Accounting Test 3 Study Guide - Ch. 7-9 PDF

Preview

Summary

Study guide for financial accounting test 3. Includes chapters 7, 8, and 9. Has chapter summaries, class notes, and examples. Will help you pass!...

Description

ACCOUNTING TEST 3 STUDY GUIDE – CH. 7-9 Chapter 7: Reporting and Analyzing Receivables Types of Receivables: 

Accounts receivable: o amounts due from individuals and companies (accounts receivable = oral promise to pay from customer) from sale of goods/services o called trade receivables (since arise from the sale of goods or services to customers) o expected to be collected in cash (typically in 30 to 90 days) o non-interest bearing & one of the most liquid assets of the company.



Notes Receivable: formal written promises agreement from individual or company to receive money in future (they owe us $$)



Non-Trade Receivables: arise from other sources (e.g. interest receivable, taxes receivable, advances to employees, etc.)

Recognizing Accounts Receivable: 

Sales on Credit: -To record for a sale on credit: Dr. Accounts Receivable – ABC Company Cr. Sales Dr. COGS Cr. Merchandise Inventory -To record when an A/R has been paid: Dr. Cash Cr. Accounts Receivable – ABC Company



Recognition of A/R is straightforward and guided by the revenue recognition principle. o Service organizations: recognize receivables when services are provided on account. o Merchandising or Manufacturing companies: recognize receivables at the point of sale when the goods are exchanged or when title to the goods transfers 

(e.g. FOB shipping point & FOB destination point).

o Receivables can be reduced due to sales discounts (if customer pays within discount period) or reduced by sales returns & allowances. 

Each single A/R is recorded in the Accounts Receivable Subsidiary Ledger



Credit Card Sales:

o Cash Received Immediately on Deposit: Dr. Cash Dr. Credit Card Expense Cr. Sales Dr. COGS Cr. Merchandise Inventory o Cash Received Some Time after Deposit: -Time of Purchase Dr. Accounts Receivable – Credit Card Co. Dr. Credit Card Expense Cr. Sales Dr. COGS Cr. Merchandise Inventory -When Cash is later received from credit card company (usually through electronic funds transfer) Dr. Cash Cr. Accounts Receivable – Credit Card CO. o Some firms report credit card expense in the income statement as a type of discount deducted from sales to get net sales. Other companies classify it as a selling expense or even as an administrative expense. o Some companies allow their credit customers to make periodic payments over several months – Instalment Sales and Receivables 

Comparing different types of credit cards:

o

Valuing Accounts Receivable – Direct Write-Off Method: 

The accounts of customers who do not pay are uncollectable accounts, commonly called bad debts



Companies use 2 methods for uncollectable accounts: o Direct write-off Method: records the loss from an uncollectable account receivable when it is determined to be uncollectable o Allowance Method: matches estimated loss from uncollectible accounts receivable against sales they helped produce



To write-off a bad debt: Dr. Bad Debts Expense Cr. Accounts Receivable - Smith



While uncommon, sometimes a written-off account is later collected. To record this, first reinstate the written off account: Dr. Accounts Receivable – Smith Cr. Bad Debts Expense Then record the payment: Dr. Cash Cr. Accounts Receivable - Smith



Assessing the Direct Write-Off Method: o Matching (expense recognition) principle: GAAP requires expenses to be reported in the same accounting period as the sales they helped produce. The direct write-off method does not best match sales and expenses because bad debts expense is not recorded until an account becomes uncollectible, which often occurs in a period after the credit sale. o Materiality constraint: states that an amount can be ignored if its effects on the financial statements is unimportant to users’ business decisions. This constraint allows the use of the direct write-off method when bad debts expenses are very small in relation to a company’s other financial statement items such as sales and net income

Valuing Accounts Receivable – Allowance Method 

Receivables are valued at net realizable value (NRV) on the balance sheet. NRV is the net amount expected to be received in cash



Net Realizable Value (NRV) = Accounts Receivable - Allowance for Uncollectible/Doubtful Accounts



