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MGMT 201: Financial Accounting > Chapter 6: Cash and Accounts Receivable > Flashcards

Chapter 6: Cash and Accounts Receivable Flashcards

1
Q

company’s most liquid assets.

A

Cash and accounts receivable

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2
Q

Accounts receivable (also known as trade receivables)

A

amounts due from customers as a result of sales of goods or services and are typically due within 30 days.

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3
Q

Uncollectible accounts

A

Accounts receivable that are deemed to be bad debts. The point at which they are deemed uncollectible is generally established by company policy

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4
Q

Liquidity

A

An organization’s short‐term ability to convert its assets into cash to be able to meet its obligations and pay its liabilities.

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5
Q

Cash

A
  • The cash physically on hand at a company, such as the cash in the cash register drawers
  • the cash represented by the customers’ cheques held by the company for deposit and the cash held on deposit in the company’s accounts at financial institutions (banks, credit unions, and so on)
  • includes amounts known as cash equivalents
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6
Q

Cash equivalents

A

Current assets that are very liquid and readily convertible into cash, or current liabilities that may require the immediate use of cash. Examples are short‐term investments and bank overdrafts or lines of credit.
-short maturity dates (within three months of the date of acquisition)

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7
Q

The amount of cash and cash equivalents is presented on the

A

Statement of financial balance
Cash is measured at its face value at the reporting date—the date that the statement of financial position is being prepared at.

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8
Q

Who Is Responsible for an Organization’s Internal Controls?

A

The board of directors is ultimately responsible for an organization’s internal controls. The board normally oversees the development and implementation of the controls.

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9
Q

Tone at the top

A

Emphasis established by the board of directors meant to control and guide the company’s focus regarding the importance of internal controls.

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10
Q

What Are the Main Principles of Internal Control?

A

One of management’s key responsibilities is to safeguard the company’s assets. This includes ensuring that the company’s assets are used effectively within the business and are not lost or stolen.

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11
Q

Internal controls to prevent theft

A

Preventative (they prevent the theft or loss of an asset from occurring)

Detective (they detect when an asset has been lost or stolen).

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12
Q

An internal control system includes:

A 
physical controls
assignment of responsibilities
separation of duties
independent verification
documentation
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13
Q

The key elements of an effective internal control system include:

A
  1. Physical Controls
  2. Assignment of Responsibilities
  3. Separation of Duties (seperation)
  4. Independent verification
  5. Documentation
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14
Q

Internal control system

A

The set of policies and procedures established by an enterprise to safeguard its assets and ensure the integrity of its accounting system.

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15
Q

Collusion

A

What occurs when two or more employees work together to commit theft, fraud, or another crime, and conceal it.

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16
Q

Where possible, the following duties should be separated:

A

transaction authorization
recording of transactions
asset custody

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17
Q

Electronic funds transfers (EFTs)

A

Receipts or payments made directly between two bank accounts through computer networks.

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18
Q

Audit trail

A

Sequence of transactions and events as traced by an auditor or company official back to source documents.

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19
Q

What Are the Limitations of Internal Control?

A

The effectiveness of internal controls can be limited by a number of factors. These include:

  1. Cost/benefit considerations
  2. Human error
  3. Collusion
  4. Management override
  5. Changing circumstances
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20
Q

Bank reconciliation

A

The procedure that is used to identify the differences between the cash balance recorded in a company’s accounting records and the balance per its bank statement. This enables the company to ensure that everything is correctly recorded and to determine the correct amount of cash available.

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21
Q

Purpose of bank reconcilliation

A
  1. Every transaction recorded by the bank has also been recorded by the company, or the reason why not has been explained.
  2. Every transaction recorded by the company in its cash account(s) has also been recorded by the bank, or the reason why not has been explained.
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22
Q

There are many reasons why a transaction may have been reflected in the company’s accounting records but not by the bank or vice versa.

A

A cheque has been written and mailed out by the company but has yet to be deposited by the recipient. Until it is deposited, there is no way that the company’s bank could be aware of it.
The bank has charged service fees to the company’s account. The company will not be aware of the fees until it receives the bank statement at the end of the month.
The company has made a deposit on the last day of the month after the bank closed for business, by using the night deposit slot. The bank will credit the company’s account for this deposit on the first business day of the new month.
A company has deposited a cheque from one of its customers that is not honoured by the customer’s bank because there are insufficient funds in the account to cover the cheque. The company will not be aware of this until the cheque is returned with the bank statement at the end of the month.

