Intro to Financial Accounting Midterm 2

Purchase Discounts

Discounts taken by the buyer for early payment of an invoice.

FOB Shipping Point

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

Ownership of Goods: Freight on Board Shipping Point

Buyer pays the freight cost (recorded in inventory by buyer) Ownership changes when seller delivers inventory to shipping carrier.

Entries From Bank Reconciliation Collection of Electronic Funds Transfer A payment of an account by a customer is recorded in the same way, whether the cash is received through the mail or electronically. The entry is as follows...

Cash 1,035.00 AccountsReceivable1,035.00

Disposing of Plant Assets

Companies dispose of plant assets in three ways —Sale, Retirement, or Exchange (appendix). For all disposals: • Determine the book value of the plant asset at disposal date • To determine book value, book depreciation through disposal date Eliminate book value of asset by: Dr. Accumulated Depreciation Cr. Plant Asset Account

Notes Receivable

Companies may grant credit in exchange for a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. Promissory notes may be used 1. when individuals and companies lend or borrow money, 2. when amount of transaction and credit period exceed normal limits, or 3. in settlement of accounts receivable.

Risk Assessment

Companies must identify and analyze various factors that create risk and how to manage it

On September 5, De La Hoya Company buys merchandise on account from Junot Diaz Company. The selling price of the goods is $1,500, and the cost to Diaz Company was $800. On September 8, De La Hoya returns defective goods with a selling price of $200 and a fair value of $30. Record the transactions on the books of Junot Diaz Company.

Sept. 5 Accounts Receivable 1,500 Sales Revenue 1,500 Cost of Goods Sold800 Inventory 800 Sept. 8 Sales Returns and Allowances 200 Accounts Receivable 2008 Inventory 30Cost of Goods Sold 30

Segregation of Recordkeeping/Physical Custody

Accountants should not have physical custody of assets or access to them. Likewise, the custodian of assets should not have access to the accounting records. This is important to cash and inventories because these assets are very vulnerable to fraud.

Revising Periodic Depreciation

• Accounted for in the period of change and future periods (Change in Estimate) .• No change in depreciation reported for prior years. • Not considered an error. • Accounted for prospectively (recalculate new depreciation amounts for future periods based on current depreciated value). • Recalculate depreciable cost at current data • Allocate cost to remaining useful life using new method

Sarbanes-Oxley Act

• After a number of corporate scandals in the early 2000's, Congress passed the Sarbanes-Oxley Act. • All publicly traded U.S. corporations are required to maintain an adequate system of internal control. • The executives of these companies must certify that the controls are adequately designed and operating properly. • Independent auditors must attest (provide an audit opinion) on the adequacy of the internal control system. • Companies that fail to comply are subject to fines and executives may be punished if the actions are determined to be criminal. • As a result of SOX, Congress created the Public Companies Accounting Oversight Board (PCAOB) which is overseen by the SEC• The PCAOB has 800 staff members, and the primary duties include: • Registration of audit firms• Establish auditing quality controls, ethics and independence standards • Inspect firms' audits and quality control systems • Investigate and discipline firms for violations of laws, rules and professional standards

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.

Last In, First Out (LIFO)

-Cost of the latest goods purchased are the first to be sold. -Seldom coincides with actual physical flow of inventory. -Exceptions include goods stored in piles, such as coal or hay.

Record Purchases under a perpetual inventory system

-Made using cash or credit (account). -Normally record when goods are received from the seller. -Purchase invoice should support each credit purchase

Multi-step income statement

-Shows several steps in determining net income. -Two steps relate to principal operating activities. -Distinguishes between operating and non-operating activities.

Single Step income statement

-Subtract total expenses from total revenues -Two reasons for using the single-step format: 1. company does not realize any profit until total revenues exceed total expenses 2. Format is simpler and easier to read

What are the limitations of internal control?

-costs should not exceed benefit -human element -size of the business

Accounting for Intangible Assets

1. Accounted for at cost (all expenditures necessary for the company to acquire the right, privilege or competitive advantage. 2. Assets with a definite life are amortized over that life in a similar manner to depreciation. 3. Assets with an indefinite life are not amortized. 4. Typical amortization is straight-line over the life. 5. Amortization expense is an operating expense 6. Continuously reassess the useful life/amortization period based on current facts and circumstances

Depreciation of Plant Assets

1. Asset's revenue producing ability declines over time due to wear and tear 2. May also decline because of obsolescence (technical obsolescence due to technological improvements)

Two reasons for physical inventory: Perpetual System

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

Two reasons for physical inventory: Periodic System

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

Flow of Costs- Periodic System

1. Do not keep detailed records of the goods on hand. 2. A physical inventory count is made to determine the cost of goods on hand.

