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Financial Management Essay

5043 words - 21 pages

CHAPTER 6: CASH, TEMPORARY INVESTMENTS, ACCOUNTS RECEIVABLE and NOTES RECEIVABLE PROBLEM SOLUTIONS

Assessing Your Recall
Cash:
Probable Future Value – The probable future value in cash is the ability of the cash to be exchanged for goods and services in the future.
Ownership – Ownership is evidenced by possession of currency and by the right to control bank accounts.
Temporary Investments:
Probable Future Value - The probable future value in temporary investments is the cash payments that will be received from the investments in the future. These payments take the form of dividends in the case of shares and interest in the case of debt as well as the ultimate sales price of the ...view middle of the document...

That unit in Canada is the dollar. In most countries the unit-of-measure is the domestic currency.

Purchasing power risk is present for cash because when cash is held during periods of inflation the purchasing power of the dollar decreases. For example, if $100 is held in cash during a year of a price increase of 10% the $100 will buy 10% fewer goods and services at the end of the year, than at the beginning. Inventory, on the other hand, is not fixed in terms of the number of dollars that it represents. The value of the inventory can fluctuate with changing prices. If $100 worth of inventory was held during a year in which prices increased 10% it is possible that the price of the inventory could be raised to $110 to compensate. There may be supply and demand reasons why the price of inventory could not be raised to the full $110. If this is so then the inventory may be subject to some purchasing power risk but not to the same degree as cash.

At the end of every account period the accountant evaluates the cost and the current market value of the temporary investments portfolio. The book value of the portfolio at the end of the period must be the lower of the cost and market value. After this determination is made the carrying value of the portfolio (its cost less the current value in the valuation allowance account) is adjusted upwards or downwards to reflect the proper value at the end of the period. The adjustment is reported as an unrealized loss if the value of the portfolio is written down and an unrealized recovery if the value is written up.

The primary consideration in deciding if an investment should be classified as current or noncurrent is management’s intention. If management intends to hold the investment for more than one year, the investment should be classified as noncurrent. Otherwise, the investment should be classified as current as long as it can be sold.

The direct write-off method recognizes bad debt expense (loss) in the period in which the receivable is determined to be unrecoverable, not necessarily in the period in which the original sale was made. This creates a matching problem. The allowance method estimates and records the bad debt expense in the period of the original sale. This method provides a proper matching of the revenues and expenses (bad debt expense) from the sale and is the method that is most consistent with GAAP. The direct write-off method can be used f the results of applying it are not materially different from the results of applying the allowance method.

Two ratios that measure liquidity are the current ratio and the quick ratio. Both compare current assets to current liabilities, with the current ratio comparing total current assets and the quick ratio comparing total current assets less inventories and prepaid expenses. Both provide information on the ability of the company to pay its current liabilities, with the quick ratio providing more conservative...

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