Working capital and its compnents Flashcards
Purpose of measuring wc
solvency
goal
assess ability to pay debts as they become due, short term financial obligations
working capital
current assets-current liabilities
current ratio
current assets/current liabilities
quick ratio
cas_net receivables+mkt securities / current liab
backed out inventory
the bigger spread between current assets adn current liab
less risk
current assets
converted to cash, sold or consumed its its a prepaid item during next operating cycle or 1 year whichever is longer
examples: cash, trading sec, afs if liquidation or expected to sell it within the oeprating cycle or year, a/r, trade installment receivable, prepaid expenses,
cash surrender value of life insurance can be current or non current: if the policy owner INTENDS to surrender within the next operating cycle will be current otherwise normal is non current. Any portion of the premium payment that does not add to the cash surrender value is expensed
current liab
liquidation is reasonable expected to require the use of current assets or the creation of current liab.
DEF: estimates or accrued amounts and expected amounts: when the amount can be determined approximately, specific person to whom payment is made can be ascertained
sources of current liab
operations: regular business operations like accounts payable
financing: bank borrowings to meet cash needs and these have interests
current liabilities examples
current portion of long term debt; dividends declared not paid (but is subtracted from RE), accrued expenses: book expenses not paid bill yet due to matching principle
short term obligation want to refinance
1) UNDER GAAP:
you can exclude this from current and put it in long term only if the company INTENDS AND HAS ABILITY to refinance (will qualify for loan)
can reclassify only if :
1) you have refinanced it prior to the issuance of fin statement even if its after year end OR
2) you have a noncancelable financing agreement from a lender who has the financial resources to go through with the refinancing
amount and description of the financing agreement should be disclosed in the notes or in the financial statements
dr. st liability
cr. long term liability/ stock Paid in capital if you refinance it by issuing stock instead
IFRS: leave it as a current liability till you actually refinance
demand deposits
can add or withdraw money without penalty
cash and cash equivalents
1) cash-> coin, checking savings accounts, money market funds, commercial paper, treasury bills, cd’s with original maturity over 90 days
2) demand deposits and deposits that are similar
3) short term highly liquid investments (readily convertible to cash adn near maturity when acquired by the entity (90 days or less from the date of purchase ))–> insignificant risk of change in value
4) deposits held as compensating balances against borrowing arrangements with a lending institution that is NOT legally restricted
NOT cash or cash eq.
time certificates of deposit if maturity over 90 days
*legally restricted compensation balances
restricted cash
cash set aside for a specific purpose
if restriction si associated with a current asset or current liab- leave it as a current asset
if restriction associated with non current asset/liab-> non current asset
could include contractually restricted cash or compensating balance-> not included in cash or cash eq if legal restrictions
unrestricted cash
can be used for all current operations
Example on page 6
NOTE DATES
*
unadjusted balance
*important when checks are dated
+ dated before jan 1
- if its was returned bounced back due to nsf remove it
bank reconciliations
simple and reconcilation of cash receipts and disburesements
simple reconiliation
goal-> calculate the true balance between banks and books
despoits in transit or received after the bank’s cutoff date–> add to bank havent been added to bank yet
o/s check we mailed check but the receiver hasnt deposit it yet so we subtract it from the bank
service charge-> subtract from books
bank collection-> in bank balance not in books so add to book
fix errors
nfs-> subtract from book–> got check from customer and included it in our bank balance on books but not really there so subtract from books
interest income- banks aware bookkeeper isnt so add to books
credit and debit memos adjust balance sheet credit memos-> interest earned
check issued means meant to pay
simple bank recon
need to reconcile both amounts to a true balance and this balance needs to be the balance on the b/s
steps:
1) books balances adjusted
2) adjusted book balance = true balance
3) bank balances adjusted
1 and 3 should equal
*problem on 8
recon of cash receipts and disbursements
four column reconciliation or proof of cash
need reconciliation information for the present month and that of the prior month
balance -> receipt -> payment -> balance next month
A/R
t-account:
a/r oral promise to pay back generally not written down; no interest;
notes receivable written down-> promissory notes interests
come from: trade receivables (a/r from purchases of the company's goods/services)
non trade receivables
(a/r from people other than customers so like income tax receivable)
net a/r or net realizable value
gross a/r-allowance
valuation of a/r in case of discounts
discounts is about speed- encourages prompt payment so people will pay in a certain time frame
discounts
sales or cash; trade
sales or cash
generally based on % of sp
sp if 2/10,n/30 then a discount of 2% on the sale price if the payment is made within 10 days. if discount not taken then the entire payment is due within 30 days
gross method and net method
gross method
totally ignore 2% discount because i dont think they are going to take it
so book the entire receivable
adjust if they pay us within time frame-> book contra revenue and debit it
net method
fairly confident that they are going to take the discount so you record receivable now net of discount
now if they dont take the discount adjust so book sales discount not taken account so (additional revenue and it is a revenue account that is credited.)
