Acc.1 Exam 2 Material

Aging method

using a higher percentage for "old" accounts than for "new" accounts when estimating uncollectible accounts. Basically, the older the account (the debt), the less likely they are to pay. - More accurate method

Define NSF check

"Nonsufficient Funds" check. This is when a company deposits a check from a customer but it turns out the customer doesn't have the money to pay it. Ex: This is counted as a cash increase by the company, then the bank alerts the company it's NSF so the company has to decrease the cash balance. The balance in cash must be decreased to the amount before recording the check and then an accounts receivable is created until the customer pays what is owed

2.) Control Activities

2.) Control Activities - these are the policies and procedures that help ensure that management's directives are being carried out. 2 main types of control activities, 1.) Preventive 2.) Detective

3.) Last in, first out (LIFO)

3.) Last in, first out (LIFO) - Assumes last units purchased are first ones sold. This is an impractical method but still allowed. Companies that use LIFO calculate the cost of goods sold and ending inventory only once per period (at the end). - Income statement approach - Cost of goods sold reflects current cost - According to the LIFO conformity rule, companies that use the LIFO for tax reporting must also use LIFO for financial reporting - Companies using LIFO must report what the difference would've been in the ending inventory had they used FIFO, this is called the LIFO Reserve - When inventory costs are falling, LIFO results in higher reported amount for inventory and gross profit

4.) Weighted average cost

4.) Weighted average cost - Assumes each unit of inventory has a cost equal to the weighted-average unit cost of all inventory items. So, it's assumed that the cost of goods sold and ending inventory has a random mixture. - Weighted average unit cost = (cost of goods available for sale) / (number of units available for sale)

Lower of cost and net realizable value rule

A company will use whichever reporting method (cost or net realizable) reports the lower amount

Bank Statement

A monthly record of a company's activity from the bank.

Are period end adjustments required for both perpetual and periodic methods?

A period end adjustment is needed only under the periodic system

BEGIN CHAPTER 5

ACCOUNTING

Using a balance sheet approach to estimate bad debts involves calculating the desired ending balance in which account? Multiple Choice Accounts receivable. Allowance for uncollectible accounts. Correct Bad debt expense. Credit sales.

Allowance for uncollectible accounts.

The adjustment to write down inventory from cost to its lower net realizable value includes a debit to Cost of Goods Sold and a credit to Inventory. (true/false)

True

When a periodic inventory system and the FIFO are used which of the following is correct? a.) The inventory account will be continuously updated b.) The amount of cost of goods sold will be the same under a perpetual system and the FIFO method c.) The cost of goods sold account will be debited for the cost of each sale made d.) The amount of ending inventory will be larger under a perpetual system and the FIFO method

Answer: b.) the amount of cost of goods sold will be the same under a perpetual system and the FIFO method

What items appear on the "bank side" (left-hand side) and what items appear on the "company's side" (right-hand side) ?

Bank's Cash Balance + Deposits outstanding - Checks outstanding +/- bank errors Company's Cash Balance + Notes received by bank + Interest received - NSF checks received - Unrecorded debit card payments - Unrecorded EFT payments - Bank service fees +/- company errors (outt - locate)

Northwest Fur Co. started the year with $98,000 of merchandise inventory on hand. During the year, $430,000 in merchandise was purchased on account with credit terms of 1/15, n/45. All discounts were taken. Northwest paid freight-in charges of $8,000. Merchandise with an invoice amount of $4,800 was returned for credit. Cost of goods sold for the year was $371,000. What is ending inventory?

Beg. Inv. 98,000 Purchased Inv. 430,000 Inv. (from discount) 430000x(1/100)= (4300) Freight-in Inv. 8,000 Returned Inv. (4,800) From cost of goods sold (371,000) Total ending inventory: 155,900

A company reports the following amounts: Cash = 10,000 Total assets = 50,000 Liabilities = 35,000 What is the ratio of cash to noncash assets?

Both cash and total assets values include assets, So, 10,000 - 50,000 = 40,000. Thus, there is 40,000 worth of noncash assets 10,000 / 40,000 = 25%

Periodic inventory system

Calculates the inventory once per period, at the end, based on a physical count by hand. It adjusts for purchases and sales of inventory. At the end of the period a period end adjustment is needed to record the cost of goods sold and close out temporary accounts (purchases, freight-ins, purchase discounts, and purchase returns) - Does NOT maintain a continual record of inventory; and is therefore used by very few companies Entries recording the purchase of inventory during the period are recorded under Purchases (an asset) along with accounts payable. When inventory is sold during the period only 1 entry is made. Ex: Normally 2 adjustments would be made for the sale of inventory during the period (1:debit accounts receivable & credit sales revenue, 2: debit cost of goods sold & credit inventory), but under the periodic inventory system only the 1st one is made (debit accounts receivable & credit sales revenue), until the end of the period. Mid period: Record - Sales revenue - Purchases (instead of inventory) [temp acc.] - Accounts payable - Accounts receivable - Freight-in [temp. acc.] - Cash - Purchase discounts (contra purchase accounts, like how inventory is reduced when given discounts/returning goods) [temp. acc.] - Purchase returns (contra purchase account) [temp. acc.] Mid period: DONT Record - Inventory - Cost of goods sold

The following information was taken from a company's bank reconciliation at the end of the year: Bank balace = 9,900 Checks outstanding = 7,800 Notes collected by the bank = 1,500 Service fee = 35 Deposits outstanding 5,900 NSF check 460 What is the correct cash balance that should be reported in the company's balance sheet at the end of the year?

