Chapter 7 Key Points - Intermediate 1 Spiceland
If a company has accounts receivable from ordinary customers and from related parties can they combine those receivables in their financial statements under U.S. GAAP? Under IFRS?
A company has to separately disclose trade receivables and receivables from related parties under U.S. GAAP, but not under IFRS.
What are the key variables that influence a company's investment in receivables/ describe the two ratios sued by financial analysts to monitor a company's investment in receivables.
A company's investment in receivables is influenced by several related variables, to include the level of sales, the nature of the product or service, and credit and collection policies. The receivables turnover and average collection period ratios are designed to monitor receivables.
Define a compensating balance. How are compensating balances reported in financial statements?
A compensating balance is an amount of cash a depositor (debtor) must leave on deposit in an account at a bank (creditor) as security for a loan or a commitment to lend. The classification and disclosure of a compensating balance depends on the nature of the restriction and the classification of the related debt. If the restriction is legally binding, then the cash will be classified as either current or noncurrent (investments and funds or other assets) depending on the classification of the related debt. In either case, note disclosure is appropriate. If the compensating balance arrangement is informal and no contractual agreement restricts the use of cash, note disclosure of the arrangement including amounts involved is appropriate. The compensating balance can be included in the cash and cash equivalents category of current assets.
How is a petty cash fund established? How is the fund replenished?
A petty cash fund is established by transferring a specified amount of cash from the company's general checking account to an employee designated as the petty cash custodian. The fund is replenished by writing a check to the petty cash custodian for the sum of the bills paid with petty cash. The appropriate expense accounts are recorded from petty cash vouchers at the time the fund is replenished.
Explain the primary functions of internal controls procedures in the accounting area what is meant by separation of duties?
Cash equivalents usually include negotiable instruments as well as highly liquid investments that have a maturity date no longer than three months from date of purchase.
Briefly explain the accounting treatment for sales returns
Companies estimate sales returns and reduce revenue to account for them. If the company has received cash from the customer, the company credits a refund liability for the amount it expects to have to refund when products are returned. If the company instead has an outstanding receivable, the company credits an allowance for sales returns, which is a contra account to accounts receivable, and then reduces both accounts receivable and the allowance when returns actually occur in the future.
Explain the typical way companies account for uncollectible accounts receivable (bad debts). What is it permissible to record bad debt expense only at the time when receivables actually prove uncollectible?
Each period companies estimate the amount of accounts receivable that will be collected, and adjust an allowance for uncollectible accounts (contra to accounts receivable) to show net accounts receivable at that carrying value. The corresponding entry to that adjustment is bad debt expense. So, for example, if additional accounts are expected to prove uncollectible, the allowance is credited (increasing it) and a corresponding debit increases bad debt expense for the period. If uncollectible accounts are immaterial, any bad debts that do arise can be written off as bad debt expense at the time they prove uncollectible.
Explain the primary functions of internal controls procedures in the accounting area what is meant by separation of duties?
Internal control procedures involving accounting functions are intended to improve the accuracy and reliability of accounting information and to safeguard the company's assets. The separation of duties means that employees involved in recordkeeping should not also have physical responsibility for assets.
What are the responsibilities of management described in Section 404 of the Sarbanes-Oxley Act? What are the responsibilities of the company's auditor?
Management must document the company's internal controls and assess their adequacy. The auditors must provide an opinion on management's assessment. The Public Company Accounting Oversight Board's Auditing Standard No. 5, which supersedes Auditing Standard No. 2, further requires the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting.
Do US GAAP and IFRS differ in the ability of a company to recognize in net income the recovery of impairment losses of accounts and notes receivable?
No. Under both U.S. GAAP and IFRS, a company can recognize in net income the recovery of impairment losses of accounts and notes receivable.
Explain how the CECL model (introduced in ASU No. 2016-13 and required in 2020) differs from current GAAP in its calculation of bad debt expense
The CECL model still uses the allowance method, and it still uses the same journal entries, but it differs from current GAAP in two important ways. First, the "probable" threshold for identifying bad debts is removed. Therefore, even if the seller is considering a single receivable for which payment is highly likely, the seller likely will make some estimate of credit losses. Second, while current practice tends to focus on events that already have occurred when considering the potential for bad debts, the CECL model explicitly requires creditors to also consider additional information such as reasonable and supportable forecasts about the future.
Explain any possible differences between accounting for an account receivable factored with recourse compared with one factored without recourse.
The accounting treatment of receivables factored with recourse depends on whether certain criteria are met. If the criteria are met, the factoring is accounted for as a sale. If they are not met, the factoring is accounted for as a loan. In addition, note disclosure may be required. Accounts receivable factored without recourse are accounted for as the sale of an asset. The difference between the book value and the fair value of proceeds received is recognized as a gain or a loss.
