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Chapter 7: Q3Q (page 362)

Define a 鈥渃ompensating balance.鈥� How should a compensating balance be reported?

Short Answer

Expert verified

The minimum balance required by the customers of financial institutions in their respective accounts is called compensatory balance. It is reported as cash and cash equivalents under the current assets side for short-term borrowings and as investments or other assets under the non-current assets side for long-term borrowings.

Step by step solution

01

Meaning of Compensating Balance

The SEC (Security and Exchange Commission) has stated in its guidelines that customers of financial institutions are required to maintain minimum balances in their accounts to help the institutions avoid misleading investors or customers.

02

Recording of compensating balance

A company can record the compensating balance in two different ways, such as short-term borrowings and long-term borrowings, depending on the duration of the period. Short-term borrowings are reported as part of current assets, whereas long-term borrowings are reported as part of non-current under the head of assets on the balance sheet.

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Most popular questions from this chapter

Presented below are a number of independent situations.

Instructions

For each individual situation, determine the amount that should be reported as cash. If the item(s) is not reported as cash, explain the rationale.

1. Checking account balance \(925,000; certificate of deposit \)1,400,000; cash advance to subsidiary of \(980,000; utility deposit paid to gas company \)180.

2. Checking account balance \(600,000; an overdraft in special checking account at same bank as normal checking account of \)17,000; cash held in a bond sinking fund \(200,000; petty cash fund \)300; coins and currency on hand \(1,350.

3. Checking account balance \)590,000; postdated check from customer \(11,000; cash restricted due to maintaining compensating balance requirement of \)100,000; certified check from customer \(9,800; postage stamps on hand \)620.

4. Checking account balance at bank \(37,000; money market balance at mutual fund (has checking privileges) \)48,000; NSF check received from customer \(800.

5. Checking account balance \)700,000; cash restricted for future plant expansion \(500,000; short-term Treasury bills \)180,000; cash advance received from customer \(900 (not included in checking account balance); cash advance of \)7,000 to company executive, payable on demand; refundable deposit of $26,000 paid to federal government to guarantee performance on construction contract.

Use the information presented in BE7-16 for Horton Corporation. Prepare any entries necessary to make Horton鈥檚 accounting records correct and complete.

Part 1: On July 1, 2017, Wallace Company, a calendar-year company, sold special-order merchandise on credit and received in return an interest-bearing note receivable from the customer. Wallace Company will receive interest at the prevailing rate for a note of this type. Both the principal and interest are due in one lump sum on June 30, 2018.

Instructions

When should Wallace Company report interest revenue from the note receivable? Discuss the rationale for your answer.

Part 2: On December 31, 2017, Wallace Company had significant amounts of accounts receivable as a result of credit sales to its customers. Wallace uses the allowance method based on credit sales to estimate bad debts. Past experience indicates a reliable estimate of uncollectible accounts can be developed based on an aging analysis of receivable balances. This pattern is expected to continue.

Instructions

(a) Discuss the rationale for using the allowance method based on the balance in the trade receivables accounts.

(b) How should Wallace Company report the allowance for doubtful accounts on its balance sheet at December 31, 2017? Also, describe the alternatives, if any, for presentation of bad debt expense in Wallace Company鈥檚 2017 income statement.

When is the financial components approach to recording the transfers of receivables used? When should a transfer of receivables be recorded as a sale?

Indicate three reasons why a company might sell its receivables to another company.
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