Accounting Exam 2
Accounting Exam 2 BMGT220
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Date Created: 02/22/16
Accounting Exam 2 Study Guide Corporate FinancialAccounting (Warren) Chapter 6: Inventories I. Control of Inventory A. Safeguarding Inventory 1. Purchase order - authorizes the purchase of the inventory from an approved vendor 2. Receiving report - establishes initial record of the receipt of the inventory, is compared with the purchase order to make sure the inventory received is the same as what’s ordered and ﬁnally compared with a Vendor’s Invoice 3. Subsidiary inventory ledger - keeps track of the amount of inventory B. Reporting Inventory 1. Physical inventory - physical count of inventory II. Inventory Cost FlowAssumptions A. Cost FlowAssumption 1. speciﬁc identiﬁcation inventory cost ﬂow method - when units are sold, the speciﬁc cost of the unit sold is added to cost of goods sold 2. First-in, First-Out (FIFO) - Cost ﬂow is in the order in which costs were incurred 3. Last-in, First-Out (LIFO) - Cost ﬂow is in the reverse order in which costs incurred 4. WeightedAverage Cost - Cost ﬂow is an average of the costs III. Inventory Costing Methods Under a Perpetual Inventory System A. First-in, First Out (FIFO) 1. costs included in cost of merchandise sold in same order they were purchased 2. ﬁrst units purchased are assumed to be sold and the ending inventory is made up the most recent purchases 3. produces roughly same results as speciﬁc identiﬁcation method B. Last-in, First-Out (LIFO) 1. cost of the units sold is the cost of the most recent purchases 2. the last units purchased are assumed to be sold and the ending inventory is made up of the most recent purchases 3. LIFO is most widely used even when it does not represent the physical ﬂow of units 4. When LIFO is used, subsidiary inventory ledger is sometimes maintained in units only, units are converted to dollars when ﬁnancial statements are prepared at end C. WeightedAverage Cost Method 1. The weighted average unit cost for each item is calculated each time a purchase is made (the cost of individual units would be the average of all the prices of all the units) IV. Inventory Costing Methods Under a Periodic Inventory System A. First-in, First-Out (FIFO) 1. Under periodic FIFO, a physical count is taken of inventory and the ﬁrst purchased are the ﬁrst to be sold, and they are sold at the same cost at which they were purchased 2. The ending inventory is made up of the most recent costs B. Last-in, First-Out (LIFO) 1. Under periodic LIFO, the cost of the merchandise on hand at the end of the period is made up of the earliest costs 2. The ending inventory is made up of the earliest costs C. WeightedAverage Cost Method 1. Average Unit Cost = Total Cost of UnitsAvailable for Sale / UnitsAvailable for Sale D. Inventory Calculations 1. Beginning Inventory + Purchases = Cost of GoodsAvailable for Sale 2. Cost of GoodsAvailable for Sale - Ending inventory = Cost of Goods Sold 3. Beginning Inventory + Purchases = Cost of Goods Sold + Cost of Ending Inventory V. Comparing Inventory Costing Methods A. Costing under Increasing Prices (High / Low) 1. Cost of Goods Sold: LIFO / FIFO 2. Gross Proﬁt: FIFO / LIFO 3. Net Income: FIFO / LIFO 4. Ending Inventory: FIFO / LIFO B. Costing under Decreasing Prices (High / Low) 1. Cost of Goods Sold: FIFO / LIFO 2. Gross Proﬁt: LIFO / FIFO 3. Net Income: LIFO / FIFO 4. Ending Inventory: LIFO / FIFO C. Inventory Proﬁts 1. Inventory Proﬁts (Illusory Proﬁts) - FIFO reports higher gross proﬁt and net income than LIFO with rising costs, yet in periods of rapid rise, the inventory sold must be replaced faster and at higher costs 2. During rising costs, LIFO matches more recent costs against sales on the income statement, and can be argued that LIFO method more nearly matches current costs with current revenues D. Taxing under Costing Methods 1. Under rising prices LIFO results in lower gross proﬁt, which means less taxable net income 2. Conversely, under decreasing prices, LIFO results in higher gross proﬁt, which means more taxable net income 3. Weighted average is a compromise between LIFO and FIFO, in terms of taxation VI.Reporting Merchandise Inventory in the Financial Statements A. Valuation at Lower of Cost or Market 1. Lower-of-cost-or-market method (LCM) - used to value the inventory based on the cost or replacing inventory and any declines can be determined by the following a) Each item in the inventory b) Each major class or category of inventory c) Total inventory as a whole 2. The amount of any price decline is included in the cost of merchandise sold, which reduces gross proﬁt and net income in the period in which the price decline occurs 3. If a unit can