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Unformatted text preview: CHAPTER 6 DISCUSSION QUESTIONS 1. The three types of business activities are operating activities, investing activities, and financing activities. 2. The purchase of inventory for resale to cus- tomers is classified as an operating activity rather than an investing activity because op- erating activities are associated with the primary purpose of a business. Purchasing inventory for resale is essential to selling a product. Investing activities are related to purchasing assets for use in the business. 3. Revenues should be recognized and repor- ted when (1) the work has been substan- tially completed and (2) cash, or a valid promise of future payment, has been re- ceived. For example, revenues generally should not be reported until a sale has been made or a service has been performed. 4. Some of the reasons revenues are mis- stated to manipulate financial statements are: a. It is quite easy. All one has to do to overstate revenues is record fictitious sales, record sales earlier than they should be recorded, or overstate the amount of legitimate sales. b. When revenues are overstated, assets (accounts receivables) are also over- stated. By overstating revenues and as- sets, financial statements look good. c. Determining when to recognize reven- ues is not always easy and requires pro- fessional judgment. 5. It is important to have separate sales re- turns and allowances and sales discounts accounts rather than to reduce Sales Rev- enue directly because a knowledge of the original amount of sales (undisturbed by ad- justments for returns and discounts) is valu- able when assessing what percentage of sales is returned and/or what the net reven- ue from sales is. For example, if a company found that a significant percentage of sales was being returned (as calculated by divid- ing sales returns and allowances by sales), it might decide that it is selling inferior mer- chandise or has a return policy that is too liberal. 6. Companies need more controls over cash than other assets because cash is the most liquid asset and the easiest one to lose and/ or have stolen. It is very common to hear of cash being stolen, but very unusual to hear of major plant or intangible assets being misplaced. 7. The three most generally practiced controls for cash are: a. Separation of the duties of accounting for and handling of cash. b. Making daily deposits in a bank of all cash received. c. Paying all obligations by prenumbered checks. The purpose of all these controls is to pro- tect and safeguard cash. 8. Most companies tolerate a small percentage of uncollectible accounts receivable because if they monitored their customers so closely that there were never any bad debts, their credit policy would be so strict that many po- tential customers would be lost and ill will would be created among others. On the oth- er hand, if a company has too many bad ac- counts, it could eventually go bankrupt....
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This note was uploaded on 02/02/2010 for the course FNEC 140 taught by Professor Clark during the Spring '08 term at Vanderbilt.
- Spring '08