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23
Q

How Is a Bank Reconciliation Prepared? Example

A

The balance in Gelardi’s bank account on October 31 was $8,916.39. This is the starting point for the bank portion of the reconciliation, labelled “Bank Balance.”

The balance in the company’s Cash account in the general ledger on October 31, 2020, was $9,770.44. This is the starting point for the company portion of the bank reconciliation, labelled “G/L Balance.”

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24
Q

If the company knows but the bank does not

A

Company knows but bank does not.

Therefore, adjust bank side.

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25
Q

If the bank knows but the company does not

A

Bank knows but company does not.

Therefore, adjust company side.

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26
Q

If the company makes an error and the bank is correct

A

Error! Made by company.

Therefore, adjust company side.

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27
Q

If the bank makes an error and the company is correct

A

Error! Made by bank.

Therefore, adjust bank side.

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28
Q

Bank balance should equal the

A

General ledger balance

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29
Q

The main objective of a bank reconciliation is to determine

A

the correct cash balance. Therefore, items that the bank has not yet recorded must be added to, or deducted from, the balance shown on the bank statement, while items that the company has not yet recorded must be added to, or deducted from, the balance shown in the company’s Cash account.

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30
Q

The second thing to determine is whether the error resulted in the cash amount being too high or too low.

A

If it is too high, then the error should be subtracted on the reconciliation. If it is too low, then the error should be added on the reconciliation.

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31
Q

When do I complete bank reconciliations?

A

They are normally made each month for every bank account, as soon as the bank statements are received. Practically, this means that bank reconciliations are always prepared effective the last day of the month, but are completed early in the subsequent month when the bank statement is received.

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32
Q

Separation of duties

A

Transaction authorization
Recording of transaction
Asset custody (gives the laptop)

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33
Q

Accounts receivable

A

amounts owed to a company by its customers.

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34
Q

Why Do Companies Sell on Account?

A
  • increase total sales
  • remain competitive
  • generate additional forms of revenue (interest income)
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35
Q

Are There Any Additional Costs from Selling on Account?

A

When selling on account, companies incur costs such as:
wages for the credit granting function
wages for the collections function
bad debts expense

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36
Q

The most significant cost from selling on account is likely to be

A

The bad debts associated with those customers who fail to pay their accounts

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37
Q

Bad debts expense

A

Bad debts resulting from customers who fail to pay their accounts, as a result of selling on account.

38
Q

At What Amount Are Accounts Receivable Reflected on the Statement of Financial Position?

A

Accounts receivable are reflected on the statement of financial position at their carrying amount

39
Q

Carrying amount

A

The full value of all of a company’s accounts receivable less the allowance for doubtful accounts.

In the context of long‐term assets, carrying amount or carrying value is equal to the asset’s cost, less accumulated depreciation, less accumulated impairment losses. It represents the portion of the asset’s cost that has yet to be expensed.

Simple: the net amount expected to be received in cash from receivables

40
Q

Allowance for doubtful accounts

A

A contra‐ asset account to accounts receivable, reflecting the estimated amount of accounts receivable that will be uncollectible and eventually have to be written off.

41
Q

Contra asset

A

This means that it is associated with another asset account, but its normal balance is contrary or opposite of what we would normally expect for an asset account.

42
Q

Allowance method

A

A method used to value accounts receivable by estimating the amount of accounts receivable that will not be collected in the future. Makes it possible to recognize bad debts expense in the period of the sale rather than waiting until specific non‐paying customers can be identified.

43
Q

Control account

A

An account that contains the overall amounts related to a particular item in the financial statements, with the details recorded in a subledger. For example, Accounts Receivable is a control account, containing the total balance for all of a company’s receivables, while the Accounts Receivable subledger would contain the balances for each of the individual customers. The balance in the control account should equal the sum of all the balances in the related subledger.

