Full Test Bank Working Capital Chapter 8 13th Edition

Chapter 8

Multiple Choice

1. Of the following items, the one that should be classified as a current asset is
2. Trade installment receivables normally collectible in 18 months
3. Cash designated for the redemption of callable preferred stock
4. Cash surrender value of a life insurance policy of which the company is beneficiary
5. A deposit on machinery ordered, delivery of which will be made within six months
6. The advantage of relating a company’s bad debt experience to its accounts receivable is that this approach
7. Gives a reasonable correct statement of receivables in the balance sheet
8. Relates bad debts expense to the period of sale
9. Is the only generally accepted method for valuing accounts receivable
10. Makes estimates of uncollectible accounts unnecessary
11. Assuming that the ideal measure of short-term receivables in the balance sheet is the discounted value of the cash to be received in the future, failure to follow this practice usually does not make the balance sheet misleading because
12. Most short-term receivables are not interest bearing
13. The allowance for uncollectible accounts includes a discount element
14. The amount of the discount is not material
15. Most receivables can be sold to a bank or factor
16. An account that would be classified as a current liability is
17. Dividends payable in stock
18. Accounts payable - debit balance
19. Reserve for possible losses on purchase commitments
20. Excess of replacement cost over LIFO cost of basic inventory temporarily liquidated
21. Jamison Corporation’s inventory cost on its statement of financial position was lower using first-in, first-out than last-in, first-out. Assuming no beginning inventory, what direction did the cost of purchases move during the period?
22. Up
23. Down
24. Steady
25. Cannot be determined
26. If inventory levels are stable or increasing an argument that favors the FIFO method as compared to LIFO is
27. Income taxes tend to be reduced in periods of rising prices
28. Cost of goods sold tends to be stated at approximately current cost in the income statement
29. Cost assignments typically parallel the physical flow of the goods
30. Income tends to be smoothed as prices change over time
31. An inventory pricing procedure in which the oldest costs incurred rarely have an effect on the ending inventory valuation is
32. FIFO
33. LIFO
34. Conventional retail
35. Weighted average
36. When inventory declines in value below original (historical) cost, and this decline is considered other than temporary, what is the maximum amount that the inventory can be valued at?
37. Sales price net of conversion costs
38. Net realizable value
39. Historical cost
40. Net realizable value reduced by a normal profit margin
41. Which of the following inventory cost flow methods involves computations based on broad inventory pools of similar items?
42. Regular quantity of goods LIFO
43. Dollar-value LIFO
44. Weighted average
45. Moving average
46. When the allowance method of recognizing bad debt expense is used, the entries at the time of collection of an account previously written off would
47. Increase net income
48. Have no effect on total current assets
49. Increase working capital
50. Decrease total current liabilities
51. Which inventory costing method most closely approximates current cost for each of the following:

Ending Inventory Cost of Goods Sold

• 1. FIFO LIFO
  2. LIFO FIFO
  3. LIFO LIFO
  4. FIFO FIFO

1. The original cost of an inventory item is above the replacement cost. The replacement cost is below the net realizable value less the normal profit margin. Under the lower of cost or market method the inventory item should be priced at its
   1. Original cost
   2. Replacement cost
   3. Net realizable value
   4. Net realizable value less the normal profit margin
2. Liquidity is the ability

a. To increase net assets through regular operations

b. To generate cash from sources other than regular operations

c. To convert existing assets into cash

d. Of financial statement users to predict a company’s cash flows

1. Liquidity ratios measures the

a. Operating success of a company over a period of time

b. The ability of a company to survive over a long period of time

c. The short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash

d. The number of times interest is earned

15. Working capital is a measure of

a. Financial flexibility

b. Liquidity.

c. Profitability.

d. Solvency.

16. A common measure of liquidity is

a. Return on assets.

b. Accounts receivable turnover.

c. Profit margin.

d. Debt to equity.