Advantages of the Allowance Method: o Records estimated bad debts expense in the period when the related sales are recorded o Reports accounts receivable on the balance sheet at the estimated amount of cash to be collected



First, you record your estimated bad debt expense at the end of the accounting period: Dr. Bad Debts Expense Cr. Allowance for Doubtful Accounts o Allowance for Doubtful Accounts is a contra asset account, meaning its normal balance is a credit 

The normal balance in the Allowance for Doubtful Accounts is a credit. However, this account may sometimes however have a debit balance before the AJE is recorded to accrue 

Bad Debt Expense if a company writes off more customer accounts than they previously anticipated would become uncollectible.



This account reduces accounts receivable to its estimated realizable value. Realizable value refers to the expected proceeds from converting an asset into cash. On the balance sheet, the accounts receivable (less allowance for doubtful accounts) will be shown, more accurately stating how much cash the company will actually get.



When a specific account is identified as uncollectible, they are written off against the Allowance for Doubtful Accounts: Dr. Allowance for Doubtful Accounts Cr. Accounts Receivable – Smith o Posting this write-off entry to Accounts Receivable removes the amount of the bad debt from the general ledger (also posted to A/R sub-ledger). The write-off does not affect the realizable value of accounts receivable. Neither total assets nor net income is affected by the write-off of a specific account. Instead, both assets and net income are affected in the period when bad debts expense is predicted and recorded with an adjusting entry.



To recover a bad debt, you must reverse the write off:

Dr. Accounts Receivable – Smith Cr. Allowance for Doubtful Accounts -Then you must collect the reinstated account: Dr. Cash Cr. Accounts Receivable - Smith o If just part of a recovered bad debt is paid off you only reinstate the whole account if you think they will eventually pay off it all, if they are only going to pay you part of the A/R, you only reinstate how much they are going to pay. Comparing Methods:

Estimating Bad Debts: 

Percent of Sales Method: o (also known as the income statement method) o The allowance account ending balance on the balance for this method would rarely equal the bad debts expense on the income statement. This is because its allowance account only equals zero if the prior amounts written off as uncollectible exactly equal the prior estimated bad debts expense. o To compute Bad Debts: 

Current period credit sales x bad debt % = estimated bad debts expense

o To record your estimated bad debts expense: Dr. Bad Debts Expense

Cr. Allowance for Doubtful Accounts 

Percent of Receivables Method: o (aka balance sheet method) o To compute bad debts: 

Year-end accounts receivable x bad debts % = desired ending balance of allowance for doubtful accounts



Estimated adjusted balance in Allowance for Doubtful Accounts – unadjusted year-end balance in Allowance for doubtful accounts = Estimated bad debts expense

o Adjustment to bring the allowance account its estimated balance: Dr. Bad Debts Expense Cr. Allowance for Doubtful Accounts Allowance for Doubtful Accounts Unadjusted year-end balance (Amount you are solving for, which will be in your adjusting entry) Current year estimate of Allowance for Doubtful Accounts



Aging of Receivables Method: o Uses both past and current receivables information to estimate the allowance amount o Assumes the longer past due a receivable is, the more likely it is to be uncollectible o Uses balance sheet accounts

o o (same as above in regard to needing to solve for the amount for the AJE) o For aging, it is the same as the % of A/R, however you use different %’s for how past due the receivables are o AJE:

Dr. Bad Debts Expense Cr. Allowance for Doubtful Accounts

 Notes Receivable: 

Principle of a note – specified amount of money



Computing Maturity and Interest: o Maturity date of a note: day the note (principle and interest) must be paid o How to find interest: 

Principle of the note x annual interest rate x time expressed in fraction of year = interest 



We treat a year as having 360 days for interest computations

Recognizing Notes Receivable: o At the time of a sale: Dr. Notes Receivable Cr. Sales Dr. COGS Cr. Merchandise Inventory o Sometimes, a seller accepts a note from an overdue customer to grant a time extension for a past-due account receivable. 

