Chapter 7 Flashcards
cash
amounts readily available to pay off debt or to use in operations
examples of cash
currency, coins, balances in checking accounts
cash equivalents
short term, highly liquid investments, readily convertible to cash with little risk/loss
have a maturity date no longer than three months from the date of purchase
examples of cash equivalents
money market funds, treasury bills, commercial papers
purpose of internal control procedures
safeguard assets/prevent fraud/material misstatement
5 internal controls
control activities (separation of duties)
control environment
information and communication
risk assessment
monitoring
one of major internal control procedures for cash receipts
separation of duties in the cash receipts process
So
Employee A opens mail each day and prepares multicopy listing of call checks including the amount and payor’s name
Employee B takes the checks, along with one copy of the listing, to the person responsible for depositing the checks in the company’s bank acct
Employee C a second copy of check listing is sent to acct dpt where they enter receipt into the accounting records
what is the purpose of cash disbursements
to prevent unauthorized payments
to ensure that disbursements are recorded properly
important elements for cash disbursements
all disbursements should be made by check
all expenditures should be authorized
checks should be signed only by authorized individuals
restricted cash
cash that is restricted in some way and not available for current use
- specific purpose: ex: future plant expansion
- contractually imposed: ex: debt instruments require the borrow to set aside funds
- if debt –> noncurrent –> then restricted cash –> noncurrent
- if debt –> current –> then restricted cash –> current
compensating balances
an amount that compensates the bank for granting the loan/extending the line of credit
1) borrow is asked to maintain a specified balance in a low interest or noninterest-bearing acct at the bank
2) required balance equals some percetnage of committed amount
3) borrow pays effective interest rate higher than the stated rate on the debt
does the compensating balance make the effective interest rate higher? If so, higher than what?
Yes, EIR > stated rate
example: company borrows 10,000,000 from bank, interest rate 12%
bank requires a compensating balance of $2,000,000 to be held in a noninterest-bearing checking acct
Total borrowing from bank is 10,000,000
interest is 10,000,000 x .12 = 1,200,000
actual borrowing (10,000,000-2,000,000) = 8,000,000
EIR: 1,200,000/8,000,000 = 15%
So EIR of 15% > stated rate of 12%
AR
created when sellers recognize rev associated with a credit sale
performance obligation is satisfied at point of delivery
revenue and related receivable are recognized at that time
most businesses provide credit to their customers
AR are informal credit arrangements supported by an invoice and normally are due in 30 to 60 days after the sale
classified as current assets because their normal collection period is part of the operating cycle of the business
trade discounts
% reduction from list price
usually dealing with buying in bulk
quantity discounts to large customers
sale discounts
reductions in the amount to be paid by a credit customer if paid within a specified period of time
intended to provide incentive for quick payment
2/10, n/30 - 2% discount if paid within 10 days, otherwise full payment within 30 days
gross method vs net method (1):
co offers a 2% sales discount if sales price is paid within 10 days; any amounts not paid within 10 days are due in 30 days (2/10,n/30). Co sold merchandise at 20,000 on Oct 5th
Gross method: given
Debit: AR (20,000)
Credit: Sales Rev (20,000)
Net Method: deducting
Debit: AR (19,600)
Credit: SR (19,600)
19,600 = 20,000 x .98
gross method vs net method (2): on Oct 14th, customer paid 13,720 (14,000 - 2% sales discount)
Gross method:
Debit: Cash (13,720)
Debit: Sales Discounts (280)
Credit: AR (14,000)
Net Method:
Debit: Cash (13,720)
Credit: AR (13,720)
gross method
buyer views a discount not taken as part of the cost of inventory
seller views a discount not taken by the customer as part of sales of rev
Gross method vs net method (3): on Nov 4th, customer paid remaining balance of 6,000 –> did not pay within period
Gross method:
Debit: Cash (6000)
Credit: AR (6,000)
Net Method:
Debit: Cash (6,000)
Credit: AR (5880)
Credit: Sales discounts forfeited (120)
example for net method (3) if paid within the period
Debit: Cash 5880
Credit: AR 5880
major difference between gross method and net method example
for gross, subtracting sales discount of 280 from 20,000
for net, adding sales discount forfeited of 120 to 19,600
NOTE: for example 3 gross method if customer paid within the period
if customer paid within the discount period”
Debit: Cash (5880)
Debit: Sales Disct (120)
Credit: AR (6000)
NOTE: if customer paid within discount period for net method
Debit: Cash (5880)
Credit: AR (5880)
sales discount fortefied
records amount of discount customer could have taken but did not because paid after discount period expired
only used under net method
at the beginning of the sale, co initially assumes customer will take the disct and records revenue net of discount at the time of sale
