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2nd Exam Study Guide

by: Kiersten Notetaker

2nd Exam Study Guide Accounting 230

Kiersten Notetaker

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Study Guide for 2nd Exam
Accounting 230
Mark Cussatt
Study Guide
Accounting 230
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This 8 page Study Guide was uploaded by Kiersten Notetaker on Thursday January 7, 2016. The Study Guide belongs to Accounting 230 at Washington State University taught by Mark Cussatt in Spring 2015. Since its upload, it has received 26 views. For similar materials see Accounting 230 in Accounting at Washington State University.


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Date Created: 01/07/16
Chapter 4 Explain the impact of the Sarbanes-Oxley Act A.K.A. the Public Company Accounting Reform and Investor Protection Act of 2002 (SOX). This act establishes guidelines related to auditor-client relations and internal control procedures Major Provisions: -Oversight board: PCAOB has the authority to establish standards dealing with auditing, quality control, ethics, independence, and other activities relating to the preparation of audited financial reports. -Corporate executive accountability: Corporate executives must personally certify the company’s financial disclosures. Severe penalties (possibly prison) is fraudulent. -Nonaudit services: It’s unlawful for the auditors of public companies to also perform certain nonaudit services, such as consulting, for their clients. -Retention of work papers: Auditors of public companies must retain all work papers for seven years or face a prison term for willful violation. -Auditor rotation: The lead auditor in charge of auditing a particular company must rotate off that company within five years and allow a new audit partner to take the lead. -Conflicts of interest: Audit firms are not allowed to audit public companies whose chief executives worked for the audit firm and participated in that company’s audit during the preceding year. -Hiring of auditor: Audit firms are hired by the audit committee of the board of directors of the company, not by company management. -Internal control: Section 404 of the act requires (a) that a company management document and assess the effectiveness of all internal control processes that could affect financial reporting and (b) that company auditors express an opinion on whether management’s assessment of the effectiveness of internal control is fairly stated. Smaller companies are exempt from requirement. Describe internal controls and what they are used for. Internal Control: (1) safeguard the company’s assets (2) improve the accuracy and reliability of accounting information Builds a wall to prevent misuse of company funds by employees and fraudulent of errant financial reporting. Strong internal control systems allow greater reliance by investors on reported financial statements. 5 components that internal controls consist of: -Monitoring: continual monitoring of internal activities and reporting of deficiencies is required. Monitoring includes formal procedures for reporting control deficiencies. -Control Activities: control activities are the policies and procedures that help ensure that management’s directives are being carried out. These activities include authorizations, reconciliations, and separation of duties. -Risk assessment: risk assessment identifies and analyzes internal and external risk factors that could prevent a company’s objectives from being achieved. -Control environment: The control environment sets the overall ethical tone of the company with respect to internal control. It includes formal policies related to management’s philosophy, assignment of responsibilities, and organizational structure. -Information and communication: methods for collection of relevant information and communication in a timely manner, enabling people to carry out their responsibilities. Explain the role of the internal auditor. The company’s auditors provide an opinion on management’s assessment and they express whether they think the company has maintained effective internal control over financial reporting. Define cash and cash equivalents. -Cash: the one most susceptible to employee fraud -Ex. Currency, coins, and balances in savings and checking accounts, checks received -Cash equivalents: short-term investments that have a maturity date no longer than three months from the date of purchase. --Ex. Money market funds, treasury bills, and certificates of deposits Both are usually combined and reported as a single asset in the balance sheet of most companies. Describe the controls related to cash receipts and cash disbursements. Cash Receipts: Internal control over cash receipts could include the following policies: -Open mail each day, and make a list of checks received, including the amount and payer’s name. -Designate an employee to deposit cash and checks into the company’s bank account each day, different from the person who receives cash and checks. - Have another employee record cash receipts in the accounting records as soon as possible. Verify cash receipts by comparing the bank deposit slip with the accounting records. - Accept credit cards or debit cards, to limit the amount of cash employees handle. Cash Disbursements: Important elements of a cash disbursement control system include the following policies: -Make all disbursements, other than very small ones, by check, debit card, or credit card. This provides a permanent record of all disbursements. -Authorize all expenditures before purchase and verify the accuracy of the purchase itself. The employee who authorizes payment should not also be the employee who prepares the check. -Make sure checks are serially numbered and signed only by authorized employees. Require two signatures for larger checks. -Periodically check amounts shown in the debit card and credit card statements against purchase receipts. The employee verifying the accuracy of the debit card and credit card statements should not also be the employee responsible for actual purchases. -Set maximum purchase limits on debit cards and credit cards. Give approval to purchase above these amounts only to upper-level employees. -Employees responsible for making cash disbursements should not also be in charge of cash receipts. Be able to reconcile a bank statement, including the corresponding journal entries. Be able to record entries and adjust petty cash. Be able to describe and sort transactions