Cpa Review- Far 4-1 (Working Capital And Its Components)

Front 1

Working Capital

Back 1

Current assets minus current liabilities. Often a measure of the solvency of a company and is used in many financial ratios.

Hint 1

Ability to pay debt as due. Indicates the short-term financial risk of a company.

Front 2

Working Capital Ratios

Back 2

1. Working Capital
2. Current Ratio
3. Quick Ratio
-The higher the ratio the lower the amount of risk.

Hint 2

1. Current assets - Current liabilities
2. Current assets ÷ Current liabilities
3. (Cash + Net receivables + Marketable securities) ÷ Current liabilities

Front 3

Current Assets

Back 3

Those resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer.

Hint 3

Typically consist of: 1) Cash 2) Trading securities 3) Other short-term investments (AFS securities if liquidating within the year) 4) A/R and N/R 5) Inventories 6) Trade installment receivables 7) Other short term receivables 8) Prepaid expenses 9) Cash surrender value of life insurance

Front 4

Current Liabilities

Back 4

Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities.

Hint 4

The concept of current liabilities includes estimates or accrued amounts that are expected to b required to cover expenditures within the year for known obligations when 1) the amount can be determined only approximately or 2) where the specific person(s) to whom payment will be made is unascertainable (matching principle)

Front 5

Types of Current Liabilities

Back 5

1. Trade accounts and notes payable
2. Current portions of long term debt
3. Cash dividends payable

Hint 5

4. Accrued liabilities
5. Payroll liabilities
6. Taxes payable
7. Advances from customers (deferred revenues)

Front 6

Short-Term Obligations Expected to be Refinanced

Back 6

-Under GAAP a short-term obligation may be excluded from current liabilities and included in noncurrent debt if the company intends to refinance it on a long-term basis and the intent is supported by the ability to do so as evidenced either by:

Hint 6

1. The actual refinancing prior to the issuance of the F/S's
2. The existence of a non cancelable financing agreement from a lender having the financial resources to accomplish the refinancing.

Front 7

IFRS vs. U.S. GAAP- Refinancing

Back 7

Under IFRS, short-term obligations expected to be refinanced on a long-term basis may not be classified as noncurrent

Front 8

Cash and Cash Equivalents

Back 8

Includes both currency and demand deposits with banks and/or other financial institutions. It also includes deposits that are similar to demand deposits.

Hint 8

The term cash equivalents broadens the definition of cash to include short-term, highly liquid investments that are both readily convertible to cash and so near their maturity when acquired by the entity (90 days or less from date of purchase) that they present insignificant risk of changes in value.

Front 9

Restricted vs. Unrestricted Cash

Back 9

-Restricted cash is cash that has been set aside for a specific use or purpose

Hint 9

-Unrestricted cash is used for all current operations

Front 10

Bank Reconciliations- Simple

Back 10

Simple Reconciliation: goal is to calculate a "true balance" between the cash balance reported by the bank and by the depositor's records.
1. Deposits in Transit: add to bank
2. Outstanding Checks: subtract from bank

Hint 10

3. Service Charges: subtract from book
4. Bank Collections: add to book
5. Errors: made by either bank or depositors
6. Nonsufficient Funds (NSF): subtract from book
7. Interest Income: add to book

Front 11

Simple Bank Reconciliation Procedure

Back 11

1. Book balance is adjusted to reflect any corrections reported by the bank.
2. After the above adjustments are made: Adjusted Book Balance = True Balance

Hint 11

3. The bank balance per the bank statement is reconciled to the "true balance" determined in step #2

Front 12

Reconciliation of Cash Receipts and Disbursements

Back 12

-Commonly referred to as the four-column reconciliation or proof of cash, serves as a proof of the proper recording of cash transactions.

Hint 12

-Additional info is required (present and prior month information)

Front 13

Accounts Receivable

Back 13

Oral promises to pay debts and are generally classified as current assets. Classified as either trade* or non-trade** receivables.

Hint 13

*A/R from purchasers of the company's goods and services.
**A/R from persons other than customers such as advances to employees, tax refunds, etc.

