Accounting 207 Exam 2

Straight Line Depreciation Method

- (COST - SALVAGE LIFE) / (USEFUL LIFE) = DEPRECIATION EXPENSE - Companies expense an equal amount of depreciation each year of the asset's useful life

Gross Profit

- (The EXCESS of net sales) / (COGS)

(2/10, N/30)

- 2 = 2% Discount - 10 - ^ If paid within 10 days - 30 - MUST be paid within 30 days

Petty Cash Fund (1 Q on test)

- A Cash fund used to pay relatively SMALL AMOUNTS 1) Appoint a petty cash custodian who will be responsible for the fund 2) Determine the size of the fund

If you sell an asset for MORE than its book value then it is...

- A GAIN ON SALE (debit)

If you sell an asset for LESS than its book value then it is...

- A LOSS ON SALE (credit)

Notes Receivable

- A Written Promise for amounts to be received - Companies GAIN CREDIT in exchange for a promissory note - USED when.. individuals/companies lend//borrow money, Settlement of accounts rec. - DEBIT NOTES REC., CREDIT ACCOUNTS REC.

EXAMPLE QUESTION

- A company made a sale on account (2/10, N/30) on 5/1/15 for $3000... $600 of this sale had been returned on 5/7/15... "How much money will be collected on 5/9/15 if he pays in full?" ANSWER: - 3000-600 = 2400 - 48 = 2% of 2400 - 2400-48 = $2362

Sales Discount

- A reduction given by a SELLER for a prompt payment of a credit sale

Average Cost Method

- Allocates the cost of goods available for sale on the bases of Weighted Average Unit Cost incurred - Smooths out the Price Changes - (Beginning Inventory + Ending Inventory) / (2)

Accounts Receivable

- Amounts CUSTOMERS OWE on account - Result: from the sale of goods and services - Report as CURRENT ASSET on balance sheet

Receivables

- Amounts DUE from individuals and companies - Claims that are expected to be paid in CASH

Salvage Value

- An ESTIMATE of the asset's value at the END of its useful life for its owner

Useful Life

- An ESTIMATE of the expected productive life (service life) of the asset for its owner - Terms of time, units of activity (hours), units of output

Bad Debit Expense

- An Expense Account to record losses from extending credit - Use ADJUSTING ENTRY --> UNCOLLECTIBLE ACCOUNTS RECEIVABLE - Percent of Sales Method - The # of credit sales X the percent that is uncollectible

Cost for an Asset (Plant Assets)

- Any cost required to get an asset ready for its intended purpose (PHYSICAL SUBSTANCE) - NOT INTENDED FOR SALE ASSETS (ex: equipment, land, buildings) - MUST be included in the ASSETS COST - You BACK OUT of the DISCOUNT, whether or not taken (subtract discount even if it isn't taken) - Record Assets at original cost

Gain on Sale EXAMPLE

- Assume: Sell after owning asset for 18 months for $7000 - Journal Entry: - Debit Cash 7000 - Debit Accumulative Depreciation 3000 (2000 for 1 year, add 1000 for half year = 3000) - Credit Equipment 8000 - Gain on Sale = 2000!!!

Book Balance

- Balance WE, the COMPANY, HAVE

Bank Balance

- Balance on bank statement at the END of the MONTH

Nature of COGS

- Beginning inventory + purchases = Goods available for sale - Ending inventory = Cost of goods sold

(N/60)

- Bill must be paid within 60 days - NO DISCOUNT

Limitations of Internal Control

- COSTS should NOT EXCEED BENEFITS - provides reasonable assurance - Human Element - laziness, collusion (cannot prevent this) - Size of Business - small businesses may find it difficult to implement certain controls

Periodic Inventory System

- Companies do NOT keep detailed inventory records of the goods on hand throughout the period - Companies determine the cost of goods sold ONLY AT THE END OF THE ACCOUNTING PERIOD (periodically) --> companies then take a physical inventory count to determine the cost of goods at hand - Ex: Hardware Stores (Smaller Volume, Higher Prices/Ticket Items)

