ACCOUNTING TEST 2
gross margin % =
(Sales - COGS) / net sales
3 methods for inventory cost flow under a perpetual system
- FIFO - LIFO - weighted average
bonded employees: (internal control)
- a fidelity bond provides insurance that protects a company from losses caused by employee dishonesty - to become bonded, an employees background is investigated
SEC:
- a government agency authorized to establish and enforce the accounting rules for public companies - public companies have to follow the reporting rules of the SEC as well as GAAP
procedures manual: (internal control)
- accounting and other important procedures should be written in a procedures manual - periodically, management should conduct an investigation to see that required procedures are actually being followed
requires absences: (internal control)
- an employee may be able to cover up fraudulent activities if they are always present at work - all employees should be required to take regular vacations and their duties should be rotated periodically
materiality and financial audits
- auditors do not guarantee that financial statements are absolutely correct- only materially correct. - material item: an error, or other reporting problem, that would influence the decision of an average prudent investor.
controlling cash involves several duties:
- cash receipts- should be recorded immediately upon receipt and deposited intact daily - a deposit ticket should be used for all deposits - cash payments should be made by prenumbered check. - a monthly bank reconciliation should be prepared by an independent party - an up to date signature card should be maintained
how can a financial analyst know that a company really did follow GAAP?
- certified public accountants - audits
COSO components
- control environment - control activities - risk assessment - information and communication - monitoring
financial analyst sections:
- financial statements - notes to the financial statements - managements discussion and analysis - auditors report
limitations
- internal controls can be circumvented by collusion among employees. - two or more employees working together can hide embezzlement by covering for each other. - no system can completely prevent fraud.
performance evaluation: (internal control)
- internal controls should include independent verification of employee performance - for example, someone other than the person who has control over inventory should take a physical count of inventory. - internal and external audits serve as independent verification of performance.
lower of cost or market (LCM)
- inventory must be reported at the LOWER cost or market
Sarbanes-Oxley Act of 2002
- prior to 2002, the SEC left much of the regulation and oversight of independent audits to the AICPA - however, SOX establishes the PCAOB to enforce audit standards for SEC audits.
internal control procedures to protect cash receipts:
- record cash collections immediately - provide customers with receipts - deposit cash collections immediately
procedures to safeguard cash:
- record receipts of cash in the company's accounting system immediately - provide customers w prenumbered receipts - deposit cash in external financial institutions immediately
internal control is a process designed to ensure:
- reliable financial reporting - effective and efficient operations - compliance w applicable laws and regulations
LCM is applied online 3 ways:
- separately to each individual item - to major classes or categories of assets - to the whole inventory
four acceptable methods to determine the amount of cost to transfer are:
- specific identification - first in, first out -last in, last out - weighted average
quality of employees: (internal control)
- the availability of cross-trained employees to substitute for one another prevents disruptions in the workplace - job rotation may help relieve boredom and increase productivity
types of audit opinions:
- unqualified - qualified - adverse - disclaimer
segregation of duties: (internal control)
- when duties are segregated, the work of one employee can act as a check on the work of another employee - the likelihood of fraud or theft is greatly reduced
procedures used when a petty cash fund is established:
-assigning a petty cash custodian - use of petty cash vouchers - physical control over the petty cash fund
nine features of internal control system
-establishment of clear lines of authority - having employees covered by a fidelity bond - requiring regular vacations for certain employees -separating duties so that fraud or theft requires collusion - hiring or training competent employees - bonding employees to recover losses through insurance - requiring employees to be absent from their jobs so that their replacements can discover errors or fraudulent activity that might have occurred - establishing proper procedures for processing transactions - using prenumbered documents - implementing physical controls such as locking cash in a safe - conducting performance evaluations through independent internal
authority and responsibility: (internal control)
-general authority applies to all members of the organization. for example, all employees are required to fly coach and purchase airline tickets from a specific vendor. - specific authority applies only to a specific position within the organization. For example, all checks must be co-signed by the controller and treasurer.
purchasing inventory often involves:
-inventory returns - cash discounts - transportation costs - purchase allowances
key features of INTERNAL CONTROL
1) segregation of duties 2) quality of employees 3) bonded employees 4) required absences 5) procedures manual 6) authority and responsibility 7) prenumbered documents 8) physical control 9) performance evaluations
average number of days to sell inventory formula
365/ inventory turnover
petty cash funds:
A petty cash fund is used to make small expenditures that cannot wait for the formal check writing process. The fund is operated on an impressive basis. this means that when the phone gets low on cash it is replenished. The petty cash custodian is always responsible for the cash in the fund.
asset use transaction
A transaction that DECREASES both an asset and a claim on assets; the three types of asset use transactions are distributions (transfers to owners), liability payments (to creditors), or expenses (costs incurred to operate the business).
asset exchange transaction
A transaction that DECREASES one asset while INCREASING another asset so that total assets do not change; for example, the purchase of land with cash.
asset source transaction
A transaction that INCREASES both an asset and a claim on assets; the three types of asset source transactions are acquisitions from owners (equity), borrowings from creditors (liabilities), or earnings from operations (revenues).
physical control: (internal control)
All companies should maintain adequate physical control over valuable assets that may be misappropriated. For example, inventory should be properly stored in a secure location. Serial numbers should be placed on all valuable assets to assist in a physical count of these assets.
weighted average
Average of data that takes other factors such as the number of incumbents into account.
