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Chapter 7 Solution of fundamental of financial accouting by EDMONDS (4th edition)

Chapter 7 Solution of fundamental of financial accouting by EDMONDS (4th edition)

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Published by: awais_azeemi on Sep 23, 2009
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11/21/2013

 
ANSWERS TO QUESTIONS - CHAPTER 7
1.Accounts receivable are the expected future receipts when acompany permits one of its customers to buy now and paylater. The amounts are usually small with a short term tomaturity.Notes Receivable have longer terms to maturity and areusually for larger amounts. The note specifies the maturitydate, interest rate, and other credit terms.2.The net realizable value is the amount expected to becollected from accounts receivable. It is the face amount of receivables less an allowance for uncollectible accounts.3.The going concern assumption is based upon the premisethat since companies believe that they will continue tooperate, they assume that they will be responsible forpaying the full balance of their obligations. Accordingly,receivables are carried at net realizable value and payablesat full value on the balance sheet.4.The allowance method is a method of accounting for baddebts where bad debts are estimated and expensed in thesame period in which the corresponding sales arerecognized. The receivables are reported at net realizablevalue in the financial statements.The direct write-off method is the practice of recognizingbad debt expense only when accounts are determined to beuncollectible.5.The most common format for reporting accounts receivableon the balance sheet is gross receivables less the allowancefor doubtful accounts. This format allows the users to seeboth the total amount owed by the customers and theamount the company expects to collect.6.Estimating bad debts expense improves the accuracy ofinancial statements by (1) reporting expected realizablevalue of receivables (i.e., future cash flows) and (2)presenting a better matching of expenses with relatedrevenues. This provides a better measure of managerialperformance.
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7.The practice of reestablishing a previously written ofaccount, then recording its collection as a payment onaccount, reflects a complete record of account activity. Sucha record provides an accurate picture of the source of cashflows and improves the customer’s credit history.8.Factors for use in estimating bad debts include:(1) the percentage of uncollectible accounts from years'past.(2) adjustment for new circumstances that are anticipated tobe experienced in the future.(3) industry averages or experiences of similar businesses.(4) examination of current accounts and company creditpolicies.9.Recognizing bad debts expense reduces accounts receivableon the asset side and reduces the retained earnings on theequity side.10.A write-off of an uncollectible account when the allowancemethod is used has no effect on the accounting equationbecause the allowance account, a contra asset account, isreduced and the accounts receivable account, also on theasset side, is reduced.When the direct method is used, a write-off of anuncollectible account reduces assets (accounts receivable)and reduces retained earnings (increases bad debtsexpense).11.The recovery of a bad debt when the allowance method isused does not affect the income statement. Only accountsreceivable, cash, and allowance for doubtful accounts areaffected. Cash flow from operations increases as a result of the collection.12.The advantage of using the allowance method is that itimproves the accuracy of the financial statements; theadvantage of using the direct write-off method is that it isconvenient to use.
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13.The direct write-off method is not GAAP, but is allowed if theamount of uncollectible accounts is immaterial (i.e.,insignificant).14.It is generally beneficial to accept major credit cardsbecause the business then avoids the risk of bad debts aswell as the cost of maintaining credit records. It may alsoattract more customers.15.The acceptance of major credit cards enables a business toavoid the cost of uncollectible accounts and the clerical costsof maintaining accounts receivable records. In addition, thebusiness avoids the implicit cost of lost opportunities due todelayed cash flows.16.Warranty - a promise to correct a deficiency ordissatisfaction in quality, quantity, or performance.17.The recognition of warranty expense reduces the amount of retained earnings shown on the balance sheet and reducesnet income on the income statement. It also increases theamount of liabilities on the balance sheet.18.Warranty cost is shown on the statement of cash flows whenthe actual cost is incurred (i.e., paid).19.At maturity, the amount due on an interest-bearing note isthe face amount plus accrued interest. Discount notes havethe interest included in the face value of the note.20.The carrying value of a discount note is computed bysubtracting the amount of unamortized interest held in thediscount on notes payable account from the face valueamount shown in the notes payable account.21.The effective rate of interest is higher on the discountednote because the actual amount of interest paid is more thanthe amount of the discount rate applied to the amount of cash received at issue. The amount received when makingdiscount notes is less than that of interest-bearing notesbecause the interest portion is subtracted.
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