Exam 2 Prep

Elements of the Statement of Cash Flows

operating activities, investing activities, financing activities

debit cards offer significant advantages to banks and merchants in

reduced transaction-processing costs. Thus, banks and merchants have incentive to design debit cards that minimize or eliminate the disadvantages and costs to card users.

expense recognition (or matching) principle

requires expenses to be matched with the related revenues in the period in which the revenues are recognized on the income statement.

GAAP (Generally Accepted Accounting Principles)

requires receivables to be shown at net realizable value on the balance sheet.

If the customer does pay within the discount period

sales revenue should be decreased by the amount of the discount.

The matching principle

says that an expense should be recognized in the period in which it helps generate revenues.

Disadvantages for bank credit card

service charge

True

After company personnel (other than the petty cash custodian) determine that the documents are authentic and that each transaction is supported by appropriate documentation, the custodian is given an amount to replenish the petty cash fund. The company then records the amounts spent in the accounting records. Because the custodian replenishes petty cash at the end of the month, the accounting records are appropriately updated each month.

True

adjustments are necessary for any company errors or items such as bank charges or interest that the company does not find out about until receiving the bank statement.

Nonbank credit cards (American Express)

also result in a receivable for the seller because the issuer of the credit card does not immediately pay the cash to the seller

debit card

authorizes a bank to make an immediate electronic withdrawal (debit) from the holder's bank account. The debit card is used like a credit card except that a bank electronically reduces (debits) the holder's bank account and increases (credits) the merchant's bank account for the amount of a sale made on a debit card.

Allowance accounts

normal credit balance

Receivables

normal debit balance

the direct write-off method and the allowance method.

2 methods to record bad debt expense

Estimated Bad Debt Expense (Percentage of Credit Sales Method)

= Total Credit Sales × Percentage of Credit Sales Estimated to Default

Allowance for doubtful accounts

A contra-asset account that is established to "store" the estimate of uncollectible accounts until specific accounts are identified as uncollectible.

Disadvantages of non bank credit cards

American Express also charges a higher service charge to the seller. Consequently, sellers find American Express to be more costly than bank cards, such as Visa or MasterCard, which explains why many businesses do not accept American Express.

interest revenue in the period the interest was earned.

Any excess of amount repaid over principal is recognized as

Accounting Equation

Assets = Liabilities + Owner's Equity

Cash Over and Short

At the end of each day, the amount of cash received during the day is debited to the cash accounts to which it has been deposited. The amount deposited should equal the total of cash register tapes. If it does not (and differences will occasionally occur even when cash-handling procedures are carefully designed and executed), the discrepancy is recorded in an account called

Allowance for Doubtful Accounts

Because defaults for the current period's sales have not yet occurred, the specific accounts receivable are not lowered; instead, an account is established to "store" the estimate until specific accounts are identified as uncollectible. This account is called

Cost of Goods Sold

Beginning Inventory + Net Purchases - Ending Inventory =

Cost of Goods Available for Sale

Beginning Inventory + Net Purchases =

Short-term investments

Beyond delaying payments and speeding up collections, businesses try to keep their bank cash balances to a minimum because most bank accounts earn relatively small amounts of interest. And are purchased with temporary cash surpluses

Recievable info

Companies can increase the speed of cash collection on receivables by factoring, or selling, their receivables. The buyer of the receivables will charge a fee to compensate themselves for the time value of money, the risk of collectability, and the tasks of billing and collection.

LCNRV step 3

Compare the net realizable value to historical cost (usually on an item-by-item basis) and value the inventory at the lower of the two amounts.

LCNRV step 1

Determine the cost of inventory using a costing method (e.g., specific identification, FIFO, or average cost)

LCNRV step 2

Establish the net realizable value of the inventory.

The percentage of credit sales and the aging method

Estimate and recognize bad debt expense in the period the sale is made—even though we do not know which accounts will be uncollectible using...

