Financial Accounting

Merchandise inventory is:

Goods held for resale in the normal course of business

Periodic inventory system

Updates inventory and COGS only at the end of the period using a physical count

Perpetual Inventory system:

Continuously updates inventory and COGS with each purchase and sale

FOB shipping point means

Buyer owns goods while in transit and usually pays freight-in

FOB destination means:

Sellers owns goods while in transit and usually pays freight-out

Freight-in is:

Cost of shipping goods from suppliers to the company, added to the inventory cost

Freight-out is:

Cost to ship goods from the company to customers, usually a selling expense

Net cost of inventory purchased is:

Purchases + freight-in - purchase returns and allowances - purchase discounts

Net sales revenue is:

Sales revenue - sales discounts - sales returns and allowances

Gross profit is:

Net sales - Cost of Goods Sold

Consistency principle:

Requires a company to use the same accounting methods from period to period

Disclosure principle

requires financial statements to include enough information for informed decisions

Materiality concept:

Allows ignoring very small amounts that do not affect decisions

Conservatism

choose the option that is least likely to overstate assets or income

Specific identification

Traces the actual physical flow and cost of each specific unit

FIFO (first in, first out)

Assumes that oldest units are sold first

LIFO (last in, last first out)

Assumes most recent units are sold first

Weighted-average cost method:

Assigns each unit a cost equal to the average cost of all units available

Lower-of-cost-or market (LCM) rule:

Inventory must be reported at the lower of its cost or current market value

Internal control is:

Policies and procedures to safeguard assets, ensure reliable accounting, and promote efficiency

Control procedures

Specific policies and activities used to achieve internal control objectives

Cash receipts are

Cash collected from customers and other sources

Cash payments are

Cash spent for inventory, expenses, and liabilities

Bank reconciliation

Compares company’s cash records with the bank statement and explains differences

Accounts receivable

Amounts due from customers on credit sales

Notes receivable

Written promises to pay a specific amount plus interest at a future date

Direct write-off method:

Records bad debts only when a specific account is deemed uncollectible Al

Allowance method:

Estimates uncollectible accounts in advance using an allowance amount

Bad debts expense:

Expense for estimated uncollectible receivables

Percent-of-sales method:

Estimates bad debts as a percent of credit sales

Percent-of-receivables method:

Estimates ending allowance for bad debts as a percent of accounts receivable

Aging-of-accounts-receivable method:

Estimates uncollectibles by applying different percentages to receivables based on how long they have been outstanding

Principal (of a note):

Face amount of money borrowed or loaned

Maturity value of a note:

Principal plus all interest due at maturity

Interest revenue

revenue earned from lending money or extending credit

Plant assets are:

Long-lived tangible assets used in operations

Capital expenditures

Cost that increases the asset’s capacity or useful life and is capitalized

Revenue expenditure

Ordinary repair or maintenance cost that is expensed immediately

Depreciation

Allocation of the cost of a plant asset over its useful life

Debt securities:

Investments in notes or bonds that pay interest

Equity securities

Investments in stock representing ownership

Short-term investment

Investment expected to be sold or converted to cash within one year

Long-term investment

Investment intended to be held for more than one year

Fair value method

Reports certain investments at current market price with unrealized gains/losses

Equity method

used when investor owns between 20% and 50% and has significant influence

Consolidation method

used when investor controls the investee, usually by owning more than 50%

Current liability

obligation expected to be settled within one year or operating cycle

Long-term liability

Obligation due beyond one year or operating cycle

Current portion of long-term debt

Portion of a long-term liability due within the next year

Gross pay

total earnings before deductions

Net pay

Gross pay minus all payroll deductions (take-home pay)

Payroll withholding deductions

Amounts withheld from an employee’s pay (taxes, FICA, etc)

Bonus (as a liability)

Additional pay tied to performance, recorded as an estimated liability

Warranty

Agreement to repair or replace defective products, creating an estimated liability

Contigent liability:

