Accounting 201 -Exam 2

Purchase Returns and Allowances - The buyer

*Journal*: Debit: Accounts Payable/ Credit: Inventory

Purchase Discounts - The buyer

*Journal*: Debit: Accounts payable (minus sales returns-without considering the discount yet) Credit: Inventory (discount amount) and Credit: Cash (total - discount amount)

Purchase Discounts - The seller

*Journal*: Debit: Cash (The total amount received with the discount) Debit: Sales Discount (to record the amount of the discount) Credit: Account Receivable (the total amount without discount)

Recording Sales of Merchandise - The Seller

*Journal*: Debit: Cash or Accounts Receivable/ Credit: Sales Revenue *To Adjust Inventory*: Debit: Cost of goods sold/ Credit: Inventory

Purchase Returns and Allowances - The seller

*Journal*: Debit: Sales returns and allowances/ Credit: Accounts Receivable *Adjust Inventory*: Debit: Inventory/ Credit: Cost of goods sold -(on non-defective merchandise)

Non-operating activities

*Other Revenues and Gains* - Interest revenue, dividend revenue, rent revenue, gain. *Other Expenses and Losses* - interest expense, casualty losses, loss form sale or abandonment of property, plant, and equipment, loss from strikes from employees and suppliers.

Balance Sheet effects- FIFO method

- A major advantage of _________________- is that in a period of inflation, the costs allocated to ending inventory will *approximate their current cost*.

Operating Cycles

- The _________________________ of a merchandising company ordinarily is longer than that of a service company.

Sales Returns and Allowances

-"flip side" of purchase returns and allowances -Contra-revenue account to Sales Revenue (Debit) -Sales not reduced (debited) because: -would obscure importance of sales returns and allowances as a percentage of sales. -could distort comparisons.

Balance Sheet effects - LIFO method

-A major shortcoming of the ________________ - is that in a period of inflation, the costs allocated to ending inventory may be *significantly understated* in terms of current cost.

Income Statement Effects of inventory errors

-Affect the computation of cost of goods sold and net income in two periods -Beginning Inventory + Cost of goods purchased minus Ending inventory = Cost of goods sold

Average-Cost

-Allocates cost of goods available for sale on the basis of *weighted-average unit cost* incurred. -Applies weighted-average unit cost to the *units on hand* to determine cost of the ending inventory. (Total cost of units on hand/ total units = average cost of all units available for sale) - Compute COGS: ex. 550 units sold x ave cost $12 = $6600 -compute ending inventory: Total cost -COGS = ending inventory. -Shows an average net income and medium tax effects

Current Assets

-Assets that a company expects to convert to cash or use up within one year or the operating cycle, whichever is longer

Merchandising Companies

-Buy and sell goods -Primary source of revenues is referred to as sales revenue or sales.

Current Assets- on Balance Sheet

-Cash and cash equivalents -short-term investments -Accounts receivable -Inventories -Prepaid expenses and other current assets (Usually listed in the order they expect to convert them into cash)

Inventory is accounted for at cost

-Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. -Unit costs are applied to quantities to compute the total cost of the inventory and the cost of goods sold using the cost flow assumptions (specific identification, FIFO, LIFO, and Average cost. )

FIFO

-Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold. -Often parallels actual physical flow of merchandise -companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed - will show higher net income -LISH assumption- last in still here

LIFO

-Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. -Seldom coincides with actual physical flow of merchandise. -Exceptions include goods stored in piles, such as coal or hay. -Shows a lower net income which means lower taxes paid. FISH assumption- first in still here -

The Classified Balance Sheet-Liabilities and Owner's Equity

-Current liabilities -Long term liabilities -Owner's (Stockholders') equity

Freight Cost incurred by the Buyer

-FOB shipping Point -Part of the cost of merchandise purchased -Journal - Debit: Inventory/Credit: Cash

Freight Cost incurred by the Seller

-FOB shipping destination - part of operating expense -Journal - Debit: Freight-out/ Credit: cash

Inventory errors on the Financial Statement: Common Causes

-Failure to count or price inventory correctly -Not properly recognizing the transfer of legal title to goods in transit. -Errors affect both the income statement and balance sheet.

Long-term Investments

-Investments in stocks and bonds of other companies. -Investments in long-term assets such as land or buildings that is not currently being used in operating activities. -Long-term notes receivable.

Cost of goods sold

-Is the total cost of merchandise sold during the period.

Property, Plant, and Equipment

-Long useful lives. -Currently used in operations. -Depreciation - allocating the cost of assets to a number of years. -Accumulated depreciation - total amount of depreciation expensed thus far in the asset's life.

