Accounting Final
19. (a) What is a voucher system? (b) What principles of internal control apply to a voucher system?
(a) A voucher system is a network of approvals by authorized individuals acting independently to ensure that all disbursements by check are proper. (b) The internal control principles applicable to a voucher system are: (1) establishment of res-ponsibility, (2) segregation of duties, (3) independent internal verification, and (4) documentation procedures.
15. (a) What are the principal differences between common stock and preferred stock? (b) Preferred stock may be cumulative. Discuss this feature. (c) How are dividends in arrears presented in the financial statements?
(a) Common stock and preferred stock both represent ownership of the corporation. Common stock signifies the basic residual ownership; preferred stock is ownership with certain privileges or preferences. Preferred stockholders typically have a preference as to dividends and as to assets in the event of liquidation. However, preferred stockholders generally do not have voting rights. (b) Some preferred stocks possess the additional feature of being cumulative. Most preferred stock is cumulative—preferred stockholders must be paid both current-year dividends and unpaid prior year dividends before common stockholders receive any dividends. (c) Dividends in arrears are disclosed in the notes to the financial statements.
10 Assume that Remington Inc. sold bonds with a face value of $100,000 for $104,000. Was the market interest rate equal to, less than, or greater than the bonds' contractual interest rate? Explain.
(a) Face value is the amount of principal due at the maturity date. (b) The contractual interest rate is the rate used to determine the amount of cash interest the borrower pays and the investor receives. This rate is also called the stated interest rate because it is the rate stated on the bonds. (c) A bond indenture is a legal document that sets forth the terms of the bond issue. (d) A bond certificate is a legal document that indicates the name of the issuer, the face value of the bonds, the contractual interest rate and maturity date of the bonds.
11 If a 7%, 10-year, $800,000 bond is issued at face value and interest is paid annually, what is the amount of the interest payment at the end of the first semiannual period?
$28,000. $800,000 X 7% X 1/2 year = $28,000.
7 Contrast the effects of the three depreciation methods on annual depreciation expense.
The effects of the three methods on annual depreciation expense are: Straight-line—constant amount; units of activity—varying amount; declining-balance—decreasing amounts.
25 What is the formula for the payout ratio? What does it indicate?
The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends. Restrictions may result from the following causes: legal, contractual, or voluntary.
9 Describe the two major obligations incurred by a company when bonds are issued.
The two major obligations incurred by a company when bonds are issued are the interest payments due on a periodic basis and the principal which must be paid at maturity.
8 How are bad debts accounted for under the direct write-off method? What are the disadvantages of this method?
Under the direct write-off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is debited to Bad Debt Expense. The direct write-off method makes no attempt to match bad debt expense to sales revenues or to show the cash realizable value of the receivables in the balance sheet.
10. What internal control objectives are met by physical controls?
(a) Independent internal verification involves the review of data prepared by employees. (b) Maximum benefit is obtained from independent internal verification when: (1) The verification is made periodically or on a surprise basis. (2) The verification is done by an employee who is independent of the personnel responsible for the information. (3) Discrepancies and exceptions are reported to a management level that can take appropriate corrective action.
6 a)What are long-term liabilities? Give three examples. b) What is a bond?
(a) Long-term liabilities are obligations that are expected to be paid after one year. Examples include bonds, long-term notes, and lease obligations. (b) Bonds are a form of interest-bearing notes payable used by corporations, universities, and governmental agencies..
4. (a) What are the major sources (inflows) of cash in a statement of cash flows? (b) What are the major uses (outflows) of cash?
(a) Major inflows of cash in a statement of cash flows include cash from operations; issuance of debt; collection of loans; issuance of capital stock; sale of investments; and the sale of property, plant, and equipment. (b) Major outflows of cash include purchase of inventory, payment of wages and other operating expenses, payment of cash dividends; redemption of debt; purchase of investments; making loans; redemption of capital stock; and the purchase of property, plant, and equipment.
