Accounting exam 2
Terms
2/10, n/30 = 2% discount if invoice paid within 10 days or total balance due in 30 days
Control environment, risk assessment, control activities, information and communication, and monitoring activities
5 Components of internal control
Safeguards over assets and records
A construction company stores, large, steel, girders in an open yard surrounded by a 5 foot fence and stores welding supplies and a controlled access tightly secured concrete building
Petty cash
A fund used to pay for small amounts to avoid the time and expense of writing a check
The day the meals are served
A local catering company should recognize revenue from its catering services when?
net realizable value (the amount we expect to receive in cash)
Accounts Receivable - Allowance for Doubtful Accounts
Risk assessment procedures(component of internal control)
Also called ERM are designed to identity, analyze , and manage strategic risks and business processes risks
Information and Communication (component of internal control)
An internal control system will be unable to help a company achieve its objective, unless adequate information is identified and gathered on a timely basis. This information must be communicated to the appropriate employees in the organization. If Information is not gathered and communicated, then management may not become aware of problems until it is too late.
Deposit in transit
And I'm not received and recorded by the business, but not yet recorded by the bank
Checks on recorded amounts
At regular intervals, internal audit reviews a sample of expenditure transactions to determine that payment has been made to a bona fide supplier that the related goods or services were received an appropriately used
When does stockholders equity decrease using the allowance method
At the end of the accounting period when the adjusting entry for bad debts is recorded.
% of receivables method
Balance sheet approach; aging analysis of AR - different rates applied to different age categories. Calculates the required final balance in the allowance account
Checks
Cash controls are more effective when companies pay with ___ for a majority of transactions
Checks on recorded amounts
Cash registers display the price of each item, purchase to the customer as it is recorded and produce customer receipt that describes each item and gives its price
Control activities (component of internal control)
Clearly defined authority and responsibility, segregation of duties, adequate documents and records, safeguards over assets and records, and checks on recorded amounts
(risk management-component of internal control)
Common processes include material acquisition, logistics and distribution, branding and marketing, and Human Resources
Sales Returns and Allowances
Contra revenue accounts that constitutes an adjustment to sales
Gross Method of Cash Discounts
Discounts taken are a reduction of sales revenue, adjust when it happens
Clearly defined authority and responsibility
Division managers are evaluated annually on the basis of their divisions profitability
Adequate documents and 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
Segregation of duties
Employees with access to the accounting records are not permitted to open the mail because it contains many payments by check from customers
When a company uses the direct write off method of accounting for that does the establish an allowance for doubtful accounts?
False
Control environment and ethical behavior
Foundation of internal control; collection of environmental factors that influence the effectiveness of control procedures
timing of revenue recognition
GAPP requires accrual-basis accounting which recognizes revenue when is performance obligation is satisfied
Gross Profit Margin
Gross Profit/net Sales
True
If a bank credits a customers account that customers cash balance increases
False
If a company hires honest employees and its top management acts with integrity, NO internal control procedures will be necessary
True
In a sound system of internal control, cash receipts should be deposited daily
Internal controls
Include all the policies and procedures established by top management and the board to provide reasonable assurance that the companies objectives are being met in the following areas 1) effectiveness, and efficiency of operations 2) reliability of financial reporting 3) compliance with applicable laws and regulations
% of sales method
Income statement approach, credit sales estimated bad best %; calculates the amount of bad debt expense to be recognized
Face value * rate * time (x/12)
Interest calculation
adequate documents and records
Invoices received from outside suppliers are filed with purchase orders
Petty cash
Issuing checks to pay small amounts is usually more costly than paying cash, so companies establish a son to pay for items, such as stamps or a cake for an employee birthday party. Overseen by a petty cash custodian
Short-term investments
Keep bank cash balances to a minimum and purchase short-term investments with temporary cash surpluses.