Is any special accounting treatment required for the assigning of accounts receivable in general as collateral for debt?
The assignment of all accounts receivable in general as collateral for debt requires no special accounting treatment other than note disclosure of the agreement.
Briefly explain the difference between the income statement approach and the balance sheet approach to estimating bad debts.
The balance sheet approach to estimating future bad debts determines bad debt expense by estimating the appropriate carrying value for accounts receivable that exist at the end of the period. In other words, the allowance for uncollectible accounts at the end of the period is estimated and then bad debt expense is determined by adjusting the allowance account to reflect the appropriate carrying value of accounts receivable. The income statement approach to estimating bad debts determines bad debt expense by relating uncollectible amounts to credit sales.
Distinguish between the gross and net methods of accounting for cash discounts
The gross method of accounting for cash discounts initially records accounts receivable at their gross value, without reducing them for sales discounts, and then reduces sales revenue for discounts taken. The net method initially records accounts receivable at their net value, having already reduced them for sales discounts, and then, if collection does not occur in the discount period, increases sales revenue for discounts not taken.
In a two-step bank reconciliation, identify the items that might be necessary to adjust the bank balance to the correct cash balance. Identify the items that might be necessary to adjust the book balance ot the correct cash balance.
The items necessary to adjust the bank balance might include deposits outstanding (including undeposited cash), outstanding checks, and any bank errors discovered during the reconciliation process. The items necessary to adjust the book balance might include collections made by the bank on the company's behalf, service and other charges made by the bank, NSF (nonsufficient funds) check charges, and any company errors discovered during the reconciliation process.
Explain the difference between a trade discount and a cash discount.
Trade discounts are reductions below a list price and are used to establish a final price for a transaction. The reduced price is the starting point for initial valuation of the transaction. A cash discount is a reduction, not in the selling price of a good or service, but in the amount to be paid by a credit customer if the receivable is paid within a specified period of time.
Do US GAAP and IFRS differ in the criteria they use to determine whether a transfer of receivables is treated as a sale? Explain.
U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee. In contrast, IFRS focuses on whether the company has transferred "substantially all of the risks and rewards of ownership," as well as whether the company has transferred control. Under IFRS: 1. If the company transfers substantially all of the risks and rewards of ownership, the transfer is treated as a sale. 2. If the company retains substantially all of the risks and rewards of ownership, the transfer is treated as a secured borrowing. 3. If neither conditions 1 or 2 hold, the company accounts for the transaction as a sale if it has transferred control, and as a secured borrowing if it has retained control.
Marshall Companies Inc. holds a note receivable from a former subsidiary due to financial difficulties, the former subsidiary has been unable to pay the previous year's interest on the note. Marshall agreed to restructure the debt by both delaying and reducing the remaining cash payments. The concessions impair the creditor's investment in the receivable. How is this impairment recorded?
When a creditor's investment in a receivable becomes impaired, due to a troubled debt restructuring or for any other reason, the receivable is remeasured based on the discounted present value of currently expected cash flows discounted at the loan's original effective rate (regardless of the extent to which expected cash receipts have been reduced). The extent of the impairment is the difference between the carrying amount of the receivable (the present value of the receivable's cash flows prior to the restructuring) and the present value of the revised cash flows discounted at the loan's original effective rate. This difference is recorded as bad debt expense or as an impairment loss at the time the receivable is reduced.
What is meant by the discounting of a note receivable? Describe the four-step process used to account for discounted notes
When a note is discounted, a financial institution, usually a bank, accepts the note and gives the seller cash equal to the maturity value of the note reduced by a discount. The discount is computed by applying a discount rate to the maturity value and represents the financing fee the bank charges for the transaction. The four-step process used to account for a discounted note receivable is as follows: 1. Accrue any interest revenue earned since the last payment date (or date of the note). 2. Compute the maturity value. 3. Subtract the discount the bank requires (discount rate times maturity value times the remaining length of time from date of discounting to maturity date) from the maturity value to compute the proceeds to be received from the bank (maturity value less discount). 4. Compute the difference between the proceeds and the book value of the note and related interest receivable. The treatment of the difference will depend on whether the discounting is accounted for as a sale or as a loan. If it's a sale, the difference is recorded as a loss or gain on the sale; if it's a loan, the difference is viewed as interest expense or interest revenue.
Do US GAAP and IFRS differ in how bank overdrafts are treated? Explain.
Yes, IFRS and U.S. GAAP differ in how bank overdrafts are treated. Under IFRS, overdrafts can be offset against other cash accounts. Under U.S. GAAP, overdrafts must be treated as liabilities.
