ACT Exam 2

Internal Control

"Process designed to provide reasonable assurance (not a guarantee) regarding the achievements of company objectives related to operations, reporting and compliance

The Blooming Miracles Flower Shop bought a delivery van on January 1, 2017. The van cost $18,000and had an expected salvage value of $3,000. The life of the van was estimated to be 5 years or150,000 miles. Using the straight-line method of depreciation, the book value of the van at the beginning of the third year would be:

$12,000

Cullumber Company purchases land for $180,000 cash. Cullumber assumes $6,000 in property taxesdue on the land. The title and attorney fees totaled $2,000. Cullumber has the land graded for $4,900.They paid $20,000 for paving of a parking lot. What amount does Cullumber record as the cost for the land?

$192,900

The Blooming Miracles Flower Shop bought a delivery van on January 1, 2017. The van cost $18,000and had an expected salvage value of $3,000. The life of the van was estimated to be 5 years or150,000 miles. The depreciation expense for 2017 using the straight-line method of depreciation is:

$3,000

If gross sales are $40,000, sales returns and allowances $1,000, sales discounts $400, and delivery expenses $100, the net sales of the business will total

$38,600 -net sales = gross sales - (return values + discount losses + sales taxes + allowances

The records for Uptown Pet Shop showed the following: Sales $75,000 Beginning merchandise inventory $10,000 Purchases 45,000 Cost of goods sold 50,000 The ending merchandise inventory must have been:

$5,000 -Beginning inventory + net purchases - COGS = ending inventory

what are two transactions to record a sale when there is a perpetual inventory system

-2 transactions: perpetual system for sale -⬆Revenue, ⬆Cash (A/R) -⬇ COGS (expense), ⬇ Inventory

What is the impact on the Balance Sheet?

-A major advantage of the FIFO method is that in a period of inflation, the costs allocated to ending inventory will approximate the inventory's current cost. -Conversely, a major shortcoming of the LIFO method is that in a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost. -The understatement becomes greater over prolonged periods of inflation if the inventory includes goods purchased in one or more prior accounting periods

Ready to use

-All necessary costs incurred in making land ready for its intended use increase the Land account -Costs to make the building ready for its intended use consist of expenditures for remodeling rooms and offices and replacing or repairing the roof, floors, electrical wiring, and plumbing. -Interest costs incurred to finance a construction project are included in the cost of the asset when a significant period of time is required to get the asset ready for use. -The cost of plant assets includes all expenditures necessary to acquire the asset and make it ready for its intended use. Once cost is established, a company uses that amount as the basis of accounting for the plant asset over its useful life

Average Cost

-Determine cost of goods available for sale. -Determine average cost by dividing cost of goods available for sale by total units available for sale. -Multiply units sold by average cost per unit

When a company uses the allowance method for accounts receivable, how does the company:

-Estimate current bad debts (percent of receivables method and aging of accounts receivable method): -The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period. This provides a closer relationship of expenses with revenues on the income statement -Record the estimate on a tabular summary -Write off accounts receivable in a future period (what is the entry? Which financial statement does this entry affect?)

FIFO

-First-in, first-out (FIFO) -the costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold. -This does not necessarily mean that the oldest units are sold first, but that the costs of the oldest units are recognized first -Determine cost of goods available for sale. -Determine ending inventory units. -Determine cost of ending inventory using cost of most recent purchase and working backward. -Subtract cost of ending inventory from cost of goods available for sale.

What is the impact on Net Income? Tax?

-In a period of inflation, FIFO produces a higher net income because lower unit costs of the first units purchased are matched against revenue. -In a period of inflation, LIFO produces a lower net income because higher unit costs of the last goods purchased are matched against revenue. -If prices are falling, the results from the use of FIFO and LIFO are reversed. FIFO will report the lowest net income and LIFO the highest. -Regardless of whether prices are rising or falling, average-cost produces net income between FIFO and LIFO. -We have seen that both inventory on the balance sheet and net income on the income statement are higher when companies use FIFO in a period of inflation. Yet, many companies have selected LIFO. Why? The reason is that LIFO results in the lowest income taxes (because of lower net income) during times of rising prices (see Helpful Hint).

where does interest expense + tax expense both go on the multi step income statement

-Included in Other expenses and losses are Interest Expense and Casualty Loss from Vandalism. -Note that companies report income tax expense in a separate section of the income statement before net income.