Cash balance = (bank balance) + (Deposits outstanding) - (checks outstanding) Cash balance = 9900 + 5900 - 7800 = 8,000

Define: Restricted cash

Cash that is not available for current operations. Examples include: Cash set aside by the company for specific purposes such as repaying debt, purchasing equipment, or making investments in the future

Which of the following is recorded upon receipt of a payment on April 7, 2021, by a customer who pays a $900 invoice dated March 3, 2021, with terms 2/10, n/60?

Credit cash 900 He pays after the 10 day period

A credit balance in the Allowance for Uncollectible Accounts before adjustment indicates that last year's estimate of uncollectible accounts may have been too high.

True "Credit BALANCE," so there is some left over meaning the amount it was assumed to be is too high

Purchase discount

Discount offered by seller to buyer for quick payment. When a discount is given for inventory that's been bought, the amount saved by the discount is subtracted (credited) out of the inventory; along with normal discount stuff like decreasing the cash credit by the discount amount. Ex: You buy inventory on account for 2700. You pay it off 5 days later, receiving a discount of 2% (or $54). To record this entry you debit accounts payable 2700, credit inventory 54, and credit cash 2646 From the sellers point of view these are sales discounts; but, from the buyer's point of view these are purchase discounts.

Gross profit

Gross profit is the profit a company makes after deducting the cost associated with making and selling its products or cost with providing service Gross profit = net revenues (or net sales) - cost of goods sold

Effects of overstating/understating ending inventory

Image displaying the affects attached Also, mistakes in ending inventory this year will carry over and affect next years beginning inventory. However, by the end of the year the error has no effect on ending inventory or retained earnings but reverses for cost of goods sold and gross profit

Single-step income statement

Income statement format that groups all revenues together and then lists and deducts all expenses together without calculating any subtotals.

Average days in inventory

Indicates how many days the average inventory is held onto. Generally, the company that has the smallest amount of days holding inventory is better at managing its' inventory; however, the type of products sold must be examined (ex: if you sell a lot of toothpicks but someone else sells a small amount of diamond rings, odds are the diamond ring seller makes more money) Average days in inventory = 365 / Inventory turnover ratio

What does a higher receivables turnover and shorter collection period mean?

It means that the company more efficiently collects cash from customers The more frequently a business is able to "turn over" its average accounts receivable, the more effective a company is at granting credit to and collecting cash from its customers

Gross profit ratio

Measures the amount by which the sale price of inventory exceeds its cost per dollar of sales. This is a good indicator to how well the company is managing inventory. Gross profit ratio = gross profit / net sales

Net Realizable Value (NRV) & Cost

Net realizable value = (estimated selling price of inventory) - (cost to sell) NRV is the amount a company expects to receive from selling inventory after the price of the inventory has fallen below its original cost. So, if at the end of the year NRV is lower than the original cost we will use that. Using NRV, inventory is reduced from cost to net realizable value. An expense (cost of goods sold) is reported for the reduction. - This reduces assets, net income, and retained earnings Cost is determined by the weighted average, FIFO, specific identification. There is no year-end adjustment needed for this (the ending inventory is reported at purchase cost).

Exam review

Questions/Answers

Inventory turnover ratio

Shows the number of times the firm sells its average inventory balance during a reporting period. A higher turnover ratio shows that the company is more effective at measuring its inventory. Inventory turnover ratio = cost of goods sold / average inventory

What 2 financial statements do companies report cash in?

The balance sheet and the statement of cash flows

Define checks outstanding

The company has incurred expenses and written checks but they're not yet reported in the banks cash balance. This causes the bank's cash balance to be more than the company's balance of cash.

If a bank and company both report different balances and the discrepancy cannot be located, how is this recorded?

The difference is recorded as either miscellaneous expense or miscellaneous revenue, depending on whether it has a debit or credit balance. Ex: If a company is unable to account for $100 of missing cash, a transaction is created increasing miscellaneous expense and decreasing cash.

Comparison between inventory turnover ratio, average days in inventory, and gross profit ratio

The inventory turnover ratio and average days in inventory seems like a good indicator as to management; however, the gross profit ratio is the best way to assess inventory management.

On September 1, 2021, Middleton Corp. lends cash and accepts a $4,100 note receivable that offers 8% interest and is due in six months. How much interest revenue will Middleton Corp. report during 2021? (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)

The loan is given in September 1 and its asking how much will be paid before the years end (so, Sept. to Dec., or, 4 months) (4100) (8/100) (4/12) = 109

In order for the reconciliation to be complete . . . ?

The reconciled bank balance must equal the reconciled company balance.

Perpetual inventory system

This system records purchases and sales on a perpetual (continual) basis. - Helps a company better manage inventory levels - Nearly every company uses this method Reporting: To Record the purchase of inventory, we debit inventory (an asset). To record the selling a product we debit cost of goods sold (an expense). When companies sell inventory they make 2 entries (1) debit an asset (increase cash or accounts receivable) and credit sales revenue (increase) and (2) increase cost of goods sold and decrease inventory.

In the Fraud Triangle, define what the following mean a.) Opportunity b.) Motivation c.) Rationalization

a.) Opportunity - the situation allows for the fraud to occur b.) Motivation - someone feels the need to commit fraud (such as a need for money) c.) Rationalization - The one committing fraud justifies the act of committing fraud

LIFO adjustment

an adjustment used to convert a company's own inventory records maintained on a FIFO basis to LIFO basis for preparing financial statements. Generally LIFO reports lower amounts for inventory and a higher cost of goods sold. So, to convert this from FIFO to LIFO you find the difference and then reduce/increase the values to fit this. Ex: Under FIFO the ending balance of inventory is 2200 but under LIFO its 1600. The difference here is 600 (2200 - 1600 = 600). So, to change this from FIFO to LIFO we debit cost of goods sold 600 and credit inventory 600. - However, if the LIFO balance is greater than the FIFO's this is done but in reverse (credit cost of goods sold & debit inventory)

During a period of rising prices, which inventory cost flow assumption would result in the highest cost of goods sold, and thereby the lowest net income? A. FIFO B. LIFO C. Weighted‐average D. Simple LIFO average

b.) LIFO Using LIFO, we assume that the last units purchased are the first ones sold. If prices are rising, cost of goods sold would be composed of the latest (and highest) costs using LIFO

Purchase returns

merchandise a buyer acquires but then returns to the seller. This is recorded with a reduction in both inventory and accounts payable.

