Term
| What is the difference between accounts receivable and notes receivable? |
|
Definition
Accounts receivable are the expected future receipts when a company permits its customers to buy now and pay later. The amounts are usually small with a short term to maturity.
Notes Receivable have longer terms to maturity and are usually for larger amounts. The note specifies the maturity date, interest rate, and other credit terms. |
|
|
Term
| What is the net realizable value of receivables? |
|
Definition
2. The net realizable value is the amount expected to be collected from accounts receivable. It is the face amount of receivables less an allowance for estimated uncollectible accounts. |
|
|
Term
| What tpe of account is the Allowance of Doubtful Accounts? |
|
Definition
3. Allowance for Doubtful Accounts is a contra asset account. |
|
|
Term
| What are two ways in which estimating uncollectible accounts improves the accuracy of the financial statements? |
|
Definition
4. Estimating uncollectible accounts expense improves the accuracy of financial statements by (1) reporting expected realizable value of receivables (i.e., future cash flows) and (2) presenting a better matching of expenses with related revenues. This provides a better measure of managerial performance. |
|
|
Term
| When using the allowance method, why is uncollectqable accounts expense an estimated amount? |
|
Definition
5. When using the allowance method, uncollectible accounts expense is matched with current revenues. A company does not know which accounts will not be collectible at the time a sale is made; consequently, in order to record the expense currently, an estimate is used. |
|
|
Term
| What is the most common format for reporting accounts receivable on the balance sheet? What information does this method provide beyond showing only the net amount? |
|
Definition
6. The most common format for reporting accounts receivable on the balance sheet is gross receivables less the allowance for doubtful accounts. This format allows the users to see both the total amount owed by the customers and the amount the company expects to collect. |
|
|
Term
| Why is it necessary to reinstate a previously written off account receivable before the collection is recorded? |
|
Definition
7. The practice of reestablishing a previously written off account, then recording its collection as a payment on account, reflects a complete record of account activity. Such a record provides an accurate picture of the source of cash flows and improves the portrayal of the customer’s credit history. |
|
|
Term
| What are some factors considered in estimating the amount of uncollectible accounts receivable? |
|
Definition
8. Factors for use in estimating uncollectible accounts include:
(1) the percentage of uncollectible accounts from years past.
(2) adjustment for new circumstances that are anticipated to be experienced in the future.
(3) industry averages or experiences of similar businesses.
(4) examination of current accounts and company credit policies. |
|
|
Term
| What is the effect on the accounting equation of recognizing uncollectible accounts expense? |
|
Definition
9. Recognizing uncollectible accounts expense reduces accounts receivable on the asset side and reduces retained earnings on the equity side. |
|
|
Term
| What is the effect on the accounting equation of writing off an uncollectible account receivable when the allowance method is used? |
|
Definition
10. A write-off of an uncollectible account when the allowance method is used has no effect on the accounting equation because the allowance account, a contra asset account, is reduced and the accounts receivable account, also on the asset side, is reduced. |
|
|
Term
| How does the recovery of a previously written-off account affect the income statement when the allowance method is used? How does the recovery of a previously written-off account affect the statement of cash flows when the allowance method is used? |
|
Definition
11. The recovery of an uncollectible account when the allowance method is used does not affect the income statement. Only accounts receivable, cash, and allowance for doubtful accounts are affected. Cash flow from operations increases as a result of the collection. |
|
|
Term
| What is the advantage of using the allowance method of accounting for uncollectible accounts? |
|
Definition
12. The primary advantage of using the allowance method is that it improves the accuracy of the financial statements. It matches the expected expense with the revenue produced in the period. |
|
|
Term
| How do companies determine the percentage estimate of uncollectible accounts when using the percent of revenue method? |
|
Definition
13. If the company is an established business, it will examine its credit history; that is, the actual write-offs for the previous year as a percentage of sales. A new business must rely on trade publications and others experienced in the industry to determine an appropriate percent. This percent is then adjusted at least annually to reflect current conditions. |
|
|
Term
| What is an advantage of using the percent of receivables method of estimating uncollectible accounts expense? |
|
Definition
14. The percent of receivables is a more accurate measure because it uses the actual receivables and the amount of time they have currently been outstanding. Those receivables that have been outstanding for a longer time are less likely to be collected. |
|
|
Term
| What is "aging of accounts receivable"? |
|
Definition
15. When using an aging schedule for estimating uncollectible accounts, accounts receivable is divided into categories based on due dates. Different percentages are then applied to each category. For instance a higher percentage would be applied to the group of accounts that are more than 90 days past due than to the group that is only 30 days past due. |
|
|
Term
| What is a promissory note? |
|
Definition
16. A promissory note is a legal document that sets forth credit terms such as interest rate, payment amounts, and maturity date. Promissory notes are commonly used when credit extended is for a large amount or for a long period of time. |
|
|
Term
Define the following terms:
a. Maker
b. Payee
c. Principal
d. Interest
e.Maturity date
f. Collateral |
|
Definition
17. a. Maker: The borrower or debtor.
