financial accounting 211 chapters 7 8 9
cash
- includes coins, currency, checks, money orders, checking accounts, and savings accounts. -Often reported combined with cash equivalents consisting of such items as certificates of deposit, Treasury bills, and money market accounts. -If it is restricted in its use must be reported separately.
Factoring and Discounting
-A company can speed up the collection of cash on accounts and notes receivable by selling the receivables. This is called factoring the receivable. -The company will receive cash, less a fee (discount), from the buyer. -If the receivables are sold without recourse, the buyer may not request reimbursement for amount ultimately not collected. -If the receivables are sold with recourse, the buyer has the right to return the uncollected receivables to the seller.
Depreciation for Income Taxes
-A company may use a different method of depreciation for its taxes than it uses for its financial reporting. -The method used for taxes is a form of accelerated depreciation called modified accelerated cost recovery system (MACRS).
Accounting for Long-Lived Assets
-Accounting issues: 1.Account for the acquisition cost. 2.Expense the asset's cost over time. 3. Determine the treatment of future expenditures on the original assets. 4.Account for the disposal of the assets.
Units-of-Production Method
-Allocate an asset's cost based on an asset's use rather than based on time. -Annual depreciation is then computed based on how many units are used. -Units may be miles for a vehicle, hours used, or units produced for a machine. Depreciation per unit = (Acquisition cost - Salvage value) / Total estimated units of production -Assume a piece of equipment is estimated to last 9,000 hours. The acquisition cost of the equipment is $5,000 and the salvage value is estimated to be $500. ($5,000 - $500) / 9,000 hours =$0.50 per hour
Declining-Balance Method
-An accelerated depreciation method that calculates depreciation expense as a constant percentage of an asset's beginning-of-year book value. -Since book value declines each year as accumulated depreciation increases, annual depreciation expense declines each year. -There are many versions of declining-balance depreciation. -Assume equipment costs $5,000, with a three-year useful life, a $500 salvage value, and is depreciated using a double-declining method. -Assets are not depreciated below their salvage value. Annual depreciation = 100% / years x 2 = double declining balance rate
operational audit
-An evaluation of activities, systems, and internal controls -Used to determine efficiency, effectiveness, and economy
Package Purchases
-Assets purchased as a group need to be allocated since different assets may have different useful lives, depreciation methods, and reporting requirements. -The allocation is done based on relative market value or appraisal values.
Losses from Accounts Receivable
-Businesses extend credit in order to increase their volume of sales relative to a cash-only policy. -Businesses understand, however, that they will likely not collect 100 percent of all of their outstanding accounts receivable. -Credit losses are considered an operating expense and are debited to bad debt expense.
Control Activities
-Control activities are the specific policies and procedures designed to reduce risk. -Can be either a prevention control or a detection control. -Prevention controls are intended to deter a problem before it occurs, whereas detection controls are designed to uncover problems after they occur. -Prevention is much more desirable that detection. -It is almost always less expensive to prevent a problem than it is to recover from one.
Depreciation Is Not for Valuation
-Depreciation is a systematic allocation for matching expenses to revenue recognition. -Depreciation is not intended to align the book value of an asset to its market value. -Market Value DOESNT EQUAL Accounting Value
Disposals of Plant Assets
-Disposals can be either sales, retirements, or exchanges. -To record a disposal Remove asset's cost Remove accumulated depreciation Record proceeds Record any gain or loss Difference between proceeds received and book value removed
types of fraud
-Embezzlement of cash -Theft of assets -Filing of false insurance claims -Financial statement fraud
A company should incorporate the following elements when it designs its prevention and detection controls:
-Establish clear lines of authority and responsibility -Implement segregation of duties -Hire competent personnel -Use control numbers on all business documents -Develop plans and budgets -Maintain adequate accounting records -Provide physical and electronic controls
Percentage of Sales Method
-Estimates bad debt expense as a percentage of credit sales for a given period. -Percentage used is usually based on historical past credit losses.
Accounts Receivable Aging Method
-Estimates the allowance for doubtful accounts as a percentage of the outstanding accounts receivable. -Bad debts expense is then determined as the amount necessary to achieve the proper balance in the allowance account. -The allowance for doubtful accounts balance is computed by computing an aging schedule on outstanding accounts receivable partitioned by age of the receivable.
Allowance Method
-GAAP requires an estimate be made of bad debt expenses at the time of the revenue recognition even though the actual accounts to be written off are unknown at this time. This is an example of the matching principle -This process is executed using this method. -The estimate results in an adjusting entry to the contra-asset account Allowance for Doubtful Accounts.
Impairment Loss
-If the value of a plant asset suddenly falls so severely that its future cash flows are estimated to be less than its current book value, the asset is deemed to be impaired and an impairment loss is then recorded. -Assume equipment with a cost of $100,000 and accumulated depreciation of $60,000 is estimated to have a current fair value of only $10,000. Impairment loss 30,000 Accumulated depreciation 30,000 To record impairment loss on equipment.
