Intermediate Accounting Exam Chapter 9

What specific items are included in the “Cash” line item on the balance sheet?

Coins, currency, bank deposits, checks, and money orders. It is classified as a Current Asset unless it is restricted from use in the current operating cycle.

What are Cash Equivalents, and what is the strict maturity rule?

Short-term, highly liquid investments.

The key rule is an original maturity of 3 months or less from the date of purchase. Examples include Treasury bills, commercial paper, certificates of deposit (CDs), and money market funds.

Bank Overdrafts

Checks written exceeding the balance.

Under US GAAP, they are treated as a Current Liability.

Under IFRS, they can be offset (netted) against cash if part of cash management.

Under US GAAP, how should bank overdrafts generally be reported?

They should generally be reported as a current liability. They cannot be offset against cash.

Restricted Cash / Compensating Balances

Minimum cash balances required to be maintained as support for credit arrangements.

• If tied to short-term debt → Keep as a Current Asset.

• If tied to long-term debt → Reclassify as a Noncurrent Asset.

A company has a compensating balance (minimum cash required by a lender). How is it classified based on the debt it supports?

• If it supports short-term debt: Classify as a Current Asset

• If it supports long-term debt: Reclassify as a Noncurrent Asset (Other Assets).

A debtor must maintain a minimum cash balance for a long-term credit agreement. How is it classified?

It is reclassified as a noncurrent asset (Because the restriction is long term, lasts longer than a year).

How do Trade and Volume Discounts affect the initial measurement of Accounts Receivable?

They reduce the catalog list price immediately. You record the Accounts Receivable and Sales Revenue at the net (discounted) price, not the gross list price.

Trade/Volume Discounts

Immediate reductions off the list price. You record the A/R at the discounted price.

Sales (Cash) Discounts

These offer incentives for early payment (2/10, n/30 which means 2% discount if paid in 10 days, otherwise net due in 30).

Describe the Gross Method for sales discounts (e.g., 2/10, n/30).

• Assumption: The customer will NOT take the discount.

• Initial Entry: Record A/R and Revenue at the full gross price.

• If Paid Late: No adjustment needed.

• If Paid Early: Debit Cash and "Sales Discounts" (a contra-revenue account) and credit A/R.

Describe the Net Method for sales discounts (e.g., 2/10, n/30).

• Assumption: The customer WILL take the discount.

• Initial Entry: Record A/R and Revenue at the net (discounted) price.

• If Paid Early: No adjustment needed.

• If Paid Late: Debit Cash (full gross), credit A/R (net amount), and credit "Sales Discounts Forfeited" (a revenue account) for the difference.

How does the Expected-Value Method work for sales discounts?

It sums the probability-weighted amounts in a range of possible outcomes.

• Example: Gross $10,000. 60% chance no discount, 40% chance of 2% discount.

• Math: ($10,000 × 60%) + ($9,800 × 40%) = $6,000 + $3,920 = $9,920.

• If the actual outcome differs, you credit "Sales Discounts Forfeited" for the variance.

List price $150,000 with a 10% volume discount. What is the initial A/R?

$150,000 × 90% = $135,000. You record the net amount immediately.

100 boots @ $100, terms 2/10, n/30. Uses Net Method. What is initial Sales/A/R?

Total = $10,000. 2% discount = $200. Initial record = $10,000 - $200 = $9,800.

Using the Net Method (recorded at $19,600), customer pays late with the full $20,000. What is credited to 'Sales Discounts Forfeited'?

Math: $20,000 (cash) - $19,600 (recorded A/R) = $400

Expected-value method. $10,000 gross, 60% chance NO discount, 40% chance 2% discount.

• No discount: $10,000 × 60% = $6,000

• Take discount: ($10,000 × 98%) × 40% = $9,800 × 40% = $3,920

• Total = $6,000 + $3,920 = $9,920.

What is the formula for Net Realizable Value (NRV) of Accounts Receivable?

Gross Accounts Receivable minus the Allowance for Expected Credit Losses

How does the Aging of Receivables method work, and how do you find the Bad Debt Expense?

It is a balance-sheet-focused approach. You categorize A/R by age and multiply by uncollectible percentages. This gives you the Target Ending Balance for the Allowance account.

• Bad Debt Expense is the "plug" (the difference between the unadjusted allowance balance and the target balance).

If the unadjusted Allowance has a $15,000 Debit balance and the target is $85,000, what is the Bad Debt Expense? What if it was a $50,000 Credit?

• Debit Balance (15k): Expense = $85,000 (Target) + $15,000 (to wipe out the debit) = $100,000

• Credit Balance (50k): Expense = $85,000 (Target) - $50,000 (existing credit) = $35,000

Aging Method

You figure out the target ending balance for the Allowance account based on how old the receivables are. Bad Debt Expense is the “plug” (the difference between the unadjusted balance.

Write-offs

Executed when an account is deemed uncollectible (Debit Allowance, Credit Accounts Receivable).

This entry has no effect on net income and no effect on net receivables (NRV)

Recoveries

Occurs when a written-off account pays. First, reinstate the receivable and allowance (Debit AR, Credit Allowance), then record the cash collection (Debit Cash, Credit AR).

Two steps.

1) Reverse the write-off (Dr A/R, Cr Allowance).

2) Record the cash (Dr Cash, Cr A/R).

What is the journal entry to write off a specific uncollectible account, and what is its effect on Net Income and NRV?