b. Payee: The person to whom the note is made payable.
c. Principal: The amount of money loaned by the payee to the borrower.
d. Interest: The economic benefit earned by the payee for loaning the principal to the maker.
e. Maturity date: The date on which the maker must repay the principal and any unpaid interest.
f. Collateral: Assets belonging to the maker assigned as security for the note. |
|
|
Term
| What is the formula for computing interest revenue? |
|
Definition
18. Interest is computed as:
Principal X annual interest rate X time outstanding |
|
|
Term
| What is accrued interest? |
|
Definition
19. Accrued interest is interest that has been earned but not yet collected. |
|
|
Term
| How does accrual of interest revenue or expense illustrate the matching concept? |
|
Definition
20. The matching concept matches revenue and expenses to the period in which they are earned or incurred. By accruing interest, the interest is recognized in the period it is earned or used regardless of when the cash is collected or paid. |
|
|
Term
| Assets are listed on the balance sheet in the order of their liquidity. Explain this statement. |
|
Definition
21. Liquidity refers to how quickly assets are expected to be converted to cash during normal operations. Cash is listed first on a balance sheet and other items are then listed in the order of expected conversion to cash. |
|
|
Term
| When is an adjusting entry for accrued interest generally recorded? |
|
Definition
22. The adjusting entry for accrued interest is generally only recorded when financial statements are prepared. At this time the accounts are adjusted to reflect the interest that has been earned, but not yet collected. |
|
|
Term
| Assume that on July 1, 2010, Big Corp, loaned Little Corp. $12,000 for a period of one year at 6 percent interest. What amount of interest revenue will Big Report for 2010? What amount of cash will Big receive upon maturity of the note? |
|
Definition
23. Big Corp. would report interest revenue of $360 for 2010 computed as follows:
$12,000 x 6% x 6/12 = $360.
Big Corp. will collect $12,720 total cash when the note matures; principal of $12,000 and one year’s interest of $720. |
|
|
Term
| In which section of the statement of cash flows will Big report the cash collected in question 23? |
|
Definition
24. When Big Corp. collects the $12,720, $12,000 will be reported as inflow from investing activities, and $720 will be reported as inflow from operating activities. |
|
|
Term
| Why is it generally beneficial for a business to accept major credit cards as payment of goods and services even when the fee charged by the credit card company is substantial? |
|
Definition
25. It is generally beneficial to accept major credit cards because the business then avoids the risk of bad debts as well as the cost of maintaining credit records. It may also attract more customers. |
|
|
Term
| What types of costs do businesses avoid when they accept major credit cards as compared with handling credit sales themselves? |
|
Definition
26. The acceptance of major credit cards enables a business to avoid the cost of uncollectible accounts and the clerical costs of maintaining accounts receivable records. In addition, the business avoids the implicit cost of lost opportunities due to delayed cash flows. |
|
|
Term
| How is the accounts receivable turnover ratio computed? What information does the ratio provide? |
|
Definition
27. Accounts
Receivable = Sales
Turnover Accounts Receivable
The A/R turnover tells how many times during the year on average accounts receivable is collected (i.e., converted to cash). |
|
|
Term
| How is the average number of days to collect accounts receivable computed? What information does the ratio provide? |
|
Definition
28. Average Days
to Collect = 365
Accounts Receivable Accounts Receivable Turnover
This ratio tells the user how many days on average it takes a company to collect its accounts receivable. |
|
|
Term
| Is accounting terminology standard in all countries? What term is used in the United Kingdom to refer to sales? What term is used to refer to inventory? What is a gearing ratio? Is it important to know about these differences? |
|
Definition
29. No, accounting terminology is not standard even in English-speaking countries. In the U.K. sales is called “turnover,” inventory is “stocks,” and the “gearing ratio” refers to the debt-to-assets ratio. Knowing this terminology is important for companies involved in international trade. |
|
|
Term
| What is the operating cycle of a business? |
|
Definition
30. The operating cycle is the length of time it takes to convert inventory to accounts receivable plus the time it takes to convert accounts receivable to cash. |
|
|
Term
| What is the difference between the functions of long-term operational assets and investments? |
|
Definition
