ACCY 111 Ch 7

  1. What is the primary function of financial accounting?
    to provide useful financial information to users who are external to the business enterprise, particulary investors and creditors
  2. What are the two assets typically listed first in a balance sheet?
    Cash and receivables
  3. What are the key issues with cash?
    internal control and classification in the balance sheet
  4. What are the key issues with receivables?
    are valuation and the related income statement effects of transactions involving accounts receivable and notes receivables
  5. Cash
    currency, coins, balances in checking accounts, and items acceptable for deposit in these accounts, such as checks and money orders received from customers. Amnts represents money available to pay off debt or to use in operations without any legal or contractual restriction.
  6. What should be described in a disclosure note about cash?
    A company's policy concerning which short-term, highly liquid investments it classifies as cash equivalents should be described in a disclosure note.
  7. Cash Equivalents
    include money market funds, treasury bills, and commercial paper. Maturity data no longer than three months from the date of purchase. A company's policy concerning cash equivalents should be disclosed in the notes to the financial statements. **Credit card receivables can be considered cash equivalents (converts to cash in a few days) must be disclosed.
  8. Internal control
    • refers to a company's plant to
    • (a) encourage adherence to company policies and procedures,
    • (b) promote operation efficiency,
    • (c) minimize errors and theft, and
    • (d) enhance the reliability and accuracy of account data.
  9. What does the Sarbanes-Oxley Act require?
    The Sarbanes-Oxley Act requires a company to document and assess its internal controls. Auditors express an opinion on management's assessment.
  10. Section 404 of the Sarbanes-Oxley Act of 2002
    requires that companies document their internal controls and assess their adequacy.
  11. What does the Public Company Accounting Oversight Board's Auditing Standard No 5 require?
    the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting.
  12. Who created the framework fir designing an internal control systems
    Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Formed in 1985, the org is dedication to improving the quality of financial reporting through, among other things, effective internal controls
  13. What does COSO define internal control as?
    a process undertaken 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 operations.
    • 2. Reliability of financial reporting.
    • 3. Compliance with applicable laws and regulations
  14. Separation of Duties
    Individuals that have physical responsibility for assets should not also have access to accounting records. Employees who handle cash should not be involved in or have access to accounting records nor be involved in the reconciliation of cash book balances to bank balances.
  15. Important element of a cash disbursement control system include:
    • 1. All disbursements, other than very small disbursements from petty cash, should be made by check. This provides a permanent record of all disbursements.
    • 2. All expenditures should be authorized before a check is prepared. For example, a vendor invoice for the purchase of inventory should be compared with the purchase order and receiving report to ensure the accuracy of quantity, price, part numbers, and so on. This process should include verification of the proper ledger accounts to be debited.
    • 3. Checks should be signed only by authorized individuals
  16. Restrictions on cash
    it can be informal, arising from management's intent to use a certain amount of cash for a specific purpose. A company may set aside funds for future plant expansion. This cash is material and should be classified as investment and funds or other assets. Sometimes contractually imposed. Debt instrument like a sinking fund which requires the borrower to set aside funds (often removed from the sinking fund to pay off debt). These would be classified as noncurrent investments and funds or other assets if the debt is classified as noncurrent. If the liability is current, the restricted cash also is classified as current. Disclosures required on restricted cash.
  17. Compensating Balances
    banks frequently require cash restrictions in connection with loans and loan commitments (lines of credit). The borrower must maintain a specified balance in a low interest or noninterest bearing account at the bank (creditor). The required balance is usually 2-5% because they compensate the bank for granting the loan or extending the line of credit. **The compensating balance is a higher interest rate on the debt.
  18. What happens with the effective interest rate in compensating balance/
    • If a company borrows 10mill, interest 12%, and bank requires 2million to be held in a noninterest bearing checking acct, the company is really borrowing 8mill. The effective interest rate EFF of 15% (1.2mill interest divided by 8million cash available for use)
    • *** a material compensating balance must be disclosed regardless of the classification of the cash.
  19. How to report concerning contractual vs. no contract
    • A contractual agreement for a compensating balance classification and disclosure depends on the restriction and the classification of the related debt. Legally binding could be classified as current or noncurrent (investments and funds of other assets) with a disclosure note.
    • If the compensating balance arrangement is informal, with no contractual agreement that restrictus the use of cash, the compensating balance can be reported as part of cash and cash equivalents with a note disclosure of arrangement.
  20. Difference between IFRS and US GAAP regarding cash and cash equivalents
    • bank overdrafts, US GAAP requires that overdrafts be treated as liabilities.
    • IFRS allows bank overdrafts to be offset against other cash accts when overdrafts are payable on demand and fluctuate between positive and negative amounts as part of the normal cash management program that a company uses to minimize its cash balances.
  21. Note receivable
    when a receivable, trade or nontrade, is accompanied by a formal promissory note, it is referred to a as a note receivable.
  22. Nontrade receivable
    those other than trade receivables and include tax refund claims, interest receivable, and loans by the company to other entities including stockholders and employees.
  23. Accounts receivable
    informal credit arrangements supported by an invoice and normally are due 30 to 60 days after the sale. Almost always classified as a current asset. Converted to cash within the normal operating cycle.
  24. Revenue recognition accounts receivable
    can be recognized only after the earnings process is virtually complete and collection from the customer is reasonably assured. Credit sales criteria is met at the point of delivery of the product or service, so revenue and the related receivable are recognized at that time.
  25. Initial Valuation of Accounts Receivables
    Recorded at the present value of future cash receipts using a realistic interest rate. So 10000 sale on credit due in 30 days should result in the present value of 10000. Interest portion should be removed and recognized as interest revenue over the 30 day period. If the monthly interest rate is 2%, the receivable would be valued at 9804, calculated by x's future cash payment of 10000 by the present value for one period at 2%.
    companys offer trade discounts to customers, usually a percentage reduction from the list price. Trade disc can be a way to change prices without publishing a new catalog or to disguise real prices from competitors. Quanity discounts.
    ** Cash discounts reduce the amount to be paid if remittance is made within a specified short period of time

    Often called sales discounts, represent reductions not in the selling price of a good or service but in the amount to be paid by a credit customer if paid within a specified period of time. Intended for quick payment.

    • The gross method views cash discounts not taken as part of sales revenue.
    • The Net Method considers sales revenue to be the net amount, after discount, and any discounts not taken by the customer as interest revenue.

    Discounts not taken are included in sales revenue using the gross method and interest revenue using the net method.
Card Set
ACCY 111 Ch 7
ACCY 111 Ch 7