Hasbeen Company completed its inventory count. It arrived at a total inventory value of $200,000. You have been given the information listed here. Discuss how this information affects the reported cost of inventory. 1. Hasbeen included in the inventory goods held on consignment for Falls Co., costing $15,000. 2. The company did not include in the count purchased goods of $10,000, which were in transit (terms: F O B shipping point). 3. The company did not include in the count sold inventory with a cost of $12,000, which was in transit (terms: F O B shipping point).

1. Goods of $15,000 held on consignment should be deducted from the inventory count. 2. The goods of $10,000 purchased F O B shipping point should be added to the inventory count. 3. Item 3 was treated correctly.Inventory should be $195,000 ($200,000 − $15,000 + $10,000).

Intangible assets arise from

1. Government Grants 2. Acquisition of a Business 3. Private arrnagements arising from contracts such as leases or franchises

Disposing of Notes Receivable

1. Notes may be held to their maturity date and repaid at that time (Honor). 2. Maker may default and payee must make an adjustment to the account. (Dishonor) 3. Holder speeds up conversion to cash by selling the note receivable.

Companies sell receivables for two major reasons.

1. Receivables may be the only reasonable source of cash. 2. Billing and collection are often time-consuming and costly.

Methods of Accounting for Uncollectible Accounts

1. direct write off Theoretically undesirable: • No matching. • Receivable not stated at cash realizable value. • Not acceptable for financial reporting. 2. allowance method Losses are estimated: • Better matching. • Receivable stated at cash realizable value. • Required by G A A P.

Control Activities: Six Principles

1. establishment of responsibility 2. segregation of duties 3. documentation procedures 4. physical controls 5. independent internal verification 6. human resource controls

3 Depreciation Methods

1. straight line 2. units of production 3. declining balance

Days In inventory

365/inventory turnover measures the average number of days inventory is held.

What is a Merchandising company

A company that buys and sells goods purchased from a wholesaler and sold to the consumer

Independent Internal Verification

All data prepared by employees must be reviewed and verified for accuracy. • Procedures for review may include surprise verification. • Must be reviewed by independent personnel.• Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action.

Determining the Cost of Plant Assets - Land

All necessary costs incurred in making the land ready for its intended use increase (debit) the Land account. Costs typically include: 1. cash purchase price, 2. closing costs such as title and attorney fees, 3. real estate broker commissions, and 4. accrued property taxes and other liens on the land assumed by the purchaser. Note: Can also include costs of clearing, grading and filling, demolition of existing buildings (net of salvage value of debris) and changes to access roads.

Bank Deposits should be made only by___________

Authorized Employees

Explain the Statement Presentation and Analysis of Inventory : Financial Statement Presentation

Balance Sheet - Inventory classified as current asset. Income Statement - Cost of goods sold is subtracted from sales.

Factors in Computing Depreciation

Cost = All expenditures necessary to acquire and make it ready for use Less: Salvage Value = Estimate of the asset's value at the end of its useful life Spread over: Useful life = Estimate of the expected life based on need for repair, service life and risk of obsolescence

Inventory Errors: Balance Sheet Effects

Effect of inventory errors on the balance sheet is determined by using the basic accounting equation: Assets = Liabilities + Stockholders' Equity.

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

FIFO Method

cost flow assumptions

FIFO, LIFO, Average Cost

Petty Cash Fund: Making Payments

Follows company policy on amount, documentation on prenumbered receipt or voucher, must be signed by custodian and purchaser (No entry needed)

If a company expects significant returns, what are the implications for revenue recognition?

If a company expects significant returns, it should make an adjusting entry at the end of the year to increase Sales Returns and Allowances by the estimated amount of sales returns. This is necessary to not overstate the amount of revenue recognized in the period.

Direct Write off

If the company determines that an account won't be collected, it removes the receivable and records "Bad Debt Expense".

Monitoring

Internal control systems must be monitored periodically for their adequacy. Deficiencies in internal controls must be report to management. Significant deficiencies or material weaknesses must be reported to top management and the board of directors.

Inventory Errors: Income Statement Effects

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 a 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 counting and costing the inventory.

The operating cycle of a merchandising company is typically ______ than that of a service company

Longer

Accounting for Credit Card Sales Illustration: Anita Ferreri purchases $1,000 of compact discs for her restaurant from Karen Kerr Music Co., using her Visa First Bank Card. First Bank charges a service fee of 3%. The entry to record this transaction by Karen Kerr Music on March 22, 2022, is as follows.

Mar. 22 Cash 970 Service Charge Expense 30 Sales Revenue 1,000

Other Receivables:

Nontrade receivables such as interest, loans to officers, advances to employees, and income taxes.

