Accounting Exam 3

dishonest act by an employee that results in personal benefit to the employee at a cost to the employer
Ethics & Integrity
1. discerning what is right and what is wrong
2. acting on what you have discerned, even at personal cost
3. don’t hide the fact that you’re doing the right thing
fraud triangle
1. opportunity
2. financial pressure
3. rationalization
Sarbones-Oxley Act of 2002 (SOX)
Law that requires companies to maintain adequate systems of internal control
Internal Control
consists of all related methods and measures adopted within an organization to safeguard its assets, enhance the reliability of its accounting records, increasing efficiency of operations, and ensure compliance with laws and regulations
Control Enviroment
responsibility of top management to make it clear that the organization values integrity & that unethical activity will not be tolerated
Risk Assesment
Companies must identify and analyze the various factors that create risk for the business and must determine how to manage these risks.
Control Activities
to reduce the occurrence of fraud, management must design policies and procedures to address the specific risks faced by the company.
Information & Communication
the internal control system must capture and communicate all pertinent information both down and up the organization, as well as communicate information to appropriate external parties.
Internal control systems must be monitored periodically for their adequacy. Significant deficiencies need to be reported to top management and/or the board of directors
Principles of Internal Control Activities
1. establishment of responsibility
2. segregation of duties
3. documentation procedures
4. physical controls
5. independent internal verification
6. human resource controls
Establishment of Responsbility
Control is most effective when only one person is responsible for a given task
Segregation of Duties
1. different individuals should be responsible for related activities
2. the responsibility for record-keeping for an asset should be separate from the physical custody of that asset
Segregation of Record-Keeping From Physical Custody
the custodian of the asset is not likely to convert the asset to personal use when one employee maintains the record of the asset, and a different employee has physical custody of the asset
Documentation Procedures
written evidence to support that a transaction has taken place
Physical, Mechanical, & Electronic Controls
safeguarding of assets and enhance the accuracy and reliability of the accounting records
Independent Internal Verification
1. companies should verify records periodically or on a surprise basis
2. an employee who is independent of the personnel responsible for the information should make the verification
3. discrepancies and exceptions should be reported to a management level that can be appropriate corrective action
Internal auditors
company employees who continuously evaluate the effectiveness of the company’s internal control systems
Other Controls
1. bond employees who handle cash
2. rotate employees’ duties and require employees to take vacations
3. conduct through background checks
Limitations of Internal Control
1. reasonable assurance
2. human element
3. collusion
Reasonable Assurance
rests on the premise that the costs of establishing control procedures should not exceed their expected benefit.
Human Element
good system can become ineffective as a result of employee fatigue, carelessness, or indifference
2 or more individuals acting together to circumvent the internal control
Voucher System
network of approvals by authorized individuals, acting independently, to ensure that all disbursements by check are proper
Petty Cash Fund
cash fund used to pay relatively small amounts
Bank Reconciliation
process of comparing the bank’s balance with the company’s balance
Basic Principles of Cash Management
1. increase the speed of receivables collection
2. keep inventory levels low
3. monitor payment of liabilities
4. plan the timing of major expenditures
5. invest idle cash
Explain the applications of internal control principles to cash receipts
Internal controls over cash receipts include:
a. designating only personnel such as cashiers to handle cash
b. assigning the duties of receiving cash, recording cash, and having custody of cash to different individuals
c. obtaining remittance advices for mail receipts; cash register tapes for over-the-counter receipts, and deposit slips for bank deposits
d. using company safes and bank vaults to store cash with access limited to authorized personnel, and using cash registers in executing over-the-counter receipts
e. making independent daily counts of register receipts and daily comparisons of total receipts with total deposits
f. conducing background checks and bonding personnel who handle ash, as well as requiring them to take vacations
Cash Budget
1. cash receipts
2. cash disbursements
3. financing
Explain the applications of internal control principle to cash disbursements
a. having only specified individuals such as the treasurer authorized to sign checks
b. assigning the duties of approving items for payment; paying the items; and recording the payment to different individuals
c. using pre-numbered checks and accounting for all checks; with each check supported by an approved invoice; after payment, stamping each approved invoice
d. storing blank checks in a safe or vault with access restricted to authorized personnel, and using a machine with indelible ink to imprint amounts on checks
e. comparing each check with approved invoice before using the check; and making monthly reconciliations of bank and book balances
f. bonding personnel who handle cash, requiring employees to take vacations, and conducing background checks
What’s the basis principles of cash management?