be replaced at a lower cost than its purchase price, that is LCM and vice versa B. Valuation at Net Realizable Value 1. Net Realizable Value - price of merchandise that is old or damaged can only be sold for lower than original value 2. Net Realizable Value = Estimated Selling Price - Direct Costs of Disposal C. Merchandise Inventory on the Balance Sheet 1. In addition to CurrentAssets, the following are reported a) method of determining cost of inventory (FIFO, LIFO, or weighted average) b) method of valuing the inventory (cost or the lower of cost or market) D. Effect of Inventory Errors on the Financial Statement 1. Reasons for errors: a) Physical inventory on hand miscounted b) Costs were incorrectly assigned to inventory (e.g. FIFO or LIFO was incorrectly applied) c) Inventory in transit was incorrectly included or excluded from inventory d) Consigned inventory was incorrectly included or excluded from inventory 2. Consigned inventory - when manufacturers (consignors) sells to retailers (consignee) on consignment and consignor retains title until goods are sold (if unsold at year-end, consignee should not include in inventory, consignor should include in inventory) E. Effect of Inventory Error on Current Period Income Statement 1. Beginning Inventory is Understated: a) Cost of Goods Sold = Understated b) Gross Proﬁt = Overstated c) Net Income = Overstated 2. Beginning Inventory = Overstated a) Cost of Goods Sold = Overstated b) Gross Proﬁt = Understated c) Net Income = Understated 3. Ending Inventory = Understated a) Cost of Goods Sold = Overstated b) Gross Proﬁt = Understated c) Net Income = Understated 4. Ending Inventory = Overstated a) Cost of Goods Sold = Understated b) Gross Proﬁt = Overstated c) Net Income = Overstated F. Effect of Inventory Errors on Current Periods Balance Sheet 1. Ending Inventory = Understated a) Merchandise Inventory = Understated b) CurrentAssets = Understated c) TotalAssets = Understated d) Stockholder’s Equity = Understated 2. Ending Inventory = Overstated a) Merchandise Inventory = Overstated b) CurrentAssets = Overstated c) TotalAssets = Overstated d) Stockholder’s Equity = Overstated VII. FinancialAnalysis and Interpretation: Inventory Turnover and Number of Days’Sales A. Inventory Turnover 1. Inventory Turnover = Cost of Goods Sold /Average Inventory B. Number of Days’Sales in Inventory 1. Number of Days’Sales in Inv. =Avg. Inventory /Avg. Daily Cost of Goods Sold 2. Avg. Daily Cost of Goods Sold = Cost of Goods Sold / 365 3. Lower number of days’sales in inventory, the more efﬁcient it is managing inventory Chapter 8: Receivables I. Classiﬁcation of Receivables A. Accounts Receivable 1. Accounts Receivable - selling merchandise or services on account (on credit), classiﬁed as current asset B. Notes Receivable 1. Notes Receivable - amounts that customers owe for which a formal written instrument of credit has been issued C. Other Receivables 1. Include interest receivable, taxes receivable, and receivables from other employees 2. If collected within one year, considered current assets 3. If collection is expected beyond one year, considered noncurrent assets, and reported as investments II. Uncollectible Receivables A. Bad Debt Expense 1. Bad Debt Expense (UncollectibleAccounts Expense) - amount of credit sales that are not expected to be received within the accounting period, which may occur because: a) Receivable is past due b) Customer does not respond to company’s attempts to collect c) Customer ﬁles for bankruptcy d) Customer closes its business e) Company cannot locate customer (1) If left unpaid, account can be turned over to collection agency 2. Direct Write-Off Method a) records bad debt expense only when the account is determined to be worthless b) not accepted under GAAP 3. Allowance Method a) records bad debt expense by estimating uncollectible accounts at the end of the accounting period, allowed under GAAP III. Direct Write-Off Method for UncollectibleAccounts 1. Under direct write-off method, Bad Debt Expense is not recorded until customer’s account is determined to be worthless.At that time account receivable is written off 2. To write off: Dr. Bad Debt Expense, Cr.Accounts Receivable 3. Later if paid: Dr.Accounts Receivable, Cr. Bad Debt Expense and Dr. Cash forAR IV. Allowance Method for UncollectibleAccounts 1. Allowance for DoubtfulAccounts - contra asset account which is credited for the estimated bad debts 2. (e.g.) Dr. Bad Debt Expense, Cr.Allowance for DoubtfulAccounts 3. affects income statement and balance sheet 4. Net Realizable Value is the amount of receivables reduced to the amount that is expected to be received (subtracting allowance for doubtful accounts) B. Write-Offs to theAllowanceAccount 