Be able to prepare entries for purchases and sales of inventory, including the ability to properly calculate and record sales discounts, returns and allowances.

-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. -Purchase allowance: The purchaser may choose to keep the merchandise if the seller is willing to grant an allowance (deduction) from the purchase price -The seller uses the Sales Returns and Allowances account. Sales Returns and Allowances is subtracted from sales revenue on the income statement to determine net sales. -If goods are returned, Inventory is increased and Cost of Goods Sold is decreased for the cost of the goods -When goods are returned, the seller records the return in Sales Returns and Allowances, and reduces Accounts Receivable

Ratios

-Ratio calculations will be limited to the following: -Gross Profit % (aka Gross Profit Rate) -Profit Margin

Purpose of internal control

-SAFEGAURD ASSETS (Preventative versus detective controls) -Enhance reliability of accounting records -Increase efficiency of operations -Ensure compliance with laws and regulations

notes receivable

-Sales transactions purchased on the account guaranteed by a written promise to pay are generally payable in 60 days or longer and are classified as notes receivable -Often they include an interest component as well

Be able to prepare a multi-step income statement

-Subtract cost of goods sold from net sales to determine gross profit. -Subtract operating expenses from gross profit to determine income from operations. -Add/subtract non operating items to income from operations to determine income before tax. -Multiply the tax rate by income before tax to determine tax expense -A multiple-step income statement shows numerous steps in determining net income, including a calculation of gross profit, income from operations, results of non operating activities, income before income taxes, and income taxes -highlights the components of net income -The multiple-step income statement has three important line items: -gross profit -income from operations -net income. -They are determined as follows. Subtract cost of goods sold from net sales to determine gross profit. Deduct operating expenses from gross profit to determine income from operations. Add or subtract the results of activities not related to operations to determine net income.

Profit margin

-That ratio is calculated by dividing net income by net sales. -It tells how effective a company is in turning its sales into income—that is, how much income each dollar of sales provides -Measures the percentage of each dollar of sales that results in net income, computed by dividing net income by net sales.

How do you calculate gross profit?

-The excess of net sales over the cost of goods sold -Gross profit expressed as a percentage by dividing the amount of gross profit by net sales.

How does the $ amount ALLOCATED for COGS differ between the methods?

-The first in, first out (FIFO) accounting method relies on a cost flow assumption that removes costs from the inventory account when an item in someone's inventory has been purchased at varying costs over time. -When a business uses FIFO, the oldest cost of an item in an inventory will be removed first when one of those items is sold. This oldest cost will then be reported on the income statement as part of the cost of goods sold. LIFO: The last in, first out (LIFO) accounting method assumes that the latest items bought are the first items to be sold. With this accounting technique, the costs of the oldest products will be reported as inventory. It should be understood that, although LIFO matches the most recent costs with sales on the income statement, the flow of costs does not necessarily have to match the flow of the physical units. -Generally speaking, FIFO is preferable in times of rising prices, so that the costs recorded are low, and income is higher. Contrarily, LIFO is preferable in economic climates when tax rates are high because the costs assigned will be higher and income will be lower

LIFO

-The last-in, first-out (LIFO) method assumes that the latest goods purchased are the first to be sold. -LIFO seldom coincides with the actual physical flow of inventory. (Exceptions include goods stored in piles, such as coal or hay, where goods are removed from the top of the pile as they are sold.) -Under the LIFO method, the costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. -determine the cost of your most recent inventory and multiply it by the amount of inventory sold

What is amortization?

-The process of allocating to expense the cost of intangibles -To record amortization of an intangible asset, a company increases Amortization Expense and decreases the specific intangible asset. (Alternatively, some companies choose to increase a contra account, such as Accumulated Amortization. For homework, you should directly decrease the specific intangible asset.) -The process of allocating to expense the cost of an intangible asset.