a. increase the speed of receivables collection
b. keep inventory levels low
c. monitor the timing of payment of liabilities
d. plan timing of major expenditures
e. invest idle cash
amounts due from individuals and companies
Accounts Receivable
amounts customers own on account; result from the sale of goods and services
Notes Receivable
represent claims for which formal instruments of credit are issued as evidence of the debt
Other Receivables
include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable
Accounts Receivable
1. Recognizing accounts receivable
2. valuing accounts receivable
Bad Debts Expense
cost associated w/ debts that may be not repaid “uncollectible accounts expense”
What impact does bad debt expense have on the Income Statement and Assets?
Income Statement: expenses are increasing, net income goes down
Assets: allowances DA is increasing; assets decrease
Direct Write-Off Method
when a company determines receivables from a particular company to be uncollectible, it charges the loss to Bad Debts Expense
Allowance Method
method by which bad debts are estimated and subsequently recorded as expenses
Allowance for Doubtful Accounts
– contra asset to Accounts/notes receivable
– normal balance is a “credit”
Cash (net) realizable value
net amount a company expects to receive in cash from receivables
Allowance Method
1. companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded
2. Companies record estimated uncollectibles as an increase (a debit) to Bad Debts Expense and an increase (a credit) to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable
3. Companies debit actual uncollectibles to Allowance for Doubtful Accounts and credit them to Accounts Receivable at the time the specific account is written off as uncollectible
Computing Interest
Face Value of Note x Annual Interest Rate x Time In Terms of One Year = Interest
Cash Realizable Value
Accounts receivable – allowance for Doubtful Accounts = Cash Realizable Value
Bad Debt Expense
cost associated with debts that may not be repaid; uncollective accounts expense
Managing accounts receivable involves 5 Steps
1. Determine to whom to extend credit
2. establish a payment period
3. monitor collections
4. evaluate the liquidity of receivables
5. accelerate cash receipts from receivables when necessary
Describe the entries to record the disposition of notes receivable?
Notes can be held to maturity, at which time the borrower (maker) pays the face value plus accrued interest and the payee removes the note from the accounts. In many cases, the holder of the note speeds up the conversion by selling the receivable to another party
How are Accounts Receivable recognized in accounts?
Accounts receivable are recorded at invoice price. They are reduced by sales returns and allowances. Cash discounts reduce the amount received on accounts receivable
Describe the methods used to account for bad debts
the two methods of accounting for uncollectible accounts are the allowance method and the direct writeoff method. Under the allowance method, companies estimate uncollectible accounts as a percentage of receivables. It emphasizes the cash realizable value of the accounts receivable.
What are companies concerned with regarding Receivables?
1. recognizing
2. valuing
3. collecting
Describe the entries to record the disposition of notes receivable
notes can be held in maturity, at which time the borrower (maker) pays the face value plus accrued interest and the payee removes the note from the accounts. In many cases, however, similar to accounts receivable, the holder of the note speeds up the conversion by selling the receivable to another party. in some situations, the maker of the note dishonors the note (defaults), and the note is written off.
Explain the statement presentation of receivables?
Companies should identify each major type of receivable in the balance sheet or in the financial statements. Short-term receivables are considered current assets. Companies report the gross amount of receivables and allowance for doubtful accounts. They report bad debts and service charge expenses in the income statement as operating (selling) expenses, and interest revenue as other revenue and gains in the non-operating section of the statement
What are the principles of sound accounts receivable management?
To properly manage receivables, management must:
a) determine to whom to extend credit
b) establish a payment period
c) monitor collections
d) evaluate the liquidity of receivables
e) accelerate cash receipts from receivables when necessary
Identify ratios to analyze a company’s receivables
The receivables turnover ratio and the average collection period both are useful in analyzing management’s effectiveness in managing receivables. The accounts receivable aging schedule also provides useful information.
