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1. (a) A receivable evidenced by a formal, written promise to pay is classified as a note receivable; an informal, unsecured promise to pay is classified as an account receivable or other appropriate title (e.g., advances to officers).

(b) Receivables arising from the normal operating activities of a business are classified as trade receivables; those from all other sources are nontrade


(c) All trade receivables and those nontrade receivables expected to be collected within 1 year (or the normal operating cycle, whichever is longer) are reported as Current Assets; all other receivables are noncurrent and are reported under the Investments or Other Noncurrent Assets caption, whichever is appropriate.

2. (a) Methods for establishing and maintaining an allowance for bad debts account are as follows:

(1) Allowance for Bad Debts is increased by a certain percentage of total sales or credit sales.

(2) Allowance for Bad Debts is adjusted to a certain percentage of receivables.

(3) Allowance for Bad Debts is adjusted to an amount determined by aging the accounts.

(b) The percentages to use in estimating uncollectible accounts should be based on the collection experience of each individual company. Analysis of the past records can be made to determine the relationships between write-offs and sales or receivables. If there has been no recognizable change in the economic conditions or in the credit policy of the company, these historical percentages may be used as the best estimate of future uncollectibles. To the extent that these conditions are changing, the percentages will require appropriate adjustment.

3. GAAP requires the allowance method because it provides for a matching of current revenues with related expenses, and it reports the receivables at their net realizable value. The direct write-off method is easy to apply and is objective but does not provide for proper matching of revenues and expenses nor appropriate valuation of receivables.

4. (a) Adjustments to be made:

Age the receivables (including the dishonored notes) in order to determine the amount by which to increase Allowance for Bad Debts or to create an allowance balance if none exists. Write off worthless accounts of $320 as follows:

Allowance for Bad Debts 320

Accounts Receivable 320

(b) Accounts Receivable should appear on the balance sheet under Current Assets at $9,572. This balance consists of the following:

Accounts from sales of

the last three months $7,460

Accounts from sales

prior to October 1 1,312

Dishonored notes

charged back to

customersÐŽ¦ accounts 800


The balance of Allowance for Bad Debts should be deducted from Accounts Receivable. The credit balances in customersÐŽ¦ accounts, $1,190, should be reported as a current liability.

5. Product warranties are obligations that clearly exist at a balance sheet date, but the amount to be paid cannot be definitely determined. The amount of the claim is therefore estimated. This estimated liability should normally be recorded on an accrual basis because the obligation created upon the sale of a product should be matched with the revenue received from the sale.

6. (a) Accounts receivable turnover is computed by dividing net sales by the average accounts receivable outstanding for the year.

(b) Average collection period is computed by dividing average daily sales (net sales „i 365) into the average receivables for the year. This measurement can also be obtained by dividing the number of days in a year by the accounts receivable turnover.

(c) The accounts receivable turnover represents the average number of sales or collection cycles completed by a firm during a particular year. The average collection period shows the average time required to collect receivables.

7. Cash, because it is the standard medium of exchange, is required to complete almost all business transactions. Therefore, a certain amount of cash must be kept immediately available for daily transactions. It is managementÐŽ¦s responsibility to see that sufficient cash, but not an excessive amount, is available for current operating purposes. To be productive, any excess of ÐŽ§idle cashЎЁ should be invested in temporary or long-term investments.

8. (a) Cash

(b) Investments, noncurrent receivables, or other assets (not currently available)

(c) Cash

(d) Other noncurrent assets (will be used to acquire a noncurrent asset)

(e) Accounts receivable

(f) Accounts receivable

(g) EmployeesÐŽ¦ accounts or notes receivable

(h) Office supplies

(i) Cash

(j) Notes receivable

(k) Cash

(l) Cash

9. The balance with Bank A should be reported as cash. The overdraft with Bank B should be reported as a current liability. Even if the overdraft arose from deposited checks that did not clear, it would represent a liability to the bank. The fact that the overdraft is canceled promptly is not

* Relates to Expanded Material.

relevant; as of December 31, it would still have to be regarded as a liability.

10. Because the compensating balance is legally restricted, the balance should be segregated and reported separately among the Cash Items in the current or noncurrent asset section of the balance sheet, depending on the nature of the restrictions.



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