© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin 7-1 financial assets chapter 7
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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
7-2
How Much Cash Should a Business Have?
How Much Cash Should a Business Have?
$
Every business
needs enough
cash to pay its bills!
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How Much Cash Should a Business Have?
How Much Cash Should a Business Have?
Cash
Short-term Investments
Receivables
Financial Assets
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How Much Cash Should a Business Have?
How Much Cash Should a Business Have?
Accounts
receivable
Marketable securities (short-term
investments)
Cash (and cash equivalents)
Collections from
customers Cash payments
“Excess” cash is
invested temporarily
Investments are sold as
cash is needed
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The Valuation of Financial AssetsThe Valuation of Financial Assets
Type of Financial AssetsBasis for Valuation in
the Balance SheetCash (and cash equivalents) Face amountShort-term investments (marketable securities)
Current market value
Receivables Net realizable value
Estimated collectible amountEstimated collectible amount
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CashCash
Coins and paper money
Checks
Money orders
Travelers’ checks
Bank credit card sales
Cash is defined as
any deposit banks will
accept.
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Combined with cash on balance sheet
Reporting Cash in the Balance Sheet
Reporting Cash in the Balance Sheet
Liquid short-term
investments
Stable market values
Matures within 90 days of acquisition
Cash Equivalents
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Not available for paying
current liabilities
Reporting Cash in the Balance Sheet
Reporting Cash in the Balance Sheet
Not a current asset
Listed as an investment
“Restricted” Cash
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Bank agrees in advance to lend
money.
Reporting Cash in the Balance Sheet
Reporting Cash in the Balance Sheet
Liability is incurred when line of credit is used.
Unused line of credit is disclosed
in notes.
Lines of Credit
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The Statement of Cash FlowsThe Statement of Cash Flows
Summarizes cash transactions for an accounting period.
Summarizes cash transactions for an accounting period.
Includes cash and cash equivalents.
Includes cash and cash equivalents.
Statement of Cash Flows
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Cash ManagementCash Management
Accurately account for cash.
Prevent theft and fraud.
Assure the availability of adequate amounts of cash.
Prevent unnecessarily large amounts of idle cash.
Accurately account for cash.
Prevent theft and fraud.
Assure the availability of adequate amounts of cash.
Prevent unnecessarily large amounts of idle cash.
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Using Excess Cash Balances Efficiently
Using Excess Cash Balances Efficiently
Cash available for long-term investment
may be used to finance growth and expansion of the business, or to
repay debt.
Cash not needed for business purposes
may be distributed to the company’s stockholders.
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Internal Control Over CashInternal Control Over Cash
• Segregate authorization, custody and recording of cash.
• Prepare a cash budget (or forecast).
• Prepare a control listing of cash receipts.
• Require daily deposits.
• Make all payments by check.
• Verify every expenditure before payment.
• Promptly reconcile bank statements.
• Segregate authorization, custody and recording of cash.
• Prepare a cash budget (or forecast).
• Prepare a control listing of cash receipts.
• Require daily deposits.
• Make all payments by check.
• Verify every expenditure before payment.
• Promptly reconcile bank statements.
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Cash Over and ShortCash Over and Short
Cash Over and Short is debited for shortages and credited for overages.Cash Over and Short is debited for
shortages and credited for overages.
On May 5, XBAR, Inc.’s cash drawerwas counted and found to be $10 over.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Bank StatementsBank Statements
Shows the beginning bank balance, deposits made, checks paid, other
debits and credits in the month, and the ending bank balance.
Bank Statement
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Reconciling the Bank StatementReconciling the Bank Statement
Explains the difference between cash reported on bank statement and cash
balance in depositor’s accounting records.
Provides information for reconciling journal entries.
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Reconciling the Bank StatementReconciling the Bank Statement
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
± Bank Adjustments
= Adjusted Balance
Balance per Depositor
+ Deposits by Bank (credit memos)
- Service Charge - NSF Checks
± Book Adjustments
= Adjusted Balance
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Reconciling the Bank StatementReconciling the Bank Statement
All reconciling items on the
book side require an adjusting
entry to the cash account.
Balance per Depositor
+ Deposits by Bank (credit memos)
- Service Charge - NSF Checks
± Book Adjustments
= Adjusted Balance
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Reconciling the Bank StatementReconciling the Bank Statement
Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31
bank statement indicated a cash balance of $9,610, while the cash ledger account on
that date shows a balance of $7,430.
Additional information necessary for the reconciliation is shown on the next page.
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Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had
not reached the bank at the statement date. The bank returned a customer’s NSF check for
$225 received as payment of an account receivable.
