Accounting Assignment -02

3.Define a “compensating balance.” How should a compensating

balance be reported?
A compensating balance is money that a company has to keep in its
bank account as part of its loan agreement. It helps to show the bank
that the company can pay back its loans.
If the company has to keep money in its account for a short time
because of a loan, it's shown as part of the cash the company has. But if
the money has to stay there for a long time, it's counted as a
noncurrent asset, like an investment, on the company's books.

4. Springsteen Inc. reported in a recent annual report “Restricted cash

for debt redemption.” What section of the balance sheet would report
this item?
Restricted cash for debt redemption would be reported in the long-term
asset section, probably in the investments section. Another alternative
is the other assets section. Given that the debt is long term, the
restricted cash should also be reported as long term.

5. What are the reasons that a company gives trade dis counts? Why
are trade discounts not recorded in the accounts like cash discounts?
Trade discounts are discounts given by sellers to buyers for various
reasons like buying in bulk or building good relationships. They're not
recorded in accounts because the final price already reflects the
product's true value. Also, trade discounts help avoid frequent catalog
changes and let sellers offer different prices based on quantity. Unlike
cash discounts where buyers can choose to pay early, trade discounts
are fixed, so there's no need for extra accounting entries.

6. What are two methods of recording accounts receivable

transactions when a cash discount situation is involved? Which is
more theoretically correct? Which is used in practice more of the
time? Why?
Two methods of recording accounts receivable are:
1. Gross Method: This means recording the full amount of money
owed without considering any discounts.
2. Net Method: This means recording the amount of money owed
after subtracting any discounts that were offered.
The net method is better in theory because it shows the true value of
what's owed. It also gives a clearer picture of the money earned from
sales. If a customer doesn't use a discount they were offered, the
company can count that extra money as income.
But in practice, companies usually use the gross method because it's
simpler. It doesn't make a big difference in how their financial
statements appear.

8. What are the basic problems that occur in the valuation of accounts
receivable?
The basic problems that relate to the valuation of receivables are-
 1. Face Value: This is about figuring out the initial amount of money
owed, which can be affected by trade discounts, cash discounts,
and allowances like returns.
2. Probability of Collection: This means predicting how likely it is that
the money owed will actually be paid back in the future.
3. Time Outstanding: It's about estimating how long it will take for
the money owed to be paid back.
These are the main challenges in valuing receivables: knowing the
starting amount, guessing if it will be paid back, and figuring out how
long it will take.

9. What is the theoretical justification of the allowance method as

contrasted with the direct write-off method of accounting for bad
debts?
The allowance method is better than the direct write-off method for
two main reasons:
1. Matching Revenues and Expenses: The allowance method
matches bad debt expenses with the sales they relate to, giving a
more accurate picture of income. This means it estimates and
records bad debts at the same time as sales, rather than waiting
until debts are actually uncollectible.
2. Realistic Balance Sheet: It shows accounts receivable at their true
value. By estimating uncollectible accounts and subtracting this
from the total receivables, it presents a more realistic view of how
much money the company expects to collect.
In short, the allowance method provides a more accurate and realistic
financial picture.
10. Indicate how the percentage-of-receivables method, based on an
aging schedule, accomplishes the objectives of the allowance method
of accounting for bad debts. What other methods, besides an aging
analysis, can be used for estimating uncollectible accounts?
The percentage-of-receivables method, using an aging schedule,
achieves the same goals as the allowance method for bad debts. This
method calculates the amount to set aside for bad debts by looking at
the collectability of open accounts receivable at the end of the year. It
involves analyzing accounts based on their due dates and assigning
average percentage rates to different age categories, considering past
experience. Individual analysis may also be used for accounts that are
significantly past due. Based on this analysis, the balance in the
allowance account is adjusted to reflect the estimated amount of
uncollectible receivables.
Besides aging analysis, other methods for estimating uncollectible
accounts include:
1. Percentage-of-Sales Method: Estimating bad debts as a
percentage of total credit sales made during the accounting
period.
2. Analysis of Historical Data: Using past experience and trends to
predict future bad debt losses.
3. Industry Averages: Comparing bad debt experience with industry
averages to estimate potential losses.
These methods help companies anticipate and account for potential
losses due to uncollectible receivables, ensuring that their financial
statements accurately reflect the true value of accounts receivable.
(Again check it)
11. Of what merit is the contention that the allowance method lacks
the objectivity of the direct write-off method? Discuss in terms of
accounting’s measurement function.
In accounting, it's crucial to measure financial data accurately.
Estimating uncollectible accounts helps ensure that receivables are
reported at their true value and provides useful information regularly.
When a company makes a credit sale, it recognizes revenue and records
the sale as an asset, assuming the customer will pay later. To be fair in
financial statements, both expenses and assets need to be adjusted for
estimated amounts that likely won't be collected.
Some argue that the direct write-off method, which records bad debts
only when they're confirmed uncollectible, may provide more accurate
decisions than the allowance method. However, the allowance method,
which estimates bad debts upfront, is considered "objective" in
accounting and ensures a fair presentation of receivables and income.
While the direct write-off method isn't entirely objective and requires
judgment, it's also used to manage uncollectible accounts.