1. Allowance for DoubtfulAccounts will normally have a balance based on an estimate 2. Credit balance if the write-offs during the period are less than the beginning balance 3. Debit balance if the write-offs exceed the beginning balance 4. If account receivable that has been written off against allowance account is collected again Dr.Accounts Receivable, Cr.Allowance for DoubtfulAccounts; Dr. Cash 4AR C. Estimating Uncollectible 1. Percent of Sales Method a) Uncollectible accounts can be estimated as a percent of credit sales to sales, applied to total sales or net sales b) Bad Debt Expense = Credit Sales * Bad Debt as a percent of credit sales 2. Analysis of Receivables Method a) Step 1: due date of account receivable determined b) Step 2: number of days each account is past due is determined c) Step 3: Each account is placed in an aged class according to days past due d) Step 4: Totals for each aged class is determined e) Step 5: Total for each aged class is multiplied by an estimated percentage of uncollectible accounts for that class f) Step 6: The estimated total of uncollectible accounts is determined as the sum of the uncollectible accounts for each aged class g) This process is called aging the receivables and helps determine that the longer an account is outstanding, the less likely it will be collected and a percentage is given for each age class D. Comparing Estimation Methods 1. Under percent of sales method, bad debt expense is focus of estimation process as well as matching expense and revenue and thus the income statement 2. Under analysis of receivables method, allowance for doubtful accounts is focus of estimation process, as well as net realizable value and thus the balance sheet V. Comparing Direct Write-Off andAllowance Methods A. Direct Write-Off: records bad debt expense when uncollectible a) Dr. Bad Debt Expense (1) Cr.Accounts Receivable b) Dr. Cash, Bad Debt Expense (1) Cr.Accounts Receivable B. Allowance Method: bad debt expense based on % sales or analysis, allowance acct. used a) Dr.Allowance for DoubtfulAccounts (1) Cr.Accounts Receivable b) Dr. Cash,Allowance for DoubtfulAccounts (1) Cr.Accounts Receivable VI. Notes Receivable A. Characteristics of Notes Receivable (promissory note used when): 1. The maker is the party making the promise to pay 2. The payee is the party to whom the note is payable 3. The face amount is the amount for which the note is written on its face 4. The issuance date is the date a note is issued 5. The term of a note is the amount of time between issuance and due dates 6. The interest rate is that rate of interest that must be paid on the face amount for term B. Interest 1. Interest = FaceAmount * Interest Rate * (Term / 360 days) 2. Maturity value - amount that must be paid at the due date of the note (sum + interest) C. Accounting for Notes Receivable 1. Dr. Notes Receivable (when note issued) a) Cr.Accounts Receivable 2. Dr. Cash (at due date) a) Cr. Notes Receivable, Interest Revenue 3. Dr.Accounts Receivable (if note dishonored or not paid in time) a) Cr. Notes Receivable, Interest Revenue Chapter 9: FixedAssets and IntangibleAssets I. Nature of FixedAssets A. FixedAssets 1. long-term or relatively permanent assets such as equipment, machinery, buildings, and land 2. Characteristics: a) They exist and are therefore tangible assets b) They are owned and used by the company in its normal operations c) They are not offered for sale as part of normal operations B. Classifying Costs 1. Is purchased item long-lived? a) No = item is recorded as an expense b) Yes = item is recorded as an asset on balance sheet (1) Is asset used in normal operations? (a) No = asset is recorded as an investment (b) Yes = asset is recorded as a ﬁxed asset C. The Cost of FixedAssets 1. Potential causes of expenses: a) Vandalism b) Mistakes in installation c) Uninsured theft d) Damage during unpacking and installing e) Fines for not obtaining proper permits from governmental agencies D. Capital and Revenue Expenditures a) Revenue expenditures - costs that only beneﬁt the current period and don't provide additional beneﬁt b) Capital expenditures - costs that improve an asset or extend its useful life 2. Ordinary Maintenance and Repairs a) costs related to the ordinary maintenance and repairs of a ﬁxed asset and are recorded as an expense of the current period b) Dr. Repairs and Maintenance Expense (1) Cr. Cash 3. Asset Improvements a) After a ﬁxed asset has been placed into service, costs may be incurred to improve the asset; a key improvement is made to improve productivity, efﬁciency of the asset: b) Dr. (Name of Capital expenditure) (1) Cash 4. Extraordinary Repairs a) After ﬁxed asset has been placed into service, costs may be