The bank statement showed $30 interest earned on the bank balance for the month of July.
Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.
A $486 deposit by Acme Company was erroneously credited to our account by the bank.
Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had
not reached the bank at the statement date. The bank returned a customer’s NSF check for
$225 received as payment of an account receivable.
The bank statement showed $30 interest earned on the bank balance for the month of July.
Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240.
A $486 deposit by Acme Company was erroneously credited to our account by the bank.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Reconciling the Bank StatementReconciling the Bank Statement
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Reconciling the Bank StatementReconciling the Bank Statement
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Jul 31 Cash 30
Interest Revenue 30
31 Supplies Inventory 28
Accounts Receivable 225
Cash 253
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Used for minor expenditures.
Petty Cash FundsPetty Cash Funds
Has one custodian.
Replenished periodically.
Petty Cash Funds
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Short-Term InvestmentsShort-Term Investments
Bond Investments
Capital Stock
Investments
Current Assets
Almost As Liquid As
Cash
Readily Marketable
Marketable Securities
are . . .
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Accounting for Marketable Securities
Accounting for Marketable Securities
Most short-term investments in marketable securities are classified as available for sale and appear on the
balance sheet at their current market value.
Classification Management's IntentTreatment of Unrealized
Holding Gains and LossesAvailable-for-sale securities
Held for short-term resale (often 6 to 18 months)
Reported in stockholders' equity section of the balance sheet
Trading securities
Held for immediate resale (often within hours or days)
Reported in "other" revenue (expense) section of the income statement
Held-to-maturity securities
Debt securities intended to be held until they mature
Not reported. Securities are reported on balance sheet at amortized cost.
Classification Management's IntentTreatment of Unrealized
Holding Gains and LossesAvailable-for-sale securities
Held for short-term resale (often 6 to 18 months)
Reported in stockholders' equity section of the balance sheet
Trading securities
Held for immediate resale (often within hours or days)
Reported in "other" revenue (expense) section of the income statement
Held-to-maturity securities
Debt securities intended to be held until they mature
Not reported. Securities are reported on balance sheet at amortized cost.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Purchase of Marketable SecuritiesPurchase of Marketable Securities
Foster Corporation purchases as a short-term investment 4,000 shares of The Coca-Cola
Company on December 1. Foster paid $43.98 per share, plus a brokerage commission of $80.
Foster Corporation purchases as a short-term investment 4,000 shares of The Coca-Cola
Company on December 1. Foster paid $43.98 per share, plus a brokerage commission of $80.
Total Cost: (4,000 × $43.98) + $80 = $176,000
Cost per Share: $176,000 ÷ 4,000 = $44.00
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Recognition of Investment RevenueRecognition of Investment Revenue
On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000
shares of Coca-Cola.
On December 15, Foster Corporation receives a $0.30 per share dividend on its 4,000
shares of Coca-Cola.
4,000 × $0.30 = $1,200
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Sales of InvestmentsSales of Investments
On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission.
On December 18, Foster Corporation sells 500 shares of its Coca-Cola stock for $46.04 per share, less a $20 brokerage commission.
Sales Proceeds: (500 × $46.04) - $20 = $23,000
Cost Basis: 500 × $44 = $22,000
Gain on Sale: $23,000 - $22,000 = $1,000
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Adjusting Marketable Securities to Market Value
Adjusting Marketable Securities to Market Value
On December 31, Foster Corporation’s remaining shares of Coca-Cola capital stock have a current
market value of $42,000. Prior to any adjustment, the company’s Marketable Securities account has a
balance of $44,000 (1,000 × $44 per share).
On December 31, Foster Corporation’s remaining shares of Coca-Cola capital stock have a current
market value of $42,000. Prior to any adjustment, the company’s Marketable Securities account has a
balance of $44,000 (1,000 × $44 per share).
Unrealized Loss: $42,000 - $44,000 = ($2,000)
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Accounts ReceivableAccounts Receivable
If a company makes credit sales to customers, some
accounts inevitably will turn out to be uncollectible.
If a company makes credit sales to customers, some
accounts inevitably will turn out to be uncollectible.
PAST DUE
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Reflecting Uncollectible Accounts in the Financial Statements
Reflecting Uncollectible Accounts in the Financial Statements
At the end of each period, record an estimate of the uncollectible
accounts.
At the end of each period, record an estimate of the uncollectible
accounts.
Contra-asset accountContra-asset accountSelling expenseSelling expense
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The Allowance for Doubtful Accounts
The Allowance for Doubtful Accounts
Accounts receivableLess: Allowance for doubtful accountsNet realizable value of accounts receivable
The net realizable value is the amount of accounts receivable that the business
expects to collect.
