Shared Flashcard Set


Accounting Test 2
Chapter 5
Undergraduate 1

Additional Accounting Flashcards




What is credit good and bad for?
It is good because: Customers who don't have the money at that time can buy it on credit. Company profits and sales increase because of this.

It is bad because: The company will be unable to collect from some credit customers.
Explain the allowance method.
Managers estimate how much bad-debt (money not able to be collected) on the basis of the company's collection experience. The business records the estimated amount as Uncollectible-Account Expense and sets up an Allowance for Uncollectible Accounts. This is a contra account to Accounts Receivable. It shows the amount of the receivables that the business expects not to collect.
What is the balance sheet?
It lists the assets at the top, followed by the liabilities and stock-holders' equity below.

A = L + E
What is the Income Statement?
It contains Revenue, Expenses, and Net Income.

Net sales revenue - Cost of Goods sold = Gross Profit. Gross Profit - expenses - Income tax expense = Net Income
Explain Short-Term Investments and the three types.
Short-term investments, also called marketable securities, are investments that a company plans to hold for 1 year or less. Short term investments fall into three categories:

1. Held-to-maturity investments, which the investor expects to hold until the securities' maturity date.
2. Trading investments, which the investor holds to generate a gain by selling the securities within a few weeks or months.
3. Available-for-sale investments, which are all investments other than held-to-maturity investments and trading investments.

Trading investments are reported on the balance sheet at their current market value.
Explain the Direct Write Off Method
The direct write-off method is a method of accounting for bad debts in which the company waits until the credit department decides that a customer's account receivable is uncollectible and then debits Uncollectible-Account Expense and credits the customer's Account Receivable.

This direct write-off method is defective for two reasons:

1. The direct write-off method does not set up an allowance for uncollectibles. As a result, receivables are always reported at their full amount, which is more than the business expects to collect. Assets on the balance sheet are overstated.
2. The direct write-off method causes a poor matching of uncollectible-account expense against revenue.

According to the matching principle, expenses should be matched against the revenue of the same period. Thus the direct write-off method is acceptable only when uncollectibles are so low that there is no significant difference between bad-debt expense by the allowance method and the direct write-off method.
Explain the balance sheet and the current ratio.
The balance sheet lists assets in the order of relative liquidity:

* Cash and cash equivalents
* Short-term investments
* Accounts (or trade) receivables

Current assets are the most liquid assets. They will be converted to cash, sold, or consumed during the next 12 months or within the business's normal operating cycle if longer than a year. Current liabilities are debts that must be paid within 1 year or within the entity's operating cycle if longer than a year.

The current ratio is the ratio of an entity's current assets to its current liabilities. The current ratio is computed by dividing current assets by current liabilities. The current ratio measures a company's ability to pay current liabilities with current assets.
Explain the Acid Test Ratio
A more stringent measure of ability to pay current liabilities is the acid-test ratio.
The acid-test ratio
is the sum of cash plus short-term investments plus net current receivables to total current liabilities. It tells whether the entity can pay all its current liabilities if they come due immediately. It is also called the quick ratio. (Sum of cash + short term investments + net current receivables)/Current liabilities.

Inventory is excluded from the acid-test ratio because inventory is not a liquid asset. A company with lots of inventory may have an acceptable current ratio but find it hard to pay its bills.
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