Chapter 7 Terms Flashcards
internal controls
the policies and procedures implemented by management to protect assets
Records and activities must be adequate, accurate, timely, legal, authorized, efficient, verified, separate:
- keeps recordkeeping accurate and adequate
- keeps financial statements timely
- ensures compliance with laws and regulations; ensures transactions are authorized
- promotes efficient operations
- employees’ work is checked by others
- recordkeeping and control of assets are two categories
- two forms discussed in chapter 7 are petty cash, and preparation of bank reconciliations
Effectiveness is limited by human error and fraud
Effective cash control
- separation of duties (people handling cash = custodial, should not be responsible for maintaining cash records = record-keeping duties)
- same day deposits: must deposit daily in the bank account
- non-cash means when possible because the record is kept automatically so it is more secure and efficient (electronic funds transfer or check is common)
petty cash fund
A small amount of cash kept on hand to pay for small, infrequent expenses
Re-occurring expenses should not go through the petty cash fund
how do you record money missing from petty cash?
cash over / short expense $2
cash $2
“To reimburse the petty cash fund $2.00 shortage”
And then have cash give petty cash the $2
how do you reduce the size of petty cash (for example, if it is not being used, you can do this to reduce chance of theft)
debit any expenses (must total more or equal to the petty cash reduction amount)
credit petty cash
credit cash as needed to make up the difference
Or
Debit cash
credit petty cash
cash short
when petty cash does not have the money it needs because some went missing or an expense receipt went missing
cash over
when petty cash strangely has more money in it than it should given the expenses that we see in the receipts
How do you calculate over or short in petty cash using receipt expenses and actual expenses?
How do you calculate the reimbursement to petty cash?
Basically what it is supposed to have minus what it already has:
The original amount that was there + increase (or - decrease) - what is actually left
When it is a cash over do you debit or credit “cash over and short”?
credit
This allows you to debit expenses, credit cash over, and credit cash, making it so you do not have to pay as much cash to the petty cash
When it is a cash short, do you debit or credit “cash over and short”?
debit
This allows you to see the cash short as an expense, and then the cash must be credited even more than usual to help bring the petty cash back where it needs to be
Why do we do a bank reconciliation?
- explains the difference between the balances reported by the company (in the cash account in the general ledger, AKA books) and by the bank (in the bank statement) on a given date
- proves the accuracy of both the company’s and the bank’s records, and reveals any errors made by either party
- tool to help detect theft and manipulation of records
reconciling items
- discrepancies between the cash account in the general ledger, and the bank statement
- will change the business’s cash balance
unreconciled cash balance
cash balance prior to reconciliation
reconciled cash balance
the balance after adding and subtracting the reconciling items
Book reconciling item examples
LOOK AT BANK TO CORRECT BOOKS:
collection of notes receivable
NSF cheques (incidentally, the company will have to request that the customer give another cheque now that it bounced)
Book errors
bank service charges: bank service charges are deducted from the customer’s bank account.
Bank reconciling items
outstanding deposits
outstanding cheques
bank errors
Is collection of notes receivable (book reconciling item) added or subtracted?
added
Is NSF cheques (book reconciling item) added or subtracted?
subtracted
returned cheques cause the general ledger cash account to be overstated
Is outstanding deposits (bank reconciling item) added or subtracted?
added
Outstanding deposits cause the bank statement cash balance to be understated.
Is outstanding cheques (bank reconciling item) added or subtracted?
subtracted
Is bank service charges (book reconciling item) added or subtracted?
subtracted from the unreconciled book balance of cash on the bank reconciliation
Since the service charges have not yet been recorded by the company, the general ledger cash account is overstated.
If the company incorrectly records that they had a cheque (to give money away) of $520 when the correct amount is really $250, the balance reported on the books (the cash account) is __________.
understated / overstated
understated by $270 as a result of the error
If the company records a deposit as $520 when the correct amount of the deposit was $250, would the difference be subtracted or added to the unreconciled book balance on the bank reconciliation?
subtracted
The cash balance reported on the books is overstated by $270 as a result of the error. This is just an accounting error, not that the actual money is in the wrong place.
deposits in transit
Where the company has recorded the cash receipt, but the bank has not yet recorded the change and it is now time to prepare bank statements.
Outstanding deposits cause the bank statement cash balance to be understated.
To record estimated uncollectible accounts, what is the adjusting entry?
Estimating bad debt expense is the same thing as estimating uncollectable accounts; you will see it written in the questions both ways so know the lingo.
debit bad debts expense
credit Allowance for Doubtful Accounts
Notice how accounts receivable is not touched. This is because on the balance sheet you will have accounts receivable minus AFDA since AFDA has a normal credit balance, so you get a net accounts receivable once you see the balance sheet, but that account doesn’t actually exist. (Estimating an uncollectable account is one thing you can do. You can also make a write-off which is shown on another card. Write offs are the second step in the process, otherwise you would not have a way of expensing this. So in order to write-off you will need to first estimate the uncollectible portion like on this card.)
