Accounting Fundamentals

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Accounting Fundamentals

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

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Chapter 7 Sales and Collection Cycle

• Agenda
• Control Procedures for Cash
• Bank Reconciliations
• Accounts Receivables and Bad Debts
• Other Accounting Issues

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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.

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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.

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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.

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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.

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Accounting For CashReconciling 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 companys books,
  the companys records should be updated.

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Agenda

• Bank Reconciliations

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Terminology

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

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More Terminology

• Outstanding check
• A check written by the company that has been
  recorded on the companys 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 banks
  record keeping system yet.

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More Terminology

• NSF check

• A bad check written by a customer that must be
  deducted from the companys records. The company
  recorded the check as a cash receipt (and then
  deposited it), but the check writer didnt have
  the money in his or her account to cover it. The
  bank will have already deducted it from the
  companys balance (in the banks records), but
  the company will have to make an adjustment to
  their records.

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More Terminology

• Credit memo
• An addition to the companys balance in the
  banks 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 companys balance in the
  banks records for a reason such as a bank
  service charge.

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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
• Customers NSF check 100
• (returned with bank statement)
• Bank collected note receivable 1,000 for
  company

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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

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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

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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
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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
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There Is One True Cash Balance

• Bank balance per statement is reconciled to the
  TRUE cash balance
• Book balance (companys records) is reconciled to
  the TRUE cash balance

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Cash (Bank) Reconciliation Has Two Independent
Parts
Balance per bank
Balance per books

• deposits in transit
• -- outstanding checks
• --
• True cash balance

• collections for us made by the bank
• -- NSF checks (from customers)
• -- Service charges
• True cash balance

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Agenda

• Accounts Receivables and Bad Debts

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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.

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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.

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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
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The Most Common Method

• 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 dont know whose
  accounts will be bad.

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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.

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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 doesnt 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.

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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
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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
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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
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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
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Financial Statements At The End Of Year 19X4
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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
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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
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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
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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
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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.
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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
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To summarize

• Two methods
• the allowance method
• the direct write-off method
• Which one involves estimating future
  uncollectibles?

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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.

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Agenda

• Other Accounting Issues

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Other Accounting Issues Related to Sales
Warranty Costs

• Why give warranties?
• When should expense be recognized?

We will repair or replace this item...
Warranty
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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?

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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.

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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
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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
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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
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