into the major categories of cash flow. Chapter 11 Classify transactions as operating, investing, and financing activities, or as noncash activities. Cash Flows from Operating Activities Inflows Outflows -Sale of goods or services -Purchase of inventory -Receipt of interest and dividends -For operating expenses -For interest -For income taxes Cash Flows from Investing Activities Inflows Outflows -Sale of investments -Purchase of investments -Sale of long-term assets -Purchase of long-term assets -Collection of notes receivable -Lending with notes receivable Cash Flows from Financing Activities Inflows Outflows -Issuance of bonds or notes payable -Repayment of bonds or notes payable -Issuance of stock -Reacquisition of stock (treasury stock) -Payment of dividends Prepare the operating section of the statement of cash flows. Operating activities include cash receipts and cash payments for transactions relating to revenue and expense activities. Common examples: the collection of cash from customers or the payment of cash for inventory purchases, salaries, and rent. Indirect method- we begin with net income and then list adjustments to net income, in order to arrive at operating cash flows. Direct method- we adjust the items on the income statement to directly show the cash inflows and outflows from operations such as cash received from customer and cash paid for inventory, salaries, rent, interest, and taxes. If the company decides to use the direct method to report operating activities, it must also report the indirect method either along with the statement of cash flows or in a separate note to the financial statements. Prepare the investing section of the statement of cash flows. Investing activities include cash transactions involving the purchase and sale of long-term assets and current investments. The purchase and sale of long-term assets and investments are common examples of investing activities. Prepare the financing section of the statement of cash flows. Financing activities are both inflows and outflows of cash resulting from the external financing of a business. A major portion comes from external sources, specifically stockholders and lenders. Examples: borrowing and repaying debt, issuing and repurchasing stock, and paying dividends. Explain how noncash activities are recorded. Transactions that do not increase or decrease cash, but that result in significant investing and financing activities, are reported as noncash activities either directly after the cash flow statement or in a note to the financial statements. Examples: -Purchase of long-term assets by issuing debt. -Purchase of long-term assets by issuing stock. -Conversion of bonds payable into common stock. -Exchange of long-term assets. Know the cash flow ratios. Cash Return on assets = Cash flow to sales x Asset turnover Operating cash flows = Operating cash flows x Net Sales _ Average total assets Net Sales Average total assets Chapter 5 Explain what accounts receivables are, what they are used for, and the journal entries related to accounts receivable. Accounts receivable represent the amount of cash owed to a company by its customers from the sale of products or services on account. This is when customers pay the company in the future (kinda like a credit card and paying at the end of the month) Explain the factors what would impact net revenues (trade discounts, sales discounts, and sales returns & allowances) and be able to understand and record the corresponding journal entries. Net revenues refer to a company’s total revenues less any amounts for discounts, returns, and allowances. Accounts Receivable 500 Service Revenue 500 Trade Discounts: represent a reduction in the listed price of a product or service. Companies usually use these to provide incentives to larger customers or consumer groups to purchase from the company. It can also be a way to change prices without publishing a new price list or to disguise real prices from competitors. Accounts Receivable 400 Service Revenue 400 (Make credit sale of $500 with a 20% trade discount) Sales discount: represents a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if the payment is made within a specified period of time. Such as a 2/10 or n/30. Cash 343 Sales Discount 7 Accounts Receivable 350 Sales returns: if a customer returns a product. After a sales return, we reduce the customer’s account balance if the sale was on account or we issue a cash refund if the sale was for cash. Sales allowance: in other cases, the customer does not return the product or service, but the seller reduces the customer’s balance owed to provide at least a partial refund. Such as a reduction or partial refund is a sales allowance. Sales Allowances 50 Accounts Receivable 50 Explain why accounts receivables need to be valued – explain and apply the allowance method. The right to receive cash from a customer is a valuable resource for the company, this is why accounts receivable is an asset. Allowance method is when a company accounts for uncollectible accounts. Uncollectible accounts have the effect of (1) reducing assets (accounts receivable) by an estimate of the amount we don’t expect to collect and (2) increasing expenses (bad debt expense) to reflect the cost of offering credit to customers. Apply both the percentage of receivables and the aging method to calculate the allowance for doubtful accounts. Percentage-of-receivables method: sometimes referred to as the balance sheet method, we base the estimate of bad debts on a balance sheet amount – accounts receivable. Bad Debt Expense 6 Allowance for Uncollectible Accounts 6 (Estimate future bad debts) ($20 million x 30% = $6 million) Aging method: A more accurate method than assuming a single percentage uncollectible for all accounts is to consider the age of various accounts receivable, and use a higher percentage for “old” accounts than for “new” accounts. Be able to journalize the write-off of bad debt and record the payment of a debt written off (collection of accounts previously written off). Allowance for Uncollectible Accounts 4,000 Accounts Receivable 4,000 (Write off a customer’s account) Understand how transactions involving account receivables and bad debt expense impact the accounting equation. Explain the direct write-off method and compare to the allowance method. Be able to account for notes receivables (including the interest calculations). Know the ratios related to receivables analysis.


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