5 Written questions
5 Matching questions
- allowance method
- open account
- net realizable value
- percentage-of-credit-sales approach
- aging schedule
- a The percentage-of-credit- sales approach is a method of estimating bad debts that multiplies a given percentage by the credit sales of a given accounting period. Percentage-of-credit-sales is a common method of estimating uncollectibles, used in conjunction with the allowance method, when accounting for accounts receivable.
- b The allowance method, under generally accepted accounting principles (GAAP) is the preferred method to account for uncollectibles and sales returns, both of which have a direct effect on the reported value of accounts receivable. The allowance method involves estimating the dollar amount of the uncollectibles or sales returns at the end of each accounting period and, based on that estimate, records an entry that reduces both net income and the balance in accounts receivable with a contra account called 'allowance for uncollectibles'.
- c An open account is an informal credit trade agreement used in cases where frequent credit transactions are conducted and a running balance of the obligation or receivable is maintained. If payments are made regularly within reasonable time periods, interest charges are not usually assessed. Open account is normally used to describe the trade terms underlying accounts receivable and accounts payable.
- d Net realizable value is the net cash amount expected from the sale of an item, usually equal to the selling price of the item less the cost to complete and sell it.
- e Aging is a method of estimating and analyzing collectible accounts receivable that categorizes individual accounts on the basis of the amount of time each has been outstanding. Each category is then multiplied by a different uncollectible percentage under the assumption that older accounts are more likely than new accounts to be uncollectable. This method is used primarily by management to identify and maintain control over uncollectible accounts receivables.
5 Multiple choice questions
- Current assets - Current liabilities. Working capital measures the extent to which a company's current assets cover its current liabilities. It is viewed as a measure of solvency and is often used in debt covenants to ensure that the borrower maintains a sufficient buffer of current assets to current liabilities. Like the current and quick ratio, however, working capital is a relatively weak measure of a company's solvency position.
- (Cash + Marketable Securities accounts Receivable)/Current liabilities. The quick ratio compares a company's highly liquid assets to its current liabilities, providing a measure of the portion of the current liabilities that could be paid off in the near future.
- A markdown is a reduction in sales price normally due to decreased demand for an item. Markdowns are very common in the retail industry, especially at the close of the seasons. These discounts are designed to accelerate sales of old items (boosting inventory turnover), making room for new inventories market price The market price is the price at which an asset can be exchanged in the open (output) market as of a particular point in time. See fair market value and stock price.
- The exchange rate is the value of one currency expressed in terms of another currency. Like the prices of all goods and services, the exchange rates among currencies vary from one day to the next. Companies that transact in more than one currency face the risks associated with fluctuating exchange rates, which can give rise to gains and losses—some of which are reflected on the financial statements. Fledging is a strategy that can be used to reduce such risks.
- When a good or service is sold on credit, the selling company wishes to collect the cash as soon as possible. To encourage prompt payment, many companies offer cash discounts on the gross sales price. Cash discounts specify that an amount of cash less than the gross sales price is sufficient to satisfy the obligation.
5 True/False questions
accounts receivable → Accounts receivable is a balance sheet account indicating the dollar amount due from customers from sales made on open account. It arises when revenues are recognized before receipt of the associated cash payment. Accounts receivable is normally included as a current asset and for some companies can be quite large.
operating cycle → Operating cycle is the time it takes, in general, for a company to begin with cash, convert the cash to inventory (or a service), sell the inventory (or service), and receive cash payment.
current assets → Current assets/Current liabilities. The current ratio is often used to assess a company's current asset management and its solvency position. It is normally an important part of financial statement analysis.
physical control → The procedures designed to ensure that the cash account on the balance sheet reflects the actual amount of cash in the company's possession.
current ratio → Current assets are assets on the balance sheet expected to be converted to cash or expired in one year or the operating cycle, whichever is longer.