Question

• Why are internal controls important for entities' cash?
• What is 'restricted cash' and how is it presented in the balance sheet?
• What is the difference between gross and net approaches to accounting for sales discounts?
• Why does an organization need to account for actual and expected sales returns?
• Why does an organization need to account for possible and actual non-payment by its customers?
• Why do entities engage in receivables financing transactions? What accounting issues do these arrangements cause, and how do we resolve them?

Answer 1

Ans: 1) Internal controls are important for entities' cash because of the followinf reasons:-

· Account for all cash transactions accurately so that correct information is available regarding cash flows and balances.

· Make certain that enough cash is available to pay bills as they come due.

· Avoid holding too much idle cash because excess cash could be invested to generate income, such as interest.

· Prevent loss of cash due to theft or fraud.

The need to control cash is clearly evident and has many aspects. Without the proper timing of cash flows and the protection of idle cash, a business cannot survive.

Ans: 2) Restricted cash refers to money that is held for a specific purpose and thus not available to the company for immediate or general business use. Restricted cash appears as a separate item from the cash and cash equivalents listing on a company's balance sheet..

Ans :3)The difference of net and gross of sales discount is as under:-

· Under gross method, sales are recorded at full invoice value without considering discount.

· Under net method, sales are recorded at value arrived at after reducing cash discount from invoice value.

· Under gross method, entry for cash discount is made when the customer avails it on prepayment. Cash discount is recorded separately as an expense.

· Under net method, no entry is made for cash discount separately. Cash discount forfeited would be recorded as an income in case cash discount is not availed.

     

Ans: 4) If a company cannot reasonably estimate the amount of future returns and/or has extremely high rates of returns on sales, they should recognize revenues only when the right of return expires.

ASC 606 requires that rights of return be treated as variable consideration. Upon transfer of control, an entity that has entered into a contract with a right of return should recognize (1) revenue in the amount of consideration the entity expects to receive after returns are made, (2) a refund liability for the amount the entity expects to return to the customer, and (3) an asset for the goods the entity expects to receive from the customer.

Revenue should not be recorded for the portion of the sale the entity expects to be returned. Instead, this portion should be credited as a refund liability because the entity expects to pay that amount back to the customer. A refund asset should be recognized to reflect the actual value of the goods expected to be returned after considering any expected reduction in the value of the returned goods. Inventory costs that exceed this expected return value of the inventory should be expensed as cost of goods sold.

With this method, revenue recognized at the point of the original sale does not include amounts to which the entity does not expect to be entitled, and the refund asset is not overvalued. Upon lapse of the time period in which returns are allowed, the remaining refund liability and asset should be derecognized by an offsetting entry to revenue and cost of goods sold.

Entities must follow all of the guidance for variable consideration when accounting for rights of return, including applying the constraint. An entity must determine the likelihood and magnitude of a future revenue reversal and only recognize revenue to the extent that a significant reversal of revenue is not probable

Ans:5) The entities needs to account for possible and actual non-payment by its customers because to ascertain the actual profit to recognize.

The amount received by customer is actual sale but is not received then it not income and it should be account for as sales against the same might be recorded earlier. The possible payment will allow entity to recognize loss or bad debt before it occurrence so that provision can be made accordingly.

Ans 6) Account receivable financing is a means of short-term funding that a business can draw on using its receivable. It is very useful if a timing mismatch exist between the cash inflow and outflow of the business. AR financing can be of many types but the three major are:-

Accounts receivable ,Factoring and Asset-backed securities

Accounts Receivable tracks the revenue owed from the customers at any given point in the financial year. As the business records an increase in sales, so does the balance of Accounts Receivables increase. Consequently, as the business receives the payments from the customers, there is a subsequent decrease in the balance of the Accounts Receivables. Therefore, Accounts Receivable is an asset to a business and the effective handling of the same is essential. An understanding of the common accounting errors helps to solve them successfully and organize your books better. Of all the errors that your accounts receivables can face, they come under 3 common issues. The three accounting issues associated with accounts receivable are:

1. Recognizing

2. Valuing

3. Disposing

Basis of Every Accounting Problem in Accounts Receivable

The three accounting issues associated with accounts receivable are listed below. Every error while recording and managing accounts receivables is to do with three processes:

· Recognizing – When to recognize revenue as Accounts Receivable.

· Valuing – How to estimate the Accounts Receivable balance.

· Disposing – How to write off an amount as uncollectible

To find the right solution to an error, informed problem-identification and the most appropriate solution-selection is integral., we will talk about the common accounting errors in AR.

Three Accounting Issues Associated With Accounts Receivable:

Problem 1: How Should A Business Determine Their Income Balances and Their Total Accounts Receivable?

