ACCT 2001 Kimberly Peters, Exam 2

What is the primary source of revenue?

sales revenue (sales)

Retailers

directly to cusomers

Wholesales

directly to retailers

COGS

total cost of the merchandise sold during the period

Inventory

added account for a merchandising company (current assets)

Which generally takes more time?

merchandising

Ending Inventory

good not sold at end of period

What two inventory systems do companies use to account for inventory?

perpetual and periodic

Perpetual

1. maintains records of costs of inventory purchases and sales

2. records continuously show inventory on hand

3. company determines COGS every time sale occurs

Periodic

1. Do NOT keep detailed records of the goods on hand

2. Cost of goods sold determined by count at the end of the accounting period

FOB

Free on Board

FOB shipping point

buyer pays freight costs

FOB destination

seller pays ownership passes at destination

Equation to Gross Profit

(sales - sales returns and allowances - sales discounts) / net sales - COGS

Balance Sheet:

includes an inventory account (current asset)

Income Statement:

most prefer a multi step income statement

Single Step Income Statements have:

2 categories:

1. revenue

2. expenses

Multi Step Income Statements have:

Gross profit

Income from operations

Income before income taxes

Net income

What component is only used in a multiple step income statement?

income from operations

What are the three important line items of a multiple step income statement?

1. Gross profit

2. Income from operations->sustainable

3. Net income

Other Revenues and Gains include:

1. Interest revenue

2. Dividend revenue

3. Rent revenue

4. Gain

Other Expenses and Losses include:

1. Interest expense

2. Casualty losses

3. Loss from sale

4. Loss from strikes

Interest revenue

from notes receivable and marketable securities

Dividend revenue

from investments in capital stock

Rent revenue

from subleasing a portion of the store

Gain

from the sale of property, plant, and equipment

Interest expense

on notes and loans payable

Casualty losses

from such causes as vandalism and accidents

Loss

1. from the sale or abandonment of property, plant, and equipment

2. from strikes by employees and suppliers

In addition to Net income, what is another earnings measure?

comprehensive income

Comprehensive income

is reported in a company's financial statements

The fair value principle indicates

that certain assets and liabilities are recorded at fair value

The unrealized gains and losses are included in:

1. net income

2. not included at all

3. may be reported as comprehensive income

Gains and losses which are included in Comprehensive Income include:

1. adjustments to pension plan assets

2. gains and losses on foreign currency translations

3. unrealized gains and losses on certain types of investments

Comprehensive Income Statement may be used to report

Comprehensive Income

Under Perpetual,

a company records Costs of Goods Sold every time a sale is made

Under Periodic,

a company does not record Cost of Goods Sold until the end of the period

Cost of Goods Sold Equation

Beginning Inventory + Purchases of merchandise - Ending Inventory

What does Profit Margin mean?

% of net sales kept in net income

Classifying Inventory

classifies as current assets on BS regardless of stage in process

Classifying Inventory is divided into 2 categories:

1. Merchandising Company

2. Manufacturing Company

Merchandising Company has one classification:

1. Merchandise Inventory

Manufacturing Company has three classifications:

1. Raw Materials

2. Work in Process

3. Finished Goods

Perpetual System

1. Check accuracy of inventory records.

2. Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

Periodic System

1. Determine the inventory on hand

2. Determine the cost of goods sold for the period

Taking a Physical Inventory involves:

counting, weighing, or measuring each kind of inventory on hand

When is Physical Inventory taken?

1. when the business is closed or when business is slow

2. at end of the accounting period

Determining Ownership of Goods:

1. Items in the Warehouse

2. Goods in Transit

3. Consigned Goods

Goods in Transit:

1. Purchased goods not yet received

2. Sold goods not yet delivered

3. Legal title is determined by the terms of the sale

Consigned Goods:

goods held for sale by one party although ownership of the goods is retained by another party

Inventory counted by the company that has ownership-

NOT the one holding the item

Inventory Count

should include all items in which the company has legal title

FOB Shipping Point (Legal title)-

when the public carrier accepts goods from the seller

FOB Destination (Legal title)-

remains with the seller until the good reaches the buyer

If I am buyer FOB Destination-

Do NOT include goods in transit in inventory

If I am buyer FOB Shipping Point-

includes goods in transit in inventory

Cost Flow Assumptions include:

1. Specific Identification

2. First-in, first-out (FIFO)

3. Last-in, first-out (LIFO)

4. Average-cost

First-In-First-Out (FIFO):

1. earliest goods purchased are first to be sold

2. often parallels actual physical flow of merchandise

3. Generally good business practice to sell oldest units first

Gross Profit Equation

Net Sales - COGS

Last-In, First-Out (LIFO):

1. latest goods purchased are first to be sold

2. seldom coincides with actual physical flow merchandise

3. exceptions include goods stored in piles, such as coal or hay

Average Cost:

1. allocates cost of goods available for sale on the basis of average unit cost incurred

2. assumes goods are similar in nature

3. applies weighted-averages unit cost to the units on hand to determine cost of inventory

In periods of rising prices, FIFO reports lowest

cost of goods sold

In periods of rising prices, FIFO reports highest

end inventory, nets income

In periods of rising prices, LIFO reports lowest

end inventory, net income

In periods of rising prices, LIFO reports highest

cost of goods sold

Using Cost Flow Methods Consistently:

1. method should be used consistently, enhances comparability

2. although consistency is preferred, a company may change its inventory costing method

Lower-of-Cost-or-Market:

Net Realizable Value(NRV)= selling price-selling cost

When the value of inventory is lower than its cost:

1. companies can write down the inventory to its NRV market value in the period in which the price decline occurs

2. market value= replacement cost

3. example of conservatism- less likely to overstate assets and net income

Inventory management

is a double-edged sword and can be very critical

Inventory management includes:

1. high inventory levels

2. low inventory levels

High Inventory Levels

may incur high carrying costs

Low Inventory Levels

may lead to stockouts and lost sales

Inventory Turnover Equation

cost of goods sold/average inventory

Days in Inventory Equation

365/inventory turnover

LIFO Reserve includes:

1. use of different inventory methods complicated analysts' attempts to compare companies

2. companies using LIFO are required to report to difference between inventory using LIFO and inventory using FIFO

3. this amount is referred to as the LIFO reserve

FIFO Equation

LIFO+ LIFO reserve

What is fraud?

A dishonest act by an employee that results in personal benefit to the employee at a cost to the employer

The three main factors that contribute to fraudulent activity are depicted by

the fraud triangle

The three elements of the fraud triangle:

1. opportunity

2. financial pressure

3. rationalization

Which element of the fraud triangle is the most important?

opportunity

After numerous corporate scandals came to light in the early 2000s, congress addressed fraud by passing

the Sarbanes Oxley Act (SOX)

All publicly traded U.S. corporations are required to maintain an adequate system of internal control

under SOX

SOX also created the ________________________________________________ to establish auditing standards and regulate auditor activity.

Public Company Accounting Oversight Board (PCAOB)

Internal controls are processes designed to

safeguard assets, enhance the reliability of accounting records, increase efficiency of operations, and ensure compliance with laws and regulations.

Internal controls

processes designed to provide reasonable assurance regulating the achievement of the company's objectives

Internal control systems have 5 primary components:

1. control environment

2. risk assessment

3. control activities

4. information and communication

5. monitoring

Control Environment

"Tone at the Top", responsibility of management to set the environment/organization values of integrity and intolerance of unethical behavior

Risk Assessment

identifying and analyzing the risks of the entity - How do we manage these risks?

Control Activities

policies and procedures put in place to reduce the assurance of fraud/opportunity

Information and Communication

MUST document and communicate controls

Monitoring

continuous monitoring for adequacy; deficiencies should be reported

What are the back bone of the company's efforts to address the risks is faces, such as fraud?

control activities

The specific control activities used by a company will vary depending on

the risk assessment of the risks faced; this assessment is heavily influenced by the size and nature of the company.

What are the six principles of control activity?

1. establishment of responsibility

2. segregation of duties

3. documentation procedures

4. physical controls

5. independent internal verification

6. human resource control

When is control most effective?

when only 1 person is responsible for a task

Establishing responsibility often requires

limited access only to authorize personnel, and then identifying those personnel

There are two common applications of segregation of duties

1. different individuals should be responsible for related activities

2. responsibility for record-keeping for an asset should be separate from physical custody

Making one individual responsible for related activities ________________ the potential for errors and irregularities.

increases

The account should have neither

physical custody of the asset nor access to it

Documentation procedures

source documents- evidence that transaction occured