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Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
When an account is determined to be uncollectible, it no longer qualifies as an
asset and should be written off.
When an account is determined to be uncollectible, it no longer qualifies as an
asset and should be written off.
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Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
Assume that on January 5, K-Max determined that Jason Clark would not pay
the $500 he owes.K-Max would make the following entry.
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Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Doubtful Accounts balance
was $2,500.
Let’s see what effect the write-off had on these accounts.
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Writing Off an Uncollectible Account Receivable
Writing Off an Uncollectible Account Receivable
Before Write-Off
After Write-Off
Accounts receivable 10,000$ 9,500$ Less: Allow. for doubtful accts. 2,500 2,000 Net realizable value 7,500$ 7,500$
Notice that the $500 write-off did not change the net realizable value nor did it affect any income
statement accounts.
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Monthly Estimates of Credit LossesMonthly Estimates of Credit Losses
At the end of each month, management should estimate the probable amount of
uncollectible accounts and adjust the
Allowance for Doubtful Accounts to this new
estimate.
At the end of each month, management should estimate the probable amount of
uncollectible accounts and adjust the
Allowance for Doubtful Accounts to this new
estimate.
Two Approaches to Estimating Credit Losses:
1. Balance Sheet Approach
2. Income Statement Approach
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Estimating Credit Losses — The Balance Sheet Approach
Estimating Credit Losses — The Balance Sheet Approach
Year-end Accounts Receivable is broken down into age
classifications.
Year-end Accounts Receivable is broken down into age
classifications.
Each age grouping has a different likelihood of being
uncollectible.
Each age grouping has a different likelihood of being
uncollectible.
Compute a separate allowance for each age grouping.
Compute a separate allowance for each age grouping.
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Estimating Credit Losses — The Balance Sheet Approach
Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
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Estimating Credit Losses — The Balance Sheet Approach
Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Estimating Credit Losses — The Balance Sheet Approach
Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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EastCo’s unadjusted balance in the allowance account is
$500.
Per the previous computation, the desired balance is $1,350.
EastCo’s unadjusted balance in the allowance account is
$500.
Per the previous computation, the desired balance is $1,350.
Estimating Credit Losses — The Balance Sheet Approach
Estimating Credit Losses — The Balance Sheet Approach
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Let’s look at another way to estimate
credit losses!
Let’s look at another way to estimate
credit losses!
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Estimating Credit Losses — The Income Statement Approach
Estimating Credit Losses — The Income Statement Approach
Uncollectible accounts’ percentage is based on actual uncollectible accounts from
prior years’ credit sales.
Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.
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Estimating Credit Losses — The Income Statement Approach
Estimating Credit Losses — The Income Statement Approach
Net Credit Sales% Estimated Uncollectible
Amount of Journal Entry
Net Credit Sales% Estimated Uncollectible
Amount of Journal Entry
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Estimating Credit Losses — The Income Statement Approach
Estimating Credit Losses — The Income Statement Approach
In 2007, EastCo had credit sales of $60,000.
Historically, 1% of EastCo’s credit sales has been uncollectible.
For 2007, the estimate of uncollectible accounts expense is $600.
($60,000 × .01 = $600)
Now, prepare the adjusting entry for December 31, 2007.
In 2007, EastCo had credit sales of $60,000.
Historically, 1% of EastCo’s credit sales has been uncollectible.
For 2007, the estimate of uncollectible accounts expense is $600.
($60,000 × .01 = $600)
Now, prepare the adjusting entry for December 31, 2007.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Estimating Credit Losses — The Income Statement Approach
Estimating Credit Losses — The Income Statement Approach
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Uncollectible AccountsSummary
Uncollectible AccountsSummary
Aging of Receivables
Aging of Receivables
Emphasis on Realizable Value
Emphasis on Realizable Value
Accts. Rec. All. for
Doubtful Accts.
Balance Sheet Focus
Balance Sheet Focus
% of Credit Sales% of Credit Sales
Emphasis on Matching
Emphasis on Matching
SalesUncoll. Accts. Exp.
Income Statement
Focus
Income Statement
Focus
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Concentrations of Credit RiskConcentrations of Credit Risk
Concentrations of credit risk occur if a significant portion of a company’s receivables are due from a few major customers or from customers operating in the same
industry or geographic region.
Concentrations of credit risk occur if a significant portion of a company’s receivables are due from a few major customers or from customers operating in the same
industry or geographic region.
