Financial Accounting: Accrual Concepts, Merchandising Operations, and Inventory Reporting

Vocabulary practice flashcards covering accrual accounting principles, adjusting and closing entries, merchandising accounting, multi-step income statements, and inventory valuation systems.

Revenue Recognition Principle

The accounting principle dictating that companies recognize revenue in the period when a performance obligation has been satisfied.

Expense Recognition Principle

The accounting principle dictating that companies recognize expenses in the period when the company makes efforts to generate those revenues.

Cash-Basis Accounting

An accounting system in which companies record events only in the periods in which the company receives or pays cash.

Accrual-Based Accounting

An accounting method where companies record, in the periods in which the events occur, events that change a company's financial statements even if cash has not been exchanged.

Adjusting Entries

Entries made at the end of an accounting period to ensure that revenues are recorded in the period when performance obligations are satisfied and expenses are recognized when incurred.

Accruals

Revenues for services performed or expenses incurred in the current accounting period that have not yet been recognized through daily entries, metaphorically represented as the horse (event) occurring before receipt of the cash cart.

Deferrals

Prepaid expenses or unearned revenues where cash has been exchanged before goods or services are delivered or incurred, metaphorically represented as the cart (cash) before the horse (event).

Adjusted Trial Balance

A trial balance prepared at the end of an accounting period that shows the balances of all accounts, including those that have been adjusted, showing the effects of all financial events during the period.

Closing Entries

Entries recorded at the end of an accounting period to transfer net income or net loss to Retained Earnings and to zero-out all temporary accounts so they start the new period with a zero balance.

Temporary Accounts

Accounts that are closed at the end of an accounting period, specifically revenue accounts, expense accounts, and Dividends.

Worksheet

A spreadsheet device that facilitates preparing adjusting entries and financial statements, arranged from left to right with column pairs for the unadjusted trial balance, adjustments, adjusted trial balance, income statement, and balance sheet.

Perpetual Inventory System

An inventory system that counts merchandise continuously in real time, recording additions to inventory upon purchase and expensing items to Cost of Goods Sold immediately upon sale.

Periodic Inventory System

An inventory system that uses multiple temporary accounts (such as Purchases and Freight-In) and determines the cost of goods sold only at the end of the period via a physical count.

Purchases Account

A temporary account with a normal debit balance used under a periodic inventory system to record goods purchased on account or for cash.

Freight-In (Transportation-In)

A temporary account with a normal debit balance used under a periodic inventory system when the purchaser directly incurs shipping costs on goods purchased; considered part of the cost of goods purchased.

Purchase Returns and Allowances

A temporary account with a normal credit balance used under a periodic inventory system to record returns of purchased goods or price reductions granted by the supplier.

Purchase Discounts

A temporary account with a normal credit balance used under a periodic inventory system to record cash discounts claimed for paying within the specified discount period.

Sales Returns and Allowances

A contra revenue account with a normal debit balance used to record credit granted or cash refunded to customers for returned goods or damaged merchandise.

Sales Discounts

A contra revenue account with a normal debit balance used to record cash discounts allowed to customers for prompt collection of accounts receivable within a discount period.

Single-Step Income Statement

An income statement format in which companies classify all financial data under two categories—revenues or expenses—and determine net income in one step.

Multiple-Step Income Statement

An income statement that displays multiple intermediate subtotals in arriving at net income, prominently distinguishing gross profit, operating income from core activities, and nonoperating items.

Gross Profit

The excess of net sales over cost of goods sold ($\text{Gross Profit} = \text{Net Sales} - \text{Cost of Goods Sold}$).

Operating Income (Income from Operations)

A subtotal presented on a multiple-step income statement that indicates the profit earned directly from a company's primary activities of buying and selling merchandise.

Comprehensive Income Statement

A statement that adds or subtracts items of other comprehensive income (such as loss on disposal of plant assets) to net income to arrive at comprehensive income.

Gross Profit Rate

A company's gross profit expressed as a percentage of net sales, computed as $\frac{\text{Gross Profit}}{\text{Net Sales}}$.

Profit Margin

A profitability ratio measuring the percentage of each dollar of sales that results in net income, computed as $\frac{\text{Net Income}}{\text{Net Sales}}$.

Allowance for Sales Returns and Allowances

A contra account to Accounts Receivable used at the end of the accounting period to accrue estimated future returns from credit sales at selling price.

Estimated Inventory Returns

An asset account debited at the end of an accounting period for the cost of estimated future merchandise returns, which is generally added to the Inventory account.

Merchandise Inventory

The single inventory classification used by merchandising companies to describe all the different items available for sale that make up total inventory.

Raw Materials

A classification of manufacturing inventory representing basic goods on hand that will be used in production but have not yet entered the manufacturing process.

Work in Process

A manufacturing inventory category representing partially finished units that have entered production but are not yet complete.

Finished Goods

A manufacturing inventory category representing manufactured items that are completely produced and ready for sale.

Specific Identification Method

An inventory costing method that tracks and charges the actual specific physical cost of each particular unit sold and retained in ending inventory.

FIFO (First-In, First-Out)

An inventory cost flow method where the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold, leaving the most recent costs in ending inventory.

LIFO (Last-In, First-Out)

An inventory cost flow method where the cost of the most recent purchase prior to sale is charged to cost of goods sold, leaving the earliest historical costs in ending inventory.

Average-Cost Method

An inventory costing method that allocates cost of goods available for sale based on a weighted-average unit cost recomputed after purchases.

Lower-of-Cost-or-Net Realizable Value (LCNRV)

An inventory valuation basis requiring companies to recognize an inventory loss in the period when net realizable value drops below historical cost.

Inventory Turnover

A liquidity ratio measuring how many times inventory is sold during a period, calculated as $\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$.

Days in Inventory

The average number of days inventory is held before being sold, computed as $\frac{365}{\text{Inventory Turnover}}$.

LIFO Reserve

The dollar difference between ending inventory reported using LIFO and what ending inventory would be if FIFO were employed instead.