ACCT 229 Exam 2

Involuntary disposal

occurs when assets are lost or destroyed through theft, acts of nature, or by accident.

Voluntary disposal

occurs when the company determines that the asset is no longer useful.

Management wants to make sure that employees

operate within the scope of their assigned responsibility and act for the good of the business

Operating Margin=

operating income/net sales

purchase discounts

price reductions

The historical cost principle requires that a company

record its fixed assets at the exchange price at the time the asset is purchased.

Asset management

refers to how efficiently a company is using the resources at its disposal.

Inventory

represents products held for resale and is classified as a current asset on the balance sheet.

Finished goods inventory

represents the cost of the final product that is available for sale.

Cost of goods sold

represents the outflow of resources caused by the sale of inventory and is the most important expense on the income statement of companies that sell goods instead of services.

Accumulated depreciation

represents the total amount of depreciation expense that has been recorded for an asset since the asset was acquired

Safeguarding

requires physical protection of the assets through, for example, fireproof vaults, locked storage facilities, keycard access, and anti-theft tags on merchandise.

Gross margin

sales revenue minus cost of goods sold.

third stage of the operating cycle

selling inventory

Periodic System

All items purchased for resale are debited to a "PURCHASES" account. Uses the COGS formula

Control of Cash Disbursements

All major disbursements made by check, Pay only small, misc. expenditures from Petty Cash, Prepare Bank Reconciliation

straight-line depreciation method

allocates an equal amount of an asset's cost to depreciation expense for each year of the asset's useful life.

average cost method

allocates the cost of goods available for sale between ending inventory and cost of goods sold based on a weighted average cost per unit.

last-in, first-out (LIFO) method

allocates the cost of goods available for sale between ending inventory and cost of goods sold based on the assumption that the most recent purchases are the first to be sold

specific identification method

allocates the cost of purchases according to the physical flow of specific units through inventory; based on a flow of goods principle

Cost Allocation concept of intangible assets

amortization

Principal

amount borrowed

Allowance for Doubtful Accounts

amount of AR that you DO NOT expect to receive

cash over and short

an account that records discrepancy between deposited accounts of actual cash received and and the total of the cash register tape

Segregation of duties

assure that no one person prepares all the documents & records for an activity

Clearly defined Authority & Responsibility

authority and responsibility for approval of purchases/writing checks, etc.

debit card

authorizes a bank to make an immediate electronic withdrawal (debit) from the holder's bank account.

Average Age of fixed assets =

accumulated depreciation / depreciation expense

Information and communication

adequate information is identified and gathered on a timely basis to help a company achieve its objectives

depreciable cost

the amount that will be depreciated (expensed) over the asset's useful life.

Raw materials inventory

the basic ingredients used to make a product.

The length of the operating cycle influences

the classification of assets and liabilities on balance sheets.

If a customer returns an item for some reason

the company will make an adjustment to decrease sales revenue for the amount of the return.

Bad Debts

the cost of doing business on credit with customers who do not pay

purchase return

the cost of merchandise returned to supplier

a company should use the net method when

the customer is expected to pay within the discount period

a company should use the gross method when

the customer is not expected to pay within the discount period.

2 categories of Long-term Tangible Assets

non-depreciable assets & depreciable assets

salvage (residual) value

$ amount expected to be recovered at the end of the asset's life when it is sold

Depreciation cost per unit =

(cost - residual value) / expected usage of the asset

depletion rate =

(cost - residual value) / recoverable units

Straight-line depreciation expense =

(cost-residual value)/useful life

Declining Balance Rate =

(m) x Straight-line rate

Components of Notes:

- principal - interest - maturity value - time period

Advantages of FIFO

1. Assigns current cost to ending inventory 2. Good method when inventory turnover is rapid

Periodic System:

1. Debts all inventory items to "Purchases" account 2. Make NO entry to update "COGS" & "Inventory" accounts with each sale 3. Make a physical count @ year end to determine "COGS" using formula

Perpetual System:

1. Debts all inventory items to "inventory" account 2. Updates "COGS" & "Inventory" account with each sale 3. Uses physical count @ year end to determine "Loss on Shrinkage"

Disadvantages of FIFO

1. Fails to match most recent costs with revenues 2. If prices are rising, matches oldest unit costs with current revenues, therefore making Net Income higher (Inventory Profits)

Disadvantages of LIFO

1. Gives non current value to inventory on balance sheet 2. If/when international financial reporting standards (IFRS) are adopted in the US, LIFO will not be allowed as a reporting method

The recording of sales revenue involves two journal entries:

1. In the first journal entry, sales revenue is recognized. 2. The second journal entry recognizes, consistent with the expense recognition principle, the cost of the goods related to the products that are sold.

