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COB 241 Test 2 Study Guide

by: Charles Miller

COB 241 Test 2 Study Guide COB 241

Marketplace > James Madison University > Business > COB 241 > COB 241 Test 2 Study Guide
Charles Miller
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This study guide covers chapters 4-7 and Appendix E.
Financial Accounting
Dr. Irving
Study Guide
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This 12 page Study Guide was uploaded by Charles Miller on Sunday October 16, 2016. The Study Guide belongs to COB 241 at James Madison University taught by Dr. Irving in Fall 2016. Since its upload, it has received 75 views. For similar materials see Financial Accounting in Business at James Madison University.


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Date Created: 10/16/16
COB 241 Test 2 Chapter 4­ Accounting for Merchandise Business  2 Types of Companies o Companies that generate revenue by providing a service o Companies that generate revenue by selling goods (inventory)  Inventory can be  Purchased from a supplier and resold to customers  (retailers)  Purchased from a supplier and resold to other companies  (wholesale)  Produced entirely by the company and sold to customers or  other companies (manufacturers)  Inventory Vocabulary  o Inventory is a primary asset for merchandisers as well as manufacturers.  Modern companies use a perpetual inventory system to maintain their  inventory records. The inventory account is adjusted continually  (perpetually) throughout the accounting period. o COGS( Cost of Goods Sold) is a primary expense for these companies o Gross Margin is the difference between the sales revenue and COGS o Product Costs are the costs associated with purchasing and preparing  inventory for sale.  o Period Costs  are costs that are not included in inventory (usually  referred to as selling and administrative)   COGS Model o Start with Beginning Inventory o Add Purchases o Subtract Cost of Goods Sold o Equals: Ending Inventory  Multi Step Income Statement o COGS is deducted from revenues to arrive at gross margin. COGS is  reported separately from other operating expenses. o Operating expenses are deducted from Gross Margin to arrive at  Operating Income o Non Operating Items, which include Interest Revenue/Expense and  Gains/losses, are added/deducted from operating income to arrive at pre­ tax income o Income Tax Expense is deducted from Pre­Tax Income to arrive at Net  income Transportation Costs  FOB terms designate when title passes and who pays for the cost of transporting inventory from the seller to the buyer. FOB stands for Free On Board  FOB Shipping Point o Ownership transfers from the seller to the buyer when the seller provides  the goods to the carrier  o Buyer pays the transportation cost o Cost of transportation is added to the buyer’s inventory account balance  for that particular purchase  FOB Destination o Ownership transfers from the seller to the buyer when the buyer receives  the goods o Seller pays the transportation costs  o Cost of transportation is not added to the buyer’s inventory account  balance for that particular purchase Lost, Damaged, or Stolen Inventory   Most companies that sell goods experience inventory shrinkage, a term which  reflects decreases in inventory for reasons other than sales to customers (e.g.,  lost, damaged, or stolen items)  The journal entry for this is a debit to COGS and a credit to inventory  Discount Rate Vocab  Example Rate: 2/10,n/30 o The 2 is equal to the discount if the balance is paid within the allotted time  frame o 10 is the length of the discount period o n= the the amount due that is not paid in the discount period o 30= # of days when the full amount of payment is due Purchase Discounts, Returns, and Allowances  A company is eligible for a purchase discount when it pays the supplier for  inventory within an agreed upon discount window  A purchase return occurs when the company returns inventory to the supplier for  reasons such as wrong size, wrong color, wrong design, or simply because the  company changes its mind  Dissatisfied companies will agree to keep goods instead of returning them to the  supplier if the supplier offers to reduce the price. This price reduction is referred  to as a purchase allowance.  These transactions require a debit to accounts payable and a credit to inventory. Sales Discounts, Returns and Allowances  A sales discount is recorded as a debit to revenue and a credit to accounts  receivable   A sales return (customer returns inventory to the company) is recorded as a  double entry the first being a debit to Revenue and a credit to Accounts  Receivable. The second entry is a debit to inventory and a credit to COGS  A Sales Allowance allows the customer to keep the purchased inventory but  requires the company to reverse the original sales entry. This is recorded as a  Debit to Revenue and a Credit to Accounts Receivable. Net Sales  Gross Sales  Minus: Sales Discounts  Minus: Sales Returns  Minus: Sales Allowances  Equals: Net Sales Chapter 5­ Accounting for Inventories Inventory Cost Methods 1. FIFO­ First In, First Out­ is a cost flow assumption that the first goods purchased  are also the first goods sold. In most companies, this assumption closely  matches the actual flow of goods, and so is considered the most theoretically  correct inventory valuation method. 1. Cost of the oldest purchases comprise the cost of goods sold 2. Cost of the newest purchases comprise the ending balance inventory b. LIFO­ Last In, First Out­  is used to place an accounting value on inventory. The  LIFO method operates under the assumption that the last item of inventory  purchased is the first one sold. 1. Cost of the newest purchases comprise the cost of goods sold 2. Cost of the oldest purchases comprise the ending balance inventory b. Weighted Average­  divide the cost of goods available for sale by the number of  units available for sale. The cost of goods available for sale is the sum of  beginning inventory and net purchases. c. Specific Identification­  is a method of finding out ending inventory cost. It  requires a detailed physical count, so that the company knows exactly how many of each goods brought on specific dates remained at year end inventory. Financial Statements Impact  FIFO­ Results in profit maximization, Higher ending inventory and lower cost of  goods sold. Contingent on increasing costs.  LIFO­ Results in tax minimization. Lower ending inventory and higher COGS.  