gross method and net method je page 11
*
gross if discount taken:
dr. cash
dr. sales discount taken
cr. a/r
net if not received within the discount period:
dr. cash
cr. a/r
cr. sales discount not taken
trade discounts
quantity discounts are quoted in %
sales rev and a/r and recorded NET of trade discounts
trade discounts are applied sequentially
** example
Total ar= list price- % disc 1 because they are a buying a certain number= subtotal 1 - %disc 2 = subtotal 2 or total
Sales returns and allowances
1) *EXPECTED EXCHANGES: do not affect sales, inv, cogs
if it actually occurs (wait for it to occur) and then are deducted from a/r and sales
EXCHANGE: shirt for shirt wrong size, difficult to estimate
Even return same story unless past history + reasonably estimate and material
RETURN:
Here expected is okay:
2) if returns are normal and “ material and can be reasonable estimated” establish an allowance
dr. sales returns and allowance (contra rev)
cr. a/r
uncollectible
contra asset; allowance; want to reduce the account to net realizable assets
direct write off method -> not for gaap usually for tax purposes
allowance method -> gaap
direct write off
account is written off and bad debt is recognized when it actually becomes uncollectible
a/r in this case is always overstated because we assume that we are actually going to collect everything unless we actually dont collect it
dr. bad debt expense
cr. allowance
NOT ALLOWED:
because non accrual; not matching
allowance
our favorite
based on past experience:
% sale (direct- i/s)
% a/r (indirect- b/s)
aging (indirect - b/s )
b/s gives you ending balance of allowance
goal: matching principle
book it when you record rev
aging method
emphasizes asset valuation
older receivable less likely to collect it
Bad Debt exp
includes: provision made during the period; possibly adjustment at year end to increase or decrease the allowance account
write off under allowance
write off is when a receivable is formally determined to be uncollectible
direct write off is not allowed under gaap
b/s only affected in form and not in value
Subsequent reversal of write off
direct write off:
dr. cash
cr. uncollectible account recovered (revenue account)
allowance:
dr. cash
cr. a/r
no change in current assets in total just in form
reverse write off
dr. a/r
cr. allowance
problem on f4-15
if you need a lower desired balance you have to adjust bad debt exp
pledging - pnly FN
i am in desperate need for cash and the lender is going to need some collateral so
the company retains title to the receivable but pledges that it will use the proceeds to pay the loan
- only needs note disclosure
a/r is not adjusted
dr. cash
cr. note payable
could be long term or short term and can be interest bearing
factoring of a/r
process by which a company can convert its receivables into cash by assigning them to a factor
1) without recourse-> true sale. once you sell it to the factor it is upto them to collect thet cant bother you; the factor assumes the risk
JE: Dr. cash Dr. loss on sale of receivable Dr. due from factor (factor's margin) Cr. A/R
Due from factor is the proceeds retained by the factor
my total a/r is 100,000
I will get 94,000 in cash; 1,000 is held by the factor as security (thats receivable and we may receive it or not)
2) with recourse- could either be a sale or a loan
recourse: sale (Same journal entry)
or loan (if you pledge it as collateral just footnote and same journal entry as pledging)
With recourse if the factor has the option to resell any uncollectible receivables back to the seller
when is with recourse a sale - JE
all met:
1) seller’s obligation for uncollectible accounts can be reasonably estimated -> post some security, and come up with a number for due from
2) transferor surrenders control of future economic benefits
3) transferor cannot be required to repurchase receivables BUT may be required to replace receivables with some other similar receivables
big one is the first one
if any of these not met then LOAN-> Footnote
Summary
Pledging-> loan just FN
without recourse -> true sale
with recourse -> just FN if loan or true sale
Transfer and servicing of financial assets
question: should the transaction be considered a sale or a secured borrowing
objective:
recognize only the assets it has control over and the related liabilities it has incurred in the process
derecognize only when the control has been surrendered and the liab have been extinguished
Financial components approach
UNDER GAAP: financial assets and liab can be divided into many components based on control
Surrender of control
when ALL conditions have been met:
1) transferred assets have been isolated from the transferor
2) transferee has the right to pledge or exchange the assets
3) transferor does not maintain control over the assets under repurchase agreement
scenarios
1) control surrendered with no continuing involvement-> sale, with reduction in receivables and gain or loss
