ACCT 2117 Exam 3 Review

bank reconciliations

Purpose is to reconcile the bank statement to the accounting records.

Each shipment to customers from inventory is recorded on a specially printed form bearing a sequential number; these forms are the basis for entries into the computer system, which makes entries to inventory records and procedures periodic reports of sales and shipments.

Adequate documents and records.

management should monitor both sales discounts and returns and allowances for the following reasons

1) Changes in how sales discounts are used by customers may indicate that they are having cash flow problems and are credit risks to the company or whether the discount is too small. 2) Changes in sales returns and allowances may indicate defective merchandise from certain vendors.

a company's control environment includes the following

1) Philosophy and operating style of management. 2) Personnel policies and practices of the business. 3) Overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control (i.e., tone at the top).

# of days in receivables

365 / accounts receivable turnover. This ratio expresses the average number of days it takes to collect accounts receivable.

accounts receivable turnover

Accounts receivable turnover = net sales / average net accounts receivable. This ratio provides a measure of how many times average trade receivables are collected during the period. A higher number is better as it indicates the company is more quickly collecting cash. Changes in this ratio over time are also very important. For example, a significant reduction in receivables turnover may indicate that management is extending credit to customers who are not paying.

Invoices received from outside suppliers are filed with purchase orders.

Adequate documents and records.

allowance for D/A

Allowance for doubtful accounts is a contra asset to A/R.

analyzing receivables

Analysts are also concerned with asset management. Asset management refers to how efficiently a company is using the resources at its disposal. One of the most widely-used asset management ratios is accounts receivable turnover.

allowance method

Bad debt expense is recorded in period of sale. - Required by GAAP. - Proper matching, because estimate of bad debt expense is recorded in period of sale. - Proper valuation of A/R on the balance sheet, because A/R is valued at net realizable value. - Two approaches commonly used to estimate bad debt expense: percentage of credit sales and aging method.

direct write-off method

Bad debt expense recorded only when account is deemed uncollectible. - Not GAAP; therefore, not allowed unless difference is immaterial. - Poor matching - because no estimate of bad debt expense is recorded in period of sale. - Poor balance sheet valuation - because A/R is valued at gross, not NRV.

three most important ways to strengthen control over cash

Bank reconciliations, cash over and short monitoring, and petty cash management.

cash over and short monitoring

Cash deposited should equal the total of cash register tape. When it doesn't, the difference is recorded in cash over and short. Both overages and shortages are recorded into this same account. Debit balance represents "other expense" and credit balance represents "other revenue."

petty cash

Cash fund used to pay for small amounts that would be impractical to pay with a check.

accounting and reporting cash

Cash is not only currency and coins, but also includes savings and checking accounts and negotiable instruments like checks and money orders. Cash is reported on both the balance sheet and the statement of cash flows which shows the sources and uses of cash. The balance sheet reports the amount of cash and cash equivalents available at the balance sheet date. Cash equivalents include "all highly liquid investments with an original maturity of three months or less at date of inception."

At regular intervals, internal audit reviews a sample of expenditure transactions to determine that payment has been made to a bona fide supplier and that the related goods or services were received and appropriately used.

Checks on recorded amounts.

Cash registers display the price of each item purchased to the customer as it is recorded and produce a customer receipt that describes each item and gives its price.

Checks on recorded amounts.

Division managers are evaluated annually on the basis of their division's profitability.

Clearly defined authority and responsibility.

Only the cashier assigned to the cash register is allowed to perform transactions.

Clearly defined authority and responsibility.

internal control activities

Clearly defined authority and responsibility. Segregation of duties. Adequate documents and records. Safeguards over assets and records. Checks on recorded amounts.

two methods of recording bad debt expense related to uncollectible accounts receivable

Direct write-off method and allowance method.

What are sales discounts?

Discount offered to customers who pay early. For example, the invoice of a seller who expects payment in 30 days and offers a 2% discount if payment is made within 10 days would bear the notation 2/10, n/30 (which is read "2/10, net 30"). GAAP prefers the net method, which means sales are recorded net of discount. If the customer does not pay within the discount period, additional revenue related to the discount not taken is recorded when payment received. The gross method records the sale and associated receivable at the gross amount of the invoice, recognizing the decrease to revenue when the discount is taken. 1) Enter the receivable and sale at the gross amount. 2) Recognize sales discounts only when payment is received.

when employees' goals don't line up with company goals, unethical acts may occur

Example: Employee pressures to meet earnings quotas. Post Sarbanes-Oxley, many companies have Ethics Hotlines to encourage anonymous reporting of unethical behavior.

A balance sheet approach to estimating bad debt expense is not permitted under GAAP (generally accepted accounting principles).

False

A check written by a company but not yet presented to the bank for payment is called a check in transit.

False

Collections of accounts receivable are considered to be cash equivalents.

False

If a company accepts a major credit card such as Visa from a customer, then the company is responsible for the amount of the sale in case of nonpayment from a carholder.

