ACT 101 Exam 2
specific identification
an alternative to FIFO, LIFO, and AVG cost
allowance method
bad debt expense is recorded in the period of sale, which allows it to be properly matched with revenues. the result is that bad debt expense is recognized before the actual default. because defaults for the current period's sales have not actually occurred, the specific accounts receivable are not lowered; instead, an account is established to store the estimate until specific accounts are identified as uncollectible. this account is called Allowance for Doubtful Accounts
revenue recognition principle
depends on when the earnings process is complete
strategic risks
possible threats to the organization's success in accomplishing its objectives and are external to the organization.
rising purchase prices
FIFO produces: highest ending inventory lowest cost of goods sold highest income LIFO produces: lowest ending inventory highest cost of goods sold lowest income
falling purchase prices
FIFO produces: lowest ending inventory highest COGS lowest income LIFO produces: highest ending inventory lowest COGS highest income
straight line method
allocates an equal amount of as asset's cost to depreciation expense for each year of the asset's useful life appropriate to apply this method to those assets for which an equal amount of service potential is considered to be used each period provides a constant amount of depreciation expense in each period of the asset's life and is consistent with a constant rate of decline in service potential (cost - residual value)/Expected useful life
outstanding check
a check issued and recorded by the business that has not been cashed by the recipient of the check
inventory systems
companies are buying goods from wholesalers are reselling them to try to make a profit
components of internal control
control environment and ethical behavior risk assessment control activities information and communication monitoring relationship between control activities and the accounting system
perpetual inventory system vs. periodic inventory system (in terms of how the labels go)
inventory vs. purchases perpetual will ALWAYS be labeled inventory. The inventory account is used to record the costs associated with acquiring merchandise. periodic - purchases, purchase discounts, purchase returns, and transportation charges, purchase return, purchase allowance
operating cycle
the elapsed time between the purchase of goods for resale and the collection of cash from customers.
direct write-off
not permitted by GAAP
transactions recorded by the business, but not yet by the bank
outstanding checks deposits in transit
FOB shipping point
ownership of the inventory passes from the seller to the buyer at the shipping point the buyer normally pays the transportation costs, commonly termed FREIGHT-IN costs are considered part of the total costs of purchases and the inventory account is increased seller would normally recognize revenue at time of the shipment
FOB destination
ownership of the inventory passes when the goods are delivered to the buyer the seller is usually responsible for paying the transportation costs, commonly termed FREIGHT-OUT costs are not considered part of inventory; instead, the seller will expense these costs as a selling expense on the income statement revenue is not normally recognized until delivery of the goods has occurred
depreciation
process of allocating, in a systematic and rational manner, the cost of a tangible fixed asset to expense over the asset's useful life depreciation expense = amount of depreciation recorded each period accumulated depreciation = represents total amount of depreciation expense that has been recorded for an asset since the asset was acquired, reported on the balance sheet as a contra-asset book value = accumulated depreciation is deducted from the cost of the asset residual value = amount of cash or trade-in consideration that the company expects to receive when an asset is retired from service depreciable cost = cost of the asset minus its residual value
internal control system
the policies and procedures established by top management and the board of directors to provide reasonable assurance that the company's objectives are being met in three areas: (1) effectiveness and efficiency of operations, (2) reliability of financial reporting, (3) and compliance with applicable laws and regulations
control activities
the policies and procedures top management establishes to help insure that its objectives are met. most directly related to the accounting system and financial statements vary widely from one business to another, but generally can be identified with one of the following 5 categories: -clearly defined authority and responsibility -segregation of duties -adequate documents and records -safeguards over assets and records -checks on recorded amounts
risk management
these procedures are designed to identify, analyze, and manage strategic risks and business process risks
operating assets