2) control is surrendered -> continuing involvement
components with interest are treated as not sold adn are still carried on the books
components with no interest are treated as sold and gain or loss recognized on those items
3) No control is surrendered -> pledging. Accounting for the collateral depends on whether the debtor has defaulted and the secured party has the ability to sell or repledge the collateral
Notes receivable
PV of future cash flow
Written promise to pay debt; interest bearing
current or not based on the collection that will occur
Valuation and presentation
unearned interest and finance charges are deducted from the face amount of the promissory note = pv
if the promissory note is non interest bearing or the interest rate is below market the value or PV is determined by using the market interest rate
interest bearing promissory notes are assumed to be issued at arms length transaction are assumed to be issued at the market rate of interest
discounting notes receivable
need cash now, im going to sell it-> always at a loss
discount = cash received - value of the note at maturity
notes receivable
can be with or without recourse
with recourse:
dr. cash
cr. note receivable discounted (contra receivable)
or
cr. note receivable and disclose a contingent liability in the note
with recourse: buyer can come after you
without recourse -> no further liability, its as if they were sold just remove it from the b/s
with recourse
the holder is contingently liable, can come after you, second liable
without recourse
no further liability
dr. cash
dr. loss
dr. due
cr. note receivable
discount note at bank
example on 19**
1) calculate what you would have received = fv of note + interest
2) calculate discount
discount rate * days to maturity * amount in 1 = pv of that
3) remove that discount from 1 and that is the amount that the bank will pay you
4) difference between the face value of the receivable and the amount that the bank will pay you that
the interest income that you will receive
interest = face value * rate * total period/360 days diff interest rate
current/non current
due AFTER a year
due within a year
cash
imp ORIGINAL maturity has to be 90 DAYS or less
cash on b/s
not bank statement balance
checkbook balance + check to be paid but not mailed so add back to balance sheet to reconcile with bank balance
overdraft/ negative bank balance
positive and negative bank balance can be offset against each other
adjustment to allowance for uncollectibles at year end
bad debt expense
discounting
is for notes receivbale not a/r
a/r is factoring
current liab
1) dont include deferred tax liab because all deferred tax liab are classified as non current (always? DBT)
2) Discount on bonds payable decrease that from the face value of the bond because a discount always reduces the carrying value of the bond
short term debt refinanced with long term debt
if no more information given assume that the refinancing has gone through
footnote disclosure of refinancing loan
required!!
cash
original maturity 3 months or less
petty cash
checking account
NOT
bond sinking account - specific purpose so restricted
date of check imp- if post dated a month after b/s date not this time’s cash balance
DBT: Overdraft in savings account
reported as current liab;
not offset against positive balance? if two diff accounts checking and savings
exchange of equipment for non interest bearing receviable is like exchanging for cash
monetary transaction
recorded at fv of asset (equipment or note whatever is more easily available)
pv of face value
then int on that fv = carrying amount
then int on hat carrying amount for yr 2
nsf check
not included in yr end bal
if any amount is paid prior to refinancing
that is still included in current assets
example where prepaid part of the loan before refinancing went through
A/P
Balance + checks written but not mailed
reduce a/p when checks are mailed beause till then the creditors will not cash the checks and we still owe them money
record a/p when purchase not when you record invoice
pleding
retains title to receivables; will repay loan using proceeds from receivables
factoring is not the only way in which the title can be transferred
factoring without recourse
commission can be similar to loss
reconciling bank to books etc.
reconcile only the bank items to bank balance to get to adjusted
and book items to books balance
if only bank balance given and extra book items given dont use the extra book items
credit
line of credit only the amount that is drawn is a liability
balloon payment- the whole payment is due at maturity
tax that is refundable in the future
long term asset
get it beyond 5 years
and getting some benefit in the future
current assets
merchandise inventory and investment in trading securities
unearned rent and deposits received from customers are liabilities