Operating margin
Key ratio for financial analysts. Tells how much is left from a sales dollar after paying for the product and all its operations
Means operating efficiently
Lower # of days in inventory
Gross method
Make the assumption up front that the customer will NOT take the discount
Net method
Make the assumption up front that the customer will take the discount
Allowance method - contra asset account
Makes an estimate of uncollectible accounts at the end of each period. Creates an allowance account that is decreased when actual write offs occur. Better matching of expense and revenue
365/accounts receivable turnover
Measures the average # of days A/R are on the books
buying inventory; objective keep inventory levels low to decrease cash need
Money that is tied up in inventory sitting on the shelves is not earning any return
Accounts Receivable Turnover
Net Sales / Average net Accounts Receivable
selling inventory
Often produces receivables; increasing collection can include selling receivables at a reduced rate to access faster cash collection.
Net Profit Margin
One of the most important indicators of a companies overal financial health
Clearly defined authority and responsibility
Only the cashier assigned to the cash register is allowed to perform transactions
safeguards over assets and records (control activity)
Pertains to the physical safety of assets and documents. Secured against theft and destruction. Physical protection such as vaults, locks, keycard access, anti theft tags
True
Petty cash is not considered to be a cash equivalent
Control activities (component of internal control)
Policies and procedures top management establishes to help insure that objectives are met. These are most directly related to the accounting system and financial statements
Strategic risks (risk management-component of internal control)
Possible external threats to the organization's success in accomplishing its objectives
Allowance
Price allowance for minor defects
Monitoring Activities(component of internal control)
Process of tracking potential and actual problems in the internal control system. It is accomplished through normal supervising activities, such as when a manager asks a subordinate how things are going. For example internal audit group
Maker: promises to pay Payee: receives payment (records N/R) Recorded at face value Stronger legal claim/ requires interest
Promissory note
It serves as a control function by identifying errors and providing an inspection of detailed records that detects theft and it detects bank transactions so the business can make the necessary entries in its records
Purposes of bank reconciliation are:
direct write-off method
Recognized when a specific account is deemed uncollectible, only actual losses are reflected in bad debt expense. Expense is often recognized in a different period than the revenue associated with the sale. Violates matching principle. FASB does not allow unless bad debt is insignificant
Control Environment (component of internal control)
Recognizes that an individual employee's goals may differ from the goals of the business, leading to unethical acts, like shipping sales at the end of the year. Ethics hotline created to encourage anonymous reporting of unethical behavior
segregation of duties (control activity)
Reduces the likelihood that record could be used to conceal irregularities and increases likelihood irregularities will be discovered
SOX and COSO
Refers to an influential report released in 1992 by the committee of sponsoring organizations of the Tradeway commission. The report was the culmination of the committees exhaustive research and deliberation on the elements of sound internal controls.
Liquidity
Refers to the ease with which an asset can be converted to cash. More liquid assets are more likely to be stolen.
True
Replenishment of petty cash does not impact the balance of the petty cash fund
checks on recorded amounts (control activity)
Requires independent verification, reconciliation of accounts etc. these procedures include clerical checks, reconciliations, comparison of asset inspection reports with recorded amounts, computer-programed controls, and management review of reports.
Section 404 of Sarbanes Oxley
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 assessing the effectiveness of these controls
Credit memos
Results if the bank collects a note receivable for the business and deposits it into the business bank account; these are recorded by the bank, but not recorded by the business, causing the bank account to be larger than the business cash account balance
Debit memos
Results with prearrange deductions, by a bank from a business account to pay a bill, like utility bill; these are recorded by the bank, but not yet recorded by the business causing the bank balance to be smaller than the business cash balance
Top Management of the company
Sarbanes-Oxley Act says who is primarily responsible for establishing/maintaining a system of internal control over the company's financial reporting?
True
The accounts receivable turnover ratio provides a measure of how many times average trade receivables are collected during the period
Cash Over and Short
The amount deposited should equal the total of cash register tapes. If it does not, an account that records the discrepancies between deposited amounts of actual cash received and the total of the cash register tape.