Know how to write off an account

-To write-off the receivable, you would debit allowance for doubtful accounts and then credit accounts receivable

Ending Inventory: LIFO and FIFO

-Under FIFO, since it is assumed that the first goods purchased were the first goods sold, ending inventory is based on the prices of the most recent units purchased (see Helpful Hint). That is, under FIFO, companies obtain 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. In this example: -Under LIFO, since it is assumed that the first goods sold were those that were most recently purchased, ending inventory is based on the prices of the oldest units purchased (see Helpful Hint). That is, 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. In this example

How do we dispose of an asset?

-Understand how to perform tabular analysis for disposals with a loss/gain -Understand how to dispose of a fully depreciated asset

Know how to calculate LIFO, FIFO and Average Cost for both ending inventory balance and cost of goods sold under a periodic system. (Notably, we use these methods in the periodic systems, versus the perpetual in Chapter 6)

-We assume a periodic system because very few companies use perpetual LIFO, FIFO, or average-cost to cost their inventory and related cost of goods sold.

How do we calculate operating income?

-When non-operating items are included, the label Income from operations (or Operating income) precedes them -takes a company's gross income, which is equivalent to total revenue minus COGS, and subtracts all operating expenses.

What is the book value of an asset?

-cost less accumulated depreciation—of a plant asset may differ significantly from its fair value -As noted earlier, the book value of plant assets is rarely the same as the fair value. In instances where the value of a plant asset declines substantially, its fair value might fall materially below book value. This may happen because a machine has become obsolete, or the market for the product made by the machine has dried up or has become very competi -Whatever the disposal method, the company must: Determine the book value of the plant asset at the time of disposal in order to determine the gain or loss. Recall that the book value is the difference between the cost of the plant asset and the accumulated depreciation to date. Record depreciation for the fraction of the year to the date of disposal if the disposal does not occur on the first day of the year. -Eliminate the book value by reducing Accumulated Depreciation for the total depreciation associated with that asset to the date of disposal and reducing the asset account for the cost of the asset. -In a disposal by sale, the company compares the book value of the asset with the proceeds received from the sale. If the proceeds from the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds from the sale are less than the book value of the plant asset sold, a loss on disposal occurs

FIFO Calculation

-determine the cost of your oldest inventory and multiply that cost by the amount of inventory sold -During rising prices, FIFO will have highest net income -if prices are rising, FIFO will always give higher net income

What are the Limitations of Internal Controls?

-human element -size of the business

Internal control is used in a business to:

-safeguard its assets. -enhance the accuracy and reliability of its accounting records. -ensure compliance with laws and regulations.

5 primary elements of Internal control

1. Control Environment 2. Risk Assessment 3. Control Activities - OUR FOCUS 4. Information and Communication 5. Monitoring

6 Principles of Control Activities

1. Establishment of Responsibility 2. Segregation of Duties 3. Documentation Procedures 4. Physical Controls 5. Independent Internal Verification 6. Human resource Controls

Steps in Income Statement

1. Subtract cost of goods sold from net sales to determine gross profit. 2. Deduct operating expenses from gross profit to determine income from operations. 3. Add or subtract the results of activities not related to operations to determine net income.

If the credit terms are 2/10, n/30, the discount is ______________. Select answer from the options below - Correct!

2% of the net purchase price

Purchase allowance

A deduction made to the selling price of merchandise, granted by the seller, so that the buyer will keep the merchandise

Sales discount

A reduction given by a seller for prompt payment of a credit sale.

Purchase return

A return of goods from the buyer to the seller for cash or credit

Which of the following would affect the gross profit rate?

An increase in cost of goods sold

In a periodic inventory system, the cost of goods sold is determined:

At the end of the accounting period.

What are the relationships between FIFO / LIFO / Average Cost inventory systems?

COGS: -How does the $ amount ALLOCATED for COGS differ between the methods?What is the impact on Net Income? Tax? ENDING INVENTORY: -How does the $ amount ALLOCATED for Ending Inventory (stuff left on shelves) difference between the methods -What is the impact on the Balance Sheet? -For all 3 methods: COGS + ENDING INVENTORY =COGAFS

________ are the costs incurred to increase the operating efficiency or useful life of a plant asset.

Capital expenditures

purchases

Companies may purchase inventory for cash or on account (credit). They normally record purchases when they receive the goods from the seller. -Companies record purchases of assets acquired for use and not for resale, such as supplies, equipment, and similar items, as increases to specific asset accounts rather than to Inventory. For example, to record the purchase of materials used to make shelf signs or for cash register receipt paper, REI would increase Supplies

What costs are included when we capitalize long-lived assets?