This partial payment forces a concession from the customer, reduces the customer’s debt (and the sellers risk), and produces a note for a smaller amount



The following entry is made to record this: Dr. Cash Dr. Notes Receivable Cr. Accounts Receivable - Smith



Valuing and Settling Notes:

o When a note is honored, it is paid in full, both the principle and the interest. To record this on its maturity date, you record this entry: Dr. Cash Cr. Notes Receivable Cr. Interest Revenue 

Interest revenue, also called Interest Earned, is recorded on the income statement

o When a notes’ maker is unable or refuses to pay at maturity, the note is dishonored. When a note is dishonored, we put it in accounts receivable because you still want to collect this. 

Changing these notes into Accounts receivables removes the amount of the note from the Notes Receivable account and records the dishonored note in the maker’s account. Also, if the maker of the dishonored note applies for credit in the future, his or her account will show this past dishonored note. Changing it into an A/R also reminds the company to continue collection efforts.



The entry is recorded as follows: Dr. Accounts Receivable – Smith Cr. Interest Revenue Cr. Notes Receivable

o Recording end-of-period Interest Adjustment: 

When notes receivable are outstanding at the end of a period, any accrued interest earned is computed and recorded.



Compute the interest but for days, only do the number of days that you have earned interest for. The following adjusting entry records this revenue: Dr. Interest Receivable Cr. Interest Revenue 

Interest Revenue appears on the Income Statement and Interest Receivable appears on the balance sheet as a current asset



When the note is collected, the entry to record the cash receipt is as follows: Dr. Cash Cr. Interest Revenue Cr. Interest Receivable

Cr. Notes Receivable Disposal of Receivables: Companies can convert receivables to cash before they are due. This could be due to the need for cash or the desire not to be involved in collection activities. They are usually sold or used as security for a loan 

Selling Receivables: o A company can sell a portion of its receivables to a finance company or a bank. The buyer, called a factor, charges the seller a factoring fee and then the buyer takes ownership of the receivables and receives cash when they come due o To record the sale of a receivable: Dr. Cash Dr. Factoring Fee Expense Cr. Accounts Receivable



Pledging Receivables: A company can raise cash by borrowing money and pledging its receivables as security for the loan o This does not transfer the risk of bad debts to the lender because the borrower retains ownership of the receivables. If the borrower default on the loan, the lender has a right to be paid from the cash receipts of the receivable when collected o To record for pledging a receivable: Dr. Cash Cr. Note Payable 

Since pledging receivables are committed as security for a specific loan, the borrowers financial statement disclose the pledging of them

Chapter 8: Reporting and Analyzing Long-Term Assets **Pay special attention to months for this chapter and chapter 9!** Property, Plant, and Equipment 

Plant Assets: tangible assets used in a company’s operations that have a useful life of more than one accounting period. Commonly referred to as property, plant and equipment (PPE) or fixed assets. They are long-term assets such as land, building & equipment. PPE possess certain characteristics that distinguish them from other assets owned by a business including: o PPE are acquired for use in operations, and are not intended for resale to customers. o PPE are durable, long term in nature (> 1 accounting period) and are usually subject to depreciation. (An exception to this is Land is not depreciated.)

o PPE have physical substance, they are tangible in nature. o PPE are recorded/valued at cost. Cost means the purchase price plus all costs necessary to get the asset to the company’s place of business and get it ready for its intended use. 

Often, we say we “capitalize” the costs of these assets which means we record the costs as a debit to the asset account. The costs capitalized are then depreciated over the life of the asset. (An exception to this is that land is not depreciated).