44
Q

Subledger

A

Ledger that contains the details of information included in a general ledger account; for example, with accounts receivable, all of the account details for each customer are specified in the accounts receivable subledger. The total of all accounts in the subledger must equal the total in the related general ledger account, which is known as the control account. Synonym for subsidiary ledger.

45
Q

A/R subledger must equal

A

total of the Accounts Receivable account

control account = total in related subledger

46
Q

Bad debts expense is generally included as part

A

selling, general, and administrative expenses, rather than being separately disclosed.

47
Q

Bad debit IFRS (not ASPE)

A

IFRS must disclose changes in the allowance for doubtful accounts balance in the notes to the financial statements. The annual bad debts expense is presented as part of this note.

48
Q

What Is the Allowance Method of Accounting for Bad Debts?

A

The company establishes an allowance for these doubtful accounts and records the bad debts expense. This means that the bad debts expense is being recorded in the same period in which the credit sales have been recorded.

49
Q

3 transactions that may occur under the allowance method

A
  1. Establishing the allowance and recording the bad debts expense. This is called the allowance entry.
  2. Writing off a specific receivable. This is called the write off entry.
  3. Recovery of a specific receivable that has been previously written off. This is called a recovery entry.
50
Q
  1. Establishing the allowance and recording the bad debts expense. This is called the allowance entry.
A

It is important to understand that, at this point, management does not know which specific customers will not pay their accounts. Instead, they are using past collection experience (or industry averages if they are a new company), adjusted to reflect any changes in economic conditions (local, national, or international) that could affect the collection of receivables, to make an estimate.

Since they do not know which specific customers will not be paying, they cannot make any entries in the A/R subledger and, therefore, they cannot make any entries in the Accounts Receivable control account. Instead, the contra-asset account, Allowance for Doubtful Accounts, is used.

This entry affects both the statement of income, by increasing expenses, and the statement of financial position, by reducing the carrying amount of accounts receivable.

51
Q

Write off

A

The process of removing an account receivable from a company’s books when the account is deemed uncollectible.

52
Q
  1. Writing off a specific receivable. This is called the write off entry.
A

the company generally continues to try to collect the account. The company may do this itself or it may use a collection agency.

Note that this entry has no effect on the statement of income, nor does it change the carrying amount of receivables, because it has offsetting effects on the two accounts making up this amount.

53
Q

Recovery

A

The reinstatement and collection of an account receivable that was previously written off.

54
Q
  1. Recovery of a specific receivable that has been previously written off. This is called a recovery entry.
A

This entry has no effect on the statement of income. However, it does affect the statement of financial position by increasing cash and decreasing the carrying amount of accounts receivable. The mix of assets changes, but total assets remains the same.

55
Q

The Allowance for Doubtful Accounts is a contra asset, and therefore it is a _______ whose balance is cumulative and carried forward from one period to another.

A

permanent account

56
Q

Bad Debts Expense (like all expenses) is a _____ and therefore begins each period with a zero balance.

A

temporary account

57
Q

There are two methods used to estimate the amount of receivables that will not be collectible

A

1) percentage of credit sales method

2) The aging of accounts receivable method.

58
Q
  1. Percentage of credit sales method:
A

This method uses sales on account as the basis for the estimate. It is also known as the statement of income method because it is based on information from the statement of income.

59
Q
  1. Aging of accounts receivable method:
A

This method uses an aging of the various receivables as the basis for the estimate. It is also known as the statement of financial position method because it is based on information from the statement of financial position.

60
Q

Which method should i use?

A

It depends on whether management wishes to focus on income measurement (with credit sales driving the bad debts expense) or on asset valuation (by determining the net realizable value of the accounts receivable).

  • The aging method is the method used by most Canadian public companies.
  • Possible to use a combination of both
61
Q

Percentage of credit sales method

A

Bad Debts Expense=Sales on Account×Historical%
(Therefore, an overestimate or underestimate in one period will be corrected by an adjustment to the percentage used in a subsequent period.)

62
Q

In other words, writeoffs exceeded the amount of the allowance that had been established for doubtful accounts. If this was the case, then we know two things about the prior year’s financial statements:

A
  1. The bad debts expense for that year was understated (an insufficient allowance was established) and, therefore, net income was overstated.
  2. The carrying amount of accounts receivable on the statement of financial position was overstated because an insufficient allowance was established.
63
Q

Under the percentage of sales method,

A

you adjust the allowance account by the amount calculated when you multiply the given percentage by the credit sales figure.

