CPA Exam Study - FAR - Select Financial Statement Accounts

Factoring - Parties Involved

3 parties Involved in Factoring: 1. Seller - Company that owns the original AR 2. Factor - Finance company or bank that buys the AR for a fee (the new owner) 3. Debtor - Customer who has financial liability to pay the AR (now pays the Factor)

Allowance for Doubtful Accounts

A contra account offsets another account (AR). It will have a credit balance - reduces AR by an estimate for uncollectible accounts (bad debts). Don't write off the AR until a specific customer doesn't pay.

Securitization A/R

AR sold to financial entity Financial entity bundles our AR with other companies' AR and sells bundle to investors Less expensive than factoring Only available to large business with high-quality receivables

3 month rule

Applies to highly liquid investments. If ORIGINAL maturity is 3 months or less it is a cash equivalent.

Bank Reconciliation Format

Balance per Books: + N/R Collected by Bank + Interest Income - Bank Service Charges - NSF Checks +/- Errors (undo the error, add the correction; 2 steps makes it easier) Balance Per Bank: + Deposits in Transit - Outstanding Checks

Parentage-of-Receivables Approach

Based upon an aging of outstanding receivables. Receivables reported at NRV Companies may apply this method using: One composite Rate Aging schedule with different rates

T-account for Allowance problems

Beginning balance debit write offs credit recovered accounts credit bad debt expense Ending balance

Pledging A/R

Business uses AR as collateral on a loan - line of credit Lender limits loan to a percentage of AR Business retains ownership and risk of loss Debtors are not notified

Examples of Cash

Cash, coins, petty cash, checks not yet deposited, checkings and savings

Cash equivalents

Highly liquid assets that can readily be converted to cash and are near to maturity (three month rule). Minimal risk of changes in value. Ex - commercial paper, money market holdings, US treasury bills, certificates of deposits (CD)

Determining Cost of Inventory

Includes all costs incurred to bring the inventory to purchasers and get it ready for sale includes purch price, shipping, handling, insurance, warehouse

Interest on Note Receivable

Interest= Price X Interest Rate X Time PIT = $25,000 x .10 x 30/360 (round 365 days to 360)

Perpetual System

Inventory transactions run through the inventory account No purchase account

Periodic system

Inventory transactions run through the purchases account Inventory account adjusted at the end of period

Allowance Methods

Losses are estimated and recognized at the time of Sale. Date of Sale: AR, net $10,000 Sales 10,000 Bad Debt Exp (I/S) 1,500 Allow for Doubt Accts (B/S) 1,500 Date of Default-Specific Acct: Allow for Doubt Accts 850 AR, (Name of acct) 850 Recover Amount Previously Written Off: AR 850 Allow for Uncoll 850 Cash 850 AR 850

NR Discounting Terms

Maturity Value - principal interest at the original terms (amount bank will receive) NR + (NR x interest x time) Discount Rate - annual interest rate charged by the bank Discount Period - time between notes sale and notes due date (banks waiting period) Discount - fee charged by bank maturity value x discount rate x discount period

Trade and Quantity Discounts

Motivate credit customers to purchase more items Apply each discount to a declining balance. Ex: List price = $1000 Trade discount = 10% Quantity Discount = 15% NRV = $1000 - 10%($1000) = $900 NRV = $900 - 15%($900) = $765

Note Receivable Discounting

NR can be sold to a financial institution for cash, usually at a discount and with recourse. Seler has contingent liability which must be disclosed in financial statements

Bad Debts

Need to reduce AR by management's best estimate of the amount that will never be collected. AR must be at NRV on the balance sheet. Ex: Credit Sales = $10,000 Bad Debt Estimate = 15% = $1,500 Must match revenue recognized with expense in the same period

Bond Sinking Fund Account

Not a cash equivalent. Used to pay down debt; reported as noncurrent asset

Methods for allowance for doubtful accounts

One Method is NOT acceptable under GAAP: Direct write-off method (only acceptable per GAAP if AR are immaterial) Two Methods acceptable under GAAP: Allowance Method: Percentage-of-Sales Allowance Method: Percentage-of-Receivables