Classifying Inventory Merchandising Company

One Classification: Inventory

Purchase Return

Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash

Uncollectible Accounts Receivable

Sales on account raise the possibility of accounts not being collected. Companies record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense).

Recognizing Accounts Receivable

Service organization records a receivable when it performs service on account. Merchandiser records accounts receivable at the point of sale of merchandise on account.

Lower-of-Cost-or-Net Realizable Value Illustration Inventory balance - cost $15,000 Inventory balance - net realizable value $10,000

Since net realizable value is $5,000 below cost, the balance must be reduced. Dr. Inventory obsolescence expense $5,000 Cr. Inventory $5,000 New inventory balance = $15,000 - $5,000 = $10,000 (net realizable value)

Classifying inventory: Manufacturing Company

Three Classifications: Raw Materials Work in Process Finished Goods

Tax: FIFO

When costs are rising, both inventory and net income are higher

Income Statement: LIFO

When costs are rising, cost of goods sold will approximate current costs

Balance Sheet: LIFO

When costs are rising, costs in inventory will not reflect current cost

Income Statement: FIFO

When costs are rising, costs of good sold will not reflect current cost

Tax: LIFO

When costs are rising, net income will be lower A tax rule, often referred to as the LIFO conformity rule, requires that if companies use LIFO for tax purposes they must also use it for financial reporting purposes.

Balance Sheet: FIFO

When costs are rising, the costs allocated to ending inventory will approximate their current cost

Notes Receivable:

Written promise for amounts to be received. Normally requires the collection of interest.

Declining Balance Method

a depreciation method that applies a constant rate to the declining book value of the asset and produces a decreasing annual depreciation expense over the asset's useful life

Asset Impairment

a significant, unexpected decline in the service utility of a capital asset

The control features of a bank account do not include: a. having bank auditors verify the correctness of the bank balance per books. b. minimizing the amount of cash that must be kept on hand. c. providing a double record of all bank transactions. d. safeguarding cash by using a bank as a depository.

a. having bank auditors verify the correctness of the bank balance per books.

Types of Receivables

accounts receivable, notes receivable, and other receivables

Inventory Turnover

measures the number of times on average the inventory is sold during the period. Inventory Turnover= Cost of goods sold/ Average inventory

Sale of Receivables to a Factor

• Finance company or bank. • Buys receivables from businesses and then collects the payments directly from the customers. • Typically charges a fee to the company that is selling the receivables. • Fee ranges from 1-3% of the receivables purchased.

Statement Presentation for Receivables: Balance Sheet

• Identify in the balance sheet or in the notes each major type of receivable. • Report short-term receivables as current assets. • Report both gross amount of receivables and allowance for doubtful accounts.

National Credit Card Sales

• Recorded the same as cash sales. • Retailer pays the credit card issuer a fee of 2-4% of the invoice for its services.

Statement Presentation for Receivables: Income Statement

• Report bad debt expense and service charge expense as operating expenses.• Report interest revenue under "Other revenues and gains.

Writing Checks

• Written order signed by a depositor directing bank to pay a specified sum of money to a designated recipient • Three parties - maker (who issues check), payee (to whom check is payable) and bank (payer of the amount)

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

Specific Identification

- Items still in inventory reflect the cost paid for each individual item -Practice is relatively rare. -Most companies make assumptions (cost flow assumptions) about which units were sold.

Allowance Method for Uncollectible Accounts

1. Companies estimate uncollectible accounts receivable at the end of each period. 2. Debit Bad Debt Expense and credit Allowance for Doubtful Accounts (a contra-asset account). 3. Companies debit Allowance for Doubtful Accounts and credit Accounts Receivable at the time the specific account is written off as uncollectible.

Accounts Receivable:

Amounts customers owe on account that result from the sale of goods and services.

Bank Reconciliations

Bank reconciliations address the following: • Time lags - prevent one of the parties from recording the transaction in the same period • Deposits in transit• Outstanding checks • Bank memorandum• Errors by either party in recording

Sale of Receivables to a Factor Illustration: Assume that Hendredon Furniture factors $600,000 of receivables to Federal Factors. Federal Factors assesses a service charge of 2% of the amount of receivables sold. The journal entry to record the sale by Hendredon Furniture on April 2, 2022, is as follows.

April 2 Cash 588,000 Service Charge Expense 12,000* Accounts Receivable 600,000*($600,000 × 2% = $12,000)

Petty Cash Fund: Replenishing Fund

At minimum level, company replenishes fund. Custodian requests amount, submits schedule of payments/receipts and receipts to management (Treasurer). (Entry recorded at replenishment). Replenishment should typically also occur at the end of an accounting period to recognize the effects of payments in the ledger.