Advantages of LIFO

1. Matches current costs with current revenues 2. in periods of rising prices, Net Inc. is always less

Operating assets are divided into three categories:

1. PPE 2. Intangible assets 3. Natural Resources

Average Cost Method - Periodic

1. Uses weighted average of all costs for GAS ("Goods Available for Sale" 2. Assigns average cost to both Ending Inventory & COGS

cash management principles entail the following:

1. delaying payments to suppliers 2. speeding up collection from customers in order to invest the cash sooner or reduce the need for additional financing 3. earning the greatest return on any excess cash

The control environment includes the following:

1. philosophy and operating style of management, 2. personnel policies and practices of the business 3. overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control

how many years does a trademark have?

10 years; can be renewed indefinitely

How many years does a patent live?

20 years granted by the federal gov

Ave. Collection Period

365/ AR turnover

average days to sell inventory =

365/inventory turnover

how many years does a copyright have?

70 years + life of the creator

maturity value

= principal + interest

Accounts affected from bad debts:

Bad Debt Expense, Accounts Receivable, Allowance for Doubtful Accounts

certificates for amortizing revolving debts (CARDs)

Banks use similar arrangements to package their credit card receivables into securities

Inventory Turnover Ratio =

COGS/Average Inventory

Tools of Effective Cash Management include:

Cash controls over receipts and disbursements, Preparation of bank reconciliations, Use of Petty Cash fund

Examples of Cash

Cash on Hand + Cash in Banks + Undeposited ChecksCash appears on Balance Sheet & Statement of Cash Flows

What is a liability for a bank?

Checking account

account receivable

Classified as a "current asset" on the Balance Sheet. Must be reported at "the amount the business expects to collect"... this is called the Net Realizable Value

What does Control Activities: Internal Control Procedures consist of?

Clearly defined Authority & Responsibility, Segregation of duties, Adequate documents & Records, Safeguarding assets and records, and Independent review and appraisal

What does Internal Control consist of?

Control environment, risk assessment, information & communication, monitoring, and control activities

First-In, First-Out (FIFO)

Cost of first item purchased = cost of first item sold (COGS)

Last-In, First-Out (LIFO)

Cost of last item purchased = cost of first item sold

Good Cash Management Practices

Delay payments to suppliers (earning interest), Keep inventory low to not tie up cash, Speed collection from customers (invest cash/reduce financing), Highest return on excess cash, Deposit Cash Collections Daily

When should we record uncollectable receivables?

Direct Write-Off Method, Allowance Method, Journal entries

Income Statement Method

Est. = % of Credit Sales for year * Once you calculate your estimate, this is "Bad Debt Exp." On Income Statement - "Credit Sales" $Estimate = Bad Debt Expense

Balance Sheet Method

Est. = % of End A/R. $ Estimate = End. ADA

Allowance Method

Estimates Bad Debt Expense at end of year and recorded through an AJE. Follows MATCHING!

revenue expenditures

Expenditures that do not increase the future economic benefits of the asset

capital expenditures

Expenditures that extend the life of the asset, expand the productive capacity, increase efficiency, or improve the quality of the product

Goods available for sale =

Inventory available for sale x Cost per unit

Components of Notes Receivable

Maker, Payee, Note Payable

CASH MANAGEMENT

Necessary to ensure company has neither too little nor too much cash on hand.

Net Purchasing Costs =

Net Purchases + Other Purchasing Costs

Accounts Receivable Turnover=

Net Sales / Average Net Accounts Receivable

Fixed Asset Turnover Ratio =

Net Sales / Average Net Fixed Assets

Opportunity

One of the elements typically cited in discussions of theft and fraud

Reasons why cash controls are more effective when companies pay with a check for the following reasons:

Only certain people have the authority to sign the check Supporting documents are marked paid to avoid duplicate payment. Checks are prenumbered, which makes it easy to identify any missing checks.

What does INTERNAL CONTROL SYSTEM consist of?