64
Q

Under the aging of receivables method,

A

you adjust the balance in the allowance account to the amount indicated by the aging analysis.

65
Q

direct writeoff method

A

A method that only recognizes bad debts when the accounts receivable of specific customers are written off. No estimates of future writeoffs are made, and the allowance for doubtful accounts is not required.

  • Specific, they know the customer not paying
  • must writeoff period (such as 180 days overdue) or bankruptcy notification
66
Q

There are two main methods for dealing with bad debts:

A
  • The allowance method
  • The direct writeoff method.

If the allowance method is used, which should be the case whenever bad debts are significant, there are two alternative approaches to estimating the amount of bad debts:

  • the aging of accounts receivable method
  • the percentage of credit sales method.
67
Q

material equals cash and tangbile

A

The allowance method must be used when bad debts are material.

68
Q

How Do Companies Shorten Their Cash-to-Cash Cycle?

A

They do this is to accept credit cards as a form of payment.
Motivate their customers to pay their accounts receivable before the end of the 30-day credit period.
-Sell their accounts receivable to another company, typically a financial institution.

69
Q

Cash-to-cash cycle

cash to cash cycle

A

This cycle is the time between when companies pay out the cash to purchase goods or raw materials for manufacturing products until those goods are ultimately paid for by the customer.

70
Q

Credit card discount

A

Fee charged by credit card companies to merchants making sales. Also known as a swipe fee or processing fee

71
Q

Factoring

A

The process whereby a company sells its accounts receivable to another company, typically a financial institution (known as the factor). Often done to shorten the cash‐to‐cash cycle

72
Q

With recourse

A

Characteristic of a company’s receivables purchased by a factor whereby the factor can go back to the seller for payment if it is unable to collect the receivable.

73
Q

Without recourse

A

Characteristic of a company’s receivables purchased by a factor whereby the factor will bear the loss of any receivable it is unable to collect.

74
Q

There are two very common ratios that provide quantitative measures of short-term liquidity:

A

1) current ratio

2) quick ratio.

75
Q

Current ratio (aka working capital ratio)

A

Current ratio = current assets / current liabilities

76
Q

Current asset / liability

A

Remember that current assets are those that are going to be converted into cash within the next year or operating cycle, and that current liabilities are going to require the use of cash within the next year or operating cycle.

77
Q

As such, if this ratio is greater than __, then it means that the company has more than $1 in current assets for every $1 of current liabilities

A

1

78
Q

Quick ratio (aka acid test ratio)

A

=(Current assets−Inventory−Prepaid expenses) / Current liabilities

79
Q

How current ratio varies from quick ratio

A

It differs from the current ratio because the numerator includes only the quick assets, which are the company’s current assets excluding inventory and prepaid expenses.

80
Q

Quick assets

A

the company’s current assets excluding inventory and prepaid expenses.

81
Q

Covenants

A

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.

82
Q

Accounts receivable turnover ratio

A

Credit sales / average accounts receivable

83
Q

Average accounts receivable =

A

(Accounts receivable at the beginning of the year + Accounts receivable at the end of the year) ÷ 2

84
Q

A good rule of thumb when thinking about asset turnover is that a higher number is better than a lower number.

A

WORDDD

85
Q

Average collection period

A

365 days / accounts receivable turnover

86
Q

Common reconciling items include

A 
Outstanding cheques
Outstanding deposits
Bank service charges
Errors in recording items
Any other item that affects cash
87
Q

Under the direct write-off method, what is the only journal entry used?

A

debit Bad Debts Expense, credit Accounts Receivable

88
Q

Allowance entry

A

Debit: Bad debts expense

Credit: Allowance for doubtful accounts

89
Q

Writeoff entry

A

Debit: Allowance for doubtful accounts

Credit: Accounts receivable

90
Q

Recovery entry

A

Debit: Accounts Receivable
Credit: Allowance for doubtful accounts

Debit: Cash
Credit: Accounts receivable

MGMT 201: Financial Accounting (12 decks)

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