Acct 2331 1st EditionExam # 2 Study Guide Lectures: 9 - 15Lecture 9 (February 24)Chapter 4Incorrect Financial StatementsReasons: 1) Errors- accidental errors in recording transactions or applying accounting principles2) Fraud- a person intentionally deceives another person for personal gain or to damage that personOccupational fraud: the use of one’s occupation for personal enrichmentThree elements are present for every fraud that occurs:1) Motive (or pressure)2) Rationalization3) OpportunityManagers- act as stewards/caretakers of the company’s assetsAccounting Fraud:Enron- avoided reporting billions of dollars in debts and lossesWorldCom- misclassified expenditures to overstate assets and profitabilitySarbanes-Oxley Act of 2002 (Public Company Accounting Reform/Investor Protector Act of 2002) Passed by Congress and applies to all companies that are required to file financial statements with the SECMajor Provisions: Oversight Board, Corporate executive accountability, Non-audit services, Retention of work papers, Auditor rotation, Conflicts of interest, Hiring of auditor, Internal controlInternal Controls: eliminate the opportunity of fraudComponents of Internal Control:Monitoring of internal activities and reporting of deficienciesControl Activities are the policies and procedures that help ensure that management’s directives are being carried outRisk Assessment identifies and analyzes internal and external risk factorsControl Environment sets the overall ethical tone of the company with respect to internal controls.1) Preventative Controls-Separation of duties, Physical controls, Proper authorization, Employee management, E-commerce controls2) Detective Controls-Reconciliations, Performance reviews, Audits*Limitations of internal control: bad employees; procedures cannot be 100% effective for success; top level employees can override internal control procedures; susceptible to collusion- 2 or more people acting together to circumvent internal controlsLecture 10 (February 26) Bank Reconciliation: matching the balance of cash in the bank account with the balance of cashin the company’s own recordsReasons: 1) Timing difference- company records transaction before/after the bank records that same transaction2) Errors**a deposit (increase in cash balance) is recorded as a credit in bank statements, a withdrawal (decrease in cash balance) is recorded as a debitSteps for a bank reconciliation: 1) adjust bank’s cash balance deposits outstanding- deposits by the company that have not yet been added to the bank’s record of the company’s balancechecks outstanding- checks the company has written that have not been subtracted from the bank’s record of the company’s balance2) adjust company’s cash balancemay include interest earned by the company, collections made by the bank on the company’s behalf, service fees, charges for Nonsufficient Fundschecks (NSF) which are customers’ checks written on nonsufficient funds3) record items that reconcile the company’s cash balanceCash: CurrencyCoinsBalances in savings/checking accountsChecksCash equivalents (mature within 3 months): Money market fundsTreasury billsCertificates of depositPetty Cash: company takes cash from the a major account to put aside for petty expenses*Requires 3 journal entries to: 1) establish fund (debit Petty Cash, credit CASH)2) record expenses (debit Expenses, credit Petty Cash)3) replenish account (debit Petty Cash, credit CASH)Cash FlowsStatement of Cash Flows:- Operating Activities (cash transactions involving revenues & expenses i.e. paying rent, purchasing supplies, providing services)- Investing Activities (cash investments in long term assets and investment securities i.e. purchasing equipment & land)- Financing Activities (transactions designed to finance the business i.e. borrowing/investment from owners)*Non-Operating Revenues include: dividends, interest earned, etc.Chapter 5Credit Sales- sales/services on account (recorded as debits to Accounts Receivable & credits to Revenue)Accounts Receivable (Trade Receivables)- cash owed to the company by its customers from saleson account; recorded at the time of the credit saleNet Revenues (Net Sales) = Sales - Sales Discounts - Sales Returns & AllowancesTrade/Sales Discounts- provides incentive for customers; reduced from the list prices of a product or service (not recognized directly; record sale at discounted price) Sales Return- customer returns a product & (a) customer’s account balance is reduced if the salewas on account or (b) a full cash refund is givenSales Allowances- product/service NOT returned but seller partially reduces the customer’s balance owed (recorded with a debit to Revenue (decrease) & credit to Accounts Receivable)**Sales Allowances are Contra-RevenuesSales Discount- reduction in the amount to be paid by a credit customer if payment made withina specified time (discount terms); *example: 2/10 = 2% discount if balance is paid in 10 daysn/30 = if customer does not take discount, full balance is due in 30 daysProblems worked from the book: BE4-8Lecture 11 (March 3)Valuing Accounts Receivable*If the company expects to receive payment within a year, the receivable is classified as acurrent asset, otherwise the receivable is classified as a long-term assetTo be useful to decision makers, accounts receivables should be reported at the amount of cash the firm expects to collect, or the Net Realizable Value (NRV)NRV = Total Accounts Receivables - Allowance for Uncollectible AccountsUncollectible Accounts (bad debts)- customers’ accounts that are no longer considered collectible (extending credit to customers boosts sales, but not all customers will pay fully on their accounts) *decreases assets (accounts receivable), increases expenses Bad Debt Expense- represents the cost of the estimated future bad debtsThe Allowance Method: accounts for these uncollectible accounts by allowing for the possibilitythat some accounts will be uncollectible at some point in the future (future bad debts that have not yet occurred but are likely to occur and are recorded in the current year)2 Methods for Estimation of Uncollectible Accounts:1) Percentage-of-Receivables Method (balance sheet method)**adjust TO the amount of uncollectible accounts estimate (estimate will equal the total balance of the Allowance for Uncollectible Accounts)example: 30% of the $20 million of accounts receivables are expected to not be collected ($20million x 30%