Companies usually show plant assets under "Property, plant, and equipment"; they show intangibles separately under "Intangible assets." Either within the balance sheet or in the notes, companies disclose the balances of the major classes of assets, such as land, buildings, and equipment, and accumulated depreciation by major classes or in total. They describe the depreciation and amortization methods used, and disclose the amount of depreciation and amortization expense for the period

Which of the following statements are not true regarding LIFO:

Ending inventory is based on the price of the most recent units purchased

When do we expense research and development costs?

Expenditures that may lead to patents, copyrights, new processes, and new products; must be expensed as incurred

FIFO/LIFO/AVE COST are methods to estimate cost flows

FIFO ("First-In, First-Out") assumes that the oldest products in a company's inventory have been sold first and goes by those production costs. The LIFO ("Last-In, First-Out") method assumes that the most recent products in a company's inventory have been sold first and uses those costs instead

sales of inventory

For each sale, the seller: -Increases Accounts Receivable or Cash, as well as Sales Revenue (see Helpful Hint). -Increases Cost of Goods Sold and decreases Inventory. As a result, the Inventory account will show at all times the amount of inventory that should be on hand.

gross profit rate

Gross profit expressed as a percentage by dividing the amount of gross profit by net sales.

Compared to other methods of calculating depreciation, how does the declining balance method affect net income in the first year?

It usually results in the lowest net income.

Bank Reconciliation - Detective Control:

Know how to complete a bank reconciliation and the resulting adjustments on a tabular summary.

LIFO

LIFO=Ending inventory x COGS Calculations

Net realizable value

Net realizable value (NRV) is a valuation method, common in inventory accounting, that considers the total amount of money an asset might generate upon its sale, less a reasonable estimate of the costs, fees, and taxes associated with that sale or disposal -net realizable value? =A/R-Allowance ACCT

What is Collusion?

Occasionally, two or more individuals may work together to get around prescribed controls. Such collusion can significantly reduce the effectiveness of a system, eliminating the protection offered by segregation of duties.

How do you calculate straight-line depreciation?

Partial year depreciation. I.e.: what if you acquire the asset on 7/1 instead of 1/1of the current year? How much of the asset is depreciated in the first year, compared to a full year? -Under the straight-line method, companies expense an equal amount of depreciation each year of the asset's useful life. Management must choose the useful life of an asset based on its own expectations and experience. To compute the annual depreciation expense, we divide depreciable cost by the estimated useful life. As indicated above, depreciable cost represents the total amount subject to depreciation; it is calculated as the cost of the plant asset less its salvage value.

What is the difference between a periodic and perpetual inventory system?

Perpetual inventory system: A detailed inventory system in which a company maintains the cost of each inventory item, and the records continuously show the inventory that should be on hand. -Periodic Inventory system: An inventory system in which a company does not maintain detailed records of goods on hand throughout the period and determines the cost of goods sold only at the end of an accounting period

How do you calculate net sales?

Sales less sales returns and allowances and sales discounts. -less sales allowances, less sales returns

The income statement of a merchandising company contains the following unique features:

Sales revenue, cost of goods sold, and gross profit.

accounts receivable.

Sales transactions purchased on an account expected to be paid within 30 to 60 days

Flow of Costs:

The flow of costs for a merchandising company is as follows. -Beginning inventory plus the cost of goods purchased is the cost of goods available for sale. -As goods are sold, they are assigned to cost of goods sold. -Those goods that are not sold by the end of the accounting period represent ending inventory.

What is the cash realizable value of accounts receivable?

The net amount a company expects to receive in cash from receivables.