Used commonly by oil companies. Contingent on rising prices  Weighted Average­ Results fall in between FIFO and LIFO Chapter 6­Internal Controls and Accounting for Cash  Internal Controls o Are policies and procedures to provide assurance that enterprise  objectives are accomplished o Accounting Controls­are designed to safeguard company assets and  ensure reliable accounting records o Administrative Controls­ are for evaluating performance and assessing  compliance with the company policies and public laws o Key Elements of Internal Controls  Separation of Duties­ Employees can act as a check if duties are  separated, greatly reducing the chance of fraud  Quality of Employees­ Better employees allow you to rotate duties  which relieves job boredom and can increase productivity, also  reduces the chance of fraud  Bonded Employees­ A fidelity bond provides insurance that  protects a company from loss caused by employee dishonesty.   Required Absences­ 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.  Procedures Manual­ Procedures for accounting and other  operational guidelines should be written in a manual.  Authority and Responsibility­ General authority applies to all  members of the organization. Specific authority applies only to  employees that are a specific position within the organization.    Prenumbered Documents­ 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 the forms issued during a particular period   Physical 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.  Performance Evaluations­ 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.  Internal Control Limitations o 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 is impenetrable.  Type of Audit Opinions  o Unqualified Opinion= The books and records of this company are fairly  stated w/in accounting rules o Adverse Opinion= Significant problems or departures from the accounting  rules o Qualified Opinion= In Between unqualified and adverse o Disclaimer of Opinion= It gives an exclusion to the auditor’s  opinion. Not  able to analyze records in a certain part of the business.  Adjusting the Books o Every recording item that appears on the unadjusted book balance section requires a journal entry to adjust the general ledger cash balance to the  true cash balance.  Confidentiality o The confidentiality rules in the code of ethics for CPAs prohibit auditors  from voluntarily disclosing information they have acquired as a result of  their accountant­client relationships  SEC­ Government agency that enforces accounting rules for publicly traded  companies  Sarbanes­Oxley Act­ Created and enforced audit standards for SEC audits Chapter 7  Types of Receivables o Accounts Receivable­ A current asset. When a company allows customers to buy a good or service on credit. Usually small and collectible within 30  days. o Notes Receivable­ A long term asset. A long term form of credit. Usually  larger sums of money and have an interest rate attached to them. o The Allowance Method­ records collection of losses on the basis of  estimates instead of waiting to see which customers the business on the  basis of estimates instead of seeing which customers it can collect from. o Direct Write Off Method­ If uncollectible accounts are not material,  companies are permitted to account for them using the direct write­off  method. Under this approach a company simply recognizes uncollectible  accounts expense in the period which it identifies and writes off  uncollectible accounts. o Accounting for Notes Receivable­ When a company extends a credit for a  long time, or when the amount extended is large, the parties often enter  into a credit agreement, the terms of which are specified in a promissory  note. o Accounting for Credit Card Sales­ Many companies find it more efficient to accept third­party credit cards instead of offering credit lines directly to  customers. The credit card companies deduct a fee. This come froms the  amount of gross sales and then pays the company the balance. Appendix E  The method of investment accounting used in this course is the Fair Value  Method of accounting. This is used for investors who own less than 20% of the  stock in a company.  3 Types of Fair Value Method Accounting  o A held­to­maturity security is purchased with the intention of holding the  investment to maturity. This type of security is reported at amortized cost  on a company's financial statements and is usually in the form of a debt  security with a specific maturity date. Unlike held­for­trading securities,  temporary price changes are not shown in accounting statements for held­ to­maturity securities, and the interest income received from a held­to­ maturity security is run through the income statement. o A trading security refers to debt and equity investments that are  purchased with the intent of selling them within a short period of time,  usually less than one year. Accounting standards necessitate that  companies classify any investments in debt or equity securities when they  are purchased, with options to classify as "held to maturity," "held for  trading" or "available for sale." With a held­for­trading security, gains and  losses resulting from changes in the investment's value are recorded on  an income statement as gains and losses. o An available­for­sale security is a debt or equity security purchased with  the intent of selling before it reaches maturity, or selling prior to a lengthy  time period in the event the security does not have a maturity. Accounting  standards necessitate that companies classify any investments in debt or  equity securities when they are purchased as held to maturity, held for  trading or available for sale. Available­for­sale securities are reported at  fair value; changes in value between accounting periods are included in  comprehensive income until the securities are sold.  Accounting for Inventories Process o Record the purchase using the Fair Value method   DR Fair Value Method Investing and CR cash o As you receive investment revenue record it  DR Cash and CR Investment Revenue o (Trading and AFS only) At the end of a reporting period make an adjusting entry to mark the investment at its fair value. (unrealized gain)  DR FVMI and CR Unrealized gain for a gain in value  DR Unrealized Loss and CR FVMI for a loss in value  For trading this difference appears on the Income Statement  For AFS it appears on the Balance Sheet  o At the point a company sells its investment record the sale and the  accompanying realized gain or loss on the sale  Unrealized Gain­  It is a profitable position that has yet to be  sold in return for cash, such as a stock position that has  increased in capital gains but still remains open. A gain  becomes realized once the position is closed for a profit.


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