The primary distinction between operating activities and nonoperating activities in a multiple-step income statement is whether the activity is:

part of primary business operations

Freight Charges

the cost of shipping merchandise from the seller to the buyer Freight-in (shipments from suppliers). The cost of freight is considered a part of the cost of purchased inventory. So, it's added to the balance of inventory. Ex: If you buy $400 of inventory and spend another $100 having it delivered; you have spent $500 on inventory and have $500 recorded as inventory. This is because when the inventory is eventually sold all $500 becomes cost of goods sold. Freight-out (shipments to customers). The cost a company incurs by shipping goods to customers is reported as either cost of goods sold or as an operating expense (selling expense). FOB shipping point means that the title passes when the seller ships the inventory FOB destination means that the title passes when the inventory reaches the buyer's destination

On December 31 before adjusting entries, a company reports the following balances: Accounts Receivable: $100,000 Allowance for Uncollectible Accounts:. $2,000 (credit) The company estimates bad debts to be 20% of accounts receivable. The adjusting entry would be . . ?

(100,000) (20/100) = 20,000 20,000 - 2,000 = 18,000 Thus, debit bad debts 18,000 and credit allowance for uncollectible accounts

Internal controls for petty cash fund (employee expenditures)

- Employees should be required to provide receipts and justification for those receipts on a timely basis - A separate employee reviews receipts and supporting documents to ensure all expenditures are made appropriately - Credit card receipts are reconciled to credit card statements, just like we reconciled checks and debit card transactions to the bank statement - Spending limits are placed on employees who are authorized to use a company credit card or have access to company cash. Major expenditures require pre-approval through formal purchasing procedures - Only those employees that need to make timely business expenditures should receive authorization

What are some reasons for why one company would have more/less cash on hand than another?

- Growth. A company that is trying to grow is investing more money into growing, which means they have less cash on hand - Volatility of Operations. Companies have more volatile operations (unreliable/hard to predict) keep more cash on hand to cover anything that comes up - Foreign Operations. U.S. companies earning money oversees gets taxed when that money comes home; thus, companies (like apple, google, & microsoft) keep their money oversees so it doesn't get taxed. This means that the company reports more cash on hand (counting oversees cash) Dividend Policy. Companies that pay greater dividends generally have less cash on hand.

What is a limitation of Internal Control?

- Internal controls can be circumvented when 2 or more people work together. - Top level employees who have the ability to override internal control features also have an increases opportunity to commit fraud

Percentage-of-receivables method

Method of estimating uncollectible accounts based on the percentage of accounts receivable expected not to be collected - Less accurate method - The percentage is based on current economic conditions, company history, and industry guidelines

What are the steps for reconciliation?

1.) Adjust/reconcile the banks cash balance. These are cash transactions recorded by the company but not yet recorded by the bank. Ex: deposits outstanding, checks outstanding, and bank errors 2.) Adjust/reconcile the companies cash balance. These are cash transactions recorded by the bank but not by the company. "Common things that can increase the company's cash balance include:" - Bank collections on the company's behalf - Interest earned on average daily balance "Common items that will decrease the company's cash balance:" - Electronic Funds Transfer (EFT) - Customer's checks written on nonsufficient funds (NSF) - Debit card purchases - Bank service fees - Errors 3.) Update the company's cash account by recording items identified in the previous step (the companies cash balance) - Debit cash for items that add to the balance (ex: notes receivable, interest receivable, interest revenue) - Credit cash for items that subtract from the balance (ex: rent expenses)

4 methods for finding inventory cost

1.) Specific Identification 2.) First-in, first-out (FIFO) 3.) Last in, first out (LIFO) 4.) Weighted average cost Only the 1st method uses actual costs, the other 3 (FIFO, LIFO, and weighted-average) use assumptions. These assumptions do NOT have to match actual costs The method chosen affects the reported ending inventory (asset) and reported cost of goods sold (expense; and therefore profit)

1.) Specific Identification

1.) Specific Identification - Matches each unit of inventory with its actual cost. This requires the company to know the exact amounts of each product sold and to then match the actual price with that product in order to determine inventory cost; this is impractical for large businesses so this method is used primarily by companies with unique, expensive products with low sales volume.

2.) First-in, first-out (FIFO)

2.) First-in, first-out (FIFO) - Assumes the first units purchased are first ones sold. So, we assume that beginning inventory sells first, followed by inventory from the first purchase during the year, and so on. - This method matches physical flow for most companies. The ending inventory should also match current cost - Ending inventory = Units assumed not to have sold x their respective unit costs - When inventory costs are rising, FIFO results in higher reported amount for inventory in the balance sheet and higher reported gross profit in the income statement

Tudor Corp. has an ending balance in the accounts receivable account of $20,000. Tudor recorded bad debt expense of $1,000. Tudor has an ending balance in the allowance for uncollectible accounts of $2,000. What is the net accounts receivable balance?

20,000 - 2,000 = 18,000 This is asking for the total amount for the accounts receivable. Debt expense is NOT an accounts receivable. But, allowance for uncollectible accounts is a contra accounts receivable account. Thus, the difference between the allowance for uncollectible accounts and accounts receivable gives the net accounts receivable balance

3.) Risk Assessment

3.) Risk Assessment - identifies and analyzes internal and external risk factors that could prevent a company's objectives from being achieved. - Examples of internal risks (movie theatre example) are faulty lighting, unclean bathrooms, faulty video projectors, popcorn quality, parking lot security, etc. These internal and external factors can put the company's objectives at risk.