2/10n n/30 calculations

The term net in "net 30" means the remaining amount due after subtracting any sales returns and allowances and partial payments -Customers who purchase on credit are given 30 days to settle their obligation. However, if paid within 10 days, customers enjoy a 2% discount on the goods purchased. -If a customer purchases $10,000 from Company A on the terms 2/10 net 30 and pays within 10 days, the customer only needs to pay $10,000 x 0.98 = $9,800

What are the 3 components of the fraud triangle?

The three factors that contribute to fraudulent activity by employees: opportunity, financial pressure, and rationalization.

what is allowance in doubtful accounts? contra=assets

a contra asset account to Accounts Receivable -Companies record actual uncollectibles by decreasing the Allowance for Doubtful Accounts and Accounts Receivable at the time the specific account is written off as uncollectible -shows the estimated amount of claims on customers that companies expect will become uncollectible in the future. -reduces the amount of an asset, in this case the accounts receivable. The allowance, sometimes called a bad debt reserve, represents management's estimate of the amount of accounts receivable that will not be paid by customers

In a bank reconciliation, deposits in transit are

added to the bank balance.

The method of accounting for bad debt expense, which conforms to GAAP is:

allowance method.

An aging schedule of accounts receivable

arranges the accounts by the length of time they have been unpaid

To ensure receivables are not overstated on the balance sheet, they are reported:

at their cash (net) realizable value.

The reconciling item in a bank reconciliation that will result in an adjustment by the depositor is

bank service charges

Control over cash disbursements is generally more effective when a company uses ________ to make most payments.

checks

All of the following are intangible assets except

coal reserves

When do we record goodwill?

companies record goodwill only when there is an exchange transaction that involves the purchase of an entire business. When an entire business is purchased, goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired.

An exclusive right to reproduce and sell artistic or published work is a

copyright

The extent of internal control features adopted by a company must be evaluated in terms of

cost-benefit.

Fraud

deception or misrepresentation in anticipation of unauthorized benefit. Some examples include overstating revenue, inflating an asset's NET worth (understate depreciation, for example), and hiding liabilities from a Balance Sheet

A company receives a discount for paying for merchandise purchased within the discount period. How will the amount of the discount be recorded in a perpetual inventory system?

decrease to Inventory

operating expenses

difference between gross profit and income from operations

The buyer received an invoice from the seller for merchandise with a list price of $400 and creditterms of 2/10, n/60. The number 10 in the credit terms is the:

discount period

Permitting only designated personnel such as cashiers to handle cash receipts is an application of the principle of:

establishment of responsibility

The inventory method that results in an ending inventory valued at the most recent cost is

first-in, first-out (FIFO).

One advantage of using the multiple-step income statement is that it ______________.

highlights the components of net income.

The principles of internal control do not include:

management responsibility. -Do include -establishment of responsibility. -documentation procedures. -independent internal verification

Gross profit from sales is the difference between:

net sales and the cost of goods sold

NSF check transaction

not sufficient funds from customer

Which of the following affects the cash balance per bank?

outstanding checks

Dixon Industries sold an old printer with a purchase price of $3,400 and accumulated depreciation of $2,100 for $1,500. This would require Dixon to

record a $200 gain on disposal of plant assets.

To record the sale of goods on credit under a perpetual inventory system:

record the increase to AR and sales revenue; and record the cost of goods sold and reduction of inventory.

The Coca-Cola company ________ its trade name and trademark ________ to maintain continuous legal protection.

renews; every twenty years

The most widely used method of depreciation is the

straight-line method

The process of calculating depreciation is

systematic and rational.

Retired or exchanged asset

the company does not receive cash

asset is sold

the company does receive cash.

Multistep Income Statement

three important line items: -Gross profit -Income from operations -Net income. -They are determined as follows: -Subtract cost of goods sold from net sales to determine gross profit. -Deduct operating expenses from gross profit to determine income from operations. -Add or subtract the results of activities not related to operations to determine net income -companies report income tax expense in a separate section of the income statement beforenet income

LIFO Calcuation

to calculate LIFO (Last-in, First-Out) determine the cost of your most recent inventory and multiply it by the amount of inventory sold

Error Transaction

whoever makes the error, adjusts the error

what is transaction to reward depreciation expense?

⬆Expense , ⬆Accumulated depreciation