“to record the adjustment estimating uncollectible accounts receivable”
The bad debt expense is shown on the income statement as it is an expense. AFDA is shown on the balance sheet as it is a contra-asset account (subtracted from account receivable)
two different methods for estimating uncollectible accounts
- income statement method (apply an estimated loss percentage to credit sales for the period, based on actual losses experienced in prior years) This one is in the picture. You will be adding on to a credit balance in the AFDA, so keep that in mind.
- balance sheet method (aging of accounts receivable is used sometimes here) , but you can also use the simplified balance sheet method here. You will be making sure the AFDA account has the proper credit balance by finding out what that difference is to get it there and then debiting bad debt and crediting AFDA to get to that new AFDA account total.
Practice both of these in 7.4
The image below is great at showing the difference between net credit sales and net sales. Notice that you have to take a proportion of the sales amount. The image only shows the income statement method.
You’ll notice that there is already a credit balance on AFDA but that reflects prior years only. So that is why you can use the full amount that is not likely to come in that year in your adjustment entry and not need to account for prior entries that year (since there were no adjusting entries that year!). So assume that if you already have a credit balance on AFDA that the bad debts expense will probably be at 0 since bad debt expense will be closed as a temporary account. You’ll see that in this image that is not necessarily clear, except that they say that the AFDA account has not been adjusted. So when they say that it has not been adjusted they are telling you that bad debt expense is currently at 0, and that we need to change both accounts by the same amount, further increasing the credit balance on AFDA but just making a new debit balance on bad debts expense.
aging of accounts receivable (a more complicated balance sheet method that we don’t really learn)
The total of estimated uncollectible accounts is calculated by analyzing accounts receivable according to how long each account has been outstanding. The longer a receivable is outstanding, the less chance there is of collecting it.
You will still use past experience to estimate the bad debt percentage but it will be broken up by 30 day periods, or even 0.5 years to 1 year as a period, and finally over 1 year. Then the rate of uncollectability in those time periods will give you a percentage to use.
Instead, use the simplified method as presented in the image. In the simplified method we can use this calculation:
Adjustment entry for bad debt and AFDA = (Accounts receivable regardless of how long it has been there)(% of AR uncollectable in the past) - AFDA credit that is already there
We want to redo the AFDA in this method, not add on to it. The adjustment entry needs to show the difference to make the AFDA account go to the number needed.
Notice how this is different from the income statement method in that we care about how much is in the AFDA account even though it is unadjusted. In the income statement method we made sure to just keep piling on the AFDA even though there were previous years of AFDA (and none that year in bad debt expense until we made the adjustment). Now with this accounts receivable method, we are continually adjusting our AFDA directly to get a certain total in the AFDA rather than trying to get a certain total in the bad debt expense. Remember that the bad debt expense is a temporary account (an expense account) that is closed at the end of the year and returns to 0. The income statement method gets you to see the bad debt expense for that year only once you make the adjustment entry. The balance sheet method (this one) gets you to see the AFDA to see what was calculated that year, instead of the bad debt expense.
Describe the simplified balance sheet method (one way to estimate uncollectable accounts)
Make the AFDA have a certain total even though it contains data from previous years, you are essentially redoing the calculation each year.
The simplified balance sheet method calculates the total estimated uncollectible accounts as a percentage of the outstanding accounts receivables balance
debit bad debts expense
credit allowance for doubtful accounts
BUT remember to get this amount that you will be looking at what you want in the end for AFDA and that the entry above will just reflect the difference to get to that new AFDA amount. This is how this is different from the income statement method.
You will use the ending AFDA balance that is already known in order to calculate the extra AFDA and bad debt expense that needs to be accounted for.
bad debt expense = (year-end accounts receivable balance)(percentage bad debts estimate for that year) - AFDA year-end balance before adjustment
Notice that bad debt expense may not equal AFDA since AFDA is a permanent account, but bad debt expense is a temporary account. So the bad debt expense will be closed at the end of the year to the income summary, and thus will be zeroed out at the end of the year that way. The AFDA is dependent on the accounts receivable that are not looking like they will be able to be collected, but that have not yet been written off since we are not entirely sure if we will get the money but we think it is still coming in.
Practice 7.4 balance sheet method more to get more comfortable with this method since it is harder than the income statement method for estimating uncollectible accounts
Describe the income statement method for estimating uncollectible accounts
- apply an estimated loss percentage to credit sales for the period, based on actual losses experienced in prior years
To find bad debt expense: You will need to take the net sales and multiply by the ratio of credit sales to total sales and then further multiply by the estimated loss percentage to credit sales.
To find Allowance for Doubtful Accounts you will credit the bad debt expense amount that you just found above.
AFDA New Balance: The amount credited to the AFDA will affect the running balance of the AFDA, so remember that AFDA has a normal credit balance. You will add the new AFDA amount to the old stuff if the AFDA is currently a credit in the account. But if the account is in debit (so a negative credit balance), then you will need to remember to not just blindly add.
