Cash and receivables

Question 1

Define cash equivalents

Answer 1

Short term, highly liquid investments that are readily convertible to known amounts of cash and not subject to any significant risk of change in value

Question 2

Examples of cash and cash equivalents

Answer 2

• domestic currency
• foreign currency
• chequing account balance
• term deposits< 3months
• treasury bills< 3months

Question 3

Why should a company implement internal controls over cash?

Answer 3

To protect it form theft or fraud. If the same person was responsible for recording sales, receiving payments from customers and recording payments, the risk of manipulation is high. Companies should segregate duties to reduce the risk

Question 4

List the tasks that internal controls require to be segregated, examples of controls:

Answer 4

• sales staff shouldn’t be able to modify or delete accounts receivable
• Employees that handle cash should not have access to receivables records
• a separate employee should bring the cash to the bank
• Accounts receivable staff (separate employee from above) should track and record payments to specific accounts

Question 5

controls a company where it’s difficult to segregate duties(ex small company) should try to implement

Answer 5

• supervision
• preparing bank reconciliations

Question 6

How are trade receivables typically recorded?

Answer 6

at face value since they are normally collected within a few months

Question 7

2 methods for accounting for cash discounts

Answer 7

gross vs net

Question 8

Explain the gross method of accounting for cash discounts

Answer 8

record the gross accounts receivable when the sale is made and then record a discount as a reduction in revenue when the payment is received.

Question 9

Net method of accounting for cash discounts

Answer 9

record the net amount, if customer doesn’t pay during the discount window, the discount is forfeited and recorded back as income.
- assumes customer will pay on time
- separates the income related to the sale and the interest, so is considered more representationnally faithful

Question 10

How to account for possibility of clients not being able to pay their accounts, and the two approaches to estimate this

Answer 10

Accounts receivable should be valued at their net realizable value(how much we think will be actually collected)
2 ways to estimate:
income statement approach
balance sheet approach

Question 11

Explain the income statement and balance sheet approach to estimating doubtful accounts

Answer 11

Income Statement Approach:
- record a bad debt expense based on the percentage of sales made on credit. Typically based on historical data
Balance Sheet Approach:
-begins with estimating the value of the allowance for doubtful accounts and then use this to determine the bad debts expense. Typically based on an analysis of individual accounts receivable and how long they have been outstanding for.

Question 12

What is factoring?

Answer 12

When a company doesn’t want to wait to collect their receivables, sell them to a factor, at a lower cost than face value since factor is taking on risky accounts.

Question 13

2 types of transactions with a factor

Answer 13

• Transfer without recourse: factor takes on the risk of the uncollectible amounts
• Transfer with recourse: factor doesn’t take on the risk, can ask for the money back if the customers don’t pay

Question 14

How can accounts receivable can be used to manipulate earnings?

Answer 14

• Earnings management to increase revenues will also increase the accounts receivable balance
• Look out for the days of receivable increasing vs the increase in sales over time
• Changing credit policy to sell to clients that may not have a good credit history
• Channel stuffing (ex. Valeant)
• Estimating the allowance for doubtful accounts calculation