| 1. Long-term operational assets are those assets that are used by a business to generate revenue. In contrast, investments are simply held for the production of interest and dividends and/or for price appreciation. |
|
|
Term
| What is the difference between tangible and intangible assets? Give an example of each. |
|
Definition
2. Tangible assets are those assets that have a physical existence. Some examples include buildings and equipment. Intangible assets are those assets that represent some rights and privileges associated with owning the asset. Some examples include copyrights, leases, and trademarks. |
|
|
Term
| What is the difference between goodwill and specifically identifiable intangible assets? |
|
Definition
3. Specifically identifiable intangible assets are those assets that are purchased for a specific value or have a known value. Examples include patents, leases, and copyrights. Intangible assets that are not specifically identifiable are those purchased as part of the purchase of a whole business or group of assets. The value of these assets are determined by the excess of the purchase price of the group over the value of the specifically identifiable assets. The most common assets in this group include goodwill and covenants not to compete. |
|
|
Term
| Define depreciation. What kind of asset depreciates? |
|
Definition
4. Depreciation is the systematic allocation of the cost of property, plant and equipment to the accounting periods over which they are to be used. Some examples of assets that are depreciated include buildings, machinery, and office equipment. |
|
|
Term
| Why are natural resources called wasting assets? |
|
Definition
5. Natural resources are assets that are produced by nature. Some examples include oil, coal, minerals, timber, etc. They are called wasting assets because their value "wastes away" as the resources are removed from the earth. |
|
|
Term
| Is land a depreciable asset? Why or why not? |
|
Definition
6. Land is not a depreciable asset because land has an infinite life. Land is not destroyed by its use. Natural resources can be removed but the land will remain. When land and natural resources are purchased together, the cost of each must be accounted for separately. |
|
|
Term
| Define amortization. What kind of assets are amortized? |
|
Definition
7. Amortization is the systematic allocation of the cost of intangible assets over their estimated useful lives. |
|
|
Term
| Explain the historical cost concept as it applies to long-term operational assets. Why is the book value of an asset likely to be different from the current market value of the asset? |
|
Definition
8. The historical cost concept requires that long-term operational assets be recorded at the amount paid for them. This is the amount that will be shown on the balance sheet as long as the asset is owned. As time passes the asset may increase or decline in value, but this change is not reflected on the books of the company. However, the historical cost of assets may be reduced by depreciation over their lives. |
|
|
Term
| What different kinds of expenditures might be included in the recorded cost of a building? |
|
Definition
9. The cost of a building includes the amount paid for the building plus any amounts that are paid to put it to its intended use. Some common costs include the purchase price, title search fee, legal fees, sales commissions, remodeling, and improvements. |
|
|
Term
| What is a basket purchase of assets? When a basket purchase is made, how is cost assigned to individual assets? |
|
Definition
10. A basket purchase of assets is the purchase of a group of assets for a single purchase price. For example, building, land and equipment could be purchased for one price, $80,000. When a group of assets are purchased together, the purchase price must be allocated among the different assets. One of the more common methods of making the allocation is the relative fair market value method. The fair market value of each asset is determined and then its ratio to the total fair market value of all assets is applied to the total purchase price. |
|
|
Term
| What are the stages in the life cycle of a long-term operational asset? |
|
Definition
11. The life cycle of a long-term operational asset simply describes the process of acquiring, using, and retiring the asset. This process includes obtaining the funding to acquire the asset, acquiring the asset, using the asset, and disposing of the asset. |
|
|
Term
| Explain straight-line, units of production, and double-declining-balance depreciation. When is it appropriate to use each of these depreciation methods? |
|
Definition
12. Straight-line depreciation. This method allocates an equal amount of depreciation to each period over the useful life of the asset. Example: Asset cost of $4,000 with a 4-year life and no salvage value would produce a depreciation expense of $1,000 per year. This method is appropriate when the usefulness of an asset is consistent over the asset's life.
Units-of-production depreciation. When this method of depreciation is used, depreciation is calculated for each estimated unit of use, e.g. cost per mile. This estimated unit cost is then applied to the actual use of the asset for the period. Example: Asset cost of $4,000 with estimated use of 20,000 miles would produce a cost per mile of $.20. If the asset was used 4,000 miles in the year, the depreciation would be $800 ($.20 x 4,000). This method is more appropriate when the usefulness of an asset is related to the amount of use.
Double-declining balance depreciation. This is an accelerated depreciation method that allocates more of the cost of an asset to expense in the early years of the asset's life. It is called double-declining balance because the method applies twice the straight-line rate to the book value of the asset.
Example: Asset cost of $4,000 with an estimated useful life of 4 years would produce an expense of $2,000 in the first year [$4,000 x (2 x .25)]. The amount of depreciation expense will decrease each year of the asset's life. This method is appropriate when the usefulness of an asset decreases more in the early years of life than it does in the later years of the asset's life. |
|
|
Term
| What effect does the recognition of depreciation expense have on total assets? On total equity? |
|
Definition
13. Recognition of depreciation expense reduces total assets; while the asset account containing the asset that is being depreciated is not changed, the contra asset account, accumulated depreciation, is increased which, in turn, reduces total assets. Total equity is decreased when an expense is recognized. |
|
|
Term
| Does the recognition of depreciation expense affect cash flows? Why or why not? |
|
Definition
14. The recognition of depreciation expense does not affect cash flows. Depreciation recognition is simply the allocation of part of a previously acquired asset to expense. Cash is affected when the asset is purchased, when an improvement is made to the asset, and when it is sold. |
|
|
Term
| MalMax purchased a depreciable asset. What would be the difference in total assets at the end of the first year if MalMax chooses straight-line depreciation versus double-declining- balance depreciation? |
|
Definition
15. Total assets will be lower at the end of the first year of the asset’s life if MalMax chooses the double-declining balance method of computing depreciation rather than straight-line. This results because more expense is recognized in the early years of an asset’s life when double-declining balance is used. However, at the end of the asset’s life, total assets will be the same regardless of the method chosen because the amount of total depreciation recognized over the asset’s life is the same regardless of the depreciation method chosen. |
|
|
Term
| John Smith mistakenly expensed the cost of a long-term tangible fixed asset. Specifically, he charged the cost of a truck to a delivery expense account. How will this error affect the income statement and the balance sheet in the year in which the mistake is made? |
|
Definition
16. When the total cost of an asset is expensed in the year acquired, total expense will be overstated and net income will be understated. Because all of a plant asset's cost is erroneously expensed, assets will be understated and retained earnings will be understated because net income was understated.
|
|
|
Term
|
Definition
| 17. Salvage value is the estimated value of a plant asset at the end of its useful life to the business. |
|
|
Term
| What type of account (classification) is Accumulated Depreciation? |
|
Definition
18. Accumulated depreciation is a contra asset account. As the cost of a plant asset is expensed, a contra asset account is credited, rather than a direct reduction of the related asset account. This method is used because the cost allocation is an estimate, not an exact amount. In addition, this method provides more information to financial information users, in that the original cost is shown in the asset account and the allocated cost is shown as accumulated depreciation. |
|
|
Term
| How is the book value of an asset determined? |
|
Definition
19. Book value of an asset is its historical cost less any accumulated depreciation. |
|
|
Term
| Why is depreciation that has been recognized over the life of an asset shown in a contra account? Why not just reduce the asset account? |
|
Definition
20. Recording the depreciation recognized in the contra asset account allows the total cost of the asset and the total amount expensed to be shown in the accounts and on the balance sheet. This provides more information to the reader of the financial statements, e.g., some judgment can be made about the age and use of the asset. The use of the contra account is also required by GAAP. |
|
|
Term
| Assume that a piece of equipment cost $5,000 and had accumulated depreciation recorded pf $3,000 What is the book value of the equipment? Is the book value equal to the fair market value of the equipment? Explain. |
|
Definition
21. Book value is computed as the cost of an asset less the accumulated depreciation of that equipment, $5,000 $3,000 = $2,000. This does not represent the fair market value of the equipment because the accumulated depreciation is only an allocation of the cost based on estimates. In addition, the value of the equipment may not be related to its original cost. |
|
|
Term
| Why would a company choose to depreciate one piece of equipment using the double-declining-balance method and another piece of equipment using straight-line depreciation? |
|
Definition
22. The method of depreciation chosen should represent as closely as possible the pattern of usage of that piece of equipment. For instance, double-declining balance may be used for an asset that will decline in usefulness more in the early years of the life of the piece of equipment. Straight-line depreciation should be used when the asset’s usefulness declines at a constant rate. |
|
|
Term
| Why may it be necessary to revise the estimated life of a plant asset? When the estimated life is revised, does it affect the amount of depreciation per year? Why or why not? |
|
Definition
23. When an asset is purchased and put into service, an estimate is made of the expected useful life of the asset. However, as the asset is used, it may become apparent that the estimate was incorrect or circumstances may have changed (e.g., the asset is used more than expected) to cause the estimate to be incorrect. When these situations arise, it is necessary to revise the estimated useful life of the asset and, consequently, the amount of depreciation expense per period. The revised estimated useful life will affect the amount of depreciation per year. If the estimated life is longer than originally expected, the amount of depreciation per year will decrease; if the estimated useful life is shorter than originally expected, the amount of depreciation per year will be larger. |
|
|
Term
| How are capital expenditures made to improve the quality of a capital asset accounted for? Would the answer change if the expenditure extended the life of the asset but did not improve quality? Explain. |
|
Definition
24. When an expenditure improves the quality of an asset, this improvement is accounted for as if a new asset is purchased; the equipment account is debited. The improvement is depreciated over the remaining life of the original asset since the life of the asset is not extended; only the quality is improved.
When an expenditure extends the life of the asset, this expenditure in effect reduces some of the depreciation already taken on the asset. This is accomplished by reducing the accumulated depreciation account (a debit to accumulated depreciation). Depreciation is recalculated by spreading the remaining book value, reduced by salvage value, over the remaining estimated life of the asset.
|
|
|
Term
| When a long-term operational asset is sold at a gain, how is the balance sheet affected? Is the statement of cash flows affected? If so, how? |
|
Definition
25. When a long-term operational asset is sold for a gain, total assets and equity increase by the amount of the gain. The gain is the amount the asset is sold for over the book value of the asset. However, the cash flow from the sale of the equipment is the amount the asset is sold for (assuming it is sold for cash). The total amount of cash received is shown as a cash inflow in the investing section of the statement of cash flows. |
|
|
Term
| Define depletion. What is the most commonly used method of computing depletion? |
|
Definition
26. Depletion is the process of systematically allocating the cost of natural resources to expense based on estimated production of the asset. The most common method used to calculate depletion is units-of-production. An estimated cost per unit of resource is determined by dividing the cost of the asset by the estimated production. The amount of expense for each period is based on the number of units extracted and sold. |
|
|
Term
| List several common intangible assets. How is the life determined that is to be used to compute amortization? |
|
Definition
27. Some of the most common intangible assets include patents, copyrights, and goodwill. Amortization is generally based on the legal life of the asset, the useful life of the asset, or, in the case of goodwill, the amount of any impairment. The asset is generally amortized over the shortest of these possible lives. The period over which an intangible asset can be amortized for tax purposes is generally determined according to terms specified by tax law. These terms are generally different from those used for financial accounting. |
|
|
Term
| List some differences between US GAAP and GAAP of other countries. |
|
Definition
28. Most countries have developed accounting principles that they apply to financial statements. While there are many similarities, some significant differences do exist. For example, in Britain, any purchased goodwill is charged to retained earnings in the year of the purchase, while in the U.S., goodwill is set up as an asset. Japanese accounting principles report research and development expense differently from U.S. GAAP. In Japan, R&D is set up as an asset and expensed over a period of time, whereas, in the U.S., R&D is expensed in the year incurred. |
|
|
Term
| How do differences in expense recognition and industry characteristics affect financial performance measures? |
|
Definition
29. Some industries are very capital intensive while others are labor intensive. When evaluating managerial performance, one must understand the industry that a company is in and compare within the industry.
|
|
|