Net realizable accounts receivable = Accounts receivable balance - AFDA
(Accounts receivable is a debit normal balance, AFDA is normally a credit balance, and net realizable accounts receivable is normally a debit balance)
What are all the possible entries for following a journey of interest receivable?
What should you look out for? Where are your common errors?
Make the note receivable first:
debit notes receivable (to create the note, basically converting the account receivable to a note receivable)
credit accounts receivable (to zero out that particular customer’s account)
Then do the entries in the picture
Interest earned is the same thing as interest revenue
accounts receivable turnover
accounts receivable turnover = net credit sales / average net accounts receivable
net sales can just refer to the payment on credit and was actually listed as “net credit sales” originally in the equation above; but if a discount is applied, you will notice that the sales will reflect that net amount. Sometimes discounts are 0 in some questions so when you do this question you will just use sales in that case, but always think of it as net sales.
Really just sales minus the discounts but the lab was not being precise enough; also I assume that the lab has all credit sales?
measures the liquidity of receivables and the efficiency of collection
a low turnover indicates high levels of accounts receivable
a low turnover has unfavourable impact on liquidity since cash is tied up in receivables
average net accounts receivable = (net accounts receivable from the end of the previous year + net accounts receivable from the end of that year)/2
You can also use net revenue instead of net credit sales on the top of the equation
The higher the ratio, the more the favourable
include short-term notes receivable in the average net accounts receivable amount
Example of the use of AFDA and Bad Debt Expense
Used to estimate uncollectable accounts.
Debit bad debt expense
Credit AFDA
Remember that a write-off does not include Bad Debt Expense since that was already dealt with when we estimated the doubtful accounts. Write-off is just going to debit AFDA (to reverse what had been credited before on estimation of uncollectable accounts) and credit accounts receivable (to stop the customer oweing).
Bad debt expense will include things that have been in AFDA previously but within that year along with any uncollectable accounts at the end of the year. But recognize that bad debt expense is a temporary expense account, while AFDA is a contra-asset account with a credit balance. Debit bad debt expense and credit AFDA the same amount but you will see that the two account balances rarely match due to one account being temporary and the other being a permanent account. Also make sure that you are eventually debiting the bad debt expense for each instance, but some are already done prior so you should not do this a second time for that instance at the end of the year. Follow with the same AFDA adjustment, but the account balances will likely not match; the only thing that will match is the adjustment entry itself.
When to look at what AFDA’s final balance needs to be while estimating uncollectable accounts vs. when to look at what needs to be added to the AFDA . Which one is the balance sheet method and which one is the other method called the income statement method?
When you are ESTIMATING uncollectable accounts, that is just the one step in the process and requires these entries:
Debit bad debt expense
Credit AFDA
So you will realize that you are not just required to estimate uncollectable accounts, but that you will eventually write them off with these entries if they are actually uncollectable:
Debit AFDA
Credit Accounts Receivable
So for example if you already did this estimate of doubtful accounts during the year prior:
Debit bad debt expense $5
Credit Allowance for doubtful accounts $5
since you had that estimate prior, you will notice a credit balance on AFDA of $5 in the next year since it is a permanent account. But the temporary bad debt expense will show 0 since it will have been closed at the end of that year.
Then at the end of the next year, you realize that the uncollectable estimate should really be $100, then you can look at what has already been done by looking at the AFDA which has a credit balance of $5. You’ll need to realize that means we only have to record the $95 which is the DIFFERENCE since we have already accounted for $5. This is what we do for the BALANCE SHEET METHOD USING ACCCOUNTS RECEIVABLE.
Bad Debt Expense Debits required (also AFDA required) by the end of the entry : $100
Credits in AFDA already: $5
So you will need to credit AFDA $95 to bring the AFDA in balance with the wanted bad debt expense of $100. You will also debit bad debt expense that $95 in order to balance with the AFDA entry since debits must equal credits. The sum in the bad debt expense rarely equals the sum in AFDA but the entries must be equal to each other on journalizing. It is not about bring the AFDA to 0, it is about seeing what is already in the AFDA and making it become the new number 100 in this case, which is looking at the difference. The image with the T tables is stupid and does actually show what is going on because it doesn’t show bad debt expense which is the true amount for that year (remember that bad debt expense is a temporary account and thus only shows that year’s information). The t-table is just so that you can figure out the debits and credits since AFDA is a normal credit balance.
Essentially you will need to make AFDA credit get higher to end off with a certain amount, but you need to calculate the amount that will need to be added or subtracted. Then you will equally adjust your bad debt expense at the same time.
In contrast, the INCOME STATEMENT method will look at how much we need to journalize for that year, and thus will be easier to compute. Just figure out how much is bad debt that year and make a journal entry to show this. The AFDA will get a sum of something odd, but the journal entry will match what you see in the calculation of bad debt from sales.