Parts of an Income Statement

Expense/Losses and Revenues/Gains

the amount of cash the company expects to collect.

GAAP requires accounts receivable to be shown at their "net realizable value," which is

Segregation of Duty

If the person who writes the checks also performs the reconciliation, it is easier for him or her to cover up theft and fraud. Therefore, there are additional benefits when the bank reconciliation is performed by someone with no other responsibilities related to cash (the duties of reconciling cash and cash record keeping should be segregated).

LCNRV step 4

If the value of the inventory computed in Step 3 is less than its cost, record a journal entry to reduce inventory to the lower amount.

generally accepted accounting principles permit a departure from the historical cost concept. This departure from the historical cost principle is called the

In cases where the selling price of inventory has dropped below its original cost lower of cost or net realizable value (LCNRV) rule.

Allowance for Doubtful Accounts

In the allowance method, bad debt expense is recognized in the period of sale, which allows it to be properly matched with revenues. The result is that bad debt expense is recognized before the actual default. Because defaults for the current period's sales have not yet occurred, the specific accounts receivable are not lowered; instead, an account is established to "store" the estimate until specific accounts are identified as uncollectible.

Periodic inventoy system

In this system the inventory records are not kept continually, or perpetually, up to date. Instead the inventory account is updated at the end of the period based on a physical count of the inventory on hand.

True

Issuing checks to pay small amounts is usually more costly than paying cash

securitization

Large businesses and financial institutions frequently package factored receivables as financial instruments or securities and sell them to investors. This process is known as

LIFO

Last in, first out method. It allocates cost of goods avaliable for sale ending inventory and cost of goods solds based on the assumption that the most recent purchases are the first to be sold.

True

No adjustments are necessary for outstanding checks or deposits in transit because the accounting records have correctly recorded these amounts.

True

Observe that a cash shortage requires a debit to cash over and short, whereas a cash overage would require a credit.

Sales return

Occasionally, a customer will return goods as unsatisfactory

Recievable info

Receivables may be packaged as financial instruments or securities and sold to investors—called securitization. • A special case of selling receivables is accepting credit cards like MasterCard and Visa.

Finished goods inventory

Represents the cost of the final product that is available for sale. When the finished goods inventory is sold to a customer, it becomes an expense called cost of goods sold, which appears on the income statement.

Gross Margin

Revenue - Cost of Goods Sold =

Explain the criterion for revenue recognition

Revenue is recognized when the performance obligation has been satisfied. The performance obligation has been satisfied when delivery has occurred or services have been provided.

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

Sales discounts are properly recorded in sales revenue using the gross method when

Advantages for bank credit card

Sellers receive the money immediately. Sellers avoid bad debts because as long as the credit card verification procedures are followed, the credit card company absorbs the cost of customers who do not pay. Recordkeeping costs decrease because employees are not needed to manage these accounts. Sellers believe that by accepting credit cards their sales will increase.

Estimated Bad Debt Expense (Aging Method)

Step 1: Amount uncollectible by age = sales by age category(e. g. 31-60 days old) x percentage estimated to be uncollectible Step 2: Estimate of ending balance in allowance = Sum of account uncollectible by all age categories Step 3: Bad debt expense = Estimate of ending balance in allowance - Balance in allowance prior to adjustment

Multi-Step Income Statement(Steps)

Step 1: Prepare a heading that includes the name of the company, the title of the financial statement, and the time period covered. Step 2: Compute gross profit as the difference between net sales and cost of goods sold. Step 3: Compute income from operations by subtracting operating expenses from gross profit. Step 4: Compute income before income taxes by subtracting non-operating activities from income from operations. Step 5:Compute net income (or net loss) by subtracting income taxes expense from income before income taxes. Double-underline net income.

