Question

Chapter 8 & 9:

accounting

• When do cash equivalents mature
• Formal instruments of credit issued as proof of debt are known as…
• What is net realizable value and how to calculate
• Calculate AR turnover ratio and what does the ratio tell you? Do you want a higher AR turnover or a lower? Why or why not?
• Calculate average collection period for AR in days and what does the ratio tell you? Do you want a higher AR turnover or a lower? Why or why not?

Answer 1

Cash equivalents are those items or securities that can be easilty converted into cash .Or in other word the assets which can convertible into cash are comes under the category of cash equivalents. It will mature within 3 months of being reported in the financial statements.

Formal instruments of credit issued as proof of debt are known as notes receivable

Net realisable value or cash realisable value is the amount that company is expects to receive. It is the difference between expected selling price and total selling expenses.

Net realisable value=Expected selling price-Total selling cost

AR Ratio or Debtors turnover ratio shows the relationship between net credit sales and average debtors which includes bills receivable also. It gives us the time taken to covert the debtors into cash, how quickly debtors are realised.It shows the efficiency of the firm to collect its debtors as cash.

AR= NET CREDIT SALES/DEBTORS including BILLS RECEIVABLE

A higher AR Ratio shows the efficiency of the firm in collecting the debtors. If the AR Ratio shows a lower turnover ratio, it shows the management is not much efficient in collecting debtors. So its better to make a higher debtors turnover ratio.If the payment from debtors are delayed, it will negatively affect the running of business, because of lack of funds available for production.

Average collection period shows the number of days or months for which debtors and bills receivable remains outstanding.Simply it express the debtors turnover ratio in days or months. So we can say that ACP is purely based on AR.It is also known as debtors velocity or average age of debtors.

The ACP is 45 days can be considered as satisfactory. More over it depends upon the type of debtors and current market condition. To get the better results , it should be compared with previous years collection period. A low collection period shows the company is efficient enough to covert the debtors into cash and vice versa.