Acfm 261 - Chap 7 Bolded Concepts + Learning Objectives

Front 1

Define financial assets and explain their valuation in the balance sheet.

Back 1

Financial assets are cash and other assets that convert directly into known amounts of cash. The three basic categories are cash, marketable securities, and receivables. In the balance sheet, financial assets are listed at their current value. For cash, this means the face amount; for marketable securities, current market value; and for receivables, net realizable value.

Front 2

Describe the objectives of cash management and internal controls over cash.

Back 2

The objectives of cash management are accurate accounting for cash transactions, the prevention of losses through theft or fraud, and maintaining adequate—but not excessive—cash balances. The major steps in achieving internal control over cash transactions are as follows: (1) separate cash handling from the accounting function, (2) prepare departmental cash budgets, (3) prepare a control listing of all cash received through the mail and from over-the-counter cash sales, (4) deposit all cash receipts in the bank daily, (5) make all payments by check, (6) verify every expenditure before issuing a check in payment, and (7) promptly reconcile bank statements.

Front 3

Prepare a bank reconciliation and explain its purpose.

Back 3

The cash balance shown in the month-end bank statement usually will differ from the amount of cash shown in the depositor’s ledger. The difference is caused by items that have been recorded by either the depositor or the bank, but not recorded by both. Examples are outstanding checks and deposits in transit. The bank reconciliation adjusts the cash balance per the books and the cash balance per the bank statement for any unrecorded items and thus produces the correct amount of cash to be included in the balance sheet at the end of the month. The purpose of a bank reconciliation is to achieve the control inherent in the maintenance of two independent records of cash transactions: one record maintained by the depositor and the other by the bank. When these two records are reconciled (brought into agreement), we gain assurance of a correct accounting for cash transactions.

Front 4

Describe how short-term investments are reported in the balance sheet and account for transactions involving marketable securities.

Back 4

Short-term investments (marketable securities) are adjusted to their market value at each balance sheet date (a valuation principle often referred to as fair value accounting ). If the value of a company’s marketable securities has increased above their original cost, an unrealized holding gain is reported as a component of stockholders’ equity. If the value of its marketable securities has fallen below their original cost, an unrealized holding loss is reported as a component of stockholders’ equity. Interest and dividends generally are recognized as revenue when they are received. When securities are sold, the cost is compared to the sales price, and the difference is recorded as a gain or a loss in the income statement.

Front 5

Account for uncollectible receivables using the allowance and direct write-off methods.

Back 5

Under the allowance method, the portion of each period’s credit sales expected to prove uncollectible is estimated. This estimated amount is recorded by a debit to the Uncollectible Accounts Expense account and a credit to the contra-asset account Allowance for Doubtful Accounts. When specific accounts are determined to be uncollectible, they are written off by debiting Allowance for Doubtful Accounts and crediting Accounts Receivable. Under the direct write-off method, uncollectible accounts are charged to expense in the period that they are determined to be worthless. The allowance method is theoretically preferable because it is based on the matching principle. However, only the direct write-off method may be used in income tax returns.

Front 6

Explain, compute, and account for notes receivable and interest revenue.

Back 6

Accounts receivable usually do not bear interest. When interest will be charged, creditors usually require the debtor to sign a formal, legally binding promissory note. Promissory notes appear in the balance sheet as assets designated as notes receivable. Interest on a note receivable is a contractual amount that accumulates (accrues) over time. The amount of interest accruing over a time period may be computed by the formula Principal x Rate x Time.

Front 7

Evaluate the liquidity of a company’s accounts

Back 7

The most liquid financial asset is cash, followed by cash equivalents, marketable securities, and receivables. The liquidity of receivables varies depending on their collectibility and maturity dates. The Allowance for Doubtful Accounts should provide for those receivables that may prove to be uncollectible. However, users of financial statements may also want to evaluate the concentrations-of-credit-risk disclosure and, perhaps, the credit ratings of major debtors. The accounts receivable turnover rate provides insight as to how quickly receivables are being collected.

