Chapter 5 module 1.

Current assets: an asset that is expected to be converted into cash or used up within one year of the date of the balance sheet.

Cash- any deposit banks will accept.

- checks- money orders- traveler’s checks- bank credit card sales- most susceptible to theft.

o Internal control system – a set of policies and procedures established by the company to provide reasonable assurance that the firm’s objectives will be met. (2) goals and ways of internal controls

Provide accurate accounting records and financial statements

To safeguard assets from theft.o Segregation of duties (internal control):

Ensures that more than one person is involved in a transaction from beginning to end.

Requires that no single employee be given too much responsibility over business transactions.

Authorization – approving transactions and decisions Recording – maintaining journals and ledgers Custody – handling cash, maintaining an inventory

storeroom, receiving incoming customer checks, writing checks on the organization’s bank account (physical ownership of asset)

If one person is responsible for any two of the above then problems can arise.

Effective internal control system doesn’t mean no fraud activity. Set of policies and procedures to provide reasonably service.

Internal controls do significantly reduce the opportunities. Can be overthrown if there are 2 or more ppl working together.

Collusiono Prepare bank reconciliations (internal control):

Explains the difference between cash reported on bank statement and the cash balance in depositor’s accounting records. (general ledger/bank statement)

Necessary as the balance per bank statement and balance per the general ledger are seldom in

agreement due to timing differences and errors. (different points in time)

Should be prepared by an employee who has no other responsibilities pertaining to cash.

Reasons why the two amounts won’t be the sameo Timing differences – deposits recorded by

the company but not recorded by the bank. (deposits in transit)

You may deposit at 3:00 on May 31st but the bank may record it on the next business day (June 1st). Company has it in ledger as May 31st but bank has June 1st. (this is deposit transit)

o Outstanding checks – withdrawals that have been recorded by the company but not by the bank.

Checks the company has written but whomever we wrote the check has not presented it at the bank for payment.

o Interest earned (just example) – reports recorded by the bank but not the company yet.

Interest earned on our checking and savings account. Whenever we earn interest, the bank puts it in our account right away. However the company doesn’t know how much until we get our bank statement.

o Bank service charges and NSF checks (example) – withdrawals recorded by the bank but not the company.

NSF stands for nonsufficient funds checks. Customer gives check but not enough funds inside account to pay for that check so nonsufficient funds. We won’t know that his happened until bank statement and it will be marked NSF. A bank service charge takes the money right out of our account immediately. We wont find out how much until the bank statement comes.

o Errors (made by bank or company) – overstatement/understatement of cash. Overstatement of cash means error causing the cash balance to appear higher than it

actually is. The opposite is true for under. Must be fixed in the bank reconciliation.

BANK RECONCILIATIONo Balance per the bank statemento Add the deposits in transito Subtract the outstanding checks, o Errors can be added or subtractedo = Adjusted bank balance

COMPANY SIDEo Company’s accounting records (balance per

general ledger)o Add interest earnedo Subtract service charges and NSF checkso Errors can be added or subtractedo = Adjusted general ledger balance

adjusted values must equal

22190 20502

3680+ 600+

+175 -220

-5001 +180 - 18

MODULE 3

Accounts receivable (current assets)

- cash that is owed to the company- when the company sells a good or performs for a customer on credit or

on account.- “I’ll pay you later” from customer (the money owed is an account

receivable)

Journal entry example ******

Date Title Debit Credit

1/4/04 Accounts receivable X

Sales Revenue X

Sales discounts

- offer to a credit customer for them to pay us early.- Incentive to give us the money they owe quickly.- Ex) 3/10, n/30 discount term, the n stands for net

o it means that there is a 3% discount applied to all payments within the first 10 days of purchase. So any payment made by the customer to us within the first 10 days of purchase, is eligible for a 3% discount.

o After the first 10 days after the purchase are gone, the entire amount is due within 30 days of purchase and no discount is allowed.

o Why? Incentive to credit customers to pay early. If they pay us within 10 days of purchase, we’ll give them a

3% discount. Increase or at least maintain sales If store down the street doesn’t offer a discount but we do,

more people are likely to buy from us because they know if they pay early, we offer a discount. (increase sales of company)

Increase the speed of collection of cash Also minimize the likelihood of bad debts. – The longer an

account receivable is outstanding, the longer money is owed to us, the greater the chance that customer will never pay us. (so let’s offer discount so that that won’t happen)

“On May 1, X Company sold goods to a customer for $1,000 on account. Credit terms were 4/10, n/30. The customer paid one-half of the bill on May 9 and paid the other one-half on May 24. The goods sold had a cost to X Company of $300.”

- 4/10 = within 10 days it is a 4% discount. Half is paid so 1000 * .5 * .04 = 20. So 1000-20 = 980. 980 = amount of cash received. Net income = 980 – cost of goods sold = 980-300 = 680 net income.

- Sales discounts – contra revenue account. Called this because it reduces revenue, specifically the sales revenue, on the income statement. Sales discounts shows as a decrease to sales revenue.

o Any account that acts as a decrease, is a contra account.- Accounts receivable – represent cash owed to the company.

o When company makes a credit sale (sale on account) for selling of goods or performing services for customers on account or credit.

o Main issue Not every customer will actually pay what is owed to us.

We have to account for this in paying our bills by recording Bad Debt Expense.

When do we record the bad debt expense? Bad debt expense must be recorded within the same

year the credit sale is made. Why? – matching concept. Revenue is earned when

the sale is made, thus bad debt expense must be recorded in the same year.

We do not know in year 1 which specific accounts receivable will not be collected in year 2. Meaning that bad debt expense is an ESTIMATE!

You debit the bad debt expense and you credit allowance for bad debts. This entry is made at the end of every year making it an adjusting journal entry.

- Bad debt expense o An expense account, so found on the income statement. Expenses

reduce net income.- Allowance for Bad Debts

o Causes a decrease to our assets. Because of that, known as a contra asset account.

o Normal balance for the contra asset is on the credit side while the normal asset is on the debit side.

o Found on the balance sheet, directly underneath accounts receivable as a decrease to receivables.

o Represents the amounts of accounts receivable the company estimates.

- Net Realizable Value (NRV) o Accounts Receivable – Allowance for Bad Debts = NRVo Ex) 200,000 is owed – 12,000 estimated not collected = 188,000

net realizable value.

Module 4

- When a customer doesn’t initially pay, we don’t just immediately decide that they are not going to pay us. We try to get our money by sending letters and the collection agency call them.

- At some point, it isn’t worth while to do that.- Write-Off – write off the customer’s account from the balance sheet.

o To do this, we write the Allowance for Bad Debts in the debit and Accounts receivable into the credit site.

o What is happening is we are reducing the allowance for bad debts and at the same time, removing the accounts receivable from the balance sheet.

Bad debt expense is an adjusting entry made at the end of the year, but a write-off can occur at any point in time during the year.

o It does not affect bad debt expense (thus doesn’t affect net income) because it is recorded in the year that the credit sale happens. Most likely when we determine a customer won’t pay us, we’ve moved onto the next year. We wouldn’t write-off the receivable again so we just simply reduce the contra asset (allowance), and asset (accounts receivable). Neither are revenues or expenses.

o Write-offs do not change the NRV either! Because it reduces both the accounts receivable, and the allowance, it leaves the NRV unchanged.

o Ex) before $500 write-off Accounts receivable – 200,000

Allowance for bad debts - 12,000 = 188,000

o After $500 write-off Accounts receivable - 199,500

Allowance for bad debts - 11,500 = 188,000o REVIEW – to record the bad debt estimate:

Journal entry: the bad debt expense is debited and the allowance for bad debts are credited.

- T-account for Allowance for Bad Debts- Write-offs (actual amount and can occur at any point in the year) are on

the debt side and Bad Debt Expense (estimate that is recorded at end of year) is on the credit side.

o Balance in the allowance before the current year adjustment of bad debt expense can be either a debit or a credit.

If debit, it means that the debit side was larger. That’s why the balance is there. That means the write-offs were larger than the Bad Debt Expense.

If credit, that means we over-estimated the expense. The Bad Debt Expense estimate from the previous year was larger than what we actually ended up writing off in the current year. The actual write-offs were less than what we had expected. Hence the balance was on the right (credit) side.

NO matter what, the ending balance on the T-Account will always be on the bottom right hand side.

- How to calculate Bad debt expense?o Aging method – the older the account receivable, the greater the

chance that we will never actually collect the money. Put the accounts receivable into different categories by age.

We assign a percentage we expect to be uncollectible for each age category.

For each category, take amount of Account Receivable * the % and take the sum of all. (taken from aging schedule)

NOTE: this is NOT the estimate. Find the estimate through T-account

The above number is the required ending credit balance in our allowance for Bad Debts.

T-account_________________________

Write-offs | Bad debts expense

(accounts | (allowance for bad debts credit balance or ending balance in the | allowance for bad debts)

written off) | X

_________ | ______________

| Ending Balance (from aging schedule)

| (required ending credit balance)