1. The net realizable value of receivables is calculated as the face value of the receivables less adjustments for
2. Credit sales
3. Actual uncollected amounts adjusted for purchase discounts.
4. Bad debts already written off.
5. Estimated uncollectible accounts
6. Under what circumstances should a company with high rate of return on sales consider the inventory sold?
   1. When the retailer gives a confirmation that the goods won’t be returned
   2. When the goods are sold on installment
   3. When it can reasonably estimate the amount of returns
   4. When the payment for goods is received

19. A successful discount retail store such as Wal-Mart would probably have

a. A low inventory turnover

b. A high inventory turnover

c. Zero profit margin

d. Low volume

Acme Auto Supplies

Balance Sheet

December 31, 2020

Cash $ 60,000 Accounts Payable $ 65,000

Prepaid Insurance 40,000 Salaries Payable 10,000

Accounts Receivable 50,000 Mortgage Payable 90,000

Inventory 70,000 Total Liabilities $165,000

Land held for investment 80,000

Land 95,000

Building $100,000 Common Stock $120,000

Less Accumulated Retained Earnings 250,000

Depreciation (30,000) 70,000 Total stockholders’ equity $370,000

Trademark 70,000 Total Liabilities and

Total Assets $535,000 Stockholders’ Equity $535,000

20. The total amount of working capital is

a. $155,000.

b. $145,000.

c. $60,000.

d. $150,000.

21. The current ratio is

a. 1.86: 1.

b. 2.00: 1.

c. 3.38: 1.

d. 2.93: 1.

• 1. Why is the allowance method preferred over the direct write-off method of accounting for bad debts?
     • • 1. Determining worthless accounts under direct write-off method is difficult to do.
         2. Improved matching of bad debt expense with revenue.
         3. Allowance method is used for tax purposes.
         4. Estimates are used.
  2. Which of the following methods of determining annual bad debt expense best achieves the matching concept?

Percentage of average accounts receivable

Direct write-off

Percentage of sales

Percentage of ending accounts receivable

24. The Villas Corporation’s annual sales (all on credit) totaled $540,000 in 2020.

The company’s accounts receivable turnover ratio was 5. Villas’ average accounts receivable collection period and year end accounts receivable balance respectively were:

a. 365 days and $108,000.

b. 73 days and $120,000

c. 73 days and $108,000

d. 81 days and $108,000

25. The accounts receivable turnover and inventory turnover ratios are used to analyze

a. Long-term solvency

b. Profitability

c. Liquidity

d. Leverage

26. During the year Snedicker reported net sales of $1,920,000. The company had accounts receivable of $150,000 at the beginning of the year and $240,000 at the end of the year Compute Snedicker’s average collection period (assume 365 days a year.)

a. 28.5 days

b. 45.7 days.

c. 37.1 days.

d. 74.2 days.

1. What is a possible reason for accounts receivable turnover to increase from one year to the next year?
   1. Improved collection process.
   2. Granting credit to customers with lower credit quality.
   3. Decreased credit sales during a recession.
   4. Write-off uncollectible receivables.

28. A high accounts receivable turnover ratio indicates

a. Customers are making payments quickly

b. A large portion of the company’s sales are on credit

c. Many customers are not paying their receivables in a timely manner

d. The company’s sales have increased

29. Increasing a credit period from 30 to 60 days, in response to a similar action taken by company’s competitors, would likely result in:

a. An increase in the average collection period.

b. A decrease in bad debt losses.

c. An increase in sales.

d. Higher profits.

