Financial Accounting: Inventory, Internal Controls, Receivables, and Long-Term Assets

Comprehensive practice flashcards in Question-and-Answer format covering inventory accounting, multi-step income statements, inventory costing (FIFO/LIFO), fraud and internal controls, bank reconciliations, accounts receivable and bad debt estimation, and long-term tangible and intangible asset valuation.

How does a perpetual inventory system record transactions when goods are purchased or sold?

Under a perpetual inventory system, inventory records are updated continuously every time goods are purchased or sold.

What is the journal entry under a perpetual inventory system to record the purchase of $\$1,000$ of merchandise inventory on account?

Debit Merchandise Inventory for $\$1,000$ (increasing assets) and credit Accounts Payable for $\$1,000$ (increasing liabilities).

What is the difference between FOB shipping point and FOB destination regarding ownership and freight responsibility?

Under FOB shipping point, the buyer owns the goods once they leave the seller and generally pays freight. Under FOB destination, the seller owns the goods until they reach the buyer and generally pays freight.

How does a buyer record paying $\$100$ freight under a perpetual inventory system, and how does a seller record freight under FOB destination?

The buyer debits Merchandise Inventory for $\$100$ and credits Cash for $\$100$. The seller records Delivery Expense (or Freight-Out) rather than Inventory.

What is the difference between a purchase return and a purchase allowance?

A purchase return occurs when the buyer sends goods back. A purchase allowance occurs when the buyer keeps the goods but receives a price reduction.

What journal entry is recorded when returning $\$200$ of inventory previously purchased on account?

Debit Accounts Payable for $\$200$ and credit Merchandise Inventory for $\$200$.

What do the credit terms 2/10, n/30 mean?

The buyer receives a $2\%$ discount if the invoice is paid within $10$ days; otherwise, the full net amount is due within $30$ days.

Under a perpetual inventory system, what is the journal entry to pay a $\$1,000$ accounts payable invoice within a $2\%$ discount period?

Debit Accounts Payable for $\$1,000$, credit Merchandise Inventory for $\$20$, and credit Cash for $\$980$.

What two journal entries are recorded when selling merchandise for $\$500$ cash that cost the business $\$300$ under a perpetual inventory system?

Entry 1 (record revenue): Debit Cash for $\$500$ and credit Sales Revenue for $\$500$. Entry 2 (record inventory sold): Debit Cost of Goods Sold for $\$300$ and credit Merchandise Inventory for $\$300$.

What two journal entries are made when a customer returns a resalable item sold for $\$100$ cash that originally cost $\$60$?

Entry 1 (reverse revenue): Debit Sales Returns and Allowances for $\$100$ and credit Cash (or Accounts Receivable) for $\$100$. Entry 2 (restore inventory): Debit Merchandise Inventory for $\$60$ and credit Cost of Goods Sold for $\$60$.

What is the journal entry for granting a $\$25$ sales allowance on an unpaid account, and why is there no inventory entry?

Debit Sales Returns and Allowances for $\$25$ and credit Accounts Receivable for $\$25$. There is no inventory reversal entry because the customer keeps the goods.

What type of account is Sales Discounts, and what journal entry is made when a customer pays a $\$1,000$ account within a $2\%$ discount period?

Sales Discounts is a contra-revenue account that reduces net sales. The entry is: Debit Cash for $\$980$, Debit Sales Discounts for $\$20$, and Credit Accounts Receivable for $\$1,000$.

What is inventory shrinkage, and what journal entry is recorded if inventory records show $\$5,000$ but a physical count reveals $\$4,800$?

Inventory shrinkage is the difference between recorded inventory and the physical count resulting from theft, damage, or counting errors. The entry is: Debit Cost of Goods Sold for $\$200$ and credit Merchandise Inventory for $\$200$.

What are the formulas for Net Purchases, Goods Available for Sale, and Ending Inventory?

$\text{Net Purchases} = \text{Purchases} + \text{Freight-In} - \text{Returns} - \text{Discounts}$$\text{Goods Available for Sale} = \text{Beginning Inventory} + \text{Net Purchases}$$\text{Ending Inventory} = \text{Goods Available for Sale} - \text{COGS}$

Given Beginning Inventory of $\$2,000$, Purchases of $\$8,000$, Freight-In of $\$300$, Purchase Returns of $\$500$, Purchase Discounts of $\$100$, and COGS of $\$6,000$, what is Ending Inventory?

$\$3,700$. Net Purchases is $\$8,000 + \$300 - \$500 - \$100 = \$7,700$. Goods Available for Sale is $\$2,000 + \$7,700 = \$9,700$. Ending Inventory is $\$9,700 - \$6,000 = \$3,700$.

