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Accounting Fundamentals

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  1. Accounting Fundamentals Dr. Yan Xiong Department of Accountancy CSU Sacramento The lecture notes are primarily based on Reimers (2003). 7/11/03

  2. Chapter 7: Sales and Collection Cycle Agenda • Control Procedures for Cash • Bank Reconciliations • Accounts Receivables and Bad Debts • Other Accounting Issues

  3. Agenda • Control Procedures for Cash

  4. Controlling CASH • Cash has universal appeal and ownership is difficult to prove. • Both cash receipts and cash payments should be recorded immediately when received and made. • Checks should be prenumbered and kept secure.

  5. Safeguarding Cash • Separation of duties • Different people receive and disburse the cash. • Procedures for the record keeping of cash receipts and disbursements are separate. • Handling the cash and record keeping are completely separate.

  6. Procedures To Have In Place • Both cash receipts and cash payments should be recorded immediately when received and made. • Keep cash under strict physical control, and deposit cash receipts daily. • Have separate approvals for purchases and the payment for those purchases.

  7. Procedures • Use pre-numbered checks, and keep a log of electronic transfers. • Payment approval, check signing, and electronic funds transfer should be assigned to different individuals. • Bank accounts and cash balances should be reconciled monthly.

  8. Accounting For Cash:Reconciling The Bank Statement • An important part of internal control • Need for calculating a true cash balance • Two “sides” to be reconciled • balance per bank • balance per books • If there are any mistakes or transactions that have not been recorded in the company’s books, the company’s records should be updated.

  9. Agenda • Bank Reconciliations

  10. Terminology Bank statement Monthly report prepared by bank that contains details of a company’s deposits, disbursements, and bank charges. Bank reconciliation Report prepared by the company after receiving the bank statement that compares the bank statement with the company’s records to verify the accuracy of both.

  11. More Terminology Outstanding check A check written by the company that has been recorded on the company’s records but has not yet cleared the bank Deposit in transit A deposit that the company has made and recorded, but it has not reached the bank’s record keeping system yet.

  12. More Terminology NSF check A “bad” check written by a customer that must be deducted from the company’s records. The company recorded the check as a cash receipt (and then deposited it), but the check writer didn’t have the money in his or her account to cover it. The bank will have already deducted it from the company’s balance (in the bank’s records), but the company will have to make an adjustment to their records.

  13. More Terminology Credit memo An addition to the company’s balance in the bank’s records for a reason such as the bank having collected a note for the company (from a third party who owed the company). Debit memo A deduction from the company’s balance in the bank’s records for a reason such as a bank service charge.

  14. An Example Of A Reconciliation Given the following information: Balance per bank at 4/30 $8,750 Balance per books at 4/30 6,900 Outstanding checks at 4/30 1,380 Bank service charge for April 30 Deposit in transit at 4/30 400 Customer’s NSF check 100 (returned with bank statement) Bank collected note receivable 1,000 for company

  15. Balance Per Bank Section Of The Reconciliation Balance per bank $8,750 Plus: Deposit in transit 400 Less: Outstanding checks (1,380) Cash Balance at 4/30 $7,770

  16. Balance Per Books Section Of The Reconciliation Balance per books $6,900 Plus: Note collected by bank 1,000 Less: NSF check returned (100) Service charge ( 30) Cash balance at 4/30 $7,770

  17. Bank Reconciliation: Necessary Entries to Correct Account Balances • How would the collection of the note receivable be recorded in the journal? Date Transaction Debit Credit Apr 30 Cash 1,000 Note receivable 1,000

  18. Bank Reconciliation: Necessary Entries to Correct Account Balances • How would the NSF check and the bank service charge be recorded in the journal? Date Transaction Debit Credit Apr 30 Accounts receivable 100 Operating expenses 30 Cash 130

  19. There Is One True Cash Balance • Bank balance per statement is reconciled to the TRUE cash balance • Book balance (company’s records) is reconciled to the TRUE cash balance

  20. ++ deposits in transit ++ -- outstanding checks -- True cash balance ++ collections for us made by the bank ++ -- NSF checks (from customers) -- Service charges True cash balance Cash (Bank) Reconciliation Has Two “Independent” Parts Balance per bank Balance per books

  21. Agenda • Accounts Receivables and Bad Debts

  22. Accounts And Notes Receivable • A/R are the expected future cash receipts of a company. They are typically small and are expected to be received within 30 days. • N/R are used when longer credit terms are necessary. The note specifies the maturity date, the rate of interest, and other credit terms.

  23. Value Of Receivables • Receivables are reported at their face value less an allowance for accounts which are likely to be uncollectible. • The amount which is actually expected to be collected is called the net realizable value (NRV). • GAAP requires that A/R be reported at NRV.

  24. Two Methods GAAP Not GAAP Allowance Method Direct Write-Off Method Used only when bad debts are a very small item or when credit sales are insignificant. A/R Method Sales Method

  25. Allowance method Estimate the bad debt expense as an adjustment when it is time to prepare the financial statements. Record the amount as a reduction in ACCOUNTS RECEIVABLE, even though you don’t know whose accounts will be “bad.” The Most Common Method

  26. Allowance Method, continued • We will base the estimate on: • Sales, or • Accounts Receivable • This method attempts to match the expense (bad debt) with the revenue (sale) by recording the expense in the same period as the sale even though the company has not specifically identified which accounts will go unpaid.

