Chapter 7 Quiz

Is any special accounting treatment required for the assigning of accounts receivable in general as collateral for debt?

The assignment of all A/R in general as collateral for debt does not require any special accounting treatment except a DISCLOSURE NOTE. - pledge If specific A/R are assigned - must record cash received - finance charge expense - liability - financing arrangement * In this case ^ A/R aren't specifically sold to the bank, but kept on your balance sheet as an asset - also you have a note payable on your balance sheet as a liability

Define a compensating balance. How are compensating balances reported in financial statements?

The borrower is asked to maintain a specified balance in a low interest or noninterest-bearing account at the bank. The required balance usually is some percentage of the committed amount which is known as the compensating balance. The classification and disclosure depends on the nature of the restricition and the classification of the related bad debt. if the restricition is legally binding the cash is classified as either current or noncurrent depending on the classification of the related debt. Note diclosure is approriate in either case.

distinguish between the gross and net methods of accounting for cash discounts.

The gross method assumes customers won't take cash discounts and then reduces revenue for discounts taken. The net method assumes customers will take cash discounts and then increases revenue for discounts forfeited.

What is meant by the discounting of a note receivable? Describe the four-step process used to account for discounted notes.

Discounting of a Note Receivable - a financial institution (bank) accepts note and gives cash less a discount on maturity value of note - discount represents financing fee the bank charges for the transaction Four Step process to account for a discounted note 1. ACCRUE INTEREST REVENUE earned since last payment date 2. COMPUTE MATURITY VALUE 3. SUBTRACT DISCOUNT bank requires from maturity value - to compute proceeds to be received from bank 4. COMPUTE DIFFERENCE between proceeds and book value. Difference is - Sale - Gain/Loss on sale - Loan - Interest expense/revenue

Explain the typical way companies account for uncollectible accounts receivable (bad debts). When is it permissible to record bad debt expense only at the time when receivables actually prove uncollectible?

Even when specific customer accounts haven't been proven uncollectible by the end of the reporting period, bad debt expense properly should be matched with sales revenue on the income statement for that period. Likewise, since it's not expected that all accounts receivable will be collected, the balance sheet should report only the expected net realizable value of that asset. So, to record the bad debt expense and the related reduction of accounts receivable when the amount hasn't been determined, an estimate is needed. In an adjusting entry, we record bad debt expense and reduce accounts receivable for an estimate of the amount that eventually will prove uncollectible. If uncollectible accounts are immaterial or not anticipated, or it's not possible to reliably estimate uncollectible accounts, an allowance for uncollectible accounts is not appropriate. In these few cases, any bad debts that do arise simply are written off as bad debt expense at the time they prove uncollectible.

Do U.S. GAAP and IFRS differ in how bank overdrafts are treated? Explain.

GAAP requires that overdrafts typically be treated as liabilities. IFRS allows bank overdrafts to be offset against other cash accounts.

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 key variables that influence a company's investment in receivables? Describe the two ratios used by financial analysts to monitor a company's investment in receivables.

Key variables that influence a company's investment in receivables are - AMOUNT of sales - TYPE of product or service - CREDIT AND COLLECTION POLICIES The two ratios used by financial analysts to monitor a company's investment in receivables are Receivables Turnover Ratio = Net Sales / Avg. A/R (net) Average Collection Period = 365 Days / Rec. Turnover Ratio

What are the responsibilities of management described in section 404 of the Sarbanes-Oxley Act? What are the responsibilities of the company's auditor?

Section 404 of the Sarbanes-Oxley Act requires a company to document and assess its internal controls. The company's auditors must provide an opinion on management's assessment. The Public Company Accounting Oversight Board's 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.

Define cash equivalents

Short-term, highly liquid investments includes money market funds, treasury bills, and commercial paper.

Briefly explain the difference between the income statement approach and the balance sheet approach to estimating bad debts.

The income statement approach to estimating bad debts determines bad debt expense directly by relating uncollectible amounts to credit sales. The balance sheet approach to estimating future bad debts indirectly determines bad debt expense by estimating the net realizable 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 net realizable value

Explain the difference between a trade discount and a cash discount?

Trade discounts allow a customer to pay an amount that is below the list price, they are not variable consideration. Cash discounts reduce the amount to be paid if payment occurs within a specified short period of time, they are variable consideration.

Briefly explain the accounting treatment for sales returns.

When returns are material and a company can make reasonable estimates of future returns, an allowance for sales returns is established. At a financial reporting date, this provides an estimate of the amount of future returns for prior sales, and involves a debit to sales returns and a credit to allowance for sales returns for the estimated amount. Allowance for sales returns is a contra account to accounts receivable. When returns actually occur in the future reporting period, the allowance for sales returns is debited.

Explain any possible differences between accounting for an account receivable factored with recourse compared with one factored without recourse.

With Recourse - Seller retains risk of bad debts - compensated with lower factoring fee - Sale - whether control of assets has shifted from TRANSFEROR TO TRANSFEREE - Loan - If any of the above conditions are not met accounted for as a loan Without Recourse - Buyer can't ask seller for more money if receivables prove uncollectible - Buyer assumes risk of bad debts - Compensated with higher factoring fee - Accounted for as the sale of an asset - Difference between the book value and the fair value of proceeds received is recognized as a gain or a loss