Intangible Assets
-Intangible assets consist of the various resources that benefit the company's operations, but do not have a physical substance. -Intangible assets acquired from outside firms are recorded at their acquisition cost. -Similar to plant assets and depreciation, intangible assets are amortized over the term of their expected lives. -Unlike plant assets, there is no accumulated amortization expense, instead the credit goes straight to the intangible asset.
Acquisition Cost
-Long-lived assets are initially recorded at their acquisition cost. -Called the historical cost -Includes cash and/or cash equivalent given up to acquire the assets and get it ready for its intended use
controls for cash
-Mailroom or retail sales area for receipt -Treasurer for custody -Controller for recording -Internal audit
Corporate Social Responsibility
-Many companies include within their mission statements their commitment to being a good corporate citizen. -Commitments to sustainable business practices can reduce expenses and protect the environment by using resources more efficiently, minimizing waste, managing supply chains, and raising awareness. -requires creating a culture of ethical behavior that promotes not just making money, but making money in a responsible way. -Cutting corners may work in the short run, but is not a sustainable business practice.
Calculating Depreciation Expense
-Many different methods are allowed for calculating depreciation. -Some common methods 1.Straight-line 2.Declining balance 3.Units-of-production
Natural Resources
-Natural resources include assets such as standing timber, gas, oil, iron ore, coal, gold, silver, and other metal ores. -Natural resources are recorded at their acquisition cost plus exploration and development costs. -Similar to the units-of-production depreciation method for plant assets, natural resources are depleted over their expected useful lives. -Similar to plant assets the credit goes to accumulated depletion.
Depreciation
-Other than land, a plant asset cost must be allocated to the periods of the plant asset use. -The period of depreciation is the asset's useful life, which may differ from its physical life. -The company must also estimate the asset's salvage value, which represents the asset's value at the end of its useful life.
Types of Intangible Assets
-Patents—an exclusive privilege granted to an inventor for a period of 20 years. -Copyrights—protects an owner against unauthorized use of a written work, recorded work, or artwork for the life of the author plus 70 years. -Franchises—are exclusive rights to operate or sell a specific brand of product in a given geographic area. -Trademarks—the right to use certain terms, names, or symbols. -Goodwill—the amount paid by a company for another company above the identifiable net assets of the acquired company.
Financial Statement Audit
-Performed by an independent external auditor -Procedures established by the Public Company Accounting Oversight Board (PCAOB) -The audit report expresses an "opinion" on the financial statements
Risk Assessment
-Risk is the possibility that an event will occur that will have a negative impact on the organization. -Risk assessment involves identifying and analyzing relevant risks. -Risk assessment is an ongoing dynamic and iterative process.
Monitoring cash
-Statement of cash flows identifies inflows and outflows. -Statement of cash flows also identifies whether cash is increasing or decreasing.
Analyzing Assets
-The ability to use a firm's assets efficiently and effectively is the sign of a well managed company. -The rate of return on a company's assets is a commonly used measure of the overall company health. Return on assets=Net income/Average total assets -The asset turnover ratio evaluates a company's effective use of its assets. It indicates how effectively a firm is able to generate sales from its assets. Asset turnover=Net sales/Average total assets
Reporting Allowance for Doubtful Accounts
-The allowance for doubtful accounts is a contra-asset account with a normal credit balance. -The allowance account is subtracted from gross accounts receivable to yield a net amount.
Writing Off Specific Receivables
-The company will write off a receivable when it is determined the amount will not be collected. -The write-off will not affect either expense or total assets, rather the entry simply cleans up the accounts receivable account (the expense occurred at the time of the estimate, not at the time of the write off).
Credit Card Sales
-The seller collects cash from the credit card company, and the customer pays cash to the credit card company when billed at a later date. -The issuer of the credit card will charge the seller a fee each time a card is used. -Businesses incur this fee because credit cards provide considerable benefits to the seller.
Expenditures During the Life of the Plant Asset
-Two types of expenditures: Revenue expenditures Betterments -Revenue expenditures are debited to expense Maintenance and repairs -Capital expenditures are debited to the asset (capitalized) Extend the useful life of the asset Improve the quality or quantity of the asset's output Reduce the asset's operating costs
Direct Write-Off Method
-Under the direct write-off method, doubtful accounts are charged to bad debt expense in the period they are determined to be uncollectible. -No estimate is made for bed debts in the period of the revenue recognition, therefore no allowance for doubtful accounts is used. -Because this violates the matching principle, GAAP does not allow the direct write-off method unless the amounts of bad debts are immaterial.