Retirement of Plant Assets

At the end of the asset life, or when an asset is damaged and cannot be replaced, it must be retired. When a Plant Asset is retired, there are no sales proceeds. Dr. Accumulated Depr. 50 Dr. Loss on disposal 50 Cr. Plant Assets (100) Note: If companies are good at estimating useful lives, then there will be few losses on disposal for retired assets.

Fully-Depreciated Plant Assets

If assets are fully depreciated, but still in use, then the asset and related accumulated depreciation continue to be reported on the balance sheet. No further depreciation is recorded once the asset is fully depreciated. Once the asset is no longer in use, remove the asset and related accumulated depreciation, with no impact to the financial statements. Dr. Accumulated Depr 100 Cr. Plant Assets (100)

Determine the Cost of Plant Assets - Equipment

Include all costs incurred in acquiring the equipment and preparing it for use. Costs typically include: • Cash purchase price. • Sales taxes. • Freight charges. • Insurance during transit paid by the purchaser. • Expenditures required in assembling, installing, and testing the equipment. Note: This does note include drivers' licenses or accident insurance, which are annual recurring expenses. Costs of plant assets include one-time (non-recurring costs) and benefits relate to the life of the asset (not one year).

Determine the Cost of Plant Assets - Buildings

Includes all costs related directly to purchase or construction. Purchase costs: • Purchase price, closing costs (attorney's fees, title insurance, etc.) and real estate broker's commission. • Remodeling and replacing or repairing the roof, floors, electrical wiring, and plumbing. Construction costs: • Contract price plus payments for architects' fees, building permits, and excavation costs. Note: Interest costs are included for amounts incurred during the construction period.

Petty Cash Fund: Establishment of Fund

Must have custodian (Entry to record establishment of fund)

Information and communication

The internal control system must capture and communication all pertinent both up and down the organization and to appropriate external parties.

Explain the Statement Presentation and Analysis of Inventory: Required Disclosures

There also should be disclosure of the 1. major inventory classifications, 2. basis of accounting (cost or LCNRV), and 3. cost method (F I F O, L I F O, or average-cost).

Control Environment

This is where top management must make it clear that integrity is valued, and unethical behavior will not be tolerated. This is referred to as the "tone at the top".

Establishment of Responsibility

control is most effective when only one person is responsible for a given task • Establishing responsibility often requires limiting access only to authorized personnel, and then identifying those personnel.

Physical Controls

controls that restrict unauthorized individuals from gaining access to a company's computer facilities

Flow of Cost - 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.

Recording Sales under a perpetual inventory system

-made using cash or credit -Sales revenue, like service revenue, is recorded when the performance obligation is satisfied. -Performance obligation is satisfied when the goods are transferred from the seller to the buyer -Sales invoice should support each credit sale

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.

Internal Control: Five Primary Components:

1) Control Environment 2) Risk Assessment 3) Control Activities 4) Information and communication 5) Monitoring

Inventory Management Double Edged Sword

1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage). 2. Low Inventory Levels - may lead to stock-outs and lost sales.

Accounting Issues for Receivables

1. Recognizing accounts receivable. 2. Valuing accounts receivable. 3. Disposing of accounts receivable.

Illustration: Assume that Warden Co. writes off M. E. Doran's $200 balance as uncollectible on December 12. Warden's entry is:

Dec. 12 Bad Debt Expense 200 Accounts Receivable 200

Allowance Method True up to Estimated Reserve Illustration: Based on the aging schedule, the company must record an allowance of $2,228. The current balance in the allowance account is $500.

Dec. 31 Bad Debt Expense 1,728 Allowance for Doubtful Accounts 1,728

Allowance Method Recording an Estimated Allowance for Doubtful Accounts llustration: Hampson Furniture has credit sales of $1,200,000 in 2022, its first year of operations. Of this amount, $200,000 of receivables remains uncollected at December 31. The credit manager estimates that $12,000 of these sales will be uncollectible. The adjusting entry to record the estimated uncollectibles increases (debits) Bad Debt Expense and increases (credits) Allowance for Doubtful Accounts, as follows.

Dec. 31 Bad Debt Expense 12,000 Allowance for Doubtful Accounts 12,000

Illustration: Suppose that PW Audio Supply has an unadjusted balance of $40,500 in Merchandise Inventory. Through a physical count, PW Audio determines that its actual merchandise inventory at year-end is $40,000. On December 31 the company would make an adjusting entry as follows.

Dec. 31 Cost of Goods Sold 500 Inventory 500

Units-of-activity method

Difference expense amount for each year, measured by amount of activity. Depreciable cost (cost less salvage value) / Total Units of Activity (Production) = Depreciation Expense per Unit x # of Units during the Year = Depreciation Expense per year

What is Fraud?

