Financial Accounting: In an Economic Context

CHAPTER 6

The Current Asset Classification, Cash, and Accounts Receivable

KEY POINTS

The following key points are emphasized in this chapter:

• Current assets, working capital, current ratio, and quick ratio, and how these measures are used to assess the solvency position of a company.
• “Window dressing” and the reporting of current assets, working capital, and the current ratio.
• Techniques used to account for and control cash.
• Accounts receivable and how they are valued on the balance sheet.
• The allowance method for uncollectible receivables.
• Major concerns of financial statement users in the area of receivables reporting.

The world revolves around credit. Companies sell goods and services on account, while banks allow homeowners to borrow a substantial portion of the purchase price of a house. These loans, or “receivables,” appear on the balance sheet as assets, but nobody knows for sure when or if they will become cash. In 2008 and 2009, the excesses of home loans extended to “subprime” borrowers caused the downfall of many household names in the world of finance. Merrill Lynch and Countrywide Mortgage were purchased at distressed prices by Bank of America with the help of the U.S. government. Investment bank Bear Sterns was purchased “on the cheap” (according to BusinessWeek) by JPMorgan Chase; and the 158-year-old investment bank Lehman Brothers went out of business. These well-known and previously dominant firms all invested in securities backed by mortgage loan receivables ...