Intangible assets
-economic resources that benefit the company, but lack physical substance. -Copyrights -Trademarks -Patents -Franchises
allowance method
-involves setting aside a reserve for bad debts that are expected in the future. The reserve is based on a percentage of the sales generated in a reporting period, possibly adjusted for the risk associated with certain customers. By creating this allowance, bad debt expenses are being matched against sales within the same period, so that readers of the financial statements will have a better understanding of the true profitability of sales. EXAMPLE: The historical bad debt experience of a company has been 3% of sales, and the current month's sales are $1,000,000. Based on this information, the bad debt reserve to be set aside is $30,000 (calculated as $1,000,000 x 3%). In the following month, $20,000 of the accounts receivable are written off, leaving $10,000 of the reserve still available for additional write-offs.
fraud triangle
-pressure -opportunity -rationalization
COSO framework
1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information and Communication 5. Monitoring
Analyzing Receivables
A key measure of analyzing receivables is determining the speed of collection. Two ratios, the accounts receivable turnover and the average collection period are commonly calculated. Accounts receivable turnover=Net sales / Average accounts receivable Average collection period= 365 / Accounts receivable turnover
Expenditures Related to Land
All costs necessary to bring the land into condition for use should be capitalized. This includes: -Property taxes on purchase -Insurance on purchase -Legal fees on purchase -Fees to remove old buildings -Special assessments -Net recoveries from selling removed items reduce capitalized cost. -Limited life items of land improvements such as driveways and fences should be accounted for as separate items. -Leasehold improvements are accounted for separately.
fraud
Any act by management or employees of a business involving an intentional deception for personal gain.
Disposals of Plant Assets—Example
Assume a vehicle with an acquisition cost of $20,000 and accumulated depreciation of $18,000 is sold for $3,500. Cash 3,500 Accumulated depreciation 18,000 Vehicles 20,000 Gain on sale 1,500 To record sale of vehicle.
Straight-Line Method
Assume equipment costs $5,000, with a three-year useful life, and a $500 salvage value. ($5,000 - $500)=$1,500 per year3 yearsAnnual depreciation=(Acquisition cost - Salvage value)/Estimated useful life. Depreciation expense $1,500 Accumulated depreciation $1,500 To record depreciation expense for the year.
Assume Scripps Company has 2016 credit sales of $700,000 and past experience is that three percent of these sales will not be ultimately collected.
Bad debts expense is calculated as $700,000 x 0.03 = $21,000 Bad debt expense 21,000 Allowance for doubtful accounts. 21,000 To record bad debt expense estimate for the year. Scripps must monitor the balance in the allowance for doubtful accounts for reasonableness.
Sarbanes-Oxley Act
Congress has legislated that public companies must maintain an adequate system of internal controls. External auditors must attest to the adequacy of these controls.
Provide Physical and Electronic Controls
Examples of physical controls: -Locked doors -Safes -Fences with guards Examples of electronic controls: Security cameras -Electronic cash registers
information and communication
Individuals must receive a clear message from top management that control responsibilities must be taken seriously.
Recovery of Accounts Written Off
Occasionally an account written off will be later collected. Assume the previous $200 write off was actually collected. Two entries will be recorded 1.Reverse the original write-off 2.Collect the cash
Plant Assets
Plant assets refer to a company's property, plant and equipment. Land, Buildings, Equipment, Furniture and fixtures
Interest Calculation
Principal x Interest rate x Interest time -Assume a 3 month note for $10,000 at an annual interest rate of 6 percent Interest = $10,000 x 0.06 x 3/12 = $150
cash on hand
Sufficient cash on hand is needed to pay day-to-day costs such as wages and suppliers, however too much cash on hand is wasteful.
Segregation of Duties
The following functions should be separated: 1.Authorization 2.Recording 3.Custody
Control Environment
The foundation for all the other elements of internal control, setting the overall tone for the organization.
risk assessment
evaluation of the short-term and long-term risks associated with a particular activity or hazard
Book Value Equation
initial cost - accumulated depreciation
monitoring
involve ongoing evaluations, special evaluations, or some combination of each.
Promissory notes receivable
often used in sale transactions when the credit period is longer than the 30-60 day period common for accounts receivable. Key characteristics include: -A fixed due date or on demand -A certain principal sum to be paid -An interest rate usually stated as an annual rate
Three categories of long-lived assets
plant, intangible, natural resources
control activities
policies, procedures, and rules that provide reasonable assurance that control objectives are met and risk responses are carried out
Accounts receivable
the current asset resulting from a sale or service executed on a credit basis.
What is a Bank Reconciliation?
the process of matching the balances in an entity's accounting records for a cash account to the corresponding information on a bank statement. The goal of this process is to ascertain the differences between the two, and to book changes to the accounting records as appropriate. The information on the bank statement is the bank's record of all transactions impacting the entity's bank account during the past month.