4.) Control Environment

4.) Control Environment - This sets the overall ethical tone of the company with respect to internal control. It includes formal policies related to management, philosophy, assignment of responsibilities, and organizational structure.

5.) Information and Communication

5.) Information and Communication - This relies on the reliability of the entire accounting system. Ex: If the company stores papers everywhere and does its own accounting, an investor would be worried. A system should be in place to ensure that current transactions of the company are reflected in current reports. Employees should also be aware of ways to report fraud, ex: an anonymous employee tip option should be available to report fraud

Discuss Cash Controls by controlling Bank Reconciliation

A bank reconciliation matches the balance of cash in the bank account with the balance of cash in the company's own records (the companies cash account in the balance sheet). There are 2 things that can cause a difference in these 2 balances, 1.) Timing differences in cash occur when the company records transactions either before or after the bank records the same transaction. Ex: The company sells a ticket and immediately records a cash debit. The bank won't report the same cash debit until after the money is deposited into the bank Ex: The bank may charge a service and immediately reduce this service fee from the companies balance; however, the company may not be immediately aware of these fees 2.) Errors can be made either by the company or its bank and my be accidental or intentional. Ex: A company may mistakenly report a check being written for $117 as $171 or a bank could mistakenly report a deposit of 1100 as 1010. - Ex: An intentional error is theft. If an employee deposits only 500 when it was supposed to be 5000 and pockets the rest this is theft. A bank reconciliation will reveal the missing 4500.

Credit sales / accounts receivable / sales on account / services on account

A credit sale is when you provide a good/service now with the promise of being paid later, like within 30-60 days (it's an accounts receivable). - Credit sales are generally informal credit agreements supported by an invoice - Even though no cash is exchanged, the seller recognizes revenue immediately (once goods or services are provided). The legal right to receive payment is also recognized (through the creation of an accounts receivable / trade receivable)

Define Deposits Outstanding

A deposit outstanding is when a company receives cash but the bank has not yet reported it. This causes the bank's cash balance to be less than the company's balance of cash.

Allowance Method (An allowance for uncollectible accounts)

A method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period. - Under the allowance method a company reports its accounts receivable for the net amount EXPECTED to be collected. To do this, the company must estimate the amount of current accounts receivable that will be uncollectible in the future and record this amount as a contra asset to its accounts receivable. So, future uncollectible accounts are estimated and reported in the current year The account called "Allowance for Uncollectible Accounts" is a contra account for accounts receivable Steps, 1.) At the end of the initial year, establish an allowance by estimating future uncollectible accounts 2.) During the subsequent year, write off actual bad debts as uncollectible. Note that actual write offs may differ from the previous year's estimate 3.) At the end of the subsequent year, once again estimate future uncollectible accounts Reduce assets (accounts receivable), & increase expenses (bad debt expense)

Define: Trade Discounts

A reduction in the listed price of a good or service. This creates incentives for larger customers/consumer groups to purchase goods from the company. Ex: senior citizens, military, etc. Other things trade discounts do: - Change prices without publishing a new catalog - Disguise real prices from competitors - Give quantity discounts to customers Note: Pay attention to whether it's a timed discount or not.

Sales return

A sales return is when a customer returns goods previously purchased. If it was originally purchased with cash the seller offers a cash refund, if it was purchased on account the seller reduces accounts receivable. Recorded with a revenue contra account (called sales return)

subsidiary Ledgers

A subsidiary ledger contains a group of individual accounts associated with a particular general ledger control account. Basically, it keeps up with individual accounts to predict if it will be paid (mostly by using the aging method) Example for a subsidiary ledger for accounts receivable: The subsidiary ledger for accounts receivable keeps track of all increases and decreases to individual customer's accounts. The balances of all individual accounts then add up to the balance of total accounts receivable in the general ledger & are reported in the balance sheet. Subsidiary ledgers are used inn accounts payable, property and equipment, investments, and other accounts

Define: Nontrade receivables (Notes receivable)

Accounts receivables that originate from sources other than customers. Known as notes receivables. They're formal credit arrangements evidenced by written debt instruments (or, notes). Examples include: - Tax refund claims - Interest receivable - loans by the company to other entities (like stockholder's and employees)

which of the following statements is true? a.) Having too much cash represents idle resources that are not Being used to produce revenues? b.) One way to assess cash holdings is to compare cash assets to noncash assets b.) In recent years cash holdings have increased tremendously d.) All of the above are true

All of the above statements about cash are true

How would an NSF check from a customer be treated on a bank reconciliation ? a.) Addition on the bank side b.) Deduction on the bank side c.) Addition on the company side d.) Deduction on the company side

An NSF check would be shown on the company's side—the right-hand side—and it would be shown as a deduction. This is because when the company originally deposited the customer's check, they increased the Cash account. Now that the check has been discovered to be an NSF check, or a nonsufficient funds check, the company must reverse the cash out of its books, resulting in a decrease, or a deduction, on the company's side of the bank reconciliation

Define "Bad Debt Expense"

An expense account that represents the cost of estimated future bad debts, reported as an expense in the current year's income statement along with other expenses.

Define: Invoice

Bill. It's a source document that identifies the date of sale, the customer, the items sold, the cash amount, and any payment terms (payment terms usually require the customer to pay within 30 to 60 days).

How would an NSF check from a customer be recorded in the accounting records a.) Debit accounts receivable, credit cash b.) Debit cash, credit accounts receivable c.) Debit accounts payable, credit cash d.) Debit cash, credit miscellaneous expense

Answer: (A) = debit accounts recievable, credit cash The accounts receivable is debited to indicate that the customer still owes the company money. The cash account is credited because it must decrease the amount of cash recorded, since it already recorded the money from the purchase but now isn't getting the money until later so it must be decreased.