7 Contrast the following types of bonds: (a) secured and unsecured, and (b) convertible and callable.
(a) Secured bonds have specific assets of the issuer pledged as collateral. In contrast, unsecured bonds are issued against the general credit of the borrower. These bonds are called debenture bonds. (b) Convertible bonds may be converted into common stock at the bondholders' option. Callable bonds are subject to retirement at a stated dollar amount prior to maturity at the option of the issuer.
5. (a) What are the two principal components of stockholders' equity? (b) What is paid-in capital? Give three examples.
(a) The two principal components of stockholders' equity for a corporation are paid-in capital (the investment of cash and other assets in the corporation by stockholders in exchange for capital stock) and retained earnings. The principal source of retained earnings is net income. (b) Paid-in capital is the term used to describe the total amount paid-in on capital stock. Paid-in capital may result through the sale of common stock, preferred stock, or treasury stock.
6 Contrast the straight-line method and the units-of-activity method as to (a) useful life, and (b) the pattern of periodic depreciation over useful life.
(a) Useful life is expressed in years under the straight-line method and in units of activity under the units-of-activity method. (b) The pattern of periodic depreciation expense over useful life is constant under the straight-line method and variable under the units-of-activity method.
2 What are some common types of receivables other than accounts receivable and notes receivable?
2. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable.
20 Contrast the effects of a cash dividend and a stock dividend on a corporation's balance sheet.
A cash dividend decreases assets, retained earnings, and total stockholders' equity. A stock dividend decreases retained earnings, increases paid-in capital, and has no effect on total assets and total stockholders' equity
12 For what reasons might a company like IBM repurchase some of its stock (treasury stock)?
A corporation may acquire treasury stock: (1) to reissue the shares to officers and employees under bonus and stock compensation plans, (2) to increase trading of the company's stock and signal that management believes the stock is underpriced, which they hope will enhance its market price, (3) to have additional shares available for use in the acquisition of other companies, (4) to reduce the number of shares outstanding and thereby increase earnings per share, (5) to eliminate hostile investors, perhaps to avoid a takeover.
24 What is the purpose of a retained earnings restriction? Identify the possible causes of retained earnings restrictions.
A prior period adjustment is a correction of an error in previously issued financial statements. The correction is reported in the current year's retained earnings statement as an adjustment of the beginning balance of retained earnings.
17 Indicate how each of the following accounts should be classified in the stockholders' equity section. (a) Common stock. (b) Paid-in capital in excess of par—common stock. (c) Retained earnings. (d) Treasury stock. (e) Paid-in capital from treasury stock. (f) Paid-in capital in excess of stated value—common stock. (g) Preferred stock.
Account a)Common Stock b)Paid-in Capital in Excess of Par— Common Stock c)Retained Earnings d)Treasury Stock e)Paid-in Capital from Treasury Stock f)Paid-in Capital in Excess of Stated Value—Common Stock g)Preferred Stock Classification a)Paid-in capital—capital stock b)Paid-in capital—additional paid-in capital c)Retained earnings d)Deducted from total paid-in capital and retained earnings e)Paid-in capital—additional paid-in capital f)Paid-in capital—additional paid-in capital g)Paid-in capital—capital stock
1 What is the difference between an account receivable and a note receivable?
Accounts receivable are amounts owed by customers on account. They result from the sale of goods and services. Notes receivable represent claims that are evidenced by formal instruments of credit.
9 What factors help determine the market price of stock?
Among the factors which influence the market value of stock are the company's anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the securities markets.
13 Explain the concept of depletion and how it is computed.
Depletion is the allocation of the cost of natural resources to expense in a rational and systematic manner over the resource's useful life. It is computed by multiplying the depletion cost per unit by the number of units extracted and sold.
13 Identify five items that are adjustments to convert net income to net cash provided by operating activities under the indirect method.
Depreciation expense. Gain or loss on disposal of a noncurrent asset. Increase/decrease in accounts receivable. Increase/decrease in inventory. Increase/decrease in accounts payable.
4. "Internal control is concerned only with enhancing the accuracy of the accounting records." Do you agree? Explain.
Disagree. Internal control is also concerned with the safeguarding of company assets from employee theft, robbery, and unauthorized use.
8. Liz Kelso is reviewing the principle of segregation of duties. What are the two common applications of this principle?