Sales Discounts

-Offered to customers to promote prompt payment of the balance due -Contra-revenue account (debit) to sales revenue. -With Revenue on the income statement in a merchandising companies financial statements.

Merchandising Company

-One classification: Inventory -Regardless of the classification, companies report al inventories on the balance sheet as current assets.

Identify the sections of a classified balance sheet

-Presents a snapshot at a point in time -To improve understanding, companies group similar assets and similar liabilities together.

Closing Entries

-Sales Revenue Income summary (to close income statement accounts with credit balances) -Income Summary sales returns and allowance sales discounts cost of goods sold All expenses Freight-out (to close income statement accounts with debit balances) -Income summary owner's capital (to transfer net income to owner's capital) -Owner's Capital Owner's drawings (to close drawings to capital)

Manufacturing Company

-Three classifications: Raw materials, work in progress, and finished goods.

Consigned Goods

-To hold goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods.

Inventory errors affect the computation of cost of goods sold and net income in two periods:

-an error in ending inventory of the current period will have reverse effect on net income of the next accounting period. -Over the two years, the total net income is correct because the errors offset each other. -Ending inventory depends entirely on the accuracy of taking and costing the inventory.

Apply the steps in the accounting cycle to a merchandising company: Adjusting Entries

-generally the same as a service company -one additional adjustment to make the records agree with the actual inventory on hand. -Involves adjusting inventory and cost of goods sold.

Intangible Assets

-long-lived assets that do not have physical substance ex. Goodwill, patents, and copyrights

Record purchases under a perpetual inventory system

-made using cash or credit (on account) -normally record when goods are received from the seller -purchase invoice should support each credit purchase.

Flow of Costs - Perpetual system

-maintain detailed records of the cost of each inventory purchase and sale. -records continuously show inventory that should be on hand for every item. -Company determines cost of goods sold each time a sale occurs. - Record purchase of inventory (inventory purchased). When the item is sold, record revenue and compute and record cost of goods sold. At the end of period, there is no entry.

Inventory Costing-Using Cost Flow methods Consistently

-method should be used consistently, enhances comparability -although consistency is preferred, a company may change its inventory costing method.

Current liabilities

-obligations the company is to pay within the coming year or its operating cycle, whenever is longer. -usually list notes payable first, followed by accounts payable. Other items follow in order of magnitude. Common examples are accounts payable, salaries and wages payable, notes payable, interest payable, income taxes payable -*current maturities of long-term obligations*. Liquidity - ability to pay obligations expected to be due within the next year.

Determining ownership of goods in Transit

-purchased goods not yet received -sold goods not yet delivered.

Specific Identification

-requires that companies keep records of the original cost of each individual inventory item -Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the the ending inventory. -Practice is rare -Most companies make assumptions (cost flow assumptions) about which units were sold.

Multiple-Step Income Statement

-shows several steps in determining net income -two steps relate to principal operating activities -distinguishes between operating and non-operating activities.

Cost Flow Assumptions

-specific identification -First-in, first-out (FIFO) -Last-in, first-out (LIFO) -Average-cost -DO NOT need to be consistent with the physical movement of the goods

Advantages of the perpetual system

-traditionally used for merchandise with high unit values -shows the quantity and cost of the inventory that should be on hand at any time. -provides better control over inventories than a periodic system

Steps in Preparing a Worksheet

1-Prepare a trial balance 2- Enter Adjustment data 3- Enter Adjustment balances 4- Extend adjusted balances to appropriate statement columns (Income statement or balance sheet) 5- Total the statement columns, compute net income (or net loss) and complete worksheet

Physical Inventory taken for two reasons: Perpetual System

1. Check accuracy of inventory records 2. Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

Physical Inventory taken for two reasons: Periodic System

1. Determine the inventory on hand 2. Determine the cost of goods sold for the period.

A worksheet

A multiple-column form used in the adjustment process and in preparing financial statements. -not a permanent accounting record -the use is optional

The cost of goods sold is determined and recorded each time a sale occurs in:

A perpetual inventory system only.

Debit: Cost of goods sold Credit: Inventory

Adjust because book amount is higher than the inventory amount determined to be on hand.

Reverse effect on the income of the next accounting period

An error in ending inventory of the current period will have a ?

Prepare closing entries and post-closing trail balance

At the end of the accounting period, the company makes the accounts ready for the next period. Temporary accounts are closed - All revenues, all expense accounts, and owner's drawings account. Permanent accounts are not closed - all asset accounts, all liability accounts, and owner's capital accounts.

Flow of Costs

Beginning Inventory + Cost of goods purchased = Cost of goods available for sale Cost of goods available for sale = Cost of goods sold and ending inventory.