Operations objectives, Reporting objectives, Compliance objectives

Acquisition Cost of land =

Purchase price + commissions + taxes due + any land preparation costs - less proceeds from salvage

Bank Reconciliation

Reconciles timing differences and errors

Control of Cash Receipts

Record when received & safeguard, Deposit receipts intact, Separation of duties - Different employees for each of the following: recording, custody & authorization

Direct Write-Off Method

Records Bad Debt Expense only when the bad debt customer has been identified *Violates Matching

LIFO Inventory Value =

Reported FIFO Inventory - LIFO Reserve

examples of cash equivalents

Short-term, highly liquid investments; must be readily convertible into known amount of cash and near maturity that interest rate changes won't affect their market value. (Original maturity of 3 months or less); EX. CD, TBills (Notes, Commercial Paper, MMF, bonds)

Purpose of Tangible Assets

Spread out the original cost of the asset's useful life. Only depreciate PP&E that has a limited useful life.

Purpose of intangible assets

Spread out the original cost of the intangible over the years of the asset's useful life. Only amortize those intangibles with a limited useful life.

Purchase Discounts:

The Purchase Discounts account accumulates the amount of discounts on purchases taken during the period.

Purchase Returns and Allowances:

The Purchase Returns and Allowances account accumulates the cost of any merchandise returned to the supplier or any reductions (allowances) in the purchase price granted by the seller.

Purchases:

The Purchases account accumulates the cost of the inventory acquired during the period.

Transportation-In:

The Transportation-In account accumulates the cost paid by the purchaser to transport inventory from suppliers.

certificates for automobile receivables (CARs)

The financial institutions pay GMAC with funds raised from the sale of securities or notes

merchandise inventory

The inventory held by merchandisers

Depreciable base

The maximum amount of depreciation that can be recorded over the asset's life cost - salvage value = max AD

Payee

The party that will receive the money from a promissory note at some future date (lendor)

Reporting Objectives

The reliability and accuracy of its accounting records

Operating Objectives

The safeguarding of a company's assets & operations are effective & efficient

cost of goods available for sale

The sum of beginning inventory and purchases

The following issues may result in dissatisfaction with the merchandise:

The wrong merchandise was delivered. The merchandise did not conform to specification. The merchandise was damaged or defective. The merchandise arrived too late at its destination.

OPERATING CYCLE

Time between good purchased (for resale) and collection of cash from customers and can affect classification of assets/liabilities on balance sheet

Estimated Bad Debt Expense =

Total credit sales x % of credit sales estimated to default

Costs of Goods Sold =

Units Sold x Weighted Average Cost per Unit

Ending Inventory =

Units on Hand x Weighted Average Cost per Unit

COGS =

Units sold x Cost per Unit

outstanding check

a check issued and recorded by the business that has not been ''cashed'' by the recipient of the check

non-sufficient funds (NSF) check

a check that has been returned to the depositor because funds in the issuer's account are not sufficient to pay the check (also called a bounced check).

units-of-production depreciation method

a depreciation method that allocates the cost of an asset over its expected life in direct proportion to the actual use of the asset; depreciation expense is computed by multiplying an asset's depreciable cost by a usage ratio.

Note Payable

a liability resulting from the signing of a promissory note by the maker and the acceptance of the payee

impairment

a permanent decline in the future benefit or service potential of an asset.

Sales discount

a price reduction that companies may offer to encourage prompt payment

Securization

a process in which large businesses and financial institutions frequently package factored receivables as financial instruments or securities and sell them to investors

fixed asset turnover ratio

a ratio that indicates how efficiently a company uses its fixed assets. This ratio is calculated by dividing net sales by average fixed assets.

quantity discount

a reduction in the selling price granted by the seller because selling costs per unit are less when larger quantities are ordered

trade discount

a reduction in the selling price granted by the seller to a particular class of customers

average age of fixed assets

a rough estimate of the age of fixed assets that can be computed by dividing accumulated depreciation by depreciation expense.

sales allowances

a service that was not completed on time

Bank credit cards

a special form of factoring

petty cash

an amount of cash kept on hand and used for making small payments

deposit in transit

an amount received and recorded by the business, but which has not been recorded by the bank in time to appear on the current bank statement.

interest

an expense for the borrower; income/revenue for the lender/creditor; The excess of the total amount of money collected over the amount lent

organizational costs

an intangible asset that provides a benefit to a company indefinitely.