Balance Sheet(Steps)

Step 1: Prepare a heading that includes the name of the company, the title of the financial statement, and the time period covered. Step 2: List the assets of the company in order of their liquidity or nearness to cash. Use appropriate classifications. Add the assets and double underline the total. Step 3: List the liabilities of the company in order of their time to maturity. Use appropriate classifications. Step 4: List the stockholders' equity balances with appropriate classifications. Step 5: Add the liabilities and stockholders' equity and double underline the total.

Statement of Retained Earnings(steps)

Step 1: Prepare a heading that includes the name of the company, the title of the financial statement, and the time period covered. Step 2: List the retained earnings balance at the beginning of the period obtained from the balance sheet. Step 3: Add net income obtained from the income statement. Step 4: Subtract any dividends declared during the period. Double-underline the total, which should equal retained earnings at the end of the period as reported on the balance sheet.

single-step income statement(steps)

Step 1: Prepare a heading that includes the name of the company, the title of the financial statement, and the time period covered. Step 2: List the revenues of the company, starting with sales revenue (or service revenue) and then listing other revenue items. Add the revenues to get total revenue. Step 3: List the expenses of the company, usually starting with cost of goods sold. Add the expenses to get total expenses. Step 4: Subtract the expenses from the revenues to get net income (or net loss if expenses exceed revenues). Double-underline net income.

true

The LCNRV rule is an application of the conservatism principle

Principle

The amount lent is the

Accounts Receivable.

The appropriate amount of revenue to recognize is generally the cash received or the cash equivalent of?

The length of the operating cycle influences

The classification of assets and liabilities on balance sheets and the amount of capital a business needs and the policies that govern its sales of goods and services.

Average Cost Method

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

FIFO

The earliest purcheses (first in) are assumed to be the first sold (first out), and the more recent purchases are in the ending inventory.

Interest

The excess of the total amount of money collected over the amount lent is called

Bad debt expense

The expense that results from receivables that are not paid.

buying inventory

The first stage of the operating cycle

paying for inventory

The second stage of the operating cycle is

Cost of Goods for sale

The sum of beginning inventory and purchases represnts ______________________.

selling inventory

The third stage of the operating cycle is

true

Thus, accountants tend to recognize expenses and losses as early as possible and to recognize gains and revenues as late as possible. By conservatively valuing inventory, the LCNRV rule is designed to avoid overstating the current earnings and financial strength of a company by recognizing an expense in the period that there is a decline in the selling price of inventory rather than in the period that the inventory is sold.

Freight in

When a customer receives freight and is responsible for paying the fees or delivery expense.If the goods are included in inventory, the expense is categorized as cost of goods sold and is reported beneath sales on the multi step profit and loss statement.

Freight out

When a manufacturer or supplier ships or exports goods using a freight company to a customer and is responsible for the freight charge, then the expense is considered... This charge for transport of goods is considered an operating expense and is reported on the income statement in the operating expense account section.

accounts receivable

When a specific account is ultimately determined to be uncollectible under the allowance method, it is written off by a debit to the allowance account and a credit to...

bad debts (also called uncollectible accounts)

When customers do not pay their accounts receivable

internal retail credit cards (cabellas, macys)

When these cards are used, the seller records it like any other accounts receivable and no service charge expense is incurred; however, they are accepting the risk of uncollectible accounts and the cost of servicing these accounts

True

a company may establish a petty cash fund to pay for items such as stamps or a cake for an employee birthday party. The petty cash fund is overseen by a petty cash custodian, who both pays for small dollar amounts directly from the fund and reimburses employees who have receipts for items they've bought with their own money. At the end of the month, the custodian submits all receipts

sales allowance

a customer will agree to keep goods that have minor defects, arrived late, or in some other way are rendered less valuable in return for a price reduction. It could be a service that was not completed on time, too.

Petty cash

a fund used to pay for small dollar amounts

Revenue recognition principle

a principle that requires revenue to be recognized or recorded in the period in which it is earned and the collection of cash is reasonably assured.

Historical cost principle

a principle that requires the activities of a company to be initially measured at their cost—the exchange price at the time the activity occurs.