• Entry: Debit Allowance for Expected Credit Losses; Credit Accounts Receivable.

• Effect: NO effect on Net Income and NO effect on NRV (because both Gross A/R and the Allowance decrease by the exact same amount).

What are the journal entries required when a customer pays an account that was previously written off?

• Step 1 (Reinstate): Debit Accounts Receivable; Credit Allowance for Expected Credit Losses.

• Step 2 (Collect): Debit Cash; Credit Accounts Receivable.

$25,000 A/R, only $21,500 expected to be paid. What is Bad Debt Expense?

• Math: $25,000 - $21,500 = $3,500 (This assumes a zero starting balance).

Unadjusted Allowance has a $50,000 Credit. Target required balance is $145,000. Bad Debt Expense?

You need to go from 50k up to 145k. $145,000 - $50,000 = $95,000

Gross A/R $500k, Allowance $45k. NRV = $455k. Write off $12k. What is the new NRV?

• Math: Gross becomes $488k. Allowance becomes $33k. $488k - $33k = $455,000 (Answer A). (Proves the rule that write-offs don't change NRV).

What is pledging/ assigning A/R, and how does it affect the balance sheet?

Using A/R as collateral for a loan. The receivables remain on the balance sheet (you still own them). You record a Note Payable for the cash borrowed and remit collections (plus interest) to the lender.

Factoring

Selling receivables to a third party (factor) at a discount.

What is factoring A/R "without recourse," and how is it recorded?

Selling A/R to a factor who assumes all credit risk. It is treated as a sale.

• Remove the A/R from the books.

• Record cash received.

• Record a Loss on Sale of Receivables for the factor's fee.

• If the factor holds back a percentage, record a Receivable from Factor.

How is factoring A/R "with recourse" different from "without recourse"?

The seller guarantees collection. You must record a Recourse Obligation (a liability). This liability increases the total Loss on Sale of Receivables compared to a without-recourse sale.

Factoring Accounts Receivable without Recourse

The seller guarantees collection, recognizing a Recourse Obligation liability which increases the loss on the sale.

What is securitization of receivables?

Bundling many separate receivables into a single pool and selling partial financial interests in that pool to individual investors (e.g., mortgage-backed securities).

Assign $400k A/R for a $300k loan at 6%. Collect $100k at month end. Remit principal + 1 month interest?

• Math: Principal = $100,000. Interest = ($300,000 × 6%) / 12 = $1,500. Total remitted = $101,500

Factor $200k without recourse. 6% fee + 4% holdback. Immediate cash proceeds?

Fee = $12k. Holdback = $8k. Cash = $200k - $12k - $8k = $180,000

Criteria for factoring to be a "sale" under US GAAP?

Isolated from seller, factor can pledge/exchange, seller gives up control.

How is a note recorded if the stated interest rate equals the market rate?

The note is recorded at its Face Value. Interest is accrued periodically over time based on Principal × Rate × Time.

How is a non-interest-bearing note recorded initially, and what is the contra-account called?

Recorded at its Present Value (PV). The difference between the Face Value and the PV is recorded as a Discount on Notes Receivable (a contra-asset account).

How is the Discount on Notes Receivable handled over time?

It is amortized (gradually spread out over a set period of time) to Interest Revenue over the life of the note.

• Example: A $15,000 discount on a 3-month note. If 2 months have passed, interest revenue recognized = $15,000 × (2/3) = $10,000.

Accounts Receivable Turnover Ratio:

Net Credit Sales / Average Accounts Receivable

DSO (Days Sales Outstanding):

365 / A/R Turnover.

DIO (Days Inventory Outstanding):

365 / Inventory Turnover.

DPO (Days Payable Outstanding):

365 / A/P Turnover

Operating Cycle:

Days Sales Outstanding (DSO) + Days Inventory on Hand (DIO)

How long it takes to turn inventory into cash

How do you calculate the Operating Cycle and the Cash Operating Cycle?

• Operating Cycle: DSO + DIO (Time to turn inventory into cash).

• Cash Operating Cycle: DSO + DIO - DPO. (Note: The study guide says "DPO - Operating Cycle," but the standard formula is Operating Cycle - DPO).

What does a positive vs. negative Cash Operating Cycle mean?

• Positive Cycle: The company pays its suppliers before it collects cash from customers. This requires external financing.

• Negative Cycle: The company collects cash from customers before it pays suppliers. This is a great liquidity position and provides self-funding.

What is the most critical internal control rule regarding cash?

Segregation of Duties. Individuals with physical custody of cash must never handle accounting records. This prevents theft and covering it up.

What are the common adjustments for the Bank Side vs. the Book Side of a bank reconciliation, and which side requires journal entries?

• Bank Side: Deposits in transit (+), Outstanding checks (-). No journal entries.

• Book (Ledger) Side: Interest earned (+), Service charges (-), NSF checks (-), Errors (±). Journal entries are required for these

When do you record a journal entry that affects the "Petty Cash" asset account?

Only when the fund is established (Dr Petty Cash, Cr Cash) or increased. When replenishing the fund, you debit the expenses and credit Cash. You do not touch the Petty Cash account during replenishment.

How is a shortage or overage handled at the end of a petty cash period?

Use the "Cash Short and Over" account.

• A shortage (missing money) is a Debit (expense).

• An overage (extra money) is a Credit (revenue).