Unit 2 Exam Study Guide: Internal Controls, Cash, Receivables, and Revenue Recognition

Internal Controls and Reporting Cash

Fraud and Its Impact

Fraud refers to intentional deception made for personal gain or to damage another individual. In financial accounting, fraud can lead to misstated financial statements and loss of assets.

• Fraud Impact: Can result in financial losses, legal consequences, and loss of reputation for a business.

• Common Types: Asset misappropriation, financial statement fraud, corruption.

Objectives and Components of Internal Control

Internal control systems are designed to safeguard assets, enhance the reliability of accounting records, increase efficiency, and ensure compliance with laws and regulations.

• Objectives: Safeguard assets, ensure accurate and reliable accounting records, promote operational efficiency, and encourage adherence to policies.

• Components:

  • 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 Balances: Both the bank and book sides are adjusted to reflect the true cash balance.

Example Calculation:

• Start with the bank statement balance.

• Add deposits in transit.

• Subtract outstanding checks.

• Result is the adjusted bank balance.

• Start with the book balance.

• Add interest earned and collections by bank.

• Subtract bank fees and NSF checks.

• Result is the adjusted book balance.

Journal Entries (JEs): Only the book side requires journal entries to record items not yet in the company's books.

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 so near their maturity that they present insignificant risk of changes in value.

• Included: Currency, checking accounts, petty cash, Treasury bills, money market funds (with maturities of three months or less).

• Not Included: Postdated checks, IOUs, restricted cash.

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

Receivables and Revenue Recognition

Revenue Recognition Principle

The revenue recognition principle states that revenue should be recognized when a performance obligation is satisfied, typically when goods or services are transferred to the customer.

• Performance Obligations: A promise to transfer a good or service to a customer.

• FOB Shipping Point: Title passes to buyer when goods leave seller's premises; buyer pays shipping.

• FOB Destination: Title passes to buyer when goods arrive at destination; seller pays shipping.

Journal Entries for Credit Card Sales

When a sale is made via credit card, the company records the sale and the associated fee charged by the credit card company.

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

$\begin{align*} \text{Cash} & = \$980 \\ \text{Credit Card Expense} & = \$20 \\ \text{Sales Revenue} & = \$1,000 \end{align*}$

Sales Returns & Allowances

Sales returns and allowances are contra-revenue accounts used to record returns of merchandise and reductions in selling price.

• Actual Return: Record the return by debiting Sales Returns & Allowances and crediting Accounts Receivable or Cash.

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

Sales Discounts

Sales discounts are reductions in the amount owed by customers who pay within a specified period. The gross method records sales at the full invoice amount and recognizes discounts when taken.

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

• Journal Entry: When payment is received within the discount period, debit Cash and Sales Discounts, credit Accounts Receivable.

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, reinstatements of previously written-off accounts.

• Credits: Collections, write-offs, sales returns, sales discounts.

Net Realizable Value (NRV)

Net realizable value is the amount of accounts receivable a company expects to collect. It is calculated as:

$\text{NRV} = \text{Accounts Receivable} - \text{Allowance for Uncollectible Accounts}$

• Allowance for Uncollectible Accounts: A contra-asset account used to estimate receivables that may not be collected.

Allowance Method for Uncollectible Accounts

The allowance method estimates bad debts at the end of each period, matching bad debt expense to the period's sales.

• Write-off: When an account is deemed uncollectible, debit Allowance for Uncollectible Accounts and credit Accounts Receivable.

• Balance Sheet Approach: Uses an aging schedule to estimate the required balance in the allowance account and makes an adjusting journal entry (AJE) accordingly.

Note Receivable

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

• Recording a Sale with a Note Receivable: Debit Notes Receivable, credit Sales Revenue.

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

$\text{Maturity Value} = \text{Principal} + \text{Interest}$

$\text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time}$

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

Summary Table: Key Journal Entries

Transaction	Debit	Credit
Credit Card Sale	Cash, Credit Card Expense	Sales Revenue
Sales Return (actual)	Sales Returns & Allowances	Accounts Receivable or Cash
Estimated Sales Returns (AJE)	Sales Returns & Allowances	Allowance for Sales Returns
Sales Discount (within period)	Cash, Sales Discounts	Accounts Receivable
Write-off Uncollectible Account	Allowance for Uncollectible Accounts	Accounts Receivable
Record Note Receivable	Notes Receivable	Sales Revenue
Accrue Interest on Note	Interest Receivable	Interest Revenue

Additional info: Academic context and examples have been added to expand on the brief exam review points and ensure the notes are self-contained for study purposes.