Important things to remember for adjusting entries to record estimated contra revenues at the end of the year

As discounts are made, things are returned, etc, adjusting balances have to be made to account for the changes 1.) Revenues are reported for the amount of cash a company expects to be entitled to receive from customers for providing goods & services 2.) Total revenues are reduced by sales returns, sales allowances, and sales discounts that occur during the year 3.) Total revenues are further reduced by an adjusting entry at the end of the year for the estimate of additional sales returns, sales allowances, and sales discounts expected to occur in the future but that relate to the current year

Which of the following would be true for a company that has an accounts receivable turnover of 10? a. The company turns over their accounts receivable more than once a month. b. The company would have an average collection period of 36.5 days. c. The company would be considered as doing an efficient job of collecting receivables if the terms were net 30. d. The company would have an average collection period of 20 days

Average collection period = 365 days / 10 = 36.5

Balance Sheet & Statement of Cash Flow

Balance Sheet A financial statement that reports assets (short-term / long-term), liabilities, and owner's equity on a specific date - For cash, it provides only the final balance. It does not provide any details regarding cash receipts or cash payments. Statement of Cash Flow Details regarding cash receipts and cash payments are included in the Statement of Cash Flow - The statement of cash flow tells investors about a companies cash inflow & outflow related to (1) operating activity; (2) investing activity); and (3) financing activities. - Only transactions involving cash affect a companies outflow

How do banks view increase/decreases? (debit or credit, cash example)

Banks view an increase (a deposit) in the cash balance as a credit and a decrease (withdrawal) in the cash balance as a debit.

What are the costs and benefits of extending credit? (letting someone receive a product without paying first - accounts receivable)

Benefit of extending credit is that the seller makes it more convenient for the buyer, which should increase profitability of the company Cost of extending credit is the delay in collecting cash and the fact that some customers may never pay. This reduces the companies operating efficiency and lowers profitability

BEGIN CHAPTER 4

Cash and Internal Controls

Discuss Cash Controls by controlling receipts

Cash is the most susceptible to fraud so there are many controls over cash. Controls over cash receipts - most businesses receive payment from the sale of products and services inn the form of cash or as a check received through the mail. Common controls over cash receipts include: a.) Opening the mail each day and making a list of checks received b.) Designate a different employee to deposit checks than the one who receives checks c.) Have another employee verify cash receipts by comparing the bank deposit slip with the accounting records d.) Accept credit/debit cards to limit how much contact employees have with cash

Purchase cards

Company-issued debit cards or credit cards that allow authorized employees to make purchases on behalf of the company

If a company uses a credit card to pay for an advertising fee of $1000 (they use the card for all of it), how is this transaction recorded?

Credit $1,000 to accounts payable Credit cards allow the purchaser to pay weeks or even months later. This is the same as buying "on account," or "on credit"

How do credit cards work?

Credit card companies extends credit (lends money) to the cardholder everytime a purchase is made. When you purchase something, the credit card company pays that amount to the company (less the service expense) which means you owe the credit card company what they just paid for you. - Credit card companies charge a service fee. This service fee is charged to the company (not the card holder). So, when the credit card company pays the company they deduct the amount owed for the service.

Uncollectible Accounts (bad debts)

Customers' accounts (accounts receivable) that are no longer are considered collectible. GAAP requires you to account for uncollectible accounts using the allowance method.

How would an account previously written off be readded under the allowance method?

Debit accounts receivable and credit allowance for uncollectible accounts. If the account is being reopened because a customer has made a payment, the following should also be done: debit cash, & credit accounts receivable This scenario is possible when it is assumed that a customer will not pay (creating an allowance for uncollectible accounts); however, the customer surprisingly ends up paying all or a portion of the owed amount. - Collecting cash on an account previously written off has no effect on total assets and no effect on net income

How do debit cards work?

Debit cards work just like a check. They immediately withdraw funds from the cardholder's bank account at the time of use. NOTE: Do not relate debit cards to debit/credit cash meanings. A debit card credits (decreases) your bank account, it does NOT debit it

Detective Controls

Detective - Detective controls are designed to detect fraud or errors that have already occurred. Examples of detective controls include: 1.) Reconciliation - Management must ensure that the amount of physical assets matches up with the accounting records. 2.) Performance Reviews - This is checking the actual performance of employees against their expected performance. 3.) Audits - Many companies (such as those listed on the stock exchange) are required to have an independent auditor attest to the adequacy of their internal control procedures. Other companies can volunteer to have an auditor assess their internal control practices and detect fraudulent behavior from employees.

What does EFT stand for?

Electronic Funds Transfer

Percentage of Credit Sales Method (Income statement method)

Estimates uncollectible accounts based on the percentage of credit sales. The allowance for uncollectible accounts for the current year's credit sales are adjusted for what we don't expect to collect

What does the terms "2/10" and "n/30" mean in terms of discounts?

For "2/10," it means that if you pay within 10 days you get a 2% discount. "n/30" means that if you don't take advantage of the discount, you're required to pay in full within 30 days. (note: n/10 is pronounced 'net 30,' whereas 2/10 is pronounced two ten)

What does a bank & a company do if they record different cash balances? (the brief process)

In a bank reconciliation we reconcile the bank's cash balance for (1) cash transactions already recorded by the company but not yet recorded by the bank and (2) bank errors. Similarly, we reconcile the company's cash balance for (1) cash transactions already recorded by the bank but not yet recorded by the company and (2) company errors. After we complete the reconciliations, the amount for the bank balance and the company balance should be equal. Any adjustments to the company's balance need to be recorded.