Dishonest act by an employee that results in personal benefit to the employee at a cost to the employer

Anatomy of a Fraud Mod Fashions Corporation To support their reimbursement requests for travel costs incurred, employees at Mod Fashions Corporation's design center were required to submit receipts. The receipts could include the detailed bill provided for a meal, the credit card receipt provided when the credit card payment was made, or a copy of the employee's monthly credit card bill that listed the item. A number of the designers who frequently traveled together came up with a fraud scheme: They submitted claims for the same expenses. For example, if they had a meal together that cost $200, one person submitted the detailed meal bill, another submitted the credit card receipt, and a third submitted a monthly credit card bill showing the meal as a line item. Thus, all three received a $200 reimbursement. Total take: $75,000 The Missing Control?

Documentation procedures. Mod Fashions should require the original, detailed receipt. It should not accept photocopies, and it should not accept credit card statements. In addition, documentation procedures could be further improved by requiring the use of a corporate credit card (rather than a personal credit card) for all business expenses.

Documentation Procedures

Documents provide evidence that transactions and events have occurred. Companies should establish procedures for documents. Examples include:• Prenumbered documents• Processes for sending documents to accounting • Procedures for labelling and storing documents

Natural Resources

Natural resources consist of standing timber and underground deposits of oil, gas, and minerals. Distinguishing characteristics: Physically extracted in operations. Replaceable only by an act of nature. Cost is the price needed to acquire the resource and prepare it for its intended use.

Internal Control Principles to Cash receipts

Establishment of responsibility - Only designated personnel are authorized to handle cash receipts • Segregation of duties - Different individuals receive, record and hold cash receipts• Documentation procedures - Remittance advice, cash register tapes, computer records, deposit slips should be used. • Physical controls - Store cash in a safe, limit access to storage areas, use locked cash registers or point-of-sale terminals • Independent internal verification - Supervisors count cash receipts daily, another employee compares totals to bank deposits • Human resource controls - Bond employees, require vacations, conduct background checks

Apply Internal Control Principles to Cash disbursements

Establishment of responsibility - Only designated personnel are authorized to handle cash receipts • Segregation of duties - Different individuals receive, record and hold cash receipts • Documentation procedures - Remittance advice, cash register tapes, computer records, deposit slips should be used. • Physical controls - Store cash in a safe, limit access to storage areas, use locked cash registers or point-of-sale terminals • Independent internal verification - Supervisors count cash receipts daily, another employee compares totals to bank deposits • Human resource controls - Bond employees, require vacations, conduct background checks

Estimating the amount to reserve

Estimates are based on historical write-offs as a percentage of receivables. Each company will estimate using its own experience.

Accounting for Plant Assets

Except for land, decline in service potential over their useful lives (must be depreciated) Must be kept in good operating condition Worn-out or outdated plant assets must be replaced May companies have substantial investments in plant assets.

Determining the Cost of Plant Assets

Historical Cost Principle requires that companies record plant assets at cost. Cost consists of all expenditures necessary to acquire an asset and make it ready for its intended use. Examples: Purchase price of the asset per the invoice, freight costs and installation costs Note: If acquired using noncash assets, cost equals the "cash equivalent price" or fair value of the asset given or received, whichever is more clearly determinable.

Anatomy of a Fraud Excelsior Inn Ellen Lowry was the desk manager and Josephine Rodriquez was the head of housekeeping at the Excelsior Inn, a luxury hotel. The two best friends were so dedicated to their jobs that they never took vacations, and they frequently filled in for other employees. In fact, Ms. Rodriquez, whose job as head of housekeeping did not include cleaning rooms, often cleaned rooms herself, "just to help the staff keep up." Ellen, the desk manager, provided significant discounts to guests who paid with cash. She kept the cash and did not register the guest in the hotel's computerized system. Instead, she took the room out of circulation "due to routine maintenance." Because the room did not show up as being used, it did not receive a normal housekeeping assignment. Instead, Josephine, the head of housekeeping, cleaned the rooms during the guests' stay. Total take: $95,000 Missing Control?

Human resource controls. Ellen, the desk manager, had been fired by a previous employer. If the Excelsior Inn had conducted a background check, it would not have hired her. The fraud was detected when Ellen missed work due to illness. A system of mandatory vacations and rotating days off would have increased the chances of detecting the fraud before it became so large.

Net Accounts Receivable

Net Accounts Receivable is unchanged for a write-off of A/R using the Allowance method. • A write-off affects only balance sheet accounts—not income statement accounts. • The write-off of the account reduces both Accounts Receivable and Allowance for Doubtful Accounts. • Cash realizable value in the balance sheet, therefore, remains the same.

