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Week 7

by: Petey Martin

Week 7 ACC 201

Petey Martin
GPA 3.25

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Week 7 of Notes.
Class Notes
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This 13 page Class Notes was uploaded by Petey Martin on Thursday October 15, 2015. The Class Notes belongs to ACC 201 at University of Rochester taught by WOJDAT K in Summer 2015. Since its upload, it has received 20 views. For similar materials see FINANCIAL ACCOUNTING in Accounting at University of Rochester.


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Date Created: 10/15/15
Petey Martin Notes 101315 0 Accounts Receivable 0 Accounts receivable are promises from customers to pay for merchandise that they have received 0 Accounts Receivable Records 0 General ledger contains information on total AR for nancial reporting 0 A subsidiary ledger contains information on how much is owed by each customer 0 Bad Debts 0 Firms provide credit to their customers to help facilitate sales 0 Not all customers granted credit will meet their obligation to pay Seller will seek to identify rms with good credit but probably will not seek to eliminate all non payment Tight credit policy hurts sales so have a trade off 0 Under the Expense Matching Principle the expense of not getting paid must be recognized in the same scal period as the underlying sale causing it 0 Matching Principal requires estimating bad debt expense which is recorded with following end of period adjusting entry Bad Debt Expense it non collection expense Allowance for Doubtful Accounts quot o The credit in the adjusting entry is not to Accounts Receivable because rm does not know which customer will not pay 0 Credit goes to the contra asset account quotAllowance for Doubtful Accountsquot Balance in quotAllowance for Doubtful Accountsquot at year end is an estimate of what portion of yearend accounts receivable is expected to be uncollectable Allowance for doubtful accounts has a credit balance but is included with assets as a reduction to accounts receivable 0 Bad debt expense is included in income statement as part of Selling General and Administrative Expense Aging of accounts receivable method of estimating bad debt expense 0 Aging of accounts is a balance sheet method Directly estimates how much should be in the allowance for doubtful accounts balance sheet 0 Considers a percent of balance in accounts receivable to be uncollectible Incorporates a higher estimate of uncollectable percentage as accounts become more overdue 0 Percent uncollectible is based on prior expense 0 Key with the aging method is that result is an estimate of what the allowance account balance should be when nished 0 Note the adjusting entry to record bad debts requires substantial judgment Percentage of credit sales method of estimating bad debt expense 0 Percentage of credit sales is an income statement method 0 Estimates current period bad debt expense income statement using percentage of credit sales that historically do not get paid Historical percentage equals bad debt losses relating to sales from a given past period sales from that same period 0 Bad debt loss rate Bad Debt Credit Sales 0 Percentage of credit sales method is generally simpler to apply than the aging method but is less accurate Accounting for actual write off of amount due from a speci c customer 0 Throudhout the year when a rm decides a particular customer is not going to pay the accounting department needsto Reduce or zero out the account receivable balance for that customer in the subsidiary ledger Reduce the accounts receivable account total in the general ledger with the following entry 0 Allowance for Doubtful Accounts Accounts Receivable This entry affects neither the income statement M the net book value of accounts receivable 0 Both already adjusted when bad debts expense was estimated and recorded Once know which customer s receivable promise to pay is no good remove it from accounts receivable balance and from the subsidiary ledger record of individual receivables O 0 If written off account is eventually collected then the collection must be recorded and the above entry must be reversed for the amount collected Any balance remaining in the allowance at the end of the year becomes the beginning balance for the subsequent yeah If the allowance starts getting too big or becomes too small or of the wrong sign due to differences between estimated and actual writeoffs company will lower or raise bad debt expense for the period during which the balance was determined to be too large or too small not for any prior period Accounts receivable allowance for doubtful accounts and bad debt expense are all interrelated O O 0 Accounts Receivable beg balance collections credit sales i write offs ending bal Allowance for Doubtful Accounts write off beg balance i bad debt expense ending bal Bad Debt Expense beg bal zero bad debt exnense l ending bal l closing entry zero I For Accounts Receivable Ending Balance Beginning Balance Credit Sales Collections Writeoffs For Allowance for Doubtful Accounts Ending Balance Beginning Balance Bad Debts Writeoffs Receivables and Cash 0 Getting a promised future payment AR instead of cash delays cash receipt Increases nancing costs and or lowers investment opportunities Receivables Turnover Annual Net Sales Avg Net Trade AR A receivables turnover increase implies that receivables are collected turned into cash more quickly Faster collection of receivables bene ts the company because the cash can be invested and more can be earned by the company or the cash can be used to reduce borrowing and less interest will be paid by the company And the chance of non payment is reduced A receivables turnover decrease implies that receivables are collected turned into cash less quickly Therefore an increase in receivables turnover from one period to the next can indicate that company s collection methods are more effective w a decrease can mean they are less effective A decline in receivables turnover can also indicate that a company has needed to ease its credit policies to attract more customers a company has pushed year end sales which can lead to lower following period sales or to an increase in goods returned by customers in the following period or both Once again comparisons across industries are complicated by natural difference in credit terms etc Average Days Sales in Receivables or Average Collection Period 365 Receivable Turnover Ratio assuming receivable turnover based on annual net sales These ratios can be improved via some business practices such as requiring approval of customer s credit history by a person independent of the sales function rewarding collections personnel and sales personnel for speedy collection aging accounts receivable and contacting customers that are overdue Cash includes currency on hand and bank accounts Cash presented in the balance sheet is usually cash and cash equivalents combined Cash equivalents are investments 1 readily and cheaply convertible to cash with 2 maturities of three months or less Cash management responsibilities include 0 O 0 Ensuring adequate cash exists for companies needs Preventing the accumulation of excess cash Accurate accounting and control Internal controls and cash 0 A company s system of internal controls is the set of processes by which the company Helps protect the company s assets Helps ensure the accuracy and reliability of the company s reporting by helping to prevent both error and fraud Helps ensure the efficiency of the company s operations Helps ensure the company s compliance with laws and regulations 0 Because cash is very vulnerable to theft and fraud a signi cant number of controls procedures focus on cash Effective internal control over cash will include physical controls such as the use of prenumbered checks to help control access to the documents needed to obtain cash 0 Electronic funds transfers are particularly vulnerable because they involve no control documents Petey Martin Notes 101515 0 Effective internal controls for cash also should include separation of duties Assign responsibilities for approving payment to a person other than the one signing checks or implementing electronic funds transfer A person not at all responsible for handling cash should be responsible for maintaining the accounting records associated with cash balances Having person handling accounting for cash receipts not being responsible for handling accounting for cash disbursements Persons handling cash receipts should not be responsible for handling cash disbursements Have all cash receipts deposited in the bank each day 0 The objective is to keep a single person from stealing cash and concealing the theft in the accounting records Bank Reconciliation O 0 Bank reconciliations should be prepared to determine that cash reported in the accounting records actually exists Reconciliation consists of adjusting cash per bank statement to correct cash amount and adjusting cash per the accounting records to the correct cash amount both balances will be missing some items prior to reconciliation o The bank statement lists 1 checks cleared by the bank 2 electronic funds transfers electronic payments processed by the bank 3 deposits processed by the bank 4 fees charged by the bank 5 other debits eg for NSF checks 6 other credits eg for interest and 7 a balance according to the bank But the bank balance does not re ect all cash transactions because the bank is unaware of some things Outstanding Checks written by the company and recorded in its accounts but not yet received and recorded by the bank must be deducted from the cash balance per the bank Deposits in Transit sent to the bank and recorded in the company s accounts by not yet received and recorded by the bank must be added to the cash balance per the bank Bank will record both the above in the normal course of business but only in subsequent periods 0 The company s accounts also do not re ect all cash transactions because the company is unaware of some things before the bank statements are reviewed Bank service charges only communicated to the company via the bank statement must be deducted from the company39s cash account NSF checks deposits that included checks not honored by the customer s bank will be adjusted by the firm s bank to a reduced amount must be deducted from the company39s cash account and set up as a receivable Interest the interest earned on each account balance is communicated to the company via the bank statement must be added to the company39s cash account m revenue reported at the same time o In addition either the bank statement or the company s books or both may contain errors 0 The reconciliation will reveal journal entries required to change the company39s cash accounts Bank Service Charge Bank Service Expense Cash NSF check Accounts receivable Cash Interest Cash Interest Revenue 0 The cash balance after these journal entries will be the correct cash balance for the company 0 The Bank Reconciliation performs two functions Helps make sure that cash is not stolen Identi es transactions that require journal entries to adjust the cash account to the correct balance 0 Note if the two balances do not agree after all reconciling items are considered it means there is a remaining error Transaction may have been entered in the wrong account or in the wrong amount or not have been entered in either the company s books or by the bank or both 0 Errors in the company s books require adjusting journal entries by the company 0 Banks must book adjusting entries on their books for their errors o A transposition error is likely if the difference between the bank and corporation side of the bank reconciliation is divisible by 9 eg 75 entered instead of 57 Chapter 7 Introductory Accounting 0 Inventory is goods available to be sold in normal course of business as well as the components used to make goods for sale 0 Retailers buy merchandise inventorv inventory acquired in nished condition 0 Manufacturing rms have three categories of inventory 0 Raw materials components used to manufacture a company39s products eg lumber in a warehouse for a shipbuilding company BUT not for a lumber yard 0 Work in Process WIP partially completed production eg hulls of incomplete ships UNLESS company is in business of selling these hulls Includes 1 raw materials used 2 manufacturing labor used called direct labor and 3 factory overhead other man costs such as power etc 0 Finished Goods Product ready to be sold eg completed yachts lumber in a lumber yard or hulls for a company that sells hulls includes same factors WIP includes 0 Purpose of inventory records 0 Decision Making help to determine when materials or merchandise should be ordered when manufacturing should be scheduled etc o Safeguarding assets perpetual inventory system provides records of what inventory rm should possess 0 Financial statement and tax preparation 0 Inventory calculations affect both the balance sheet and the income statement 0 Inventory is a current asset account because it is typically converted to cash within one year 0 Inventory also is critical to the correct measurement of income through its effect on cost of goods sold 0 Beginning Inventory plus Purchases equals Goods Available for Sales at cost minus Ending Inventory equals Cost of Goods Sold 0 Net Sales or Revenue Units sold times sales price minus Cost of Goods Sold Units sold times cost equals Gross Pro t minus Other Expensg equals Net Income 0 Inventory Beginning Inventory Cost of Goods Sold Purchases of Inv I Writeoffs later Ending Inventory BI Purchases COGS El 0 Inventory account serves purpose of deferring expense so as to match revenue amount received by rm for selling goods with some of the cost of generating that revenue ie cost of goods sold Revenue is units sold times price charged customers Cost of goods sold is units sold times price paid to suppliers or times each unit39s manufacturing costs Calculating accounting value of ending inventory 0 Calculate cost of each unit 0 Count the number of units in inventory 0 Determine which units remain in inventory Identical units may have been acquired at different costs 0 Inventory is initially valued at cost under the cost principle 0 All expenditures necessary to bring each unit to a usable for raw materials and WIP or saleable for nished goods condition m location prior to sale are included in the inventory value BUT EXCLUDE interest paid on funds borrowed to nance purchases 0 Inv book value includes amounts paid by the acquiring rm for Inventory production or purchase less sales discounts taken under the gross method Shipping Charges if paid by rm receiving the inventory Taxes and Duties associated with the purchase Insurance in Transit if paid by rm receiving the inventory Receiving Costs Inspection and Preparation Costs etc 0 Manufacturers include in inventory value Raw material used in production cost calculated using above Direct labor costs production line factory workers not sales staff etc Factory overhead other manufacturing costs such as machine depreciation supervisors lights and heat if for a factory or associated with providing a service for those rms selling services but not if for administrative functions such as headquarters o In general cease adding cost to value of inventory when raw materials are ready for use and when nished goods are ready for sale condition and location in both cases but see storage costs 0 Exclude from inventory values those costs incurred after inventory is ready for sale or use such as Costs to store nished goods including materials handling but receiving costs are part of inventory as shown previously Advertising expenditures Marketing and Sales Salaries Dealer Training lnterest cost of nancing the purchase of inventory These costs excluded from inventory values are selling general and administrative expenditures that are expensed in the period incurred Immaterial amounts may be excluded from inventory value for simplicity 0 Units in inventory technically include all units the rm legally owns 0 Free on Board FOB destination Purchaser owns and includes in inventory when receives seller does not own and excludes from inventory when purchaser receives Seller usually bears freight and insurance expense 0 Free on board FOB shipping point purchaser owns and includes in inventory when seller ships seller does not own and excludes from inventory when ships purchaser usually bears freight and insurance expense 0 Consignments are owned by consignor not owned by and not included in inventory of the rm having physical possession o Goods shipped on a trial basis are still owned by and in the inventory of the seller not the potential buyer 0 Goods left for pickup are owned by and in the inventory of the buyer not the seller even though the seller still has possession of them 0 Accounting for variation in acquisition cost 0 Through time a given type of unit will be acquired at various costs Acquisition costs will differ across physically identical units Speci c Identi cation of which units are sold ie tracking each unit is one way to determine which cost to apply to each unit Identifying the actual unit sold is cost prohibitive when large quantities of similar items are sold so in addition to speci c identi cation GAAP aows assumption as to which unit is sold 3 ow assumptions as to which units are sold and which remain in inventory are as follows FIFO First in First Out LIFO Last in First Out Average Cost Note LIFO is not currently acceptable under IFRS Choice of ow assumption or speci c identi cation will affect reported inventory m reported net income The four choices are alternate ways to assign the dollar cost of goods available for sale between inventory and COGS Any of the ow assumptions or speci c identi cation can be used regardless of actual physical ow eg a supermarket can use LIFO All four alternatives are acceptable under GAAP as GAAP only requires method to be rational and systematic All four alternatives are also acceptable under US tax code No justi cation is required for the choice of one cost ow method over that of another Also US GAAP aIIows different inventory items within the same companv or the same item in different locations to be accounted for using different ow assumptions or speci c identi cation But for a given inventory the cost ow method can not constantly change from period to period 0 Cost FIow Assumptions 0 O COSLS ow assumptions are applied as if all purchases in a period occurred prior to any sales from that period E First In First Out Costs of oldest units available in a given period are assigned to COGS 0 Beginning inventory is assumed sold rst then sales are assumed to come in order of current year purchases COGS is valued at slightly old cost Units remaining in inventory are assumed to be the last units bought 0 Inventory is valued at most recent costs Steps 0 Arrange goods available for sale during the period in chronological order by purchase date 0 Calculate total units sold for the year 0 Consider units sold to be the units available for sale that were purchased earliest then next earliest etc 0 Multiply remaining units by their cost and add together for inventory value 0 Beginning inventory may be lumped together even though it may be valued based on purchases occurring on separate dates in the previous year Last In First Out Costs of newest units are assigned to COGS Latest current year purchases are assumed sold rst then the next latest then beginning inventory is assumed sold all in reverse order of acquisition date 0 COGS is usually valued at most recent cost 0 Although see LIFO liquidation Units remaining in inventory are assumed to be the earliest units bought of those available for sale during the period 0 Inventory is valued at old costs or very old costs Steps are the same as for FIFO except in iii consider units sold to be the units available for sale that were purchased latest then next latest etc 0 Can change reported income by timing yearend purchases 0 Beginning inventory is not combined purchase dates used to value all units in beginning inventory are tracked o Weighted Average Cost Each unit sold is assumed to cost as much as the weighted average cost of goods available for sale Units remaining in inventory at the end of the period are also assumed to be at the weighted average cost per unit Steps 0 Calculate total cost of beginning inventory and all purchases for the period 0 Divide by number of units available for sale the total of the number of units in beginning inventory plus the number purchased during the period 0 Multiply the resulting average rate by the number of units remaining in inventory to get inventory value 0 Speci c Identi cation Each unit is identi ed as to purchase date eg may be stamped only practical when dealing with a small number of units to track Units sold are valued at their speci c acquisition cost as are units remaining in inventory Steps Same as for FIFO except iii apply units sold to purchase date identi ed on each unit sold 0 Can change reported income by choosing which of a set of identical items to sell when identical items on hand were acquired at different costs 0 Although this must be done at the time of the sale


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