then comes back later, factoring in they did not get discount because did not pay within the discount period
gross method vs net method - which is correct
net method is typically better b/c reflects that amount –> disct is a savings that prudent customers are unwilling to forgo
sales revenue and corresponding accts receivable should be stated at the amount of consideration the seller expects to be entitled to receive
save $2, customer must pay $98 twenty days earlier than due
investing $98 to earn $2
so 2/98 = 2.04% return for a twenty day period
2.04% x 365/20 = 37.23% annual effective rate
sales returns
merchandise returned for a refund/credit to be applied to other purchases
special price reduction (allowance) may be given as incentive for customer to keep merchandise rather than returning it
accrue sales returns and allowances at the time of sale
what happens if do not accrue sales returns and allowances at the time of sale
recognizing sales returns when they occur could result in overstated income in period of sale of understated income in return period
example: sell merchandise 10,000, cost is 6,000 (in 2024)
so you would recognize as co. GP of 4,000
but in 2025, all merchandise is returned
so GP is overstated by 4,000 in 2024
and GP is understated in 2025
assets overstated by 4,000
accounting for sales return example: co sold merchandise 2,000,000 cash; merchandise cost 1,200,000 (60% of selling price); experiences 10% of all sales returned which equals 200,000 (2,000,000 x .10); customers returned 130,000 of sales during 2024
Selling Goods:
Debit: Cash (2,000,000)
Credit Sales Revenue (2,000,000)
Debit: COGS (1,200,000)
Credit: Inventory (1,200,000)
NOTE: maintaining to calculate GP from SR and COGS
_____________
Returning Inventory: actual sales return
Debit: Sales Returns (130,000)
Credit: Cash (130,000)
Debit: Inventory (78,000)
Credit: COGS (78,000) –> 130,000 x 60%
example relating to sales return: “an additional 70,000 of sales returns are expected. the cost of inventory expected to be returned is 42,000 (70,000 x.60) –> at the end of 2024
Debit: Sales returns (70,000)
Credit: Refund liability (70,000)
Debit: Inventory-est returns (42,000)
Credit: COGS (42,000)
what is refund liability
because estimating, you are still expecting and may not get back –> liability
example relating to sales return: “an additional 70,000 of sales returns are expected. the cost of inventory expected to be returned is 42,000 (70,000 x.60) –> at the end of 2024
sales returns of 70,000; cost of inventory is 42,000
Debit: refund liability (70,000)
Credit: Cash (70,000)
Debit: Inventory (42,000)
Credit: Inventoy-est. returns (42,000)
correcting estimates for sales returns
if the estimate of future sales returns turns out to be wrong, new estimate is incorporated into accounting determinations in the next period –>
so say 2025 was actual returns from 2024 sales are 60,000 instead of 70,000 (originally estimated)
DECREASING:
Debit: Refund liability (10,000)
Credit: Sales Returns (10000)
Debit: COGS (6000)
Credit: Inventory-estimated returns (6000)
NOTE: This 6,000 is 60% of 10,000
NOTE:
if it was in reverse and we had to INCREASE:
Debit: sales return
Credit: Refund liability
Debit: inventory:
Credit: COGS
subsequent valuation of AR
being entitled to receive payment does not mean the seller will be paid
credit losses (bad debts) are an inherent cost of granting credit
how to acct:
direct method or allowance (GAAP)
direct method
waiting until particular acct is deemed uncollectible and write it off at that time
not allowed by GAAP
required for income tax purposes for most companies
Debit: Bad Debt Exp
credit: AR
two shortcomings of direct write off method
overstates the balance in AR in the periods prior to the write-off
distorts net income by postponing recognition of any bad debt exp until the period in which the customer actually fails to pay
allowance method
required by GAAP whenever amount of bad debts is material
companies use contra asset acct “allowance for uncollectible accts” –> reduces carrying value of AR to the amount of cash they expect to collect
both the CV and the amount of allowance typically show on BS
estimating uncollectible AR at end of period, record bad debts on basis of estimates
bad debt expense for the allowance method
not recognized when specific amounts are written off, it is recognized earlier when accts are estimated to be uncollectible and the allowance is created
when specific AR is deemed actually uncollectible, both allowance and specific AR are reduced to write off the receivable
allowance method when recognizing AUA
expects to collect 280,000 of its AR, and AR begins with 305,000
so –>
Debit: Bad debt expense (25000)
Credit: AUA (25000)
writing off acct using allowance method
Debit: AUA (15,000)
Credit: AR (15,000)
when reinstating a receivable previously written off
Debit: AR
Credit: AUA
If needing to reduce AR:
Debit: Cash
Credit: AR
estimating AUA accounts:
balance sheet approach
or CECL
balance sheet approach for estimating AUA
basing bad debt expense on appropriate CV of AR
Company estimates what the ending balance of the AUA should be, and then records the amount of bad debt expense necessary to adjust the allowance that is desired