Define: (Income before income taxes) and (Net income)

Income before income taxes = (operating income) + (nonoperating revenues) - (nonoperating expenses) Net income = (all revenues) - (all expenses)

Interest Formula

Interest = (Face value) (Annual interest rate / 100) (Fraction of the year)

Chapter 6

Inventory and cost of goods sold

Inventory

Inventory refers to items a company intends to sell to customers over the course of normal business. It is represented as a current asset in the balance sheet. At the end of the period inventory is reported as the cost of inventory not yet sold. The inventory that has been sold is reported as cost of goods sold (an expense, reported in the income statement Inventory differs depending on the company 1.) Manufacturing 2.) Merchandising

What does variations in operating cash flow indicate?

It means that the company is riskier

On December 31 before adjusting entries, a company's balance of Allowance for Uncollectible Accounts is a credit of $2,000. What does a "credit" balance prior to adjusting entries indicate?

Last year's estimate of bad debts was too high "The Allowance for Uncollectible Accounts is a contra account with a credit balance. The balance is reduced (debited) for actual bad debts. If the account balance at the end of the year is a credit, then estimated bad debts for this year are greater than this year's actual bad debts" So, you debit bad debts (increase it) and credit allowance for uncollectible accounts (increase) in the beginning. After you know which accounts aren't going to pay you credit accounts receivable (reduce them) and debit allowance for uncollectible accounts (reduce). If after doing this you still have a credit (a positive value) in your allowance for uncollectible accounts then you assumed that uncollectible expenses would be too high and thus, made your estimate of bad debts too high.

Managers act as _____ of a companies assets

Managers act as stewards of a companies assets. They're entrusted with the resources of both the companies lenders and owners. Their duty is to protect and manage those assets. (some managers exploit this duty for personal gain, aka fraud)

Discuss Cash Controls by controlling cash disbursements

Managers should create proper controls for cash disbursements to prevent any authorized payments and ensure proper recording. Examples of controls over cash disbursements: 1.) For all large cash disbursements use checks, or, debit/credit cards. This provides a permanent record of the disbursement 2.) Authorize all expenditures before purchase and verify the accuracy of the purchase itself 3.) Ensure checks are serially numbered and only signed by authorized employees. Require 2 signatures for larger checks 4.) Periodically compare amounts shown in the debit card and credit card statements with purchase receipts. The employee responsible for this should not also be the employee responsible for actual purchases 5.) Set maximum purchase limits on debit/credit cards 6.) Employees responsible for making cash disbursements should not also be in charge of cash receipts

Inventory for Merchandising Company

Manufactured goods purchased by the company to be sold to the customers. There are 2 types of merchandising companies, wholesalers and retailers 1.) Wholesalers - Resell inventory to retail companies or to professional users. Ex: Sysco corporation supplies food to restaurants but does not directly sell food 2.) Retailers - Purchase inventory from manufacturers or wholesalers and then sell this inventory directly to users. ex: Best buy, target, McDonalds Merchandising companies hold all of their inventory under 1 account, called inventory (an asset)

Inventory for Manufacturing companys

Manufacturing companies produce the inventory that they sell, rather than buying them (ex: Apple, Coke, ExxonMobil, Ford, Sony, etc. all manufacture their own merchandise). There are 3 categories for inventory for manufacturing companies 1.) Raw materials - Cost of components that will be used for the creation of the finished product but have not yet been used 2.) Work in process - Products that have been started (in the production process) but not yet finished. Total costs include (raw materials, direct labor, and indirect manufacturing costs called overhead 3.) Finished goods

1.) Monitoring

Monitoring - Continual monitoring of internal activities and reporting of deficiencies is required. Monitoring includes formal procedures for reporting control deficiencies

Multiple Step Income statement

Most companies choose to report their income in multiple levels. These levels consist of gross profit, operating income and non-operating income, income before taxes, and net income

Does the Sarbanes-Oxley Act of 2002 apply to all companies?

No. It only applies to companies who are required to file financial statements with the SEC.

Receivables Turnover Ratio

Number of times a year the average accounts receivable balance is collected Receivables turnover ratio = Net credit sales / average accounts receivables Where net credit sales = (total credit sales) - (discounts, returns, and allowances), this comes from the income statement.

Sales Discount

Offer a customer a reduction in payment if made within a specified period of time. This is intended to provide incentive to the customer for quick payment. Sales discounts are also recorded in a contra revenue account Collection during the discount period Ex: You create a discount period of 10 days, where if you pay within those 10 days you receive a 2% reduction in price. Someone purchases and pays for a 2000 product within that time period. Recorded as: [debit cash 1960], [debit sales discount 40], [credit accounts receivable 2000]. Here, assets & net revenue are reduced by 40. Accounts receivable is credited 2000 because of the 40 reduction and because 1960 has been received in cash. Collection after the discount period Ex: Going back to the 1st example, imagine that they product is not paid for until after the 10 day period is over. In this scenario the discount does not apply and the transaction is recorded as follows: [Cash debit 2000], [accounts receivable credit 2000]. - If the payment is made after the discount period ends, it is recorded like any other transaction.

Define the following, (review) Financing Activities Investing Activities Operating Activities

Operating Activities - Transactions that relate to the primary operations of the company. These are transactions involving revenues and expenses, the same values used in an income statement to determine net income. Investing Activities - Transactions that involve the purchase and sale of resources that are expected to benefit the company for several years. If the firm later sells these long-term assets this is also considered an investing activity. - Examples include: selling equipment, buying a building, and lending money. Financing Activities - Transactions the company has with investors and creditors. Ex: selling stock and borrowing money from the bank. Issuing dividends and paying off debt is also considered a financing activity. So, financing activities involve liabilities and stockholder's equity.