Conservatism principle

a principle which states that when more than one equally acceptable accounting method exists, the method that results in the lower assets and revenues or higher liabilities and expenses should be selected.

Cost of goods sold (cost of sales)

an expense that represents the outflow of resources caused by the sale of inventory. This is often computed as the cost of goods available for sale less the cost of ending inventory.

finacing activities

any cash flow related to obtaining capital of the company. This category includes the issuance and repayment of debt, common stock transactions, and the payment of dividends.

Investing Activities

any cash flow related to the acquisition or sale of investments and long-term assets such as property, plant, and equipment. Note that the cash flows from investing activities of a healthy, growing business often reflect an excess of expenditures over receipts.

Operating Activities

any cash flows directly related to earning income. This category includes cash sales and collections of accounts receivable as well as cash payments for goods, services, salaries, and interest.

Bank credit cards (Visa/MasterCards)

are really just a special form of factoring. The issuer of the credit card (i.e., the bank) pays the seller the amount of each sale minus a service charge (on the date of purchase) and then collects the full amount of the sale from the buyer (at some later date).

Notes receivable

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

Notes Receivable

are recognized for the amount of cash borrowed or goods/services purchased.

Raw materials inventory

are the basic ingredients used to make a product. When these raw materials are purchased, the Raw Materials Inventory account is increased. As raw materials are used to manufacture a product, they become part of work-in-process inventory.

allowance method

bad debt expense is recognized in the period of sale, which allows it to be properly matched with revenues. The result is that bad debt expense is recognized before the actual default.

Manufacturers

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

Merchandisers

companies, either retailers or wholesalers, that purchase inventory in a finished condition and hold it for resale without further processing.

Net realizable value

computed as the estimated selling price less costs of disposal (e.g., selling expenses). Under LCNRV, if the net realizable value of a company's inventory is lower than its cost, the company reduces the amount recorded for inventory to its net realizable value

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. These costs stay in this account until the product is complete. Once the production process is complete, these costs are moved to the Finished Goods Inventory account.

Specific ID Method

determines cost of ending inventory & cost of goods sold based on the ID of the actual units sold and in inventory

Bank reconciliations

help strengthen internal controls over cash by comparing the accounting records and the bank statement. This helps (1) identify errors, (2) deter theft, and (3) identify transactions performed by the bank so the business can make the necessary entries in its accounting records.

The inventory accounting procedures described to this point have followed the historical cost principle

inventory is recorded in the firm's records at its historical purchase price (or cost). The price for which inventory items can be sold may decline because the goods have become obsolete, have been damaged, or have otherwise diminished in value.

efforts to control bad debts

it is an expense of providing credit to customers. (The hope is that the increased business associated with providing credit will more than make up for the bad debts.)

conservatism principle

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

Retailers

merchandisers that sell directly to consumers.

Wholesalers

merchandisers that sell to other retailers.

Inventory Costing Methods

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

operating cycle

the elapsed time between the purchase of goods for resale (or the purchase of materials to produce salable goods or services) and the collection of cash from customers

the direct write-off method is inconsistent with

the expense recognition principle and can only be used if bad debts are immaterial under GAAP.

When receivables are factored

the seller receives an immediate cash payment reduced by the factor's fees. The factor, the buyer of the receivables, acquires the right to collect the receivables and the risk of uncollectibility. In a typical factoring arrangement, the sellers of the receivables have no continuing responsibility for their collection.

Cost of goods available for sale

the sum of the cost of beginning inventory and the cost of purchases

Freight in textbook

the transportation costs that are normally paid by the buyer under F.O.B. shipping point terms.

Freight out textbook

the transportation costs that the seller is usually responsible for paying under F.O.B. destination shipping terms.

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

Matching principle/Expense recognition principle

this principle requires that an expense be recorded and reported in the same period as the revenue it helped generate.

disadvantages of debit card holders

transactions cannot be rescinded by stopping payment

direct write-off method

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