Perpetual Inventory System

- Companies maintain detailed records of the cost of each purchase and sale. These records continuously (perpetually) show the inventory that should be on hand for every item - Companies determine the cost of goods sold EACH TIME A SALE OCCURS (know the inventory at all times) - Companies use when they sell merchandise with high unit values (cars, furniture, home appliances) - Ex: Bar code being scanned (High Volume, Low Price Stock)

Cost

- Companies record assets at COST (cost principle) - The COST OF AN ASSET - ITS SALVAGE VALUE

Bank Service Charges

- Companies typically DEBIT MISCELLANEOUS EXPENSE

Expenditure Example #2

- Company borrows money from bank (90 day/6%) for $10,000 on 11/1/15... Record Adjusting Entry on 12/31/15... ANSWER: - 6% of 10,000 = 600 (6% interest PER YEAR) - 600/12 (months) = 50 - 2 Month entry = 50 + 50 = 100 So... Debit Interest Expense $100 Credit Interest Payable $100

Use of a Bank

- Contributes to good Internal Control over cash - MINIMIZES amount of cash on hand - Creates a double record of bank transactions - Bank Reconciliation

Capital Expenditures (Debit Asset Account)

- Costs that are NOT EXPENSED immediately, but are instead INCLUDED in an asset account - GREATER than the materiality threshold - Adds VALUE/USEFUL LIFE - Extraordinary Expenses (ex: adding a tile roof to sustain a longer roof lifetime)

Debit Memorandum

- Decreases the account balance on bank statement - NSF CHECKS, BANK SERVICE CHARGE

Deposits in Transit

- Deposits recorded by the depositor that have not been recorded by the bank

"Freight Out"

- Expense for DELIVERY TO CUSTOMERS

FIFO Method

- FIRST IN, FIRST OUT - EARLIEST GOODS purchased are the FIRST TO BE SOLD - Sell OLDEST UNITS FIRST - Costs of the earliest goods purchased are the first to be recognized in determining COGS - Under FIFO, 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 - DURING INFLATION: Report LOWEST COGS and Lowest Income tax

Inventory Errors

- Failure to count or price inventory correctly, not properly recognizing the transfer of legal title goods in transit

"Freight In"

- Freight costs incurred by the SELLER on outgoing merchandise

Risk Assessment (internal control)

- Identify, Analyze, Manage Risks

Use LIFO when...

- If a company that sells products (retailer, manufacturer, etc.) finds the COST OF ITS ITEMS STABLE/INCREASING, the use of LIFO will result in less taxable income and less income tax payments than FIFO

Revenue Expenditures (Debit Expense Account)

- If a cost is NOT INCLUDED in an asset account, then it must be EXPENSED immediately - LESS than or EQUAL to materiality threshold - Does NOT necessarily benefit future periods - Ordinary Repairs/Maintenance/Normal Replacement Items (Ex: Tires, Batteries)

Equipment

- Include all costs incurred in acquiring equipment and preparing it for use (Ex: Price, sales tax, freight charges, insurance during transit)

Costs included in inventory purchases

- Invoice price, freight, inspection costs, and preparation costs

Allowance Method

- Involves estimating uncollectible accounts at the end of each period (bad debts) - Provides better matching of expenses with revenues on the income statement 1) DEBIT BAD DEBTS expense and CREDIT ALLOWANCE FOR DOUBTFUL ACCOUNTS ("less" on balance sheet) 2) Then → companies debit allowance for doubtful accounts and credit accounts receivable at the time the specific account is written off as uncollectible

Outstanding Checks

- Issued checks recorded by the company that have not been paid by the bank

Expenditure Example

- John has a company car for 2 years and the company replaces the car every 3 years. He Blows his engine on the way to an appointment and it's $3800 to fix it. ANSWER: - DEBIT EXPENSE 3800 because it is a Revenue Expenditure --> from negligence