CECL method for estimating the AUA
should consider all receivables and be based on all relevant info, historical experience, current conditions, reasonable and supportable forecasts
required starting 2020
1) analyzing each customer acct
2) applying an estimate of the % of bad debts to the entire outstanding receivable balance
3) applying different %’s to accounts receivable balances depending on the length of time outstanding
example to AR aging schedule
AUA: begins with credit of 11,200
gross acct receivable balance of 400,000 but believes will only collect 360,000
400,000-360,000 = 40,000
so the post adjustment balance for AUA is 40,000
so 40,000-11,200 is a credit of 28,200
JE:
Debit: Bad Debt Exp: (28200)
Credit: AUA (28200)
AR aging schedule example 2: pre adjustment AUA of 2,000; need to reach necessary 40,000 of AUA post adjustment
requires a 42,000 credit
JE:
Debit: bad Dept Exp 42,000
Credit: AUA 42,000
AR Aging schedule: AUA credit of 11,200; post adjustment balance should be 5,000
11,2000 - 5,000 = 6200
Debit: AUA (6200)
Credit: Bad Debt Exp (6200)
income statement approach
estimate bad debt expense directly as a % of each periods net credit sales
% is usually determined by reviewing the company’s recent history of the relationship between credit sales and actual bad debts
if co had sales of 1,200,000 in 2024, estimated that 2% of sales would prove uncollectible, would debit bad debts expense and credit AUA for 24,000
JE:
Debit: Bad Debt Exp: 24,000
Credit: AUA 24,000
24,000 = 1,200,000 x 2%
combined approaches for estimating
estimate bad debts on quarterly basis using income statement approach; and refine estimate using balance sheet approach at year-end
notes receivable
deals with creditor (lender) and debtor (borrower) –> formal agreements
classified as current or non-current depending on expected collection date
short term interest bearing notes
deal with payments of both principal and interest
how to calculate interest on notes for short term interest bearing notes
face amount x annual rate x fraction of the annual period
journal entries for interest bearing notes
May 1, 2024: sold
Debit: NR
Credit: Sales Revenue
November 1, 2024: collection with interest
Debit: Cash
Credit: Interest Revenue
Credit: notes receivable
Dec 31, 2024: accrued interest:
Debit: interest receivable
Credit: interest revenue
Feb 1 collection
Debit: cash
Credit: Interest rev
credit: interest receivable
credit: NR
short term NON interest bearing notes
really do have interest
interest is discounted from the face amount to determine the cash proceeds made available to the borrower at the outset
for short-term noninterest bearing notes, what is the discount on NR
discount on NR:
- represents future interest revenue that will be recognized over time
- is a contra account to the NR account
journal entries for short term NON interest bearing notes
May 1, 2024: sold
Debit: NR (face amount)
Credit: Discount on NR
Credit: Sales revenue
nov 1, 2024: payment of NR
Debit: Discount on NR
Credit: Interest Rev
Debit: Cash
Credit: NR
calculating effective interest rate for a noninterest bearing note
42,000 (interest for 6 months)
/658,000 (sales price)
= 6.383% (rate for 6 months)
x 2 (annualize the rate)
=12.766% (effective interest rate)
accrued interest for a non interest bearing note
Debit: Discount on NR
Credit: interest rev
collection of cash on Feb 1st for non interest bearing note
Debit: discount on NR
Credit: interest rev
Debit: cash
credit: NR
known journal entry for long term NR
deals with time value of money
note received solely for cash
debit: NR
Credit: cash
subsequent valuation of NR
anticipates bad debts, use an allowance account to reduce the receivable to approproiate CV
financing with receivables can be done two ways
1) secured borrowing
2) sales of receivables
secured borrowing
- is pledging accounts receivable as collateral for a loan (borrower is using expected payments from customer - on AR - to secure financing)
- if borrower fails to repay the loan, lender has right to collect AR directly from customers
- entire receivables balance serves as collateral
- responsibility for collection of the reeceivables remains solely with company
- arrangement should be described in a disclosure note
- no special accounting treatment is needed
sales of receivables
can be sold at a gain or a loss like other assets
accounting treatment is similar to that of the sale of other assets
pledging with secured borrowing
pledging AR as collateral for loan
no particular receivables are associated with the loan –> the entire AR balance serves as collateral
responsbility for collection of AR remains solely with the COMPANY
no special acct treatment is needed, but arrangement should be described in a disclosure note
secured borrwing - assigning
companies can assign particular AR to serve as collateral for loans
usually the lender lends an amount of money that is less than the amount of AR assigned by the borrower (difference provides some protection for the lender to allow for possible uncollectible accounts)
lender usually charges the borrower an up front finance charge in addition to stated interest on loan
receivables might be collected either by the lender of the borrower, depending on details of arrangement