incurred to extend asset’s useful life. b) Dr.Accumulated Depreciation (1) Cr. Cash E. Leasing FixedAssets 1. Lease - a contract for the use of an asset for a certain amount of time a) Lessor - one who owns asset b) Lessee - one who receives right to use asset, granted by lessor 2. Capital Lease - accounted for as if the lessee has purchased the asset, lessee debits an asset account for the fair market value of the asset and credits a long-term lease liability account 3. Operating Lease - accounted for as if the lessee is renting the asset for the lease term, where the lessee records operating lease payments by Dr. Rent Expense, Cr. Cash II. Accounting for Depreciation A. Depreciation - periodic recording of the cost of life 1. Physical depreciation - wear and tear during use or from exposure to weather 2. Functional depreciation - obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended B. Factors in Computing Depreciation Expense 1. Assets initial cost 2. Asset’s expected useful life 3. Asset’s estimated residual value a) Residual value (salvage/trade-in value) - ﬁxed asset at the end of its useful life is estimated at the time the asset is placed into service C. Straight-Line Method 1. Annual Depreciation = (Cost - Residual Value) / Useful Life D. Units-of-Output Method 1. Depreciation per Unit = (Cost - Residual Value) / Total Units of Output 2. Depreciation Expense = Depreciation per Unit * Total Units of Output Used E. Double-Declining-Balance Method 1. Double-Declining Rate = 2*Straight-Line Percentage = (100/Years of Useful Life)*2 2. Book value = cost minus accumulated depreciation F. Comparing Depreciation Methods 1. Straight-Line Method a) Useful Life = Years; Dep. Cost = Cost - residual val; Exp. = Constant 2. Units-of-Output a) Useful Life = Units of Output, Dep. Cost = Cost - residual val; Exp. = Variable 3. Double-Declining-balance a) Useful Life = Years; Dep. Cost = Declining book value, not below; Exp. = Decln. G. Depreciation for Federal Income Tax 1. ModiﬁedAccelerated Cost Recovery System (MACRS) a) IRS uses MACRS to compute depreciation for tax purposes, using 5-year-class depreciation rates b) for both ﬁnancial statement and tax purposes H. Revising Depreciation Estimates 1. Estimates of residual values and useful lives of ﬁxed assets may change due to abnormal wear and tear or obsolescence III. Disposal of FixedAssets A. Discarding FixedAssets 1. If a ﬁxed asset is no longer used and has no residual value, it’s discarded a) Dr.Accumulated Depreciation - Equipment (1) Cr. Equipment 2. Selling FixedAssets: a) Dr. Depreciation Expense (1) Cr.Accumulated Depreciation 3. If sold at book value: a) Dr. Cash,Accumulated Depreciation, Loss on Sale of Equipment (1) Cr. Equipment 4. If sold below book value: a) Dr. Cash,Accumulated Depreciation, Loss on Sale of Equipment (1) Cr. Equipment 5. If sold above book value: a) Dr. Cash,Accumulated Depreciation (1) Cr. Equipment, Gain on Sale of Equipment IV. Natural Resources 1. Depletion - process of transferring the cost of natural resources to an expense account 2. Depletion Rate = Cost of Resource / Estimated Total Units of Resource a) Dr. Depletion Expense (1) Cr.Accumulated Depletion V. IntangibleAssets 1. Assets that do not exist physically, that are used in the operations of a business and not held for sale B. Patents 1. Patents - exclusive rights that government issues to inventors to produce and sell goods with one or more unique features 2. Amortization - the amount of cost to transfer to expense that is written off over the years of a patent’s expected life a) Dr.Amortization Expense (1) Patents C. Copyrights and Trademarks 1. Copyright - exclusive right issued by the federal government to publish and sell a literary, artistic, or musical composition, this may be purchased and will be recorded at the price paid for it; amortized over useful life 2. Trademark - a name, term or symbol used to identify a business and its products, can be purchased from another business and its cost is recorded as an asset; when a trademark is impaired, should be written down and recognized as a loss D. Goodwill 1. Goodwill - intangible asset of a business that is created from such favorable factors such as location, product quality, reputation, and managerial skill 2. GAAP - allow goodwill to be recorded if it is objectively determined by a transaction a) Dr. Loss from Impaired Goodwill (1) Cr. Goodwill VI. FinancialAnalysis and Interpretation: FixedAsset Turnover Ratio A. Ratio 1. FixedAsset Turnover Ratio = Net Sales /Average Book Value of FixedAssets 2. The higher the ﬁxed asset turnover, the more efﬁciently a company is using it ﬁxed assets in generating sales
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