Lower of Cost or Market (LCM)

Only companies using LIFO or retail inventory can use this method Determine Cost and Market (replacement cost, ceiling (NRV), floor, market = always middle number); then determine LCM *Market Value will never be higher than ceiling or lower than floor. Ceiling = NRV = selling price - disposal & selling costs Floor = NRV less normal Gross Profit

Percentage-of-Sales Approach

Percentage based upon collection experience and anticipated credit policy. Achieves proper matching of costs with revenues. Existing balance in Allowance account not considered.

Lower of cost and net realizable value (LCNRV)

Purpose is to simplify the accounting for inventory measurement under GAAP. Cost = purchase price + all cost incurred to get inventory to a condition and location for sale NRV is the amount a company expects to realize from the sale = estimated selling price - cost of disposal, completion, and transportation If NRV is less than Cost, make an adjustment: debit "Loss due to decline of inventory to NRV" and credit "Inventory", or you could also debit COGS

Bank Reconciliation

Reconcile both book and bank to True Balance

LT Note Receivable

Recorded at present value Interest-bearing: face amount of the NR = present value

Account Receivable

Reported at Net Realizable Value (NRV) = the actual amount expected to be received, NET of reductions: Discounts - discount for prompt payment, trade and quantity discounts Bad debts

Cash Exclusions

Restricted Cash: Not free and clear; reported as current or noncurrent asset and footnote details. Restricted for: plant expansions, retirement of LT debt, compensating balances Bank Overdraft: report as current liability; offset against other cash accounts only when accounts are at sme bank Post-dated checks

Inventory Cost Flow Assumptions Acceptable under GAAP

Specific Identification - each item of inventory is identified for cost. Very time consuming and expensive FIFO (Balance Sheet Method) - Recent prices are on the balance sheet, ending inventory contains most recent prices. Old prices are on the income statement as COGS, causes distortion in matching current revenue with current expenses. During inflation: higher net income LIFO (Income Statement Method) - Recent prices are in the IS, no distortion in matching current rev with current expense. Old prices are on the balance sheet, first purchases remain in inventory, inventory base is made up of old prices; doesn't reflect true value of inventory. During inflation: lower net income Average Cost -

A/R Factoring

To speed up cash flow, companies may factor their AR invoices. Factoring = Sale of AR To a third party (called a factor) at a reduced amount to meet an immediate need for cash Sales can be done with or without recourse

Differences between book and bank

Unknown cash deposits Deposits in transit Outstanding checks Bank service charges and NSF fees Errors

Periodic: Weighted Average

Weighted average unit cost = Cost of goods available / Units Available for Sale

perpetual vs. periodic inventory system

When FIFO is used, inventory and COGS will be the same value at the end of the month whether either system is used When LIFO is used, inventory and COGS may not the the same value at the end of the month under the tow systems

Factoring - Recourse

Without Recourse: Sale is final Factor bears the risk of collection loss With Recourse: Sale is NOT final; Seller guarantees payment Seller bears the risk of collection loss Seller must record Recourse Liability

Discount for Prompt Payment

a reduction in sales price provided to credit customers for paying outstanding amounts in a timely manner Terms may be 3/10, net 30 - Deduct 3% of amount if paid within 10 days. Else, pay the net amount on the 30th day. We assume the customer will take the discount for journal entries. If discount is not taken, the plug number is interest income for the difference between full price and discount.

Cost of Goods Sold

beginning inventory + purchases = Cost available for sale - ending inventory = COGS

Perpetual Moving Average

technique that averages a number of recent actual values, updated as new values become available, Only update the moving average when units are added, NOT sold

Gross Profit Method

used to estimate the cost of ending inventory without taking a count. Used for interim reporting. Estimates inventory when there is damaged Need gross profit % and COGS % If given a markup on cost %, convert it to Gross Profit %: Markup on cost % / 100 + Markup ex. markup % = 25% 25/125 = 20%