False

If a company estimates its bad debt expense on the basis of a receivables aging, the balance in the Allowance for Doubtful Accounts account will not affect the amount of the end-of-period adjusting entry for bad debts.

False

If a company has an internal audit function, it does not need to have external auditors.

False

If a company hires honest employees and its top management acts with integrity, no internal control procedures will be necessary.

False

If the bank debits its customer's checking account, then the customer's cash balance increases.

False

No special internal control procedures are necessary with a petty cash fund because the amount is so small.

False

Selling on credit protects a company from the risk that some of its receivables will never be collected.

False

The lender of a note recognizes a note payable on the balance sheet and interest expense on its income statement.

False

When a bank collects a note on behalf of a company, the bank is likely to issue a debit memo.

False

percentage of credit sales

Focus if on bad debt expense: - Multiply the historical percentage of credit sales that have been uncollectible times credit sales in dollars to calculate the adjusting journal entry to record "bad debt expense" for the period. - This approach is most concerned with the matching principle. - The previous balance in the allowance account is ignored when recorded the adjusting journal entry to book bad debt expense. - The focus of this approach is on the income statement.

aging method

Focus is on desired ending allowance balance: - At the end of each accounting period, the individual accounts receivable are categorized by age, e.g., 30, 60, 90, 120 past due. - Based on past experience, a percentage of uncollectible A/R by age category is multiplied to each dollar age category of A/R. - The final total calculation is the estimate of the desired ending balance in the allowance account for the period. - Previous balance of allowance account must be considered when determining the necessary adjusting entry at year-end. - The focus of this approach is on the balance sheet.

valuing and reporting accounts receivable (A/R) on the balance sheet

GAAP requires that A/R be valued and reported at Net Realizable Value (NRV) on the balance sheet (i.e., the net amount that you expect to collect from customer).

sales allowances

Given when customer returns good as unsatisfactory but agrees to keep the goods if the seller will make a price allowance.

formula for calculating net sales revenue

Gross sales revenue - sale discounts - sales returns and allowances = net sales revenue.

current receivable

Maturity is less than one year.

noncurrent receivable

Maturity is more than one year.

sales returns

Merchandise returned by the customer.

NRV

NRV = A/R - allowances for D/A. NRV = net amount of cash to be collected.

accounts receivable

Not supported by formal written note - current asset.

trade receivable

Owed by customers who purchase inventory, i.e., accounts receivable.

internal controls

Policies and procedures established by top management and the board of directors to provide reasonable assurance that the company's objectives are being met in the following three areas: 1) Effectiveness and efficiency of operations. 2) Reliability of financial reporting. 3) Compliance with applicable laws and regulations.

trade discounts

Reduction in the selling price granted by the seller to a particular class of customers. (Ex: school of accountancy gets 20% at bookstore).

quantity discounts

Reduction in the selling price granted by the seller when larger quantities are ordered.

section 404 of Sarbanes-Oxley Act of 2002

Requires management to produce an internal control report acknowledging that management is responsible for establishing and maintaining an adequate internal control system and procedures for financial reporting and also assessing the effectiveness of these controls.

section 302 of Sarbanes-Oxley Act of 2002

Requires the principal executive and financial officers to certify that they are responsible for establishing and maintaining the system of internal control over financial reporting.

A construction company stores large steel girders in an open yard surrounded by a 5-foot fence and stores welding supplies in a controlled-access, tightly secured concrete building.

Safeguards over assets and records.

The extent of access to the many segments of the company's computer system is tightly controlled by individual identification cards and passwords that change at regular intervals.

Safeguards over assets and records.

Employees with access to the accounting records are not permitted to open the mail because it contains many payments by check from customers.

Segregation of duties.

The person in the controller's office who prepares and mails checks to suppliers cannot make entries in the general ledger system.

Segregation of duties.

notes receivable

Supported by formal written note (legal document) given by borrower to lender - may be current or long-term depending on maturity.

Sarbanes-Oxley Act of 2002

Top management of publicly-traded corporations have an increased responsibility for a system of internal controls that ensures the reliability of financial statements.

nontrade receivables

Transactions not involving inventory, e.g., interest receivable.

A primary advantage of the allowance method to account for bad debts is that it supports the matching principle.

True

Because the allowance method results in better matching, GAAP requires its use rather than the direct write-off method, unless bad debts are immaterial.

True

Money market accounts with original maturities of less than 90 days are cash equivalents.

True

Replenishment of petty cash does not impact the balance of the petty cash fund.

True

The higher the accounts receivable turnover the better because it indicates that the company is more quickly collecting cash (through sales).

True

The stronger the system of internal control, the higher the accuracy of the company's accounting records and financial reports.

True

The use of the allowance method is an attempt by accountants to match bad debts as an expense with the revenue of the period in which a sale on credit takes place.

True

Under the allowance method of accounting for bad debts, the company estimates the amount of bad debts before those debts actually occur.

True

petty cash management

Used to pay for items such as stamps or a cake for an employee birthday party. Issuing checks to pay small amounts is usually more costly than paying cash.