three categories: -property, plant, and equipment -intangible assets -natural resources
checks on recorded amounts
recorded amounts should be checked by an independent person to determine that amounts are correct and that they correspond to properly authorized activities. These procedures include clerical checks, reconciliations, comparisons of asset inspection reports with recorded amounts, computer-programmed controls, and management review of reports. EX: accounting records should be resolved immediately. (Bank reconciliations)
units-of-production method
used when the decline in an asset's service potential is proportional to the usage of the asset and asset usage can be measured depreciation cost per unit = (cost - residual value)/expected usage of the asset based on a measure of the asset's use units-of-production depreciation expense = depreciation cost per unit * actual usage of the asset
gross margin
sales - cost of goods sold
cash equivalents
include all highly liquid investments with an original maturity of 3 months or less to date of inception cash equivalents are: -easily convertible into known amounts of cash -close enough to maturity that they are relatively insensitive to changes in interest rates
adjusted trial balance
includes the effect of adjusting entries
transactions recorded by the bank, but not yet by the business
service charges non-sufficient funds checks debit and credit memos
sales discounts
a contra account
accounting for purchases of inventory
*in a perpetual inventory system, the inventory account is used to record the costs associated with acquiring merchandise* Purchases -refer to the cost of merchandise acquired for resale during the accounting period Purchase Discounts -price reductions companies offer to their customers (discount period - 2/10, n/30 = 2% discount within a 10 day discount period, otherwise full payment is due within 30 days) Purchase Returns and Allowances -purchase return: the cost of merchandise returned to suppliers -purchase allowance: the purchaser may choose to keep the merchandise if the seller is willing to grant a deduction (allowance) from the purchase price Transportation Costs -transportation, or freight, costs are expenditures made to move the inventory from the seller's location to the purchaser's location -shipping terms are either FOB (free on board) shipping point or FOB destination Consigned Goods -consignment: sometimes goods owned by one party are held and offered for sale by another
net accounts receivable
Accounts receivable less allowance for doubtful accounts
segregation of duties
accounting and administrative duties should be performed by different people so that no one person prepares all the documents and records for an activity. reduces the likelihood that records could be used to conceal irregularities and increases the likelihood that irregularities will be discovered. EX: AMC require one employee to collect the cash and another to collect the tickets to admit the customer into the theater
adequate document and records
accounting records are the basis for the financial statements and other reports prepared for managers, owners, and others both inside and outside the business. Summary records and their underlying documentation must provide info about specific activities and help in the evaluation of individual performance. EX: prenumbered shipping documents provide a basis for monitoring shipments of goods to customers. When warehouse employees receive a shipping document, they ship the goods. If the shipping documents were not prenumbered, a shipping document could be sent to the warehouse and later destroyed. without the missing number in the sequence to signal a missing document, nobody would realize that the document was missing
what account does "on account" refer to?
accounts payable on account if there are payment terms
perpetual inventory system
balances for inventory and cost of goods sold are continually updated with each sale or purchase of inventory. This type of system requires that detailed records be maintained on a transaction-by-transaction basis for each purchase and sale of inventory every time Walmart purchases inventory from a supplier, it records this purchase directly in its inventory records when Walmart makes a sale to a customer, it will not only record the sale but will also update its inventory and cost of goods sold balances by decreasing inventory and increasing cost of goods sold a perpetual system records both the revenue and cost side of the sales transactions
cost of goods sold
beginning inventory + purchases = cost of goods available for sale - ending inventory = COGS
safeguards over assets and records
both assets and records must be secured against theft and destruction. requires physical protection of the assets through, for example, fireproof vaults, locked storage facilities, keycard access, and anti-theft tags on merchandise. EX: access controls often mandate use of both alpha and numeric characters and require password changes every few months.
what account does "paid" refer to?