Potential liability that depends on the outcome of a future event L

Long-term note payable

Written promise to pay a specified amount plus interest beyond one year Mo

Mortgage payable

Long-term note secured by real estate

Term bonds

Bonds that mature on a single dateSe

Serial bonds

Bonds with staggered maturity datesSec

Secured bonds

Backed by specific collateral

Debentures

Unsecured bonds backed only by issuer’s credit

Bonds payable

Long-term debt issued in small amounts called bonds

Corporation

business that is a seperate legal entity owned by stockholders

Common stock

Basic voting stock of a corporation

Outstanding stock

issued stock minus treasury stock

treasury stock

corporation’s own stock that it has repurchased

Dividends

Distributions of a corporation’s earnings to shareholders

Stock split

Issuance of additional shares to reduce market price per share without charging total equity

Continuing operations

Ongoing income from parts of the business expected to continue

Discontinued operations

Results of components that have been disposed of or are held for sale

Earnings per share (EPS):

Net income available to common shareholders divided by weighted-average common shares

Appropriated retained earnings:

Retained earnings that are restricted for a specific purpose

Statement of retained earnings

Reports changes in retained earnings during a period

Statement of cashflows

shows changes in cash by operating, investing, and financing activites

Operating activities

Cash flows from day-to-day business operations

Investing activities

Cash flows from buying and selling long term assets and investments

Financing activities

Cash flows from issuing stock, borrowing, repaying debt, and paying dividends

Horizontal analysis

Comparing financial statement items over two or more periods

Trend analysis

Horizontal analysis that expresses items as percentages of a base year (base =100%)

Vertical analysis

Expressing each item in a financial statement as a percentage of a base amount in the same period

Common-size statement

Statement in which all items are shown as percentages of a base amount

Ratio analysis

Using numerical relationships between financial statement items to evaluate performance

In a perpetual inventory system, which of the following is TRUE?

Inventory and cost of goods sold are updated every time a sale or purchase occurs.

Under a perpetual inventory system, how is a purchase of merchandise on credit recorded?

Debit merchandise inventory, credit accounts payable

Freight-in on merchandise purchased for resale is usually:

added to the cost of inventory

Which of the following is the best example of the consistency principle?

Applying the same inventory method from one period to the next unless there is a justified reason to change

Which inventory method will generally produce the highest Cost of Goods Sold and lowest net income in a period of rising prices?

LIFO

If ending inventory is overstated in the current year, which of the following is TRUE for the current year?

Cost of Goods Sold is understated and net income is overstated

Which situation violates the internal control principle of seperation of duties?

The same employee receives cash and records cash in the accounting records.

Which of the following items would typically be subtracted from the bank statement balance in a bank reconciliation?

Outstanding checks

A strong system of internal control over cash payments would most likely include:

Requiring all payments (other than petty cash) to be made by pre-numbered checks or electronic transfer.

The main weakness of the direct write-off method of accounting for uncollectible receivables is that it:

Violates the matching prinicple by recognizing bad debt expense only when a specific account is written off

Under the allowance method, writing off a specific customer’s account

Decreases accounts receivable and decreases allowance for bad debts, with no effect on total assets or net income

Compared to the percent-of-sales method, the aging-of-accounts-receivable method focuses more directly on:

Estimating the desired ending balance of the Allowance for Bad Debts accountWh

When a note receivable is honored at maturity, the journal entry by the holder usually includes:

Debit cash; credit Notes Receivable, and Interest Revenue

Which of the following is most likely to be treated as a capital expenditure

Installation of a new engine that increases the truck’s useful life

If a company incorrectly expenses a major improvement that should have been capitalized, the immediate effect on the financial statements is:

Assets are understated and expenses are overstated

The purpose of recording depreciation on plant assets is to:

Allocate the asset’s cost to expense over the periods that benefit from its use

When a fully depreciated asset is disposed of for no proceeds, the journal entry will:

Remove the asset and its accumulated depreciation, with no gain or loss

Which statement best distinguishes debt securities from equity securities?

Debt securities pay interest; equity securities represent ownership in a company