Recognizing:

This is the first step in the chain of processes while calculating accounts receivable. This is, therefore, also the first place where the errors can crawl in. A business needs to recognize where the revenue is earned and where it is realized. The former is when the income is earned and the transaction is complete. The latter is when the business receives cash or claim for cash. It is this realized income that forms the base of where the accounting errors can be faced.

It is the realization of income that involves “Granting Credit”. The business needs to make a crucial decision on when to grant credit. This involves the following-

· Gathering the credit histories and the financial statements from customers determines their repaying capacity.

· The business also needs to determine the extent of credit that is allowed for each customer.

· The time that a customer will take to repay the credit owed.

Problem 2: How To Calculate The Actual Expected Accounts Receivables After Determining The Total Defaulter Accounts?

Valuing:

Picking up from the “realized loans” that business grants its customers is the idea that some of it will turn into defaulter accounts. This risk, that some of these doubtful accounts will fail to repay the dues needs to be calculated and adjusted in the balance sheets duly. The reporting of the correct amount of accounts receivables is another integral accounting decision. However, this too is where multiple errors can crawl in.

· Bad debt expenses AKA uncollectible accounts expenses need to be avoided by establishing an “allowance for doubtful accounts”. This helps in decreasing the business’ accounts receivable and income balances. This makes use of the enterprises’ past collection history to draw an estimation of the allowance.

· There are two methods for this calculation: The direct write-off method and the accounting for uncollectible accounts.

· The direct write-off method is when the company is aware that a customer will default and they write-off that balance.

· Accounting for uncollectible accounts is a method wherein your accountant records only a portion of the accounts receivable that the company believes will remain uncollected. This, in turn, reduces the net value of the accounts receivables.

· This estimation is based on the analysis of the total sales that the business has made previously and the proportion of collections it did back then. Or by creating separate categories of the accounts receivables based on how long have they been due. For this is you apply a separate percentage to each.

· The total of these amounts makes the complete estimation for the uncollectible amounts.

Problem 3: When to decide that it is the right time to dispose-off the amount due to uncollectible?

Disposing:

This is the stage when it becomes apparent that a customer is not and will not be paying the outstanding liability, it is important for the business to write off that amount. The write-off will no longer be an estimate.

· The goal here is that the overall income should not be affected as the initial allowance was already put in the picture.

· When the receivable is written-off, you decrease the allowance for the potentially doubtful accounts and decrease the accounts receivable balance accordingly.

· The purpose of this entry is to reflect on the accounts receivable balance the current outstanding amount that the business is due to collect.

How Can You Improve The Accounts Receivable Recording and Calculations?

These are some of the ways that you can adopt to do away with the common accounts receivable accounting errors. These are:

· Reducing the DSO

· Improving AR Productivity

· Reducing Portfolio Risks

· Performing An Analysis

Let us see each of them closely:

Reducing Days Sales Outstanding (DSO):

· The first step here involves improving the billing process and sending out the invoices on time. If you find that the manual process is tedious then, you can opt for an automated billing process. The longer it takes you to send the invoices, the longer does your customers take to pay you back.

· You can also offer discounts to receive quicker payments. This could also be in the shape of incentives that you offer to customers who make quick payments.

· Increase the number of modes of payment that your business expects.

· The most efficient way to reduce your bad debt expenses is to do away with the clients who are regular defaulters.

Improving AR Productivity:

· Improving your AR Productivity involves clearing and streamlining the process itself. This includes spending time on the customer’s information, updating spreadsheets, correcting data errors and other non-value adding activities. This is where outsourcing accounts receivable comes to place.

· Outsourcing Accounts Receivable can help you focus on communicating with the customers, set the logistics in place and perform other operations key to your business while being assured that your bad debt expense is minimal. This is also a time saving and cost-efficient alternative to doing your business.

Reducing Your Portfolio Risks:

Knowing your customers and their portfolio is critical to the financial health of your accounts receivables.

· Assessing the difference between good credit and bad credit is the key. What the distinction is based on:

· The credit-worthiness of a customer over time.

· Bad customer references

· Incomplete verification of customer references.

· An outsourced account receivable service can score your customers with potential credit scores, based on these points. They would also share insights on who is financially healthy to do business with and who is not.

· Additionally, they follow with credit references and send non-complying statements to defaulting accounts promptly.

Performing an Analysis:

Reviewing your AR weekly basis is essential to track the defaulting customers and to eventually reduce your AR balances over time.

Wrapping Up:

If you are running a business, its financial health is largely dependent upon how you organize the transactions and the status of the cash flow. Therefore, the status and the processing of the Accounts receivable are integral.

Needless to say, like any other accounting activity, these too face errors. Furthermore, as discussed the three accounting issues encountered in accounts receivable are recognizing, valuing and disposing of. These can be done away with expert assistance who pays heed to:

· Firstly, reducing DSO and customer portfolio risk.

· While consequently increasing AR productivity and analysis.

Outsourcing these activities helps to organize them efficiently and to save time.