CHAPTER 6

Cash and Cash Equivalents; Receivables

Answers to Questions

1. Cash is the medium of exchange; it is used to express most accounting

measurements. Cash includes currency, balances in checking accounts, and
negotiable instruments that are accepted by banks for immediate deposit and
withdrawal.
2. A compensating balance occurs when a bank makes a loan and requires the
borrower to maintain a minimum portion of the loan amount in the borrower’s
checking account. It effectively limits a portion of the loan proceeds that are
available to the borrower and also causes the true interest rate to be higher than
specified on the related loan agreement. Compensating balances should be
reported on the statement of financial position, or in a note to the financial
statements.
3. To recognize the expenses (represented by disbursements) and the reduction in
cash, which occurred since the last reimbursement. If the fund is not
replenished, cash is overstated and expenses are understated.
4. Exclude from Cash: (b) post-dated checks; (d) postage stamps; and (g)
certificates of deposit.
5. A compensating balance is that portion of any cash deposit maintained by an
enterprise which constitutes support for existing borrowing arrangements with a
lending institution.
A compensating balance representing a legally restricted deposit held against
short-term borrowing arrangements should be stated separately among the cash
and cash-equivalent items. A restricted deposit held as a compensating balance
against non-current borrowing arrangements should be separately classified as a
non-current asset in either the investments or other assets section.
6. Restricted cash for debt redemption would be reported in the non-current 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 non-current.

7. The entry to write off an account considered uncollectible is:

Allowance for doubtful accounts........................... xxxx
Accounts receivable (name)............................... xxxx
The entry for collection of an account previously written off as bad debt:
*Accounts receivable (name)................................ xxxx
Allowance for doubtful accounts........................ xxxx
Cash.................................................................. xxxx
 Accounts receivable (name)................................ xxxx
These entries will cause the debtor’s account to reflect details of all transactions
and events affecting the account. Such information may be useful in future
dealings with the customer. The reverse entry (* above) also has the advantage
of assembling the bad debt history of the customer in the account receivable.

8. A cash discount relates to accounts receivable. Payment within the discount

period reduces the amount paid. A trade discount is a way (a) to change the
sale price without changing a price list or catalog or (b) to reduce the sale price
for high quantity purchases or sales. Trade discounts are not separately
accounted for but rather serve to define the invoice price.

9. A note receivable is an unconditional written agreement to receive a certain sum

of money on a specific date. Notes receivable have two attributes not found in
accounts receivable: (1) They are negotiable instruments, which means that they
are legally and readily transferable among parties and may be used to satisfy
debts by the holders of these instruments, and (2) They usually involve interest.

10. A non-interest-bearing note is a note that does not specify an interest rate. For a
short-term non-interest-bearing note, the maturity value is listed as the face
value, and includes both principal and implicit interest. Therefore, the note is
initially recorded at its maturity value, the total interest to be earned over the life
of the note is recorded as Interest Revenue, and Sales is credited for the
difference. If the fiscal period ends prior to collection of the note an adjusting
entry must be made to reduce the interest revenue and establish a contra-asset
account for any unearned interest. In contrast, for a short-term interest bearing
note, the Note Receivable account is recorded at the face value of the note.
After issuance, interest revenue is recorded as earned and is determined by
multiplying the principal by the stated interest rate for the time the note has been
outstanding.
11. The basic problems that relate to the valuation of receivables are (1) the
determination of the face value of the receivable, (2) the probability of future
collection of the receivable, and (3) the length of time the receivable will be
outstanding. The determination of the face value of the receivable is a function
of the trade discount, cash discount, and certain allowance accounts such as the
Allowance for Sales Returns and Allowances.
12. Imputed interest is the interest ascribed or attributed to a situation or
circumstance which is void of a stated or otherwise appropriate interest factor.
Imputed interest is the result of a process of interest rate estimation called
imputation.
An interest rate is imputed for notes receivable when (1) no interest rate is stated
for the transaction, or (2) the stated interest rate is unreasonable, or (3) the stated
face amount of the note is materially different from the current cash price for the
same or similar items or from the current market value of the debt instrument.
 In imputing an appropriate interest rate, consideration should be given to the
prevailing interest rates for similar instruments of issuers with similar credit
ratings, the collateral, and restrictive covenants.
13. A receivable is considered impaired when a loss event indicates a negative
impact on the estimated future cash flows to be received from the customer. The
IASB requires that the impairment assessment should be performed as follows.
a. Receivables that are individually significant should be considered for
impairment separately. If impaired, the company recognizes it. Receivables that
are not individually significant may also be assessed individually, but it is not
necessary to do so.
b. Any receivable individually assessed that is not considered impaired should
be included with a group of assets with similar credit-risk characteristics
and collectively assessed for impairment.
c. Any receivables not individually assessed should be collectively assessed
for impairment.
14. The risks and rewards approach is used when receivables are sold with or without
recourse. A transfer of receivables should be recorded as a sale when the seller
has transferred substantially all the risks and rewards of ownership of the
financial asset. If the substantially all of the risks and rewards are not
transferred, the company treats the transfer as a secured borrowing.

15. A receivable is considered impaired when it is probable that the creditor will be
unable to collect all amounts due (both principal and interest) according to the
contractual terms of the receivable. If a receivable is considered impaired, the
loss due to impairment should be measured as the difference between the carrying
amount and the expected future cash flows discounted at the loan’s historical
effective-interest rate. The loss is recorded on the books of the creditor. The
debtor would not be aware of the entry made by the creditor and would not
make an entry until settlement or if a modification of terms resulted.

Answers to Multiple Choice Questions

1. D 11. B 21. D 31. C

2. B 12. D 22. D
3. D 13. D 23. C
4. B 14. A 24. A
5. B 15. D 25. A
6. A 16. C 26. D
7. B 17. D 27. D
8. D 18. C 28. B
9. B 19. B 29. D
10. D 20. B 30. A