Chp 7: Cash And Receivables

Front 1

Internal Control

Back 1

1. Encourage adherence to company policies and procedures
2. Promote operational efficiency
3. Minimize errors and theft
4. Enhance the reliability and accuracy of accounting data.

From a financial accounting perspective, the focus on controls is intended to improve the accuracy and reliability of accounting information and to safeguard assets.

Front 2

Committee of sponsoring organizations(COSO)

Back 2

Provides a framework for designing an internal control system

Formed in 1985 and is dedicated to improving the quality of financial reporting through effective internal controls.

Defines internal control as a process taken control by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

1. effectiveness and efficiency of financial reporting

2. reliability of financial reporting

3. compliance with applicable laws and regulations

Front 3

Separation of duties

Back 3

Bookkeepers shouldn't have physical access to assets.

Front 4

Compensating balances

Back 4

Borrower maintains balance with creditor, which is usually a lower interest or noninterst account at a bank(creditor) and the required balance is usually some percentage of the committed amount, which serves as compensation for a bank granting loan or extending credit.

Front 5

trade discounts

Back 5

Percentage reduction from the list price; allow customer to pay an amount that is below the list price.

Disguise price from competitors and give quantity discounts to large customers.

Front 6

Cash discounts(sale discounts)

Back 6

Represent reduction not in the selling price of the good, but in the amount to be paid by the credit customer if paid within a specified period of time.

Front 7

gross method

Back 7

views a discount not taken by the customer as part of sales revenue.

Front 8

net method

Back 8

Views sales revenue as the net amount after discount is taken and any discounts not taken as interest revenue.

Front 9

Allowance for sales returns account

Back 9

Contra account to A/R that reduces the net balance of A/R for estimated returns.

Front 10

Bad debt expense

Back 10

inherent cost of granting credit.

operating expense incurred to make sales.

Front 11

Net realizable value

Back 11

Amount of cash actually to be collected from the customers.

Front 12

Allowance method

Back 12

When companies account for bad debts through an adjusting entry, which debits bad debts expense and reduces A/R indirectly through a contra account(allowance for doubtful accounts).

This is an estimate of the amount to be uncollectible.

Front 13

Income statement approach

Back 13

Bad debt expense estimated as a percentage of each period's net credit sales.

Balance sheet amount is an incidental amount, resulting from the estimation of bad debts expense as a percentage of net credit sales.

Front 14

Balance sheet approach

Back 14

We determine bad debts expense by estimating net realizable value of A/R to be reported in the balance sheet.

Bad debts expense is an incidental result of estimate net realizable value of A/R.

Front 15

A/R aging schedule

Back 15

applying different percentages to accounts receivable balance depending on the length of time outstanding.

Front 16

direct write-off method

Back 16

Used rarely for financial reporting, but is required for income tax purposes.

Used when amount is immaterial and unanticipated.

Bad debts are recorded as they occur.

Certain exceptions are permitted by GAAP, but usually is impermissible.

Front 17

noninterest bearing note

Back 17

Actually do bear interest, but the interest is discounted from the face amount to determine the cash proceeds made available to the borrower at the outset.

Front 18

impaired

Back 18

When it becomes probable that a creditor will be unable to collect all the amounts due according to the contractual terms of a note.

The receivable is remeasured as the present value of the currently expected cash flows, discounted at the loan's original effective rate.

Front 19

Factoring

Back 19

Company sells its A/R to financial institution.

The institution typically buys the receivable for cash, handles the billing and collection, and charges a fee for this service.

Seller relinquishes all rights to the future cash receipts in exchange for cash from the buyer(the factor)

Fee charged by factor ranges between 2-4%, depending on quality of receivables and length of time before payment is required.

Front 20

Securitization

Back 20

A company creates an SPE(Special purpose entity, usually trust or subsidiary) to buy a pool of receivables and then sells related securities(usually debt securities) that are collateralized by the receivables.

Front 21

Without recourse

Back 21

Buyer can't ask the seller for more money.

The buyer assumes the risk of uncollectibility.

Front 22

With recourse

Back 22

The seller retains all the risk of bad debts

The seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible.

Only difference from sale without recourse is that the estimated fair value of a recourse obligation(liability) is recorded, which is the estimated amount that the company will have to reimburse its factor for uncollectible accounts.

Front 23

discounting

Back 23

Transfer of a note to a financial institution.

Financial institution gives seller cash equal to the maturity value of the note reduced by a discount.

Discount is computed by applying a discount rate to the maturity and represents the financing fee the institution charges for the transaction.

3 steps:

1. Accrue interest earned on the N/R prior to its being discounted.

2. Add interest to maturity to calculate maturity value.

3. Deduct discount to calculate cash proceeds

4.

Front 24

Cash Equivalents

Back 24

Company can disclose its policy as to what short-term, liquid investments it classifies as cash equivalents in disclosure notes.

Internal controls system developed because cash is most easily expropriated.

Front 25

Pledge

Back 25

When the entire receivables balance serves as collateral for the loan, rather than a specific receivables account.

Company is responsible for collecting the receivables

Arrangement should be described in a disclosure note

Front 26

Assign

Back 26

When particular receivables serve as collateral for loans.

Lender typically lends an amount that is less than the amount of receivables assigned as collateral

Extra amount provides cushion to lender for potential uncollectible accounts

Lender usually charges up-front fee in addition to interest

Receivable may be collected by lender or borrower, depending on the details of the agreement.

When companies assign particular A/R as collateral for debt, the balances of the receivables and the debt are offset in the balance sheet.

Typically not allowed by GAAP, but in this case N/P is deducted from assigned A/R because, by contractual agreement, the note will be paid with the cash collected from the A/R.