Financial accounting 10th pratt peters chapter 06

Chapter 6: The Current Asset Classification, Cash, and Accounts Receivable Learning Objective Describe the current asset classification and its role in financial analysis and control Current Asset Classification A current asset is defined as any asset that is intended to be converted into cash within one year or the company’s operating cycle, whichever is longer Figure 6-1 The operating cycle Relative Size of Current Assets Measures Using Current Assets – Current Ratio Limitations of the Current Assets Classification • As noted by Leopold A Bernstein: “The current ratio is not fully up to the task [of assessing short-term liquidity] because it is a static or “stock” concept of what resources are available at a given moment to meet the obligations at that moment.” • Due to these limitations, cash flow data from the statement of cash flows is increasingly being used by creditors and investors to evaluate solvency Current assets are assets which a can be used immediately to retire liabilities b are newly acquired c have been converted into cash in the previous year d are intended to be converted into cash within one year Learning Objective Explain the techniques used to manage, account for, and control cash Cash • Includes coin, currency, and checking accounts, money orders, certified checks, cashier’s checks, personal checks and bank drafts • Cash equivalents are short term highly liquid investments with maturities of three months or less • Issues include • • • Restrictions on the use of cash Proper management of cash Control of cash 10 Sales Returns • Sales returns can be a significant issue for some companies and industries • They may take place some time (60 days or more) after the initial sale • Returns are estimated similar to bad debts where they are material • The income statement and the accounts receivables on the balance sheet must be adjusted 26 Problem 6-3, Part a – Glacier Ice Company Percentage of Sales method (a) 2017 Net sales = Gross Sales – Sales Returns and Allowances = 1,800,000 - 20,000 = 1,780,000 B.D Expense = 3% of net sales = 03 (1,780,000) = $53,400 AJE at 12/31: Bad Debt Expense 53,400 Allow for D.A 53,400 27 Problem 6-3, Part b Allowance for Doubtful Accounts 65,000 Beginning 53,400 AJE W/O 70,000 48,400 End Balance Note that, for the percentage of sales method, the AJE is posted before calculating the ending balance (this is not the case for the percentage of receivables method) 28 Problem 6-4, Part c Percentage of Sales method (c) 2018 Net sales = Gross Sales – Sales Returns and Allowances = 1,500,000 - 50,000 = 1,450,000 B.D Expense = 3% of net sales = 03 (1,450,000) = $43,500 AJE at 12/31: Bad Debt Expense 43,500 Allow for D.A 43,500 29 Problem 6-4, Part d Allowance for Doubtful Accounts 48,400 Beginning 43,500 AJE W/O 85,000 6,900 End Balance 30 Albert Company uses the allowance method of accounting for bad debts Albert: a is violating the matching principle b will record bad debt expense only when an account is determined to be uncollectible c will not sell to customers on account any more d will report accounts receivable in the balance sheet at their net realizable value 31 The journal entry to record the recovery of a previously written-off $2,000 account receivable (for David Company) under the allowance method would include: a a credit to Bad Debt Expense b a credit to Cash c a debit to Accounts Payable – David Company d a credit to Allowance for Doubtful Accounts 32 Learning Objective Identify and discuss two fundamental issues important to financial statement users when considering accounts receivable 33 When Should a Receivable be Recorded? • Revenue recognition criteria must be met • This is subjective • GAAP still relies on management discretion •Timing of revenue recognition and receivables are significant in the financial statements • Premature recognition of sales is the most prevalent form of corporate fraud 34 Balance Sheet Valuation of Receivables • Receivables must be carried on the balance sheet at the actual value that can be collected • Estimating uncollectible accounts can be challenging and is subjective to management • This can have a large impact on the Income Statement and Balance sheet • Users must evaluate the allowance and bad debt write offs in addition to changes in the Accounts Receivable balance 35 Concept Practice Learning Objective Discuss the basic relationships among accounts receivable, foreign currencies, and hedging 37 International Perspective: Receivables, Foreign Currencies, and Hedging • For multinational corporations, sales and receivables can be denominated in foreign currency • This means there is a risk based on changing exchange rates • Gain or Loss possible based on the exchange rate • Hedging is a strategy companies use to limit the risk of foreign exchange transactions 38 Hedging is used to a reduce risks associated with holding receivables denominated in foreign companies b calculate the current ratio for multinational companies c translate foreign currency into U.S dollars d ‘window dress’ uncollectible accounts 39 Wiley © 2017 40 .. .Chapter 6: The Current Asset Classification, Cash, and Accounts Receivable Learning Objective Describe the current asset classification and its role in financial analysis and... accounts receivable and indicate how the allowance method is used to value accounts receivable on the financial statements 14 Accounts Receivable • • • • • Accounts receivable arise from selling goods... Beginning 43,500 AJE W/O 85,000 6,900 End Balance 30 Albert Company uses the allowance method of accounting for bad debts Albert: a is violating the matching principle b will record bad debt expense