Anatomy of a Fraud Mod Fashions Corporation Bobbi Jean Donnelly, the office manager for Mod Fashions Corporation's design center, was responsible for preparing the design center budget and reviewing expense reports submitted by design center employees. Her desire to upgrade her wardrobe got the better of her, and she perpetrated a fraud that involved filing expense-reimbursement requests for her own personal clothing purchases. She was able to conceal the fraud because she was responsible for reviewing all expense reports, including her own. In addition, she sometimes was given ultimate responsibility for signing off on the expense reports when her boss was "too busy." Also, because she controlled the budget, when she submitted her expenses, she coded them to budget items that she knew were running under budget, so that they would not catch anyone's attention. Total take: $275,000 Missing Control?

Independent internal verification. Bobbi Jean's boss should have verified her expense reports. When asked what he thought her expenses were, the boss said about $10,000. At $115,000 per year, her actual expenses were more than ten times what would have been expected. However, because he was "too busy" to verify her expense reports or to review the budget, he never noticed.

Intangible Assets

Intangible assets are rights, privileges, and competitive advantages that result from ownership of long-lived assets that do not possess physical substance. Examples: Trademarks, Copyrights, Customer Lists, Contracts, Franchises, Goodwill May have a definite life or an indefinite life

Lower-of-Cost-or-Net Realizable Value

Inventory must be recorded at the lower of "net realizable value" or cost. Net realizable value: Amount that a company expects to realize (receive from the sale of inventory). If cost is higher than net realizable value, then companies must "write down" or reduce the carrying amount of the inventory. This is an example of conservatism.

Determining Inventory Quantities

Involves counting, weighing, or measuring each kind of inventory on hand. Companies often "take inventory"• when the business is closed or business is slow.• at the end of the accounting period.

Recognizing Accounts Receivables Entry to recognize a receivable Illustration: Assume that Jordache Co. on July 1, 2022, sells merchandise on account to Polo Company for $1,000 terms 2/10, n/30.Prepare the journal entry to record this transaction on the books of Jordache Co. On July 5, Polo returns merchandise worth $100 to Jordache Co. On July 11, Jordache receives payment from Polo Company for the balance due.

July 1 Accounts Receivable 1,000 Sales Revenue 1,000 July 5 Sales Returns and Allowances 100 Accounts Receivable 100 July 11 Cash ($900 − $18) 882Sales Discounts ($900 × .02) 18 Accounts Receivable 900

Allowance Method Recovery of an Uncollectible Account Illustration: On July 1, 2023, R. A. Ware pays the $500 amount that Hampson had written off on March 1. Hampson makes these entries:

July 1 Accounts Receivable 500 Allowance For Doubtful Accounts 500 July 1 Cash 500 Accounts Receivable 500

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

LIFO Method

Recognizing Notes Receivable Illustration: Calhoun Company wrote a $1,000, two-month, 12% promissory note dated May 1, to settle an open account. Prepare the entry Wilma Company would make for the receipt of the note.

May 1 Notes Receivable 1,000 Accounts Receivable 1,000

Purchase Allowance

May choose to keep the merchandise if the seller will grant a reduction from the purchase price

Vouchers

Most medium/large companies use a voucher system to track cash disbursements. Voucher = approval forms for reimbursement 1) Once received, accounts payable records the liability in a journal called a voucher register, and initiatives a check payment. 2) The paid voucher is sent to accounting to record a journal called a check register documenting that the liability is paid.

Honor of Notes Receivable Illustration: Wolder Co. lends Higley Co. $10,000 on June 1, accepting a five-month, 9% interest note. If Wolder presents the note to Higley Co. on November 1, the maturity date, Wolder's entry to record the collection is:

Nov. 1 Cash 10,375 Notes Receivable 10,000 Interest Revenue 375**($10,000 × 9% × 5/12)

Expenditures During Useful Life

Ordinary Repairs are expenditures to maintain the operating efficiency and productive life of the asset. • Debit to Maintenance and Repairs Expense. • Referred to as revenue expenditures. Additions and Improvements are costs incurred to increase the operating efficiency, productive capacity, or useful life of a plant asset. • Debit the plant asset affected. • Referred to as capital expenditures. Note: May adopt non-GAAP policy of expensing immaterial items.

Anatomy of a FraudCenterstone Health At Centerstone Health, a large insurance company, the mailroom each day received insurance applications from prospective customers. Mailroom employees scanned the applications into electronic documents before the applications were processed. Once the applications are scanned they can be accessed online by authorized employees. Insurance agents at Centerstone Health earn commissions based upon successful applications. The sales agent's name is listed on the application. However, roughly 15% of the applications are from customers who did not work with a sales agent. Two friends—Alex, an employee in record keeping, and Parviz, a sales agent—thought up a way to perpetrate a fraud. Alex identified scanned applications that did not list a sales agent. After business hours, he entered the mailroom and found the hardcopy applications that did not show a sales agent. He wrote in Parviz's name as the sales agent and then rescanned the application for processing. Parviz received the commission, which the friends then split. Total take: $240,000 Missing Control?