Operating Income

Operating Income = Gross profit - operating expenses Examples of operating expenses are: selling, general, and administrative expenses

What are the major provisions of the Sarbanes-Oxley Act of 2002

Oversight Board - The Public Company Accounting Oversight Board (PCAOB) has the authority to establish standards dealing with auditing, quality control , ethics, independence, and other activities relating to the preparation of audited financial reports. The board consists of 5 members who are appointed by the Securities and Exchange Commission (SEC). Corporate executive accountability - corporate executives must personally certify the company's financial statements and financial disclosures. Severe financial penalties and possibility of imprisonment are consequences of fraudulent misstatement. Nonaudit Services - It's unlawful for the auditors of public companies to also perform certain nonaudit services, such as investment advising, for their clients. Retention of work papers - Auditors of public companies must retain all work papers for 7 years or face a prison term for willful violation Auditor rotation - the lead auditor in charge of auditing a particular company (referred to as the audit partner) must rotate off that company within 5 years and allow a new audit partner to take the lead Conflicts of interest - Audit firms are not allowed to audit public companies whose chief executives worked for the audit firm and participated in that company's audit during the preceding years Hiring of auditor - audit firms are hired by their audit committee of the board of directors of the company, not by company management Internal control - section 404 of the act requires (a) that company management document and assess the effectiveness of all internal control processes that could affect financial reporting and (b) that company auditors express an opinion on whether management's assessment of the effectiveness of internal control is fairly stated. Smaller companies are exempt from requirement (b)

Preventive Controls

Preventive - Preventive controls are designed to prevent errors or fraud from occurring in the first place. Examples of preventive controls include: 1.) Separation of duties - This separates employees handling of different assets so there are more people involved / everyone involved with a different step in a process so there's less chance for fraud Ex: Employees in charge of making cash disbursements are not inn charge of cash receipts 2.) Physical Controls - Assets should be physically protected. Ex: putting cash in a safe or the bank, backing up files/documents, require user ID's, keeping supplies in a locked room, etc. 3.) Proper authorization to prevent improper use of the companies resources. There should be a proper guideline for handling cash. Ex: In a theatre there could be a rule saying that only management should be authorized to make purchases over a certain amount 4.) Employee management - the company should provide employees with proper guidance so that they're aware of the companies internal control procedures, ethical responsibilities, and channels for reporting irregular activities. 5.) E-Commerce controls - This refers to the wide range of electronic activities of a company, such as buying and selling over the internet, processing digital information, and electronic information.

Net Revenue

Revenue after adjustments (e.g., for estimated returns or for amounts unlikely to be collected). Net Revenue = Total Revenues - (Sales Discounts + Sales allowances + Sales returns)

Define Cash Equivalents

Short-term investments that have a maturity date no longer than 3 months from the date of purchase. Examples include: money market funds, treasury bills, and certificates of deposit. - These are also included in the total cash balance and in the balance sheet.

Petty cash fund

Small amount of cash kept on hand to pay for minor purposes. The person in charge of this fund is called the petty cash custodian. Accounting for the petty cash fund involves: -Establishing the fund - Recognizing expenditures from the fund - Replenishing the fund Picture has an example of the creation of a petty cash fund. At the end of the period all employee expenses that used the petty cash fund are recorded and it is replenished (the amount spent is added to it by the company)

Accounting Scandals and Congressional Response (passing of Sarbanes-Oxley Act of 2002)

The 2 highest profile acts of accounting fraud are Enron and WorldCom. Enron used questionable accounting practices to avoid reporting billions in debt and losses in its financial statements. WorldCom misclassified certain expenses to overstate assets and profitability by $11 billion. Both attempted to fool investors into overvaluing the company's stock. - Other examples of fraudulent financial statements: creating fake revenues, improperly valuing assets, hiding liabilities, and mismatching revenues and expenses - After the fraud was uncovered stock plummeted (wiping out billions), employees lost their jobs, retirements, health benefits, bankruptcy ensued, etc. The fraud destroyed everyone involved (even those not committing it) In response to the fraud, the Sarbanes-Oxley Act of 2002 was passed, also known as the Public Company Accounting Reform and Investor Protection Act of 2002 (or, SOX). SOX applies to all companies that produce financial statements for the SEC. This act changed a lot by creating guidelines related to auditor-client relations; notably the provision requiring company management and auditors to assess the effectiveness of a company's internal controls.

Framework for designing Internal Control

The Committee of Sponsoring Organizations (COSO) of the Treadway Commission. COSO improves the quality of financial reporting by creating effective internal controls. COSO presents 5 components are important to internal control. These components are built on the foundation of ethical tone. 1.) Monitoring 2.) Control Activities 3.) Risk Assessment 4.) Control Environment 5.) Information and Communication

Sales Allowance

The customer does NOT return the goods/services but instead the seller reduces the customer's balance owed for the goods or services provided. This can be a total or partial refund. Ex: You get laser eye surgery for $2400 but aren't happy, so they refund you 400. Here, the amount the company was entitled to receive has bene reduced to only 2000 and the 2400 of revenue previously recorded must be reduced by the amount of the sales allowance. We record the sales allowance in a contra-revenue account, called Sales Allowance. The entry would look like: debit sales allowance 400 - If the purchase was made on account then the balance of accounts receivable would be reduced Explanation for contra: A normal revenue account is increased with a credit. A contra account is opposite - so it's increased with a debit. In the above example the amount of revenue lost from the sales allowance is represented by the contra sales allowance account, so we increase this amount owed (debit sales allowance)

The effect of a sales allowance will result in which of the following a.) An increase to net income b.) A decrease to net income c.) An increase in accounts receivable d.) An increase to sales revenue

The effect of a sales allowance is to decrease net income. A sales allowance decreases sales revenue in the income statement. A sales allowance also decreases assets by decreasing the balance of accounts receivable

Who is ultimately responsible for implementing and assessing Internal Control measures?