LIFO Method

- LAST IN, FIRST OUT - LATEST GOODS purchased are the FIRST TO BE SOLD - The COSTS OF THE LATEST GOODS PURCHASED are the first to be recognized in determining COGS - Ending inventory is based on the prices of the OLDEST UNITS PURCHASED - Most conservative since prices tend to go up - Under LIFO, companies obtain the cost of the ending inventory by taking the unit cost of the earliest goods available for sale and working forward until all units of inventory have been costed - DURING INFLATION: Report HIGHEST COGS and LOWEST income tax

Control Environment (internal control)

- Management must set tone, unethical behavior unacceptable

Specific Identification

- Most specifically, Identify WHAT YOU SELL - When units are sold, the specific cost of the unit sold is added to cost of goods sold - An actual Physical flow costing method in which particular items sold and items still in the inventory are specifically costed to arrive at cost of goods sold and ending inventory

Valuing Accounts Receivable

- NOT reported as gross amount - CURRENT ASSET - Valuation as Net Realizable Value - amount expected to be collected (ESTIMATE!!) - Direct WRITE-OFF Method - simply Debit BAD DEBTS (Expense) and Credit ACCOUNTS RECEIVABLE

Weighted Average

- New Average each time a product comes in - Cost of Goods Available for Sale / Total Units Available for Sale = Weighted Average Unit Cost - ALWAYS yields average between LIFO and FIFO

NSF Check

- Not Sufficient Funds - Check that is not paid by a bank because of insufficient funds in a bank account - Becomes an Accounts Receivable to the Depositor

Overstate Beginning Inventory

- Overstate COGS - Understate Net Income

Understate Ending Inventory (Same as overstating BI)

- Overstate COGS - Understate Net Income

Internal Controls

- PURPOSE: Consists of all the related methods and measures adopted within an organization to safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations - Ex: Cash Records --> only certain people can look - Ex: Movie theaters tickets --> Have a ticket person to honor integrity

Control Activities (internal control)

- Policies --> Address risks

Sales Revenue

- Primary Source of a revenue for a merchandising company

Sales Invoice

- Provides support for each sale - 1) INCREASES (Debit) Accounts Receivable OR Cash AND (Credit) Sales Revenue 2) INCREASES (Debits) COGS And DECREASES (Credit) Inventory

Purchase Allowance

- Purchaser chooses to keep the merchandise if the seller is willing to grant a reduction of the purchase price

Recognizing Accounts Receivable

- Service Organization - records a receivable when it provides SERVICE on account - Merchandiser - records accounts receivable at the point of a SALE or merchandise on account

Bank Statement

- Shows bank transactions and balances - Received monthly from the bank - Prepared from the BANK'S PERSPECTIVE --> "Our account is a LIABILITY" - Ex: Every deposit the bank receives is an INCREASE in the bank's liabilities - INCLUDES: 1) Debit Bank Service Charge (-) 2) Debit NSF Check (-) 3) Credit Notes Receivable (+) 4) Credit Interest (+)

Info and Communication (internal control)

- System capture relevant info --> delivers to appropriate parties

Monitoring (internal control)

- System should be regularly monitored

Net (CASH) Realizable Value

- The net amount a company expects to receive in cash from receivables - 1) companies estimate uncollectible accounts receivable and match them against revenues (in the same accounting period in which the revenues are recorded) 2) Companies record estimated uncollectibles as an INCREASE (Debit) to bad debt expense and an INCREASE (Credit) to Allowance for Doubtful Accounts (contra account to accounts receivable) - ACCOUNTS RECEIVABLE - ALLOWANCES = NET REALIZABLE VALUE

Bank Reconciliation

- The process of COMPARING the Bank's Balance with the Company's Balance, and explaining the differences to make them agree - INTERNAL CONTROL FOR CASH - If a person is PHYSICALLY handling the cash for the company, that person should NOT DO THE BANK RECONCILIATION - INCLUDES: Deposits in transit (+), outstanding checks (-), bank errors (+/-)

Depreciation

- The process of allocating to EXPENSE the cost of an asset over its useful (service) life in a rational/systematic manner - Done to match expenses with revenues - COST Allocation Process, NOT Asset Allocation process

Purchase Return

- The purchaser may return the goods to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash

FIFO/LIFO Purpose

- To determine Costs of Goods Sold in Inventory - NOTHING to do with Sales Revenue