Documentation procedures contribute to good internal control by providing evidence that transac-tions and events have occurred and, when signatures (or initials) are added, the documents establish responsibility for the transactions. The prompt transmittal of documents to accounting contributes to recording transactions in the proper period, and the prenumbering of documents helps to ensure that a transaction is not recorded more than once or not at all.
6 How does the balance sheet for a corporation differ from the balance sheet for a proprietorship?
Each of the three basic financial statements for a corporation differs from those for a proprietorship. The income statement for a corporation will have income tax expense. For a corporation, a retained earnings statement is prepared to show the changes in retained earnings during the period. In the balance sheet, the owner's equity section is called the stockholders' equity section.
20. What is the essential feature of an electronic funds transfer (EFT) procedure?
Electronic funds transfer is a cash disbursement system that uses wire, telephone, or computers to transfer cash from one location to another
2 What are some examples of land improvements?
Examples of land improvements include driveways, parking lots, fences, and underground sprinklers.
18 Under what conditions is goodwill recorded?
Goodwill is recorded only when there is a transaction that involves the purchase of an entire business. Goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired. The recognition of goodwill without an exchange transaction would lead to subjective valuations which would reduce the reliability of financial statements.
10 How is a gain or loss on the sale of a plant asset computed?
In a sale of plant assets, the book value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs.
18 Jan Kimler maintains that adequate cash is the only requirement for the declaration of a cash dividend. Is Jan correct? Explain.
In order for a cash dividend to occur, a corporation must also have retained earnings and the dividend must be declared by the board of directors.
4 What are the basic ownership rights of common stockholders in the absence of restrictive provisions?
In the absence of restrictive provisions, the basic ownership rights of common stockholders are the rights to: (a) vote in the election of board of directors and in corporate actions that require stockholders' approval. (b) share in corporate earnings through the receipt of dividends. (c) keep the same percentage ownership when new shares of common stock are issued (the preemptive right). (d) share in assets upon liquidation.
18 What is liquidity? What are two measures of liquidity?
Liquidity refers to the ability of a company to pay its maturing obligations and meet unexpected needs for cash. Two measures of liquidity are working capital (current assets - current liabilities) and the current ratio (current assets ÷ current liabilities).
12 What are natural resources, and what are their distinguishing characteristics?
Natural resources consist of underground deposits of oil, gas, and minerals, and standing timber. These long-lived productive assets have two distinguishing characteristics: they are physically extracted in operations, and they are replaceable only by an act of nature.
18. Explain how these principles apply to cash disbursements: (a) physical controls, and (b) human resource controls.
Physical controls apply to cash disbursements when: (a) blank checks are stored in a safe, and access to the safe is restricted to authorized personnel, and (b) a checkwriting machine and indelible ink are used to imprint amounts on checks. Documentation procedures apply when the company uses prenumbered checks and account for them in sequence, and stamps invoices "paid".
9 Distinguish between revenue expenditures and capital expenditures during useful life.
Revenue expenditures are ordinary repairs made to maintain the operating efficiency and productive life of the asset. Capital expenditures are additions and improvements made to increase operating efficiency, productive capacity, or useful life of the asset. Revenue expenditures are recognized as expenses when incurred; capital expenditures are generally debited to the plant asset affected.
9. How do documentation procedures contribute to good internal control?
Safes, vaults, and locked warehouses contribute to the safeguarding of company assets. Cash registers and time clocks contribute to the accuracy and reliability of the accounting records, and electronic burglary systems and sensors help to safeguard assets.
8 Contrast the advantages and disadvantages of the direct and indirect methods of preparing the statement of cash flows. Are both methods acceptable? Which method is preferred by the FASB? Which method is more popular?
The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate. The advantage of the indirect method is it is generally considered easier to prepare, and it focuses on the differences between net income and net cash provided by operating activities. It also tends to reveal less company information to competitors. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation. Both methods are acceptable but the FASB expressed a preference for the direct method. Yet, the indirect method is the overwhelming favorite of companies.