Physical controls. Centerstone Health lacked two basic physical controls that could have prevented this fraud. First, the mailroom should have been locked during nonbusiness hours, and access during business hours should have been tightly controlled. Second, the scanned applications supposedly could be accessed only by authorized employees using their passwords. However, the password for each employee was the same as the employee's user I D. Since employee user-I D numbers were available to all other employees, all employees knew all other employees' passwords. Unauthorized employees could access the scanned applications. Thus, Alex could enter the system using another employee's password and access the scanned applications.

Control Activities

Policies designed by management to address the specific risks faced by the company. These are the backbone of the company's efforts to address its risks. Each company's control activities vary based on the size and nature of the company and its business.

Ownership of Goods: Goods in Transit

Purchased goods not yet received Sold goods not yet delivered. 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.

Disposing of Plant Assets: Sale of Plant Assets, if sales proceeds are greater than book value...

Record gain on sale: Dr. Cash 100 Dr. Accumulated Depr. 50 Cr. Plant Assets (100) Cr. Gain on Sale (50)

Disposing of Plant Assets: Sale of plant asset if sale proceeds are less than the book value.

Record loss on sale: Dr. Cash 40 Dr. Accumulated Depr. 50 Dr. Loss on sale 10 Cr. Plant Assets (100)

Record Purchases and Sales under a Periodic Inventory System

Recording Purchases is the same under a perpetual and periodic inventory system. However for sales... -No Running account of charges in inventory -Ending inventory determined by physical count -cost of goods sold not recorded with each sale

Valuing Notes Receivable

Report short-term notes receivable at their cash (net) realizable value. Estimation of cash realizable value and bad debt expense are done similarly to accounts receivable. Allowance for Doubtful Accounts is used.

Straight-Line Method

Same expense amount for each year, measured by passage of time. Depreciable cost (cost less salvage value) / Useful Life (years) = Depreciation Expense per year Can also use this to apply a % (5 years = 20% per year)

Anatomy of a Fraud Aggasiz Construction Company Angela Bauer was an accounts payable clerk for Aggasiz Construction Company. She prepared and issued checks to vendors and reconciled bank statements. She perpetrated a fraud in this way: She wrote checks for costs that the company had not actually incurred (e.g., fake taxes). A supervisor then approved and signed the checks. Before issuing the check, though, she would "white-out" the payee line on the check and change it to personal accounts that she controlled. She was able to conceal the theft because she also reconciled the bank account. That is, nobody else ever saw that the checks had been altered. Total take: $570,000The Missing Control?

Segregation of duties. Aggasiz Construction Company did not properly segregate record-keeping from physical custody. Angela had physical custody of the checks, which essentially was control of the cash. She also had record-keeping responsibility because she prepared the bank reconciliation.

FOB Destination

Seller pays for freight costs Ownership of the goods remains with the seller until the goods reach the buyer. Freight costs incurred by the seller are an operating expense

Ownership of Goods: Freight on Board Destination

Seller pays freight cost (recorded as shipping expense by seller) Ownership changes when shipping carrier delivers inventory to buyer and buyer takes possession

Lawrence Fairbanks, the assistant vice-chancellor of communications at Aesop University, was allowed to make purchases of under $2,500 for his department without external approval. Unfortunately, he also sometimes bought items for himself, such as expensive antiques and other collectibles. How did he do it? He replaced the vendor invoices he received with fake vendor invoices that he created. The fake invoices had descriptions that were more consistent with the communications department's purchases. He submitted these fake invoices to the accounting department as the basis for their journal entries and to the accounts payable department as the basis for payment. Total take: $475,000The Missing Control?

Should have had a segregation of duties. The university had not properly segregated related purchasing activities. Lawrence was ordering items, receiving the items, and receiving the invoice. By receiving the invoice, he had control over the documents that were used to account for the purchase and thus was able to substitute a fake invoice.

Determine the Cost of Plant Assets - Land Improvements

Structural additions with limited lives made to land. Cost includes all expenditures necessary to make the improvements ready for their intended use. • Examples: driveways, parking lots, fences, landscaping, and underground sprinklers. • Limited useful lives. • Expense (depreciate) the cost of land improvements over their useful lives.

Petty Cash Fund

Used to pay small amounts.Involves: 1. establishing the fund, 2. making payments from the fund, and 3. replenishing the fund.