Cost of Goods Sold (COGS)

- Total cost of merchandise sold during a period

Sales Return and Allowances

- Transaction in which the seller either accepts goods back from the purchaser (Return) OR grants a reduction in the purchase price (Allowance) so that the buyer will keep the goods

Overstate Ending Inventory (same as understating BI)

- Understate COGS - Current Assets Overstated - Overstate Net Income

Understate Beginning Inventory

- Understate COGS - Overstate Net Income

Lower of Cost or Market

- Value of inventory is LOWER THAN ITS COST - May need to "write down" inventory to its market value in the period price decline occurs

General Ledger (Per Books)

- What does the bank know that we don't know? - INCLUDES: 1) adjustments to the book balance 2) Notes Collected by the banks (+) 3) NSF Checks (-) 4) Check printing or other Service Charges (-) 5) Company Errors (+/-)

Positive Cost Flow

- decrease inventory. increase accounts payable

Negative Cost Flow

- increase inventory. decrease accounts payable

Use FIFO when...

- older items may become perishable (grocery store items) - Want to sell these items at original price before they become less profitable - When prices are decreasing

Credit Memorandum

-Increases account balance - COLLECT NOTES RECEIVABLE, INTEREST

End of Year Allowances

BOY + AJE - Write Offs = EOY allowances

If More than a Company Threshold Account...

Debit ASSET Account (Cap. Expenditures)

If Less than a Company Threshold Account...

Debit EXPENSE (Rev. Expenditures)

Returned $150 of goods originally purchased on credit. Using Periodic inventory approach.

Debit accounts payable 150 Credit purchase returns and allowances 150

Purchase $500 of merchandise on credit. Periodic inventory.

Debit purchases (Expense account) 500 Credit accounts payable 500

Primary Goals of inventory management

Provide sufficient quantities of high quality inventory and minimize the costs of carrying inventory

Sales Net

Sales - Sales Returns - Sales Discounts = SALES NET - Always Start income statement with "Sales Net"

Cost of freight in: Periodic

debit freight in credit cash

Cost of Freight IN: Perpetual

debit inventory credit cash

Recovery of Uncollectible Account

1) CREDIT ACCOUNTS REC., DEBIT ALLOWANCE for doubtful accounts 2) Then.. DEBIT CASH and CREDIT ACCOUNTS REC.

Periodic Inventory Steps to Determine COGS

1) Determine the COG on hand at the beginning of the accounting period 2) Add it to the cost of goods purchased 3) Subtract the cost of goods on hand at the end of the accounting period

Internal Control and Fraud

1) Establish Responsibility - one person should be responsible for activity 2) Segregation of Duties - separate related activities 3) Documentation Procedures - use renumbered documents 4) Physical Controls - safes, vaults, locks, passwords, monitors, sensors, alarms 5) Independent Internal Verification - Records periodically verified by an employee independent of company (auditor) - discreteness reported to management 6) Human Resource Controls - Bond employees, rotate employee duties and require vacations, conduct background checks

Basic Principles of Cash Management

1) Increase SPEED of receivables collection - change credit terms, give customers less time 2) Keep INVENTORY LOW 3) Monitor Payment of Liabilities - WAIT to pay liabilities, put cash to other use 4) Plan Timing of Major Expenditures - make sure proper amount of cash available to fund projects 5) Invest idle cash

Multiple Step Income Statement

1) Net Sales - COGS = GROSS PROFIT 2) Gross Profit - Operating Expenses = INCOME from operations 3) Add OR subtract the results of activities not relating to operations to determine = NET INCOME

Petty Cash Transactions (2)

1) Set up "Petty Cash" Fund 2) Receipts - The sum of the petty cash receipts and money in the fund should equal the established total at all times

Asset that is most susceptible to improper diversion and use (from an internal control standpoint)

= CASH

LOSS on sale

= CREDITED

GAIN on sale

= DEBITED

If you need to CREDIT cash over short

= OVER

Market Value

= Replacement Cost

If You Need to DEBIT cash over short

= SHORT