What does the Sarbanes-Oxley Act require all publicly traded corporations to have?

an internal audit function that reports to the audit committee of the board of directors

nontrade receivables

arise from transactions not involving inventory

Aging Method

bad debt expense is estimated by determining the collectability of the accounts receivable rather than by taking a percentage of total credit sales

the allowance method

bad debt expense is recognized in the period of sale, which allows it to be properly matched with revenues.

perpetual inventory system

balances for inventory and cost of goods sold are continually updated with each sale or purchase of inventory

Credit memo

bank increases your cash account, addition on bank statement

Debit memo

bank reduces your cash account

first-in, first-out (FIFO) method

based on the assumption that costs move through inventory in an unbroken stream, with the costs entering and leaving the inventory in the same order

First stage of the operating cycle

buying inventory

Adequate documents & Records

capture all relevant information about a transaction and assist in proper recording and classification. All documents should be properly controlled.

accounting system

consists of the methods and records used to identify, measure, record, and communicate financial information about a business.

Bad Debt Expense

classified as a "selling expense" on the income statement and closed at the end of the year

Manufacturers

companies that buy and transform raw materials into a finished product, which is then sold.

Merchandisers

companies that purchase inventory in a finished condition and hold it for resale without further processing.

Compliance Objectives

compliance with applicable laws & regulations

Work-in-process inventory

consists of the raw materials that are used in production as well as other production costs such as labor and utilities

Weighted Average Cost per Unit =

cost of goods available for sale/units available for sale

Purchases

cost of merchandise acquired for resale during the accounting period

freight-in

costs that are considered part of the total cost of purchases and the inventory account is increased.

depletion =

depletion rate x units recovered

Cost Allocation Concept of Tangible Assets

depreciation

two methods to record bad debt expense:

direct write-off method and the allowance method

Accounts receivable

do not have a formal note

periodic inventory system

does not require companies to keep detailed, up-to-date inventory records

Trade receivables

due from customers purchasing inventory in the ordinary course of business

cost of ending inventory =

ending inventory x cost per unit

bank reconciliation

ensures that the accounting records are consistent with the bank's accounting records, any differences must be "reconciled."

Goods in Transit

goods ordered bit not yet received. (FOB Shipping Point and FOB Destination)

consignment

goods owned by one party are held and offered for sale by another.

Gross Profit Margin=

gross profit/net sales

Gross Profit Ratio =

gross profit/net sales

Risk assessment procedures are designed to

identify, analyze, and manage strategic risks and business process risks.

Goods called in

if goods are ordered, as long as goods are identified and separate, they belong to buyer

LIFO Conformity Rule

if you use LIFO for tax purposes, you must also use this method for financial reporting purposes

purchase allowance

instances where the purchaser may choose to keep the merchandise if the seller is willing to grant a reduction of the purchase price

Time Period

interest rate expressed as an "Annual Rate". To convert to shorter time periods, express as fraction of time

Acquisition Cost of equipment =

invoice price - purchase discounts + transportation in + installation costs + trial runs + sales tax

Perpetual System

keeps a running total of the inventory on hand. The only system that identifies "losses" due to theft/shrinkage/spoilage

conservatism principle

leads accountants to select the accounting methods or procedures that produce the lowest net income and net assets in the current period.

All goods in which the company has

legal title

operating assets

long-lived assets that are used by the company in the normal course of operations

Control Environment

management's competence and operating style, personnel policies, and influence by the board of directors

Examples of Business Processes

materials acquisition, production, logistics and distribution, branding and marketing, and human resources.

Retailers

merchandisers that sell directly to consumers.

Wholesalers

merchandisers that sell to other retailers

acct rec turnover

net credit sales/avg acct rec

net profit margin=

net income/net sales

F.O.B. shipping point:

ownership of the inventory passes from the seller to the buyer at the shipping point

F.O.B. destination:

ownership of the inventory passes when the goods are delivered to the buyer

second stage of operating cycle

paying for inventory

Independent review and appraisal

periodic review of the accounting system and the people operating it (external audit) to ensure that amounts are correct & correspond to properly authorized activities

PEST Factors

political, economic, social, and technological

Strategic risks

possible threats to the organization's success in accomplishing its objectives and are EXTERNAL to the organization

Interest=

principal x annual interest rate x fraction of 1 year

risk assessment

procedures designed to identify, analyze, and manage strategic risks and business process risks

internal control system

procedures that management puts in place o control employees' activities

depletion

process of allocating the cost of the natural resource to each period in which the resource is used

Depreciation

process of allocating, in a systematic and rational manner, the cost of a tangible fixed asset (other than land) to expense over the asset's useful life.