Tax effects- FIFO

Both inventory and net income are higher when companies use ______________ in a period of inflation.

Income effects of Inventory Error: Understate Ending Inventory

COGS: Overstated Net Income is: Understated

Income effects of Inventory Error: Overstates beginning inventory

COGS: Overstated Net Income: Understated

Income effects of Inventory Error: Overstating Ending Inventory

COGS: Understated Net Income: Overstated

Income Summary

Close Revenues and expenses to ______________________.

Owner's Capital

Close income summary and owner's drawings to ____________________. -This account is a permanent account. All other accounts are temporary accounts.

zero balance

Closing entries produce a _______________ in each temporary account.

Debit: Sales Revenue Credit: Income Summary

Closing temporary accounts with Credit balances

Debit: Income Summary Credit: All expenses (sales returns, sales discounts, cost of goods sold, freight-out)

Closing temporary accounts with debit balances.

The end

Companies generally journalize and post closing entries only at __________ of the accounting period.

Perpetual or periodic inventory system

Companies use these two systems to account for inventory.

Not used in a service business

Cost of Goods Sold and Gross Profit

Income effects of Inventory Error: Understates beginning inventory

Cost of Goods sold Is: *Understated* Net Income: *overstated*

Purchase Discounts

Credit terms may permit buyer to claim a cash discount for prompt payment Advantages: -Purchaser saves money -Seller shortens the operating cycle by converting the accounts receivable into cash earlier.

Which of the following is not a long-term liability?

Current maturities of long-term obligations.

Ending inventory

Depends entirely on the accuracy of taking and costing the inventory.

Classifying Inventory

Either a Merchandising Company or Manufacturing Company

owner's Equity of classic balance sheet

Ex. Stockholders' equity

Closing entries

Formally recognize in the ledger the transfer of: -net income or net loss -owner's drawings to owner's capital

Terms of sale are FOB shipping point

Goods in transit should be included in the inventory of the buyer when?

LIFO method

In a period of inflation, the cost flow method that results in the lowest income taxes is the:

Inventory

In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting:

Taking a physical inventory

Involves counting, weighing, or measuring each kind of inventory on hand. Often done when business is closed or slow and at the end of the accounting period.

Sales revenue

Is recorded when the performance obligation is satisfied. Performance obligations is satisfied when the goods are transferred from the seller to the buyser

Current Assets- operating cycle

Is the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers.

Correcting Entries

Must be posted before closing entries -Instead of preparing _____________________, it is possible to reverse the incorrect entry and then prepare the ________________________.

Long-term Liabilities

Obligations a company expects to pay after one year. -long-term debt -deferred income taxes

Offset each other

Over two years, the total net income is correct because the errors ____________________.

Freight Costs - FOB Shipping Point

Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. -Buyer pays freight costs

Freight Costs - FOB Destination

Ownership of the goods remains with the seller until the goods reach the buyer -Seller pays freight costs.

Determining Inventory Quantities

Perpetual and Periodic Systems

Preparing a Post-closing Trial Balance

Purpose is to prove the equality of the permanent account balances carried forward into the next accounting period.

Net Sales

Sales Revenue + Sales returns and allowances + sales discounts = ?

Merchandising operations - income measurement

Sales Revenue - Cost of goods sold = Gross Profit Gross Profit - Operating Expenses = Net Income (loss)

Purchase Invoice

Should support each credit purchase.

Current assets Long-term investments Property, plant, and equipment Intangible assets

The Classified Balance Sheet-Assets

cash, accounts receivable, inventory, prepaid insurance.

The correct order of presentation in a classified balance sheet for the following current assets is:

FIFO method

The cost flow method that often parallels the actual physical flow of merchandise is the?

Gross profit, cost of goods sold, and a sales revenue section.

The multiple-step income statement for a merchandiser shows each of the following:

Tax effects - LIFO

_____________ results in the lowest income taxes (because of lower net income) during times of rising prices.

Owner's Drawing

______________________ is closed directly to Owner's Capital and not to income summary.

Goods in transit

_______________________ should be included in the inventory of the company that has *legal title* to the goods. *Legal title* is determined by the terms of sale.

Liquidity

ability to pay obligations expected to be due within the next year.

Depreciation

allocating the cost of assets to a number of years.

Periodic system

companies do not keep detailed inventory records of goods on hand throughout the period. -determine the cost of goods sold only at the end of the accounting period -takes a physical inventory count to determine cost of goods on hand -Record purchase of inventory (inventory purchased). When an item is sold, record revenue only. At the end of period, compute and record cost of goods sold.

Understating ending inventory will overstate:

cost of goods sold.

Accumulated depreciation

total amount of depreciation expensed thus far in the asset's life