Ch 6 Cash and Accounts Receivable Flashcards
Cash equivalents
Amounts that can be easily (and without a doubt) converts into known amounts of cash
- Maturity dates no longer than 3 months
- Government treasury bills
- Guaranteed investments certificates (GICs)
An internal control system includes
- physical controls
- assignmnet of responsibilities
- separation of duties
- independent verification
- documentation
when possible the following duties should be separated:
- transaction authorization
- recording of transactions
- asset custody
Limitations of Internal Controls
- cost/benefit considerations
- human error
- collusion
- management override
- changing circumstances
Bank reconciliation
comparing accounting records of the company and its bank and ensuring that those match
why do companies sell on account?
- to increase sales
- to remain comprtitive
- to generate additional income (interest)
When selling on account, companies incur costs such as:
- wages for the credit-granting function
- wages for the collections function
- credit losses (or bad debt expense)
what is the carrying amount
the amount that the customers owes the company (A/R) less the allowance for expected credit losses
so the net A/R that is actually presented on the balance sheet
Allowance for expected credit losses are also known as
allowance for doubtful accounts or the expected credit loss provision
allowance for expected credit losses are recorded on the balance sheet as _______ which means that it has a ______
1) a contra asset
2) credit
It represents management’s best estimate of the total accounts receivable that it does not expect to be able to collect.
The allowance method
- at the end of every month the management of the company estimates the amount that they do not expect to collect and record it as an allowance on the balance sheet
- it is does before an actual credit loss happens
- credit losses are a.k.a. bad debts and impairment losses
Control accounts
it means that there is a sub ledger where the details of the account are recorded
A/R is a _______ account. In the case of A/R a _________ is used to manage the details of individual accounts of each of the company’s customers
1) control
2) sub ledger (subsidiary ledger)
No entry can be made to the A/R account if ______________________
an entry cannot also be made to the A/R sub ledger. That is, you must know which customer’s account os affected
Total A/R = Total in A/R Sub ledger
3 key transactions that may occur under the allowance method
1) The allowance entry
2) The write-off entry
3) The recovery entry
The allowance entry
Establishing the allowance and recording the credit losses
Journal Entry:
Credit Losses XXX
Allowance for Expected Credit Losses XXX
Since we don’t know which exact customer is not gonna pay we can’t _________. Instead we _________
1) record the credit loss on the A/R sub ledger. That means we also cannot record it on the A/R control account
2) would record an allowance for expected credit losses as a contra asset.
The allowance entry affects both _______ by ________ losses and ____________ by ________ the carrying amount of A/R
1) the statement of income
2) increasing
3) the statement of financial position
4) reducing
The write-off entry
writing off a specific entry - after some time we see that a specific customer is not gonna pay so we write it off
Journal Entry:
Allowance for Expected Credit Losses XXX
A/R XXX
The recovery entry
recovery of a specific A/R that has previously been written off
Journal Entry:
A/R XXX
Allowance for Expected Credit Losses XXX
Cash XXX
A/R XXX
The recovery entry has no effect on ____________. But it has an effect on ____________ by ________ cash and _____________ the carrying amount of A/R. The mix of __________ changes but ________________ remain the same.
1) the statement of income
2) the statement of financial position
3) increasing
4) decreasing
5) assets
6) total assets
Steps in the process of determining the allowance for expected credit losses
1) group the receivables by credit risk
2) determine the historic loss rates for each group
3) update historic loss rates to reflect future forecasts
4) determine the total expected credit losses
5) determine the amount of the adjustment required to the Allowance Expected Credit Losses account
credit losses is a ___________ account and therefore has a ________ balance at the beginning of the accounting period
1) temporary
2) 0
forecasted economic conditions that could negatively impact a company;s expected credit losses
economic downturns, increased interest rates, increased unemployment rates
Direct Write off Method
There is no allowance for expected credit losses when the sale happens, instead the credit losses are recorded when they actually happen (when a customer declares bankruptcy or didn’t pay for a set amount of time)
Journal Entry for Direct Write off Method
Credit Losses XXX
A/R XXX
There are 2 main methods to deal with credit losses. The allowance method should always be used unless the losses are __________
insignificant
credit card discount
a.k.a swipe fee or processing fee, it’s a fee that credit card companies charge the merchants for the costs of dealing with credit collection, credit losses and credit granting
Journal Entry for a Credit card transaction with a related fee
Let’s look at an example of how a company would record a credit card transaction, including the related fee. If a company made a $3,500 credit card sale, and the credit card discount was 3%, the journal entry would be as follows:
A/R—Credit Card Company 3,395
Credit Card Expense 105
Sales Revenue 3,500
Factoring
A company selling its A/R to another company typically a financial institution (known as the factor) for less than the face value of the A/R
Factoring with and without recourse
factoring with recourse costs more but the factor can come back to the seller for payment of any A/R it couldn’t collect
factoring without recourse costs less but doesn’t provide this option
2 ways to assess a company’s liquidity
1) the current ratio a.k.a the working capital ratio
2) the quick ratio a.k.a the acid test ratio
current ratio
(current assets)
_________________
(current liabilities)
quick ratio
(Current assets - inventory - prepaid expenses)
_________________________________________________
(current liabilities)
Covenants
Conditions or restrictions placed on a company that borrows money. The covenants usually require the company to maintain certain minimum ratios and may restrict its ability to pay dividends.
minimum conditions set by the lender that, if not met, can trigger immediate repayment of the loan
A/R Turnover Ratio
(credit sales)
______________
(Average A/R)
Average A/R = (A/R at the beginning of the year + A/R at the end of the year) /2
ways to shorten the cash to cash cycle
- allow purchases using credit cards (credit card fee)
- selling off A/R (factoring)
- instalment purchases (some money lost to instalment companies)