Monitoring

process of tracking potential and actual problems in the internal control system.

declining balance depreciation method

produces a declining amount of depreciation expense each period by multiplying the declining book value of an asset by a constant depreciation rate.

Notes Receivable

promissory notes that a business accepts from customers; A "note" is a legal document given by a borrower to a lender stating the timing of repayment and the amount to be repaid

Safeguarding assets and records

protect assets and accounting records from loss, theft, unauthorized use, etc.

Acquisition Cost of buildings =

purchase price + renovation costs + legal and realty fees + title fees

Net Purchases =

purchases - purchase discounts - purchase returns and allowances

profitability ratios

ratios that measure two aspects of a corporation's profits: (1) those elements of operations that contribute to profit and (2) the relationship of profit to total investment and investment by stockholders.

Notes receivable

receivables that generally specify an interest rate and a maturity date at which any interest and principal must be repaid

bank statement

shows the beginning and ending account balance and the individual deposits and withdrawals recorded by the bank during the period.

Specific Identification (perpetual)

small quantity of inventory, high-priced items. Impractical for most businesses. However, with the cost of technology going down, Specific Identification method is becoming more practical and common (Autos, art, custom jewelry)

four inventory costing methods:

specific identification first-in, first-out (FIFO) last-in, first-out (LIFO) average cost

The most common depreciation methods are:

straight line, declining balance, units of production

What are short-term investments are purchased with?

temporary cash surpluses

Generally accepted accounting principles do not require

that the cost flow assumption be consistent with the physical flow of goods.

The length of the operating cycle affects

the amount of capital a business needs and the policies that govern its sales of goods and services

residual value

the amount of cash or trade-in consideration that the company expects to receive when an asset is retired from service

principal

the amount of money borrowed and promised to be repaid

Operating cycle

the elapsed time between the purchase of goods for resale and the collection of cash from customers

The more efficiently a company uses its fixed assets,

the higher the ratio

the operating cycle plays an important role in

the measurement of income

Cosigned Goods

the owner transfers physical goods to agent for purposes of selling without giving up legal title

Maker

the party that agrees to repay the money for a promissory note at some future date (borrower)

Under the allowance procedure, two methods commonly used to estimate bad debt expense are

the percentage of credit sales method and the aging method.

useful life

the period of time over which the company anticipates deriving benefit from the use of the asset.

For intangible assets purchased from outside the company,

the primary element of the cost is the purchase price

monitoring

the process of tracking potential and actual problems in the internal control system

amortization

the process whereby companies systematically allocate the cost of their intangible operating assets as an expense among the accounting periods in which the asset is used and the benefits are received.

When receivables are factored,

the seller receives an immediate cash payment reduced by the factor's fees.

lower of cost or net realizable value (LCNRV) rule.

the value at which inventory is reported under GAAP, where cost is the historical cost of the inventory and net realizable value is the estimated selling price minus the costs of disposal

operating assets are held until

their service potential has been exhausted

Porter's Five Forces

threat of entry, threat of substitute, supplier power, buyer power, and competitive rivalry

FOB Shipping Point

title transfers to buyer when goods are accepted by common carrier

FOB destination

title transfers when goods are delivered to destination of buyer

accounts receivable turnover ratio

to compare companies' efficiency in collecting receivables. Acct. Rec. Turnover = Net Sales/ Average Net Accounts Receivable

Modified Accelerated Cost Recovery System (MACRS)

to compute depreciation expense for their tax returns

What is an important aspect of cash management?

to keep inventory levels low

The direct write-off method

waits until an account is deemed uncollectible before reducing accounts receivable and recording the bad debt expense.

The underlying difference between the percentage of credit sales method and the aging method is

what is being estimated

sales return

when a customer returns a product

freight-out

when the seller is usually responsible for paying the transportation costs

The Internal Revenue Code specifies

which depreciation method a company should use to prepare tax returns.