Why Does Fraud Occur?

opportunity: Workplace must provide opportunities that an employee can take advantage of. financial pressure: Employees may have personal financial problems or may want a lifestyle that they cannot afford rationalization: Employees may justify fraud because they believe they are underpaid while the company is making a lot of money

Cash equivalents

short-term, highly liquid investments that are both: 1. Readily convertible to known amounts of cash, and 2. So near their maturity that their market value is relatively insensitive to changes in interest rates.

Human Resources Controls

• Bond employees who handle cash. (Insurance protection against theft) • Rotate employees' duties and require vacations. (Many banks have discovered employee theft while an employee is on vacation) • Conduct background checks. (Easy inexpensive way to verify employee information)

Franchises

• Contractual arrangement between a franchisor and a franchisee. o Shell, Subway, and Marriott are franchises. • Franchise (or license) with a limited life should be amortized to expense over its useful life. • If the life is indefinite, the cost is not amortized.

First In, First Out (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.

Segregation of Duties

• Different individuals should be responsible for related activities.• The responsibility for record-keeping for an asset should be separate from the physical custody of that asset.• Making one individual responsible for related activities increases the potential for errors and irregularities

Electronic Funds Transfer (EFT)

• Disbursement systems that use wire, telephone, or computers to transfer cash from one location to another. • Use is quite common. • E F T transactions normally result in better internal control since no cash or checks are handled by company employees. • Same basic controls apply - segregation of duties is required so an employee cannot redirect an EFT into their personal account and conceal with fraudulent entries

Patents

• Exclusive right to manufacture, sell, or otherwise control an invention for a period of 20 years from the date of the grant. • Capitalize costs of purchasing a patent and amortize over its 20-year life or its useful life, whichever is shorter. • Expense any R&D costs in developing a patent. • Legal fees incurred successfully defending a patent are capitalized to the Patent account.

Copyrights

• Give the owner the exclusive right to reproduce and sell an artistic or published work. • Extend for the life of the creator plus 70 years. • Cost of the copyright is the cost of acquiring and successfully defending it. • Amortized to expense over useful life.

Ownership of Goods: Goods on Consignment

• Goods are delivered to party that tries to sell the goods, but does not take ownership • If the good is sold, the selling party keeps a fee • If the good is not sold, the selling party returns the item to the original seller without having taken ownership of the item • Allows the selling party to avoid the risk of purchasing an item that they will not be able to sell. • These items are included in the original seller's inventory balance

Goodwill

• Includes exceptional management, desirable location, good customer relations, skilled employees, high-quality products, etc. • Only recorded when an entire business is purchased. • Goodwill is recorded as the excess of cost over the fair value of the net assets (assets less liabilities) acquired. • Not amortized but must be written down if it is determined that its value has been permanently impaired.

Depreciation and Income Taxes

• Methods Used for Book Accounting are typically not the same as those used for Income Taxes. • Many corporations use the straight-line method for book income to maximize reported net income. • At the same time, they use special accelerated-deprecation on their tax return to minimize income taxes paid. This is called Modified Accelerated Cost Recovery System (MACRS)

Bank Statements

• Prepared from the bank's perspective. • Every deposit the bank receives is an increase in the bank's liabilities (an account payable to the depositor). • Lists in numerical sequence all paid checks along with the date the check was paid and its amount. • Bank includes with the bank statement memoranda explaining other debits and credits it made to the depositor's account. • A check that is not paid by a bank because of insufficient funds in a bank account is called an N S F check (not sufficient funds).

Recording Merchandise Transactions

• Record revenues when sales are made. • Do not record cost of merchandise sold on the date of sale. • Physical inventory count determines o Cost of merchandise on hand and o Cost of merchandise sold during the period. • Record purchases in Purchases account. • Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts.

Depletion

• The allocation of the cost to expense in a rational and systematic manner over the resource's useful life. • Companies generally use units-of-activity method. • Depletion generally is a function of the units extracted during the year. (Total Cost-Salvage Value)/Total estimated Units Available = Depletion Cost per Unit

Identify the control features of a bank account

• The use of a bank contributes significantly to good internal control over cash. • Minimizes the amount of cash on hand. • Creates a double record of bank transactions. • Bank reconciliation - the process of comparing the banks balance with the company's balance and explaining the differences to make them agree. • Bank statements is a record of the balance and transactions during the period obtained from the bank - either hard copy by mail or available online

Trademarks

• Word, phrase, jingle, or symbol that identifies a particular enterprise or product. o Wheaties, Monopoly, Kleenex, Coca-Cola, Big Mac, and Jeep. • Legal protection for indefinite number of 20-year renewal periods. • Capitalize acquisition costs. • No amortization.