cash
periodic inventory system
does not require companies to keep detailed, up-to-date inventory records. instead, a period system records the cost of purchases as they occur (in an account separate from the inventory account), takes a physical count of inventory at the end of the period, and applies the cost of goods sold model to determine the balances of ending inventory and cost of goods sold. provides balances for ending inventory and cost of goods sold at the end of each account period. if a company using the periodic system needs to know the balance of inventory or cost of goods sold during a period, it must do either of the following: -perform a physical count of inventory -estimate the amount of inventory using an acceptable estimation technique
FIFO
first in, first out based on the assumption that costs move through inventory in an unbroken stream, with the costs entering and leaving the inventory in the same order the earliest purchases (first in) are assumed to be the first sold (first out), and the more recent purchases are in ending inventory every time inventory is sold, the cost of the earliest (oldest) purchases that make up cost of goods available for sale is allocated to cost of goods sold, and the cost of the most recent recent purchases is allocated to ending inventory how to compute the cost of ending inventory and COGS using FIFO (perpetual): Step 1: compute the cost of goods available for sale immediately prior to the first sale Step 2: apply FIFO to determine ending inventory and COGS (the cost of goods available for sale is allocated between inventory (most recent purchases) and cost of goods sold (earliest purchases)) Step 3: repeat steps 1 and 2 for the remaining inventory transactions during the period how to compute under periodic system: compute the COG available for sale for the period apply FIFO to determine ending inventory and COGS
matching principle
guides expense recognition
LIFO
last in, first out allocates the cost of goods available for sale between ending inventory and COGS baed on the assumption that the most recent purchases (last in) are the first to be sold (first out). most recent purchases (newest costs) are allocated to the COGS and the earliest purchases (oldest costs) are allocated to inventory how to compute the cost of ending inventory and the COGS using LIFO (perpetual): Step 1: compute the cost of goods available for sale immediately prior to the first sale Step 2: Apply LIFO to determine ending inventory and COGS (the cost of goods available for sale is allocated between inventory (earliest purchases) and COGS (most recent purchases)) Step 3: repeat steps 1 and 2 for the remaining inventory transactions during the period how to compute under periodic: compute COG available for sale for the period apply LIFO to determine ending inventory and COGS
debt to total assets ratio
lower is better
current ratio
measures liquidity
profit margin ratio
measures profitability
A/R turnover
measures speed of cash collection
accounting for sales of inventory
merchandising companies must also account for the inventory effects of sales and returns *if a perpetual system is being used, the Merchandise Inventory account is also affected* Sales Sales Returns and Allowances
performing a bank reconciliation
start with the "cash balance from the bank statement" and the "cash balance from company records". these two balances are then adjusted as necessary to produced identical "adjusted cash balances" by these following steps: 1. compare the deposits on the bank statement to the deposits debited to the cash account. Any deposits in transit should be added to the "cash balance from the bank statement" 2. compare the paid checks that are electronically returned with the bank statement to the amounts credited to the cash account and the list of outstanding checks from prior months. these amounts should be subtracted from "cash balance from the bank statement" 3. look for bank service charges, interest payments, NSF checks, automatic payments, and bank collections on behalf of the company - these have not been debited or credited to the cash account yet. Bank debits subtracted from "cash balance from company records" and bank credits added to "cash balance from company records". 4. If "adjusted cash balances" are still not the same, search for errors.
depreciation methods
straight-line method units-of-production method
property, plant, and equipment
tangible operating assets used in the normal operations of a company have to be visible, physical presence in the company includes land, land improvements, buildings, and equipment
clearly defined authority and responsibility
the authority to perform important duties is delegated to specific people, and those people should be held responsible for the performance of those duties in the evaluation of their performance. EX: at Wal-Mart, cashiers enter a code into the cash register and maintain responsibility for cash entering and leaving the register
bank reconciliation
the bank's accounting records and company's accounting records often disagree because the transactions are not recorded at the same time. to ensure that the accounting records are consistent with the bank's accounting records, any differences must be "reconciled". serves two purposes: -serves a control function by identifying errors and providing an inspection of detailed records that deters theft -serves a transaction detection function by identifying transactions performed by the bank, so the business can make the necessary entries in its records
control environment
the foundation of the internal control system. the collection of the environmental factors that influence the effectiveness of control procedures. the control environment includes: -philosophy and operating style of management -personnel policies and practices of the business -overall integrity, attitude, awareness, and actions of everyone in the business concerning the importance of control (commonly called the tone at the top)
business process risks
the internal processes of the company-specifically how the company allocated its resources to meet its objectives