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Unformatted text preview: CHAPTER 6 6-1 If eventual payment on the contract is reasonably certain, $10 million should be recognized as revenue each year. For a government contract, this is generally the preferred method. In contrast, if there is concern about realization of the payment from a non-governmental customer, all $50 million might be deferred and not recognized until the time of receipt of payments as the contract is completed. 6-2 Some accounts will never be collected. Therefore, the average amount collected on credit sales is less than the total amount of the sales. For cash sales, the total amount of the sale is collected. 6-3 The seller of an item recognizes a sales return (allowance), which is deducted from sales revenue. The buyer of an item receives a purchase return (allowance), which is deducted from the amount spent for an item. 6-4 Trade discounts are traditional ways of determining net sales prices. The method begins with a gross, or list, price and applies specified reductions thereto. Trade discounts often reward high volume customers by giving them lower unit costs. Cash discounts are relatively small reductions of selling prices that are intended to spur prompt payment. 6-5 Trade discounts are used to arrive at invoice prices, which are then routinely recorded as purchases and sales occur. Reports to shareholders do not ordinarily show trade discounts, but reports to managers often do if the information is deemed helpful. 232 6-6 Retailers do pay their banks a small percentage of revenue when a credit card is used. However, offering such a credit service can increase sales. If retailers offer their own credit they bear the cost of running a credit department and also forfeit some revenue through bad debts. The fees paid to Visa or MasterCard by a merchant may be much less than the costs of running a dedicated store credit card. 6-7 Cash equivalents are highly liquid short-term investments that can be converted easily into cash with little delay. Money market funds and treasury bills are examples. 6-8 True. If a compensating balance is required, a borrower does not have use of the entire amount borrowed. For example, borrowing $1,000 at 12% interest with a required 10% compensating balance means that only $900 can be withdrawn for use. Interest of $120 is paid for $900 of usable funds, an effective rate of 120 900 = 13.3%. 6-9 Although the cash balance may be small, the cash flow for most companies is large. Good cash management may indeed be very important to the generation of profits. In addition, cash is especially attractive to thieves and embezzlers. Safeguards are generally worth more than companies spend to develop and implement them. 6-10 Good internal control requires that transactions be rung into the register so that register totals can be compared to cash levels....
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