Essay

1. Define working capital.
2. The ARB No. 43 definitions of current assets and current liabilities (see FASB ASC 210‐10‐45) include examples of each classification. List those examples.
   1. Cash available for current operations and items that are the equivalent of cash
   2. Inventories of merchandise, raw materials, goods in process, finished goods, operating supplies, and ordinary maintenance materials and parts
   3. Trade accounts, notes, and acceptances receivable
   4. Receivables from officers, employees, affiliates, and others if collectible in the ordinary course of business within a year
   5. Installment or deferred accounts and notes receivable if they conform generally to normal trade practices and terms within the business
   6. Marketable securities representing the investment of cash available for current operations
   7. Prepaid expenses, such as insurance, interest, rents, taxes, unused royalties, current paid advertising service not yet received, and operating supplies
      • • 1. Obligations for items that have entered into the operating cycle, such as payables incurred in the acquisition of materials and supplies to be used in producing goods or in providing services to be offered for sale
          2. Collections received in advance of the delivery of goods or performance of services Debts that arise from operations directly related to the operating cycle, such as accruals for wages, salaries and commission, rentals, royalties, and income and other taxes
          3. Other liabilities whose regular and ordinary liquidation is expected to occur within a relatively short time, usually 12 months, are also intended for inclusion, such as short‐term debts arising from the acquisition of capital assets, serial maturities of long‐term obligations, amounts required to be expended within one year under sinking fund provisions, and agency obligations arising from the collection or acceptance of cash or other assets for the account of third persons
3. Discuss the definitions of trading, available-for-sale and held-to-maturity securities as they related to investments in debt securities.
   1. Trading securities. Securities held for resale
   2. Securities available for sale. Securities not classified as trading securities or held‐to‐maturity securities
   3. Securities held to maturity. Debt securities for which the reporting entity has both the positive intent and the ability to hold until they mature
4. On January 5, 2016, the FASB issued Accounting Standards Update 2016‐01,
5. Define the following terms:
   1. Cash equivalents
   2. Temporary investments
   3. Receivables
   4. Inventories
   5. Payables
   6. Deferrals
   7. Current maturities
6. Define the following terms:
   1. LIFO liquidation
   2. LIFO conformity
   3. Lower of cost or market inventory valuation
7. Define and discuss the two methods of estimating bad debts on receivables.
8. Bad debts are recorded as the loss is discovered (the direct write-off method).
9. Bad debts are estimated at the end of the accounting period (the estimation, or allowance method).
10. Discuss the two approaches that may be used to estimate expected losses from nonpayment of outstanding accounts receivable balances.
11. Why are cost flow assumptions used to determine inventory valuations? Define and explain the rationale for using each of the cost flow assumptions.
    • • 1. The first in, first out (FIFO) method under which the oldest goods acquired are assumed to be the first sold. This method is based on assumptions about the actual flow of merchandise throughout the enterprise; in effect, it is an approximation of specific identification.
        2. The last in, first out (LIFO) method of inventory valuation under which the last goods acquired are assumed to be the first sold. This method is based on the assumption that current costs should be matched against current revenues. Most advocates of LIFO cite the matching principle as the basis for their stand and argue that decades of almost uninterrupted inflation require that LIFO be used to more closely approximate actual net income.
        3. Averaging techniques: whereby, each purchase affects both inventory valuation and cost of goods sold. That is, the sum of all the periodic inventory costs is divided by the sum of all of the periodic inventory qualities. As a result, averaging does not result in either a good match of costs with revenues or a proper valuation of inventories in fluctuating market conditions.
12. Discuss the perpetual vs. the periodic methods of accounting for inventories.
13. How is the accounts receivable turnover ratio computed, and what information does it provide?
14. What does the inventory turnover ratio measure and what is its significance?
15. Discuss the concept of working capital management and the factors that impact it.

• Company size and growth rates
• Organizational structure
• Sophistication of working capital management
• Borrowing and investing positions/activities/capacities
• Banking services
• Interest rates
• New technologies and new products
• The economy
• Competitors

1. Inventory management is a key aspect of working capital management.

• Transaction motive: To hold enough inventory for the ordinary production‐to‐sales cycle
• Precautionary motive: To avoid stock‐out losses, which can result in foregone sales as a result of insufficient inventory
• Speculative motive: To ensure the availability and pricing of inventory
• Economic order quantity and the reorder point. Computes the amount of inventory to acquire and the point in time when the company orders more inventory, thereby minimizing the sum of order costs and carrying costs
• Just in time: Order inventory as it is needed, thereby reducing or eliminating carrying costs
• Materials or manufacturing resource planning: A computer‐based, time‐phased system for planning and controlling the production and inventory function of a firm from the purchase of materials to the shipment of finished goods

1. Obtain a company’s financial statements and ask the students to compute the following:
   1. Working capital
   2. Current ratio
   3. Acid test ratio
   4. Cash flow from operations to current liabilities ratio
   5. Accounts receivable turnover
   6. Inventory turnover