Describe methods to accelerate the receipt of cash from receivables
If the company needs additional cash, management can accelerate the collection of cash from receivables by selling (factoring) its receivables or by allowing customers to pay
with bank credit cards.
Aging the accounts receivable
A schedule of customer balances classified by the length of time they have been unpaid.
Average Collection Period
The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the receivables turnover ratio.
Cash Realizable value
the net amount a company expects to receive in cash from receivables
Concentration of credit risk
The threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company.
Direct write-off method
A method of account- ing for bad debts that involves charging receivable balances to Bed Debts Expense at the time receivables from a particular company are determined to be uncollectible.
Dishonored note
a note that is not paid in full at maturity
a finance company or bank that buys receivables from business for a fee and then collects the payments directly from the customers
the party in a promissory note who is making the promise to pay
the party to whom payment of a promissory note is to be made
Promissory note
a written promise to pay a specified amount of money on demand or at a definite time
Receivables turnover ratio
a measure of the liquidity of receivables, computed by dividing net credit sales by average net accounts receivables
Trade receivables
notes and accounts receivable that result from sales transactions`
How does the cost principle apply to plant assets?
The cost of plant assets includes all expenditures necessary to acquire the asset and make it ready for its intended use. Cost is measured by the cash or cash equivalent price paid
the process of allocating the cost of plant, property, and equipment to an expense on the income statement in a systematic manner over the life of the asset
Plant Assets
resources that have physical substance are used in operations of a business, and are not intended for sale to customers
It’s important for companies to keep assets
1. in good operating conditions
2. replace worn-out or outdated assets
3. expand its productive assets as needed
cost principle
consists of all expenditures necessary to acquire an asset and make it ready for its intended use
The cost of land includes:
1. the cash purchase price
2. closing costs such as title and attorney’s fees
3. real estate brokers’ commissions
4. accrued property taxes and other liens on the land assumed by the purchaser
Some advantages of leasing are:
1. reduced risk of obsolescence
2. little or no down payment
3. shared taxed advantages
4. assets and liabilities not reported
Depreciation applies to 3 classes of plant assets:
land improvements, buildings, and equipment
Depreciation Expense
the expense account use to show the cost of the plant property and equipment being used
process by which an asset becomes out of date before it physically wears out
Computing Depreciation
1. cost
2. useful life
3. salvage life
Straight-line method
companies expense an equal amount of depreciation each year of the asset’s useful life
Declining-balance method
computes periodic depreciation using a declining book value
useful life is expressed in terms of the total units of production or the use expected from the asset
Accelerated-depreciation method
a depreciation method that produces higher depreciation expense in the early years than the straight-line approach
Additions & Improvements
costs incurred to increase the operating efficiency, productive capacity, or expected useful life of a plant asset
the process of allocating to expense the cost of an intangible asset
a permanent decline in the fair value of an asset
a contractual arrangement under which the franchisor grants the franchise the right to sell certain products, to provide specific services, or to use certain trademarks to trade names, usually within a designated geographic area
Intangible Assets
rights, privileges, and competitive advantages that result from the ownership of long-lived assets that do not possess physical substance
operating rights to use public property, granted by a governmental agency to a business
Operating Lease
a contractual agreement allowing one party to use the asset of another party; accounted for as a rental by the lessee
Ordinary repairs
expenditures to maintain the operating efficiency and expected productive life of the asset
an exclusive right issued by the US Patent Office that enables the recipient to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant
Research & Development costs
expenditures that may lead to patents, copyrights, new processes, and new products; must be expensed as incurred
a word, phrase, jingle, or symbol that distinguishes or identifies a particular enterprise or product
Accumulated Depreciation
contra asset used to show the past and current year depreciation expense accounted for on the plant, property, and equipment
Salvage Value
assumed value of an asset at the end of its useful life
What are some Intangible Assets?
patents, copyrights, trademarks, tradenames, franchises, licenses, & goodwill
What are the major characteristics of a corporation?