COSO stands for:
Committee of Sponsoring Organizations
t or f: GAAP do NOT allow the cost flow pattern for merchandise inventory to differ from the physical flow of merchandise within the business
FALSE
t or f: an error is considered material if it would trigger an IRS audit
FALSE
t or f: an unqualified audit opinion suggests that all aspects of financial statements are in compliance w GAAP
FALSE
t or f: the implementation of an effective internal control system eliminated the possibility of fraud
FALSE
t or f: the primary focus of financial statement audits is the discovery of fraud
FALSE
when the cost of purchasing inventory is declining, which cost flow method will produce the highest amount of cost goods sold?
FIFO
If land sells for more than its cost, the difference is a:
GAIN
if merchandise sells for more than cost, the difference is:
GROSS MARGIN
GAAP:
Generally Accepted Accounting Principles
IFRS
International Financial Reporting Standards
when prices are rising, which method of inventory, if any, will result in the lowest relative net cash outflow?
LIFO
prenumbered documents: (internal control)
Prenumbered forms are used for all important documents such as checks, purchase orders, receiving reports, and invoices. The use of prenumbered forms helps keep track of all forms issued during a particular period.
PCAOB:
Public Company Accounting Oversight Board
SEC stands for:
Securities and Exchange Commission
t or f: IFRS do not permit the use of the LIFO inventory cost flow method
TRUE
t or f: cash is difficult to protect bc it is easy to transfer and it's ownership is difficult to prove
TRUE
t or f: establishment of a petty cash fund is an asset exchange transaction
TRUE
t or f: interest revenue will be shown as a credit on a bank statement
TRUE
Specific Identification
When a company's inventory consists of many high-priced, low-turnover goods the record keeping necessary to use specific identification is more practical. (car dealership)
internal control:
a process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations
liabilities: (chap 4)
accounts payable, notes payable
which of the following is the LEAST favorable opinion issued by an external audior?
adverse opinion
which of the following is considered a PERIOD cost
advertising expense for the current month
costs of goods available for sale EQUATION
beginning inventory balance +inventory purchased during the period
how do merchandising businesses generate revenue?
by selling goods
what account is used to record the amount of cash shortages or overages relative to a petty cash system?
cash short and over
assets: (chap 4)
cash, land, merchandise inventory (products to be sold to customers)
equity: (chap 4)
common stock, retained earnings
physical flow
cost flows can be done on a different basis than physical flow
goods available for sale must be allocated between:
cost of goods sold and ending inventory
inventory turnover is calculated as:
cost of goods sold/ inventory
expenses: (chap 4)
costs of goods sold- expense of inventory being sent to customers transportation out- expense of shipping inventory to customers selling and admin. expense- various expenses for retailer interest expenses- interest payments to banks
selling and administrative costs:
costs that are NOT included in inventory
product costs:
costs that are included in inventory
how do you prevent misstatements?
count all inventory at year end. separate responsibilities of counting and recording journal entries to different employees
annual rate=
discount rate x (365 days / term of the loan)
what type of account is the cost of goods sold account
expense
FIFO
first in first out
when is the gross margin method used?
for interim financial statements when we need to estimate ending inventory and cost of goods sold
merchandise inventory
goods purchased for resale
Gross Margin Percentage
gross margin/net sales
petty cash: short or over:
happen when petty cash fund is physically counted
which of the following is not a commonly accepted internal control activity?
hiring only college students
average number of days to sell inventory measures:
how many days, on average, it takes to sell inventory
inventory turnover measures?
how quickly a company sells its merchandise inventory
perpetual inventory system:
inventory account is adjusted perpetually (continually) throughout the accounting period
LIFO
last in first out
which of the following would be considered as primarily a merchandising business
martins supermarket
cost of goods available for sale is allocated between:
merchandise inventory (balance sheet) and cost of goods sold (income statement)
which of the following statements about period costs is true?
most period costs are expenses in the period costs the costs are incurred
net income percentage
net income/net sales
if costs of goods sold is understated, the gross margin is:
overstated
which of the following is an administrative control
performance evaluation
selling and administrative costs can also be called
period costs
confidentiality rules:
prohibit auditors from voluntarily disclosing information they have acquired as a result of their accountant- client relationships - however, accountants may be required to testify in a court of law.
revenues: (chap 4)
sales revenue
gross margin EQUATION
sales revenue- cost of goods sold
what is meant by "market" in the lower-of-cost-or-market rule?
the amount that would have to be paid to replace the merchandise
many companies use the gross margin method to estimate:
the current periods ending inventort
in LCM market is defined as:
the current replacement cost (not sales price) and is consistent w the conservatism principle
first in first out (FIFO)
the first in first out cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold (milk example)
last in first out (LIFO)
the last in first out cost flow method requires that the cost of the items purchased last be assigned to cost of goods sold (gravel example)
FOB shipping point: who pays shipping costs?
the party that owns it while on the road. FOB shipping point vs. destination tells you when title transfers to the customer.
weighted average
the weighted average cost flow method assigns the average cost of the items available to cost of goods sold
when maintaining perpetual inventory records, using the weighted average or LIFO cost flow methods leads to?
timing difficulties
what is the effect of an entry to record the purchase of inventory on account under the perpetual inventory system?
total assets and total liabilities increase
which of the following is considered a PRODUCT cost
transportation cost on goods received from suppliers
which of the following opinions is the MOST favorable opinion issued by an external auditor?
unqualified opinion
when are product costs matched directly w sales revenue
when the merchandise is sold