What are the key formulas for a multi-step income statement?

$\text{Net Sales} = \text{Sales} - \text{Sales Returns and Allowances} - \text{Sales Discounts}$$\text{Gross Profit} = \text{Net Sales} - \text{Cost of Goods Sold}$$\text{Income from Operations} = \text{Gross Profit} - \text{Operating Expenses}$$\text{Net Income} = \text{Income from Operations} + \text{Other Revenues} - \text{Other Expenses}$

When is the specific identification inventory costing method used?

It is used when individual items can be specifically tracked, such as cars, jewelry, or expensive custom products.

How do FIFO and LIFO assign inventory costs to goods sold and ending inventory?

FIFO (First In, First Out) assigns the oldest inventory costs to goods sold and leaves the newest costs in ending inventory. LIFO (Last In, First Out) assigns the newest inventory costs to goods sold and leaves the oldest costs in ending inventory.

When prices are rising, how do FIFO and LIFO compare in terms of COGS, ending inventory, net income, taxes, and operating cash flow?

Under FIFO: COGS is lower, ending inventory is higher, net income is higher, income taxes are usually higher, and operating cash flow is generally lower after taxes. Under LIFO: COGS is higher, ending inventory is lower, net income is lower, income taxes are usually lower, and operating cash flow is generally higher after taxes.

What is the status of the LIFO inventory costing method under U.S. GAAP versus IFRS?

LIFO is permitted under U.S. GAAP but prohibited under IFRS.

How is Net Realizable Value (NRV) calculated for inventory, and what is the lower of cost and NRV rule?

$\text{NRV} = \text{Selling Price} - \text{Costs to Complete and Sell}$. Inventory must be written down to NRV if NRV is below cost, recognizing a loss (or COGS debit) and reducing Merchandise Inventory.

What are the formulas for Inventory Turnover and Days-to-Sell?

$\text{Inventory Turnover} = \frac{\text{COGS}}{\text{Average Inventory}}$$\text{Average Inventory} = \frac{\text{Beginning Inventory} + \text{Ending Inventory}}{2}$$\text{Days to Sell} = \frac{365}{\text{Inventory Turnover}}$

What are the three main types of fraud defined in financial accounting?

1. Asset misappropriation (stealing cash, inventory, or company property).
2. Fraudulent financial reporting (intentionally misstating financial records).
3. Corruption (abusing one's position for improper benefits, such as bribes or kickbacks).

What are the three components of the Fraud Triangle?

1. Pressure (financial or personal stress).
2. Opportunity (weak controls allowing fraud without detection).
3. Rationalization (justifying unethical behavior).

What are the six internal control activities and an example of each?

1. Segregation of duties (different employees handle cash and record transactions).
2. Physical controls (lock inventory in a secure area).
3. Documentation (keep receipts and invoices).
4. Independent verification (have another employee review bank reconciliations).
5. Authorization (require approval for purchases).
6. Human resource controls (perform background checks and rotate duties).

What are the inherent limitations of internal controls?

Human mistakes, collusion (employees/managers working together to bypass controls), management overriding controls, cost of controls exceeding benefits, and changing circumstances that make controls less effective.

In a bank reconciliation, which common items are adjusted on the bank side versus the book side?

Bank side: Add deposits in transit; subtract outstanding checks; correct bank errors. Book side: Add interest earned; subtract bank service charges; subtract NSF checks; correct company book errors.

Why are journal entries only recorded for book-side adjustments following a bank reconciliation?

Because bank-side adjustments represent timing differences already entered into the company's books, whereas book-side adjustments represent transactions the company has not yet recorded.

What is the Allowance for Doubtful Accounts, and how does it relate to Accounts Receivable?

It is a contra-asset account that estimates uncollectible receivables. It is subtracted from Accounts Receivable to report Accounts Receivable at its net realizable value.

How does the percentage of credit sales method estimate Bad Debt Expense?

It directly calculates Bad Debt Expense using the formula $\text{Bad Debt Expense} = \text{Credit Sales} \times \text{Estimated Rate}$, focusing on matching bad debt expense to the sales of the period.

How does the aging of accounts receivable method determine the bad debt adjustment?

It groups receivables by age to calculate the required total ending credit balance in Allowance for Doubtful Accounts. The Bad Debt Expense adjustment equals the difference between this required ending balance and the existing allowance balance (subtracting an existing credit balance or adding an existing debit balance).

What journal entry is made to write off an uncollectible account receivable of $\$300$ under the allowance method, and why is no expense recorded?

Debit Allowance for Doubtful Accounts for $\$300$ and credit Accounts Receivable for $\$300$. No Bad Debt Expense is recognized at write-off because the expense was already estimated and recognