Notes Chapter 7.docx - Notes Chapter 7 In the balance sheet...

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Notes Chapter 7 In the balance sheet, financial assets are shown at their current values, meaning the amounts of cash that these assets represent. Interestingly, current value is measured differently for each type of financial asset. The current value of cash is simply its face amount. But the current value of marketable securities may change daily, based on fluctuations in stock prices, interest rates, and other factors. Therefore, most short-term investments appear in the balance sheet at their current market values. (Notice that the valuation of these investments represents an exception to the cost principle.) Methods of Measuring the Current Value of Financial Assets Type of Financial Asset Basis for Valuation in the Balance Sheet Cash (and cash equivalents) Face amount Short-term investments (marketable securities) Fair market value Receivables Net realizable value Net Realizable Value – the balance sheet valuation standard applied to receivables. Equal to the gross amount of accounts and notes receivable, less an estimate of the portion that may prove to be uncollectible. Accountants define cash as money on deposit in banks and any items that banks will accept for deposit. These items include not only coins and paper money, but also checks, money orders, and travelers’ checks. Banks also accept drafts signed by customers using bank credit cards, such as Visa and MasterCard . Cash is listed first in the balance sheet because it is the most liquid of all assets. Cash Equivalents: very short term investments that are so liquid that they are considered equivalent to cash. For example: money market funds, US Treasury Bills, certificates of deposit, and commercial paper. These investments must mature within 90 days of acquisition. Some short-term investments are so liquid that they are termed cash equivalents. Examples include money market funds, U.S. Treasury bills, and high-grade commercial paper (very short-term notes payable that are issued by large, creditworthy corporations). These assets are considered so similar to cash that they are combined with the amount of cash in the balance sheet. Therefore, the first asset listed in the balance sheet often is called Cash and Cash Equivalents.
To qualify as a cash equivalent, an investment must be very safe, have a very stable market value, and mature within 90 days of the date of acquisition. Some bank accounts are restricted as to their use, so they are not available to meet the normal operating needs of the company. For example, a bank account may contain cash specifically earmarked for the repayment of a noncurrent liability, such as a bond payable. Restricted cash should be presented in the balance sheet as part of the section entitled “Investments and Restricted Funds.” Many businesses arrange lines of credit with their banks. A line of credit means that the bank has agreed in advance to lend the company any amount of money up to a specified limit. The company can borrow this money at any time simply by drawing checks on a special bank account. A liability to the bank arises as soon as a portion of the credit line is used.

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