-The philosophy and operating style of management -the personnel, policies, and practices of business -the overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control (tone at the top)
The control environment includes
What does the two in 2/10, net 30 represent on a sales invoice
The discount percentage
Safeguards over assets and records
The extent of access to many segments of the company's computer system is tightly controlled by the individual identification cards and passwords that change at regular intervals
No discount will be recorded at the point of the sale
The gross method of recording sales means...
Income Statement
The percentage of sales approach is closely related to:
Segregation of duties
The person in the comptroller's office, who prepares and mails checks to the suppliers, cannot make entries in the general ledger system
True
The stronger the system of internal control, the higher the accuracy of the companies accounting records, and financial reports
1) transactions recorded by the business, but not recorded by the bank in time to appear on the current bank statement 2)transactions recorded by the bank, but not yet recorded by the business
Three differences to resolve between the cash account balance and the bank statement balance
-bank reconciliation -cash over and short monitoring -petty cash management/fund
Three important areas were the accounting system interacts with the internal control system to strengthen cash controls (cash should be safeguarded in vaults and banks)
Information and Communication (component of internal control)
Timely reporting of returns and complaints made by dissatisfied customers allows management to respond before company reputation is damaged.
-Service charges, Nonsufficient funds (NSF), debit memos, and credit memos
Transactions are recorded by the bank, but not yet recorded by the business
Two types outstanding checks and deposits in transit
Transactions recorded by the business but not yet recorded by the bank
adequate documents and records (control activity)
Underlying documentation must be thorough to allow evaluation of performance
Accounts receivable balance - the allowance for doubtful accounts
What is the net realizable value of accounts receivable?
Net sales
What remains after all returns, allowances and sales discounts have been subtracted from gross
True
When a bank pays interest on a company's checking account balance, the bank will likely use a credit memo
False
When reconciling a bank account, the company has to prepare and adjusting entry for outstanding checks
False
When reconciling a bank account, the company must prepare an adjusting entry for deposits in transit
Bank balance
When reconciling the bank statement, would you adjust the bank balance, or company, cash balance for outstanding checks?
Bank balance
When reconciling the bank statement, would you just the bank balance for the company cash balance for a deposit in transit?
When the customers is expected to pay in the discount period
When should the net method be a used to record sales revenue?
Contra account
Which of the following best describes the allowance for doubtful accounts
Deposit in transit
While preparing a bank reconciliation, which of the following items would be added to the bank statement balance?
Company cash
While reconciling the bank statement, would you adjust the bank balance or company cash balance for a bank service charge?
A Deposit in transit
amount received and recorded by the business, but not yet recorded by the bank in time to appear on the current bank statement. This occurs for deposits made after hours or cut off times, causing the bank balance to be smaller than the business's cash account balance.
outstanding checks
are issued and recorded by the business, but I'm not yet been "cashed" out by the recipient of the recipient of the check, therefore the bank has not recorded the check lowering the businesses account ye
Business process risks (risk management-component of internal control)
arise out of an individual company's internal processes— how the company allocates its resources to meet its objectives.
Nonsufficient funds (NSF)
check our checks returned to the depositors, because the insurance amount does not have enough cash to pay the check; these cause the bank balance to be smaller than the businesses, cash account balance
Sales discount
contra revenue account that is subtracted from sales when calculating "net sales"
paying for inventory
delay payments as long as possible so more interest can be collected on cash investments
Service charges
fees, charged by the bank for checking account services; there, unrecorded by the business, causing the bank balance to be smaller than the businesses, cash account balance
The COSO framework
has become the standard for understanding what good internal controls look like
Clearly defined authority and responsibility (control activity)
identifies who has authority to perform important duties and responsibility for performance of assigned tasks. Motivates individuals to preform well
Net profit margin
net income/net sales
Operating margin
operating income/net sales (how much is left from a sales dollar)
segregation of duties (control activity)
reduces the incidence of fraud because no one person prepares all the documents and records for any one type of activity
trade receivables
represent sales revenues that have been recognized but not collected or realized in cash
Section 302
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
net method of cash discounts
sales are recorded net of discount,estimate based on experience