  27. The Other Method Direct Write-Off • No estimates of bad debts are made. • Only when a specific account is known to be uncollectible (customer files bankruptcy, for example) is bad debt expense recorded. • This doesn’t do a very good job of matching the revenue (sale) with the expense (bad debt), because a company often discovers an account is uncollectible in a period subsequent to the one in which the sale was made.

  28. How Do We Report A/R On The Balance Sheet? Net Realizable Value of AR = what we expect to collect On the balance sheet: Accounts Receivable $3,000 less allowance for uncollectible accounts (200) Net AR $2,800

  29. 1. On April 1, provided $5,000 Services On Account. • How would providing services on account be recorded in the journal? Date Transaction Debit Credit Apr 1 Accounts receivable 5,000 Service revenue 5,000

  30. 2. On April 15, Collected $4,000 Cash From Accounts Receivable. • How would the collection on account be recorded in the journal? Date Transaction Debit Credit Apr 15 Cash 4,000 Accounts receivable 4,000

  31. 3. Adjusting Entry Booked To Reflect The Estimate Of 5% Of Ending A/R To Be Uncollectible. • How would the adjusting entry be recorded in the journal? Date Transaction Debit Credit Dec 31 Bad debt expense 50 Allowance for uncollect. accts. 50

  32. Statement of Cash Flows For the year 19X4 Income Statement For the year 19X4 Cash from operations $4,000 Cash from investing -0- Cash from financing -0- Sales $5,000 Bad debt expense 50 Net Income $4,950 Total change in cash $4,000 Financial Statements At The End Of Year 19X4:

  33. Balance Sheet At 12/31/X4 Assets: Cash $4000 AR 1,000 Allowance (50) Net A/R 950 Liab. + Equity: RE $4,950 Total Assets $4,950 $4,950

  34. 1-b. On Feb 5, wrote Off A $40 A/R That Was Determined To Be Uncollectible. • How would the actual write-off of accounts receivable be recorded in the journal? Date Transaction Debit Credit Feb 5 Allowance for uncollect. accts. 40 Accounts receivable 40

  35. 1. On March 8, Provided $6,000 Services On Account. • How would providing services on account be recorded in the journal? Date Transaction Debit Credit Mar 8 Accounts receivable 6,000 Service revenue 6,000

  36. 2. On March 23, Collected $4,500 Cash From Accounts Receivable. • How would the collection on account be recorded in the journal? Date Transaction Debit Credit Mar 23 Cash 4,500 Accounts receivable 4,500

  37. Where Do We Stand? We overestimated bad debts by $10--we estimated $50 but we only wrote off $40 in the subsequent year. This year our estimate is 5% of $2460 (BB 1,000 + 6,000 credit sales - $4,500 collections -$40 accounts written off)= $123. But since we overestimated last year, we only need to record $113 this year.

  38. 3. Adjusting Entry Booked To Reflect The Estimate Of 5% Of Ending A/R To Be Uncollectible. • How would the adjusting entry be recorded in the journal? Date Transaction Debit Credit Dec 31 Bad debt expense 113 Allowance for uncollect. accts. 113

  39. To summarize: • Two methods: • the allowance method • the direct write-off method • Which one involves estimating future uncollectibles?

  40. Summary Of The Allowance Method Continued • One way to estimate bad debt expense is to use a percentage of ending A/R (or an aging schedule) • When an actual account is written off as uncollectible, it is credited out of A/R and debited out of the Allowance. THERE IS NO NET EFFECT ON ASSETS and NO EXPENSE at the time of the write-off.

  41. Agenda • Other Accounting Issues

  42. Other Accounting Issues Related to Sales: Warranty Costs • Why give warranties? • When should expense be recognized? We will repair or replace this item... Warranty

  43. Warranties • How is the warranty obligation met and subsequently removed from the balance sheet? • How do all of the above affect financial statements? • What other issues are similar to warranties?

  44. Transaction Analysis • Assume the following selected events occurred at Cell-It. For each event: • Determine how the accounting equation was affected. • Determine the effect on the financial statements. • Record the event in t-accounts.

  45. 1. On Jan 1, Sold Merchandise For $5,000 Cash That Had Originally Cost $4,000. These Goods Were Sold With A Two-year Warranty. • How would the sale of merchandise be recorded in the journal? Date Transaction Debit Credit Jan 1 Cash 5,000 Sales revenue 5,000 Cost of goods sold 4,000 Inventory 4,000

  46. 2. Estimated That $100 Of Warranty Cost Will Be Incurred Over The Next Two Years On The Goods Sold In Transaction 1. • How would the adjusting entry be recorded in the journal? Date Transaction Debit Credit Dec 31 Warranty expense 100 Estimated warranty liability 100

  47. 3. On February 7, A Customer Returned Goods Under Warranty For Repair. The Cost Of The Repair Was $30 Cash. • How would the cost of the repair be recorded in the journal? Date Transaction Debit Credit Feb 7 Estimated warranty liability 30 Cash 30