Front 8

Accounts receivable turnover rate

Back 8

(p. 309) A ratio used to measure the liquidity of accounts receivable and the reasonableness of the accounts receivable balance. Computed by dividing net sales by average receivables.

Front 9

aging the accounts receivable

Back 9

(p. 302) The process of classifying accounts receivable by age groups such as current, 1–30 days past due, 31–60 days past due, etc. A step in estimating the uncollectible portion of the accounts receivable.

Front 10

Allowance for Doubtful Accounts

Back 10

(p. 301) A valuation account or contra-asset account relating to accounts receivable and showing the portion of the receivables estimated to be uncollectible.

Front 11

Bank reconciliation

Back 11

(p. 291) An analysis that explains the difference between the balance of cash shown in the bank statement and the balance of cash shown in the depositor’s records.

Front 12

Cash Equivalents

Back 12

(p. 289) Very short-term investments that are so liquid that they are considered equivalent to cash. Examples include money market funds, U.S. Treasury bills, certificates of deposit, and commercial paper. These investments must mature within 90 days of acquisition.

Front 13

Cash Management

Back 13

(p. 290) Planning, controlling, and accounting for cash transactions and cash balances.

Front 14

Compensating Balance

Back 14

(p. 290) A minimum average balance that a bank may require a borrower to leave on deposit in a noninterest-bearing account.

Front 15

Default

Back 15

(p. 309) Failure to pay interest or principal of a promissory note at the due date.

Front 16

Direct Write-Off Method

Back 16

(p. 305) A method of accounting for uncollectible receivables in which no expense is recognized until individual accounts are determined to be worthless. At that point the account receivable is written off, with an offsetting debit to uncollectible accounts expense. Fails to match revenue and related expenses and is used primarily for tax accounting.

Front 17

Factoring

Back 17

(p. 305) Transactions in which a business either sells its accounts receivable to a financial institution (often called a factor ) or borrows money by pledging its accounts receivable as collateral.

Front 18

Fair Value Accounting

Back 18

(p. 298) The balance sheet valuation standard applied to investments in marketable securities. Involves adjusting the securities to market value at each balance sheet date. (Represents an exception to the cost principle.)

Front 19

Financial Assets

Back 19

(p. 288) Cash and assets convertible directly into known amounts of cash (such as marketable securities and receivables).

Front 20

Gain

Back 20

(p. 297) An increase in owners’ equity resulting from a transaction other than earning revenue or investment by the owners. The most common example is the sale of an asset at a price above book value.

Front 21

Line of Credit

Back 21

(p. 290) A prearranged borrowing agreement in which a bank stands ready to advance the borrower without delay any amount up to a specified credit limit. Once used, a line of credit becomes a liability. The unused portion of the line represents the ability to borrow cash without delay.

Front 22

Loss

Back 22

(p. 297) A decrease in owners’ equity resulting from any transaction other than an expense or a distribution to the owners. The most common example is the sale of an asset at a price below book value.

Front 23

Marketable Securities

Back 23

(p. 288) Highly liquid investments, primarily in stocks and bonds, that can be sold at quoted market prices in organized securities exchanges.

Front 24

Net Realizable Value (NRV)

Back 24

(p. 289) The balance sheet valuation standard applied to receivables. Equal to the gross amount of accounts and notes receivable, less an estimate of the portion that may prove to be uncollectible.

Front 25

NSF Check

Back 25

(p. 292) A customer’s check that was deposited but returned because of a lack of funds (Not Sufficient Funds) in the account on which the check was drawn.

Front 26

Unrealized Holding Gain (or Loss) on Investments

Back 26

(p. 298) A stockholders’ equity account representing the difference between the cost of investments owned and their market value at the balance sheet date. In short, gains or losses on these investments that have not been “realized” through the sale of the securities.