivables in foreign currencies (hold equal amount of payables in that currency)
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