Front 14

Accounts Receivable NRV

Back 14

-The net realizable value of A/R is the balance of the A/R account adjusted for allowances for receivables that may be uncollectible, sales discounts, and sales returns and allowances.

Hint 14

-A/R initially valued at the original transaction cost (historical cost) then adjusted for items of sales or cash discounts and for sales returns.

Front 15

Sales/Cash Discounts- Gross vs. Net Method

Back 15

1. Gross Method: records a sale without regard to the available discount. If payment is received within the discount period, a sales discount (contra revenue) account is debited to reflect the sales discount.

Hint 15

2. Net Method: records sales and A/R net of the available discount. An adjustment is not needed if payment is received with the discount period. However, if payment is received after the discount period, a sales discount not taken account (revenue) must be credited.

Front 16

Trade Discounts

Back 16

(Quantity Discounts) are quoted in percentages.Sales revenues and A/R are recorded net of trade discounts.

Hint 16

These discounts are applied sequentially (Ex: a trade discount of 40% and 10% doesn't equal a 50% discount)

Front 17

Sales Returns and Allowances

Back 17

-Goods returned represent deductions from A/R and sales. The general rule is to wait for the actual return.*
-Expected exchanges do not affect sales, inventory, or COGS

Hint 17

*If past experience shows that a material % or receivables are returned, an allowance for sales returns should be established.
-J/E:
DR. Sales returns and allowances (contra sales)
CR. Accounts Receivable

Front 18

Estimating Uncollectible A/R

Back 18

A/R should be presented at their NRV on the B/S. Thus, the amount recorded at initial transaction should be reduced by the amount of uncollectible receivables (contra-asset).

Hint 18

2 methods of recognizing uncollectible A/R exist: the direct write-off method (not GAAP) and the allowance method (GAAP)

Front 19

Direct Write-Off Method

Back 19

The account is written off and the bad debt is recognized when the account becomes uncollectible. Not GAAP b/c it does not properly match the bad debt expense with the revenue.

Hint 19

Another weakness is that A/R is always overstated b/c no attempt is made to account for the unknown bad debts included in the balance on the F/S's.
-This method is used however, for federal tax purposes (so you can't understate income)

Front 20

Allowance Method

Back 20

-Allowance for uncollectibles should be based on past experience. A % of each periods sales of ending A/R should be estimated to be uncollectible.
-The amount determined is charged to bad debts of the period and the credit is made to a valuation account such as "allowance for uncollectible accounts."

Hint 20

-When specific accounts are written off, they are debited to the allowance account, which is periodically computed.
-3 generally accepted methods of estimating uncollectible accounts or doubtful accounts under the allowance method.

Front 21

Percentage of Sales Method

Back 21

A percentage of each sale is debited to the account 'bad debt expense' and credited to the account 'allowance for doubtful accounts.' Applicable percentage is based on the company's experience.

Hint 21

-This is the I/S approach. It emphasizes matching.
-Write-offs decrease the account balance while current-year bad debt expense increases it (normally has a credit balance).

Front 22

Percentage of A/R at Year-End Method

Back 22

-The balance sheet approach.
-The amount of the estimated allowance calculated is the ending balance that should be in the allowance for doubtful accounts on the B/S.

Hint 22

-Therefore, the difference between the unadjusted balance and the desired ending balance is debited (or credited) to the bad debt expense account.

Front 23

Aging of Receivables Method

Back 23

-B/S approach, emphasizes asset valuation NRV.
-Schedule is prepared categorizing accounts by the number of days or months outstanding.

Hint 23

-Each category's total $ amount is multiplied by a % representing uncollectibility based on past experience.
-The sum of the product for each aging category will be the desired ending balance in the allowance account.

Front 24

Bad Debt Expense

Back 24

-Amount charged to bad debt expense of the period usually includes two items-
1. The provision made during the period

Hint 24

2. An adjustment made at year-end to increase/decrease the balance in the allowance for uncollectible accounts, if needed.