The top executives of the company

What does it mean to "write off" bad debt as uncollectible?

When it becomes clear a customer will not be able to pay, the company writes off their account balance as uncollectible. The write off: - Reduces the balance of accounts receivable - Reduces the balance of the allowance for uncollectible accounts The write off has no affect on total assets because the negative effects of the bad debt was recorded at the end of the previous year.

Incorrect Financial Statements (mainly fraud)

There are 2 reasons for incorrect financial statements to be released, 1.) Error - where accounting rules are sometimes not followed, transactions aren't recorded, and or there are errors in recordings 2.) Fraud - This is when one person intentionally deceives another person for personal gain or to damage that person. The Association of Certified Fraud Examiners (ACFE) defines Occupational fraud as the use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employer's (the company) resources. - The most common source of fraud is the loss of cash (theft through various means) - The 2nd main source of occupational fraud is financial statement manipulation ("cooking the books"). Managers will manipulate the reporting of financial statements for personal gain (increase stock value, maximize compensation, and preserving their jobs.) - There are 3 elements necessary for fraud, presented in the fraud triangle. In order to reduce fraud 1 of the 3 elements must be eliminated. The easiest element to eliminate is opportunity. To eliminate opportunity companies implement formal procedures known as Internal Controls. Internal controls attempt to do 2 things, 1.) Safeguard the company's assets 2,) Improve the accuracy and reliability of accounting information

If you record a sales revenue of $200 for selling a pair of sunglasses but they're then returned, what is the updating entry for sales revenue?

When sold, sales revenue was credited $200 When returned, sales returns was debited $200. Revenue for sales is reduced using sales returns, a contra revenue account. "A contra revenue account is an account with a balance that is opposite, or "contra," to that of its related revenue account." Thus, if revenue is increased with a credit then a revenue contra account (sales returns) is increased with a debit.

Direct Write-Off Method

Under this method bad debts are written off only at the time they become uncollectible (no prediction/assumption is made). This results in accounts receivable being overstated in the current year, so it is NOT GAAP accepted. Debit bad debt expense & credit accounts receivable. Used when: - Uncollectible accounts are not anticipated or immaterial - For tax reporting

Do companies like to keep a lot of cash on hand (not invested)?

Yes and no. Companies like to keep enough spare cash so that it can invest in any new opportunities, pay off debts, buy more equipment, buy more supplies, hire new employees etc. However, if the company has too much cash it represents excess resources that are idle and not being used to produce revenue. Investors could also view excess cash as meaning there aren't enough investing opportunities for profitable expansion.

Are purchases from debit card/credit cards included in the cash balance immediately after purchase?

Yes. Purchases from credit/debit cards are immediately included in the cash balance; because cash from these transactions are generally received electronically within days. - Money from credit/debit cards (even if not yet received) is counted as part of the total cash balance and included in the balance sheet

When adjusting the company's cash account balance in a bank reconciliation, how do the following the bank's cash account balance? a.) Charges for NSF checks b.) Deposits outstanding c.) Outstanding checks d.) Collections of funds by the bank

a.) NSF - These are subtracted from the book balance b.) Deposits outstanding - these should be added to the banks balance c.) Outstanding checks - These are expenses the bank hasn't yet recorded so recording them should decrease the banks balance d.) Funds collection - If the bank is collecting funds (such as on the companies behalf) then the bank balance is increasing

Which of the following items would be found on the "bank side," or left-hand side, of the bank reconciliation? a.) Interest income received on the account b.) Deposits outstanding c.) NSF check from a customer d.) Service fee charged by the bank

b.) Deposits outstanding

Which of the following items would be categorized as an investing activity on a statement of cash flows? a.) Borrowed money from the local bank by signing a note to repay the full amount two years later b.) Paid for supplies in cash c.) Paid for the purchase of equipment using cash d.) Paid salaries to employees

c.) Answer: Paid for the purchase of equipment using cash

When an entry is made to write-off an uncollectible account, a.) Bad debt expense is credited b.) Net income is decreased c.) Net accounts receivable is unchanged d.) The allowance account is credited

c.) Net accounts receivable is unchanged Overall, the write-off of an account receivable has no effect on total assets reported in the balance sheet or total expenses in the income statement

If a customer uses a check to make a purchase, the company records the transaction as a _____ _______

cash sale Ex: a local theatre sells $3,000 worth of tickets one day. $2,000 is in cash and $1,000 is in checks. Regardless of what they paid with, this is recorded as a $3,000 cash debit Cash sales include: - coins & currency - checks received - savings account - checking accounts - debit card sales - credit card sales ("sales," NOT Purchases) - balance in checking account - cash equivalents

On December 31 before adjusting entries, a company reports the following balances: Accounts Receivable $100,000, Allowance for Uncollectible accounts $2,000 (credit), Credit Sales $500,000, The company estimates bad debts to be 4% of credit sales. The adjusting entry would include: a. A debit to Bad Debt Expense = $18,000. b. A credit to Allowance for Uncoll. Accts. = $24,000. c. A credit to Allowance for Uncoll. Accts. = $22,000. d. A debit to Bad Debt Expense = $20,00

d. A debit to Bad Debt Expense = $20,00 (500,000) (4/100) = 20,000 The adjusted entry includes a debit to bad debt expense and a credit to allowance for uncollectible accounts

Which of the following inventory accounts consists of items for which the manufacturing process is complete? a. Raw Materials b. Work in Process c. Cost of Goods Sold d. Finished Good

d. Finished good

For reconciliation items that increase the companies balance of cash, we _____ cash

debit

Average Collection Period

number of days the average accounts receivable balance is outstanding Average collection period = 365 days / Receivables turnover ratio Companies want a low average collection period