16 Identify the events that result in credits and debits to retained earnings.
The debits and credits to retained earnings are: Debits Credits 1.Net loss 1. Net income 2.Prior period adjustments for overstatement of net income 2. Prior period adjustments for understatement of net income 3.Cash and stock dividends 4.Some disposals of treasury stock
4 What are the essential features of the allowance method of accounting for bad debts?
The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated and matched against revenue in the same accounting period in which the revenue occurred. (2) Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.
3. Identify and describe the five components of a good internal control system.
The five components of a good internal control system are: (1) A control environment, (2) Risk assessment, (3) Control activities, (4) Information and communication, and (5) Monitoring. • A control environment. Top management must make it clear that the organization values integrity and that unethical activity will not be tolerated. • Risk assessment. Companies must identify and analyze the various factors that create risk for the business and must determine how to manage these risks. • Control activities. To reduce the occurrence of fraud, management must design policies and procedures to address the specific risks faced by the company. • Information and communication. The internal control system must capture and communicate all pertinent information both down and up the organization, as well as communicate information to appropriate external parties. • Monitoring. Internal control systems must be monitored periodically for their adequacy. Significant deficiencies need to be reported to top management and/or the board of directors.
24. Heather Kemp asks for your help concerning an NSF check. Explain to Heather (a) what an NSF check is, (b) how it is treated in a bank reconciliation, and (c) whether it will require an adjusting entry
The four steps are: (1) determine deposits in transit, (2) determine outstanding checks, (3) discover any errors made, and (4) trace bank memoranda.
10 Describe the indirect method for determining net cash provided (used) by operating activities.
The indirect method involves converting accrual net income to net cash provided by operating activities. This is done by starting with accrual net income and adding or subtracting noncash items included in net income. Examples of adjustments include depreciation and other noncash expenses, gains and losses on the disposal of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next.
13 Your roommate is uncertain about the advantages of a promissory note. Compare the advantages of a note receivable with those of an account receivable.
The maturity date of a promissory note may be stated in one of three ways: (1) on demand, (2) on a stated date, and (3) at the end of a stated period of time.
5. Discuss how the Sarbanes-Oxley Act has increased the importance of internal control to top managers of a company.
The principles of internal control are: (a) establishment of responsibility, (b) segregation of duties, (c) documentation procedures, (d) physical controls, (e) independent internal verification, and (f) human resource controls.
10 Why is common stock usually not issued at a price that is less than par value?
The sale of common stock below par value is not permitted in most states.
2 What questions about cash are answered by the statement of cash flows?
The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period?
15 Why is the statement of cash flows useful?
The statement of cash flows is useful because it provides information to the investors, creditors, and other users about: (1) the company's ability to generate future cash flows, (2) the company's ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash investing and financing transactions during the period.
14 What are the similarities and differences between the terms depreciation, depletion, and amortization?
The terms depreciation, depletion, and amortization are all concerned with allocating the cost of an asset to expense over the periods benefited. Depreciation refers to allocating the cost of a plant asset to expense, depletion to recognizing the cost of a natural resource as expense, and amortization to allocating the cost of an intangible asset to expense.
3 Distinguish among the three types of activities reported in the statement of cash flows.
The three types of activities are: Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. Investing activities include: (a) acquiring and disposing of investments and property, plant and equipment and (b) lending money and collecting loans. Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.
6 What types of receivables does Apple report on its balance sheet? Does it use the allowance method or the direct write-off method to account for uncollectibles?
The two bases of estimating uncollectibles are: (1) percentage-of-sales and (2) percentage-of- receivables. The percentage-of-sales basis establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This method emphasizes the matching of expenses with revenues. Under the percentage-of-receivables basis, the balance in the allowance for doubtful accounts is derived from an analysis of individual customer accounts. This method emphasizes cash realizable value.
5 Identify three taxes commonly withheld by the employer from an employee's gross pay.
Three taxes commonly withheld by employers from employees' gross pay are: (1) federal income taxes (2) state income taxes, and (3) social security (FICA) taxes
14 Why and how is depreciation expense reported in a statement of cash flows prepared using the indirect method?
Under the indirect method, depreciation is added back to net income to reconcile net income to net cash provided by operating activities because depreciation is an expense but not a cash payment