Front 25

Write-Off of a Specific A/R

Back 25

-Under the allowance method- GAAP
-When a receivable is formally determined to be uncollectible:

Hint 25

DR. Allowance for doubtful accounts
CR. Accounts Receivable
-Both accounts go down and there is no net change
-Not on the I/S

Front 26

Subsequent Collection of A/R Written Off

Back 26

1. Direct Write-off Method (for Tax, not GAAP)
DR. Cash
CR. Uncollectible accounts recovered
2. Allowance Method (GAAP)
-To restore the account previously written off (reverse write-off, both accounts go up):*

Hint 26

*DR. A/R
CR. Allowance for uncollectible accounts
-To record cash collection on the account:
DR. Cash
CR. Accounts Receivable
-No change in total, change only in form

Front 27

Allowance for Doubtful Accounts- T Account Analysis

Back 27

1. Beginning Balance
2. + Bad Debt Expense
3. + Recoveries of Bad Debts
4. = Subtotal

Hint 27

5. - A/R Written-Off*
6. Ending Balance
*All debits except step 5

Front 28

Pledging

Back 28

-The process whereby the company uses existing A/R as collateral for a loan. Company retains title but "pledges" that it will use the proceeds to pay the loan.

Hint 28

-Requires only not disclosure.
-The A/R account is not adjusted.
DR. Cash
CR. Note Payable

Front 29

Factoring of A/R

Back 29

-Process by which a company can convert tis receivables into cash by assigning them to a "factor" with with or without recourse.

Hint 29

-Without recourse: treat as a sale
-With recourse: treat as a sale or loan

Front 30

Factoring of A/R- Without Recourse

Back 30

-Means sale is final and the assignee (the factor) assumes the risk of any losses on collections.
-The entry to the asset account "Due from Factor" reflects the proceeds retained by the factor. This amount protects the factor against sales returns, sale discounts, allowances, and customer disputes.*

Hint 30

*DR. Cash
DR. Due from Factor
DR. Loss on Sale of Receivable
CR. Accounts Receivable

Front 31

Factoring of A/R- With Recourse

Back 31

-Means that the factor has an option to re-sell any uncollectible receivables back to the seller.
-If the transaction meets the following criteria, it is considered a sale (otherwise considered a loan).*

Hint 31

*1. The transferor's (seller's) obligation for uncollectible accounts can reasonably be estimated
2. The transferor surrenders control of the future economic benefit of the receivables to the buyer
3. The transferor cannot be required to repurchase the receivables, but may be required to replace the receivables with other similar receivables.

Front 32

Notes Receivable

Back 32

-Written promises to pay a debt.
-The writing is called a promissory note.
-Classified the same as A/R.
-Unearned interest and finance charges are deducted from the face amount, necessary to state the receivable at its PV.

Hint 32

-If note is non-interest bearing or the interest rate is below market, the value of the note should be determined by imputing the market rate of interest and determining the value of the promissory note by using the effective interest method.
-Interest bearing notes issued in an arms-length transaction are presumed to be issued at the market rate of interest.

Front 33

Discounting Notes Receivable

Back 33

-Arise when the holder endorses the note (with or without recourse) to a third party and receives a sum of cash.
-Amount received by the holder is determined by applying a "discount rate" to the maturity value of the note.

Hint 33

-The difference between the amount of cash received by the holder and the maturity value of the note is the "discount."

Front 34

Discounting N/R- With Recourse

Back 34

-Holder remains contingently liable for the ultimate payment of the note when it becomes due.
-N/R that have been discounted with recourse are reported on the B/S w/ a corresponding contra account (N/R Discounted).

Hint 34

-N/R may also be removed from the B/S and the contingent liability disclosed in the notes to the F/S's. J/E:
DR. Cash
CR. N/R Discounted

Front 35

Discounting N/R- Without Recourse

Back 35

-Holder assumes no further liability.
-Have essentially been sold outright and should be removed from the B/S.

Hint 35

DR. Cash
DR. Loss
CR. Notes Receivable

Front 36

Dishonored Discounted N/R

Back 36

-Contingent liability should be removed by a debit to Note Receivable Discounted and a credit to Notes Receivable.

Hint 36

-Should be recorded to the estimated recoverable amount of the note.
-A loss is recognized is the estimated recoverable amount is less than the amount required to settle the note and any applicable penalties.