Cost Determination 

To record cost: Dr. PPE (or specific appropriate PPE account) Cr. How was purchased



PPE are recorded at cost when acquired. Means everything that are necessary to get it in place and ready for use. (to be a part of the cost, must be normal, reasonable, necessary). For each PPE account: o Land: All expenditures made to acquire the land are included in the cost of the land including: 

the purchase price, any back (delinquent/unpaid) property taxes or liens of the seller which the buyer assumes/pays for.



closing costs such as the title, attorney, brokerage fees, commissions, sales taxes, and recording fees.



all costs incurred to prepare the land for its intended use (e.g. costs of surveying, grading, filling, draining, & clearing the property) which are of a permanent nature (not subject to decay or replacement).



cost of demolishing and removing an old, unwanted, structures (minus any salvage value from proceeds from demolition)



Special assessments from government agencies for relatively permanent (indefinite life) improvements. 

Note: Improvements made with limited lives are not recorded as land but are recorded separately as land improvements.



Land is never depreciated. It is recorded at cost & this cost stays in the land account until we sell or dispose of it.

o Land Improvements: assets associated with land that are subject to decay, have limited lives & are depreciated. It includes temporary items such as: parking lots, driveways, signs, fences, lights, sprinkler systems, trees & shrubs, etc. o Buildings: All expenditures related directly to the acquisition or constructions are capitalized and depreciated. 

If the company constructs the building, the cost to capitalize and depreciate includes: 

attorney's, architect's & engineer’s fees, contractors' charges or contract price, building permits,



all materials, labor and overhead costs during construction, (all costs beginning with excavation (digging the hole) and ending with the completion of the building), and insurance costs while the building is under construction.



the cost of interest on money borrowed to finance the construction may also be capitalized if a significant time is required to get the asset ready for its use. Capitalization of interest costs is limited to the construction period. Note: After the construction period is over interest costs are operating expenses.



When an existing building is purchased, the cost to capitalize and depreciate includes: 

the purchased price, brokerage commission, sales and other taxes, closing costs



costs for repairing, remodeling, and renovating the building to get it ready for its intended use. Interest cost associated with construction is also included in building account until it’s completed. Once construction is complete you must expense the interest.

o Machinery & Equipment, Furniture & Fixtures: All expenditures incurred in acquiring these items & preparing them for use are capitalized and later depreciated. This includes the: 

purchase price (less any discounts), purchase commission, sales and other taxes, freight or transportation charges, insurance while in transit,



assembly & installation costs, or special preparation of facilities, repairs, reconditioning, or modifications for use, &



costs of conducting trial runs or expenditures to test the asset before it is placed in service. Once the asset is being used (ready for use & placed in service) the costs to test it & run it are normally expensed.)

o Lump Sum Purchases: In some instances a company may purchase a group of plant assets at a single lump sum price. 

The purchase price is allocated among the different assets purchased in the accounting records.



The allocation the lump-sum purchase price paid to the individual assets is based on the asset’s appraised or fair market values (FMV). (The fair market value of an asset is often determined by an independent appraisal by a qualified appraiser, or the assessed valuation for property taxes might be used.)



Example of allocating lump sum purchases: Land Land Improvements Building Totals

Land Land Improvements Building Totals

Appraised Value $157,040 $58,590

Percent of Total

Apportioned Cost

$176,670 $392,600

100%

$395,380

Appraised Value $157,040 $58,590

Percent of Total 40% 15%

Apportioned Cost $158,152 $59,307

$176,670 $392,600

45% 100%

$177,921 $395,380

Depreciation: 

The process of allocating the cost of PPE to the periods benefited from its use in a rational & systematic manner. The cost of PPE is matched against the revenue these assets help to generate over their useful lives under the matching (or expense recognition) principle. Depreciation is a process of allocating cost to future period, not a process of valuation. Net Book Value (NBV) O= Fair Market Value (FMV). Accumulated depreciation does not represent a fund of cash or reserve set aside to replace worn or obsolete assets. Accumulated depreciation is not the decline in market value of an asset since acquisition. Factors that determine depreciation are cost, salvage value, and useful life. Terms you should understand:

o Depreciable cost: the cost of the asset (that was capitalized by debiting the asset account) minus its salvage value. o Accumulated depreciation: is a contra-asset account (companion account). The balance in the accumulated depreciation account equals the total asset's cost which has already been dep...