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36 Cards in this Set

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Working Capital
Current assets minus current liabilities. Often a measure of the solvency of a company and is used in many financial ratios.
Ability to pay debt as due. Indicates the short-term financial risk of a company.
Working Capital Ratios
1. Working Capital
2. Current Ratio
3. Quick Ratio
-The higher the ratio the lower the amount of risk.
1. Current assets - Current liabilities
2. Current assets ÷ Current liabilities
3. (Cash + Net receivables + Marketable securities) ÷ Current liabilities
Current Assets
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.
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
Current Liabilities
Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities.
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)
Types of Current Liabilities
1. Trade accounts and notes payable
2. Current portions of long term debt
3. Cash dividends payable
4. Accrued liabilities
5. Payroll liabilities
6. Taxes payable
7. Advances from customers (deferred revenues)
Short-Term Obligations Expected to be Refinanced
-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:
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.
IFRS vs. U.S. GAAP- Refinancing
Under IFRS, short-term obligations expected to be refinanced on a long-term basis may not be classified as noncurrent
Cash and Cash Equivalents
Includes both currency and demand deposits with banks and/or other financial institutions. It also includes deposits that are similar to demand deposits.
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.
Restricted vs. Unrestricted Cash
-Restricted cash is cash that has been set aside for a specific use or purpose
-Unrestricted cash is used for all current operations
Bank Reconciliations- Simple
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
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
Simple Bank Reconciliation Procedure
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
3. The bank balance per the bank statement is reconciled to the "true balance" determined in step #2
Reconciliation of Cash Receipts and Disbursements
-Commonly referred to as the four-column reconciliation or proof of cash, serves as a proof of the proper recording of cash transactions.
-Additional info is required (present and prior month information)
Accounts Receivable
Oral promises to pay debts and are generally classified as current assets. Classified as either trade* or non-trade** receivables.
*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.
Accounts Receivable NRV
-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.
-A/R initially valued at the original transaction cost (historical cost) then adjusted for items of sales or cash discounts and for sales returns.
Sales/Cash Discounts- Gross vs. Net Method
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.
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.
Trade Discounts
(Quantity Discounts) are quoted in percentages.Sales revenues and A/R are recorded net of trade discounts.
These discounts are applied sequentially (Ex: a trade discount of 40% and 10% doesn't equal a 50% discount)
Sales Returns and Allowances
-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
*If past experience shows that a material % or receivables are returned, an allowance for sales returns should be established.
DR. Sales returns and allowances (contra sales)
CR. Accounts Receivable
Estimating Uncollectible A/R
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).
2 methods of recognizing uncollectible A/R exist: the direct write-off method (not GAAP) and the allowance method (GAAP)
Direct Write-Off Method
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.
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)
Allowance Method
-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."
-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.
Percentage of Sales Method
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.
-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).
Percentage of A/R at Year-End Method
-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.
-Therefore, the difference between the unadjusted balance and the desired ending balance is debited (or credited) to the bad debt expense account.
Aging of Receivables Method
-B/S approach, emphasizes asset valuation NRV.
-Schedule is prepared categorizing accounts by the number of days or months outstanding.
-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.
Bad Debt Expense
-Amount charged to bad debt expense of the period usually includes two items-
1. The provision made during the period
2. An adjustment made at year-end to increase/decrease the balance in the allowance for uncollectible accounts, if needed.
Write-Off of a Specific A/R
-Under the allowance method- GAAP
-When a receivable is formally determined to be uncollectible:
DR. Allowance for doubtful accounts
CR. Accounts Receivable
-Both accounts go down and there is no net change
-Not on the I/S
Subsequent Collection of A/R Written Off
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):*
*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
Allowance for Doubtful Accounts- T Account Analysis
1. Beginning Balance
2. + Bad Debt Expense
3. + Recoveries of Bad Debts
4. = Subtotal
5. - A/R Written-Off*
6. Ending Balance
*All debits except step 5
-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.
-Requires only not disclosure.
-The A/R account is not adjusted.
DR. Cash
CR. Note Payable
Factoring of A/R
-Process by which a company can convert tis receivables into cash by assigning them to a "factor" with with or without recourse.
-Without recourse: treat as a sale
-With recourse: treat as a sale or loan
Factoring of A/R- Without Recourse
-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.*
*DR. Cash
DR. Due from Factor
DR. Loss on Sale of Receivable
CR. Accounts Receivable
Factoring of A/R- With Recourse
-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).*
*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.
Notes Receivable
-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.
-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.
Discounting Notes Receivable
-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.
-The difference between the amount of cash received by the holder and the maturity value of the note is the "discount."
Discounting N/R- With Recourse
-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).
-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
Discounting N/R- Without Recourse
-Holder assumes no further liability.
-Have essentially been sold outright and should be removed from the B/S.
DR. Cash
DR. Loss
CR. Notes Receivable
Dishonored Discounted N/R
-Contingent liability should be removed by a debit to Note Receivable Discounted and a credit to Notes Receivable.
-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.