The FASB requires disclosure of all
significant concentrations of credit risk in the
notes to the financial statements.
The FASB requires disclosure of all
significant concentrations of credit risk in the
notes to the financial statements.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Recovery of an Account Receivable Previously Written Off
Recovery of an Account Receivable Previously Written Off
GENERAL JOURNAL
Date Account Titles and ExplanationPR Debit Credit
Accounts Receivable (X Customer) $$$$
Allowance for Doubtful Accounts $$$$
Cash $$$$
Accounts Receivable (X Customer) $$$$
Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
Subsequent collections require that the original write-off entry be reversed before the cash collection is recorded.
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Direct Write-Off MethodDirect Write-Off Method
This method makes no attempt to match revenues with the expense of
uncollectible accounts.
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Income Tax Regulations and Financial Reporting
Income Tax Regulations and Financial Reporting
Direct write-off method required to calculate
taxable income.
Taxable Income
Financial Statement Income
GA
AP
GA
AP
GA
AP
GA
AP Allowance methods
better match expenses with revenues.
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Internal Controls for ReceivablesInternal Controls for Receivables
Separate the following duties:
Maintenance of the accounts receivable subsidiary ledger.
Custody of cash receipts.
Authorization of accounts receivable write-offs.
Maintenance of the accounts receivable subsidiary ledger.
Custody of cash receipts.
Authorization of accounts receivable write-offs.
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Management of Accounts Receivable
Management of Accounts Receivable
Credit Terms
Minimize Accounts
Receivable
Extending credit encourages customers to buy from us . . .
. . . but it ties up resources in accounts receivable.
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Management of Accounts Receivable
Management of Accounts Receivable
Factoring Accounts
Receivable
Credit Card
Sales
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A promissory note is an unconditional promise in writing to pay on demand or at
a future date a definite sum of money.
A promissory note is an unconditional promise in writing to pay on demand or at
a future date a definite sum of money.
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
Maker—the person who signs the note and thereby promises to pay.
Payee—the person to whom payment is to be made.
Maker—the person who signs the note and thereby promises to pay.
Payee—the person to whom payment is to be made.
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Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
Porter Company is replacing an existing Accounts Receivable with this Note Receivable with Hall Company.
PROMISSORY NOTE
Location Date
after this date
promises to pay to the order of
the sum of with interest at the rate
of per annum.
signed
title
Miami, Fl Nov. 1, 2007
Ninety days Porter Company
John Caldwell
Hall Company
$10,000.00
12.0%
CFO, Porter Company
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On November 1, 2007, Hall Companywould make the following entry.
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
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• Interest is a charge made for the use of money.
• The borrower incurs interest expense.
• The lender earns interest revenue.
• Interest is a charge made for the use of money.
• The borrower incurs interest expense.
• The lender earns interest revenue.
Interest rates down!
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
Lender
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The interest formula includes three variables:
The interest formula includes three variables:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
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What entry would Hall Company make on December 31, the fiscal year-end?
What entry would Hall Company make on December 31, the fiscal year-end?
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
$10,00012% 60/360 = $200
$10,00012% 60/360 = $200
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What entry would Hall Companymake on the maturity date?
What entry would Hall Companymake on the maturity date?
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
$10,00012% 90/360 = $300
$10,00012% 90/360 = $300
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If Porter Company defaulted on the note, Hall Company would make the following
entry on the maturity date.
If Porter Company defaulted on the note, Hall Company would make the following
entry on the maturity date.
Notes Receivable and Interest Revenue
Notes Receivable and Interest Revenue
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Financial Analysis and Decision Making
Financial Analysis and Decision Making
Accounts Receivable Turnover Rate
This ratio provides useful information for evaluating how efficient management has
been in granting credit to produce revenue.
Accounts Receivable Turnover Rate
This ratio provides useful information for evaluating how efficient management has
been in granting credit to produce revenue.
Net Sales Average Accounts Receivable
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Financial Analysis and Decision Making
Financial Analysis and Decision Making
Avg. Number of Days to Collect A/R
This ratio helps judge the liquidity of a company’s accounts receivable.
Avg. Number of Days to Collect A/R
This ratio helps judge the liquidity of a company’s accounts receivable.
Days in Year Accounts Receivable Turnover Ratio
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Ethics, Fraud, andCorporate Governance
Ethics, Fraud, andCorporate Governance
Accounts receivable is a significant account for many companies. Accounts receivable is
particularly prone to misrepresentation because revenue often increases when accounts receivable
increase. Manipulating accounts receivable can result in the overstatement of both revenue and
income, which is the objective of many fraudulent financial reporting schemes.