Unit 2 Exam Study Guide: Internal Control, Cash, and Receivables

Chapter 4: Internal Control and Cash

Fraud and Its Impact

Fraud refers to intentional acts by individuals to deceive or mislead an organization for personal gain. In accounting, fraud can result in financial losses, misstated financial statements, and loss of stakeholder trust.

• Types of Fraud: Asset misappropriation, financial statement fraud, corruption.

• Impact: Financial loss, legal consequences, damaged reputation.

Objectives and Components of Internal Control

Internal control systems are designed to safeguard assets, ensure accurate financial reporting, and promote operational efficiency.

• Objectives:

  • Protect assets from theft and misuse

  • Ensure reliability of accounting information

  • Promote compliance with laws and regulations

• Components (COSO Framework):

  • Control Environment

  • Risk Assessment

  • Control Activities

  • Information and Communication

  • Monitoring

Bank Reconciliation

Bank reconciliation is the process of matching the balances in an entity's accounting records for a cash account to the corresponding information on a bank statement.

• Bank Side: Includes items known to the bank but not yet recorded by the company, such as deposits in transit and outstanding checks.

• Book Side: Includes items known to the company but not yet recorded by the bank, such as bank fees, NSF checks, and interest earned.

• Adjusted Bank Balance: Calculated by adding deposits in transit and subtracting outstanding checks from the bank statement balance.

• Adjusted Book Balance: Calculated by adjusting the book balance for bank fees, NSF checks, and interest.

• Journal Entries (JEs): Only the book side requires journal entries to record adjustments.

Example: Bank Reconciliation Adjustments

• Bank Statement Balance: $10,000

• Add: Deposits in Transit $2,000

• Less: Outstanding Checks $1,500

• Adjusted Bank Balance: $10,500

• Book Balance: $10,200

• Less: Bank Fees $50

• Less: NSF Check $100

• Add: Interest Earned $50

• Adjusted Book Balance: $10,100

Cash & Cash Equivalents

Cash includes currency, coins, and amounts on deposit in bank accounts. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less.

• Included: Currency, checking accounts, petty cash, Treasury bills, money market funds.

• Not Included: Accounts receivable, inventory, long-term investments.

• Balance Sheet Presentation: Cash and cash equivalents are reported as a single total on the balance sheet.

Chapter 5: Receivables and Revenue Recognition

Revenue Recognition Principle

The revenue recognition principle states that revenue should be recognized when it is earned and realizable, regardless of when cash is received.

• Performance Obligations: Revenue is recognized when a company satisfies its performance obligations to customers.

• FOB Shipping Point: Title transfers to buyer when goods leave seller's premises; revenue recognized at shipment.

• FOB Destination: Title transfers to buyer upon delivery; revenue recognized at delivery.

Journal Entry for Credit Card Sale

When a sale is made via credit card, the company records revenue and recognizes any associated credit card fees.

• Example: Sale of $1,000 with a 2% credit card fee.

• Journal Entry:

  • Debit: Cash $980

  • Debit: Credit Card Expense $20

  • Credit: Sales Revenue $1,000

Sales Returns & Allowances

Sales returns and allowances account for merchandise returned by customers or price reductions granted after a sale.

• Actual Return: Debit Sales Returns & Allowances, Credit Accounts Receivable or Cash.

• Estimated Returns: At period end, estimate future returns and record an adjusting entry.

Example: Journalizing a Sales Return

• Debit: Sales Returns & Allowances

• Credit: Accounts Receivable

Sales Discounts (Gross Method)

Sales discounts are reductions in the amount owed by customers if payment is made within a specified period. The gross method records sales at the full invoice amount and recognizes discounts only when taken.

• Example: 2/10, n/30 means a 2% discount if paid within 10 days; otherwise, full payment due in 30 days.

• Journal Entry for Collection within Discount Period:

  • Debit: Cash (amount received)

  • Debit: Sales Discounts (discount amount)

  • Credit: Accounts Receivable (full invoice amount)

Accounts Receivable (A/R) T-Account

The Accounts Receivable T-account tracks all increases (sales on account) and decreases (collections, write-offs, returns) to the receivable balance.

• Debits: Sales on account

• Credits: Collections, sales returns, write-offs

• Missing Piece: If a balance is missing, use the T-account to solve for the unknown amount.

Net Realizable Value (NRV)

Net realizable value is the amount of accounts receivable a company expects to collect after deducting estimated uncollectible accounts.

• Formula: $NRV = Accounts\ Receivable - Allowance\ for\ Uncollectible\ Accounts$

• Purpose: To present receivables at their expected cash value on the balance sheet.

Allowance Method for Uncollectible Accounts

The allowance method estimates and matches bad debt expense to the period in which related sales occur, using a contra-asset account called Allowance for Doubtful Accounts (or Allowance for Uncollectible Accounts).

• Write-off Journal Entry: Debit Allowance for Doubtful Accounts, Credit Accounts Receivable.

• Balance Sheet Approach: Use an aging report to estimate the required balance in the allowance account and adjust accordingly.

Example: Adjusting Entry for Allowance

• Debit: Bad Debt Expense

• Credit: Allowance for Doubtful Accounts

Note Receivable (N/R)

A note receivable is a written promise for amounts to be received, usually with interest, at a future date.

• Recording a Sale with N/R: Debit Notes Receivable, Credit Sales Revenue.

• Maturity Value (MV): The total amount due at maturity, including principal and interest.

• Formula for Maturity Value: $MV = Principal + Interest$

• Formula for Interest: $Interest = Principal \times Rate \times Time$

• Accrued Interest: At period end, record interest earned but not yet received with an adjusting entry.

Example: Calculating Maturity Value

• Principal: $5,000

• Interest Rate: 6%

• Time: 1 year

• Interest: $5,000 \times 0.06 \times 1 = $300$

• Maturity Value: $5,000 + $300 = $5,300$

Summary Table: Key Journal Entries

Transaction	Debit	Credit
Credit Card Sale	Cash, Credit Card Expense	Sales Revenue
Sales Return	Sales Returns & Allowances	Accounts Receivable
Sales Discount (within period)	Cash, Sales Discounts	Accounts Receivable
Write-off Uncollectible Account	Allowance for Doubtful Accounts	Accounts Receivable
Adjust Allowance (AJE)	Bad Debt Expense	Allowance for Doubtful Accounts
Record Note Receivable	Notes Receivable	Sales Revenue
Accrue Interest on N/R	Interest Receivable	Interest Revenue