1) separate legal existence
2) limited liability of shareholders
3) transferable ownership rights
4) ability to acquire capital
5) continuous life
6) corporate management
7) government regulations
8) additional taxes
Explain the accounting for the purchase of treasury stock
Companies generally use the cost method in accounting for treasury stock. Under this approach, a company debits Treasury Stock at the price paid to reacquire the shares
Differentiate preferred stock from common stock?
Preferred stock has contractual provisions that give it priority over common stock in certain areas. Typically, preferred stockholders have a preference as to
1) dividends
2) assets in the event of liquidation
Prepare the entries for cash dividends and understand the effect of stock dividends & stock splits
Companies make entries for dividends at the declaration date and the payment date. At the declaration date the entries for a cash dividend are: debit Cash Dividends and credit Dividends Payable.
Identify the items that affect retained earnings?
additions to retained earnings consist of net income. Deductions consist of net loss and cash and stock dividends. In some instances, portions of retained earnings are restricted, making that portion unavailable for the payment of dividends
Whats in a comprehensive stockholders’ equity section?
In a stockholders’ equity section of the balance sheet, companies report paid-in capital and retained earnings & identify specific sources of paid-in capital. Within paid-in capital, companies show two classifications: capital stock and addition paid-in capital. If a corporation has treasury stock, it deducts the cost of treasury stock from total paid-in capital and retained earnings to determine total stockholders’ equity
Evaluate a corporation’s dividend and earnings performance from a stockholder’s perspective?
a company’s dividend record can be evaluated by looking at what percentage of net income it chooses to pay out in dividends, as measured by the dividend payout ratio. Earnings performance is measured with the return on common stockholders’ equity ratio
a document that describes a corporation’s name and purpose, types of stock and number of shares authorized, names of individuals involved in the formation, and the number of shares each individual has agreed to purchase
a company organized as a separate legal entity, with most of the rights and privileges of a person
Cumulative dividend
a feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends
Declaration Date
the date the board of directors formally authorizes the dividend and announces it to stockholders
a distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis
Dividends in arrears
preferred dividends that were suppose to be declared but were not declared during a given period
Legal capital
the amount of capital that must be retained in the business for the protection of corporate creditors
No-par value stock
capital stock that has not be assigned a value in the corporate charter
Paid-in capital
the amount stockholders paid in the corporation in exchange for shares of ownership
Par value stock
capital stock that has been assigned a value per share in the corporate charter
Payout ratio
a measure of the percentage of earnings a company distributes in the form of cash dividends to common stockholders
Record Date
the date when the company determines ownership of outstanding shares for dividend purposes
Retained Earnings
net income that a company retains in the business
Return on common stockholders’ equity ratio
a measure of profitability from the stockholders’ point of view; computed by dividing net income minus preferred stock dividends by average common stockholder’s equity
Treasury Stock
a corporation’s own stock that has been reacquired by the corporation and is behind held for future use
Purpose of Corporations
1) purpose: for profit; not for profit
2) ownership: publicly held; privately held
Type of Corporations
C Corporations, S Corporations, LLC, LLP, LP
Stockholder Rights
1) Vote: board of directors
2) proportionate dividends: right to proportionate dividends
3) preemptive right: before they bring in new investors, they must discuss with current shareholders to keep their portion of their share
4) residual claim: the company liquidates and you get what your percentage is before all the fees and debts
Corporate Stock Categories
1) authorized shares: really big number of shares, you can never increase the amount
2) issued shares: once issued, always issued
3) treasury share: when the company wants to buy back from issued shares
4) outstanding shares: issued – treasury = outstanding shares; shares that aren’t owned by the company
Why do companies buy back their own stock?
1) give it to the employees
2) purchase other companies/buy large items
3) stock is undervalued
4) increase earnings per share ratio
5) prevent hostile takeover
Sections of Stockholders’ Equity
1) paid in capital: APIC
2) retained earnings
Par Value
lowest amount the company can sell their share for
Stated Value
par value except the first word is stated and not par
Paid in Capital in Excess of Par Value
“APIC” additional paid in capital
Treasury Stock

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