14. What is the normal procedure for handling the collection of

accounts receivable previously written off using the direct write-off
method? The allowance method?
If the direct write-off method is used, the only alternative is to debit
Cash and credit a revenue account entitled Uncollectible Amounts
Recovered. If the allowance method is used, then the accountant would
debit Accounts Receivable and credit the Allowance for Doubtful
Accounts. An entry is then made to credit the customer’s account and
debit Cash upon receipt of the remittance.
16. What is “imputed interest”? In what situations is it necessary to
impute an interest rate for notes receivable? What are the
considerations in imputing an appropriate interest rate?
Imputed interest is interest assigned to a situation where no interest
rate is stated or the given rate is too low. It's calculated to reflect a fair
interest rate.
We need to impute interest for notes receivable when:
1. No interest rate is provided.
2. The stated interest rate is too low.
3. The note's value is very different from the current cash price or
market value.
When imputing an interest rate, we consider:
- Current interest rates for similar loans.
- The borrower's credit rating.
- Any collateral or restrictions on the note.
(Again check it)

17. What is the fair value option? Where do companies that elect the
fair value option report unrealized holding gains and losses?
The fair value option allows companies to measure financial
instruments using their current market value instead of their original
cost. This method is believed to give more accurate and clear
information. If a company uses the fair value option, it records its
receivables at market value, and any unrealized gains or losses are
included in net income.
18. Indicate three reasons why a company might sell its receivables to
another company.
a. A company might sell its receivables to get immediate cash when
credit is unavailable or too expensive,
b. to avoid breaking current loan agreements,
c. and to save time and costs associated with billing and collecting
payments.

19. When is the financial components approach to recording the

transfers of receivables used? When should a trans fer of receivables
be recorded as a sale?
The financial components approach is used when receivables are sold,
but the seller still has some involvement, like recourse provisions or
servicing rights.
A transfer of receivables is recorded as a sale if:
1. The asset is isolated from the seller and its creditors.
2. The buyer can use or sell the asset.
3. The seller doesn't control the asset by an agreement to buy it back
before it matures.

20. Moon Hardware is planning to factor some of its receivables. The

cash received will be used to pay for inventory purchases. The factor
has indicated that it will require “recourse” on the sold receivables.
Explain to the controller of Moon Hardware what “recourse” is and
how the recourse will be reflected in Moon’s financial statements
after the sale of the receivables.
Recourse means Moon promises to pay the factor if some receivables
can't be collected. This keeps Moon involved even after selling them. In
the financial components model, Moon records the estimated value of
this promise as a liability on its balance sheet.

22. What is the accounts receivable turnover, and what type of

information does it provide?
The accounts receivable turnover ratio tells us how many times, on
average, a company collects its receivables in a year. It's found by
dividing net sales by the average amount of receivables during the year.
This ratio helps assess how quickly the company gets paid by its
customers and gives clues about the quality of those receivables. In
simple terms, it shows how well the company manages to collect the
money owed to it.

24. Distinguish among the following: (1) a general checking account,

(2) an imprest bank account, and (3) a lockbox account.
1. General Checking Account:
- Main bank account for most companies, often the only account for
small companies.
- Used for most transactions, either directly or through an imprest
system.

2. Imprest Bank Account:

- Used to pay for specific things like dividends, payroll, or travel
expenses.
 - Money is transferred from the main account to cover these
expenses.

3. Lockbox Account:
- Companies set up post office boxes for customers to send payments.
- The bank collects the payments, deposits them, and credits the
company's account daily.
Each type serves a different purpose and helps manage money in
different ways.

25. What are the general rules for measuring and recognizing gain or
loss by both the debtor and the creditor in an impairment?
A loan is impaired when the lender thinks they won’t get all the money
back (both principal and interest) as agreed. The lender measures the
loss as the difference between what they invested in the loan and the
expected future payments, discounted at the original interest rate. The
lender records this loss. The borrower doesn’t record anything until the
loan is settled or the terms are changed.

26. Describe the estimation of the allowance, based on expected cash

flows.
Companies commonly evaluate loans (long-term notes receivable) for
collectability based on an analysis of the expected contractual cash
flows. They then apply discounted expected cash flow methods, to
measure the allowance to report the loan at net realizable value. The
allowance for doubtful accounts and related bad debt expense on a
loan or note receivable can be estimated as the difference between the
investment in the loan (generally the principal plus accrued interest or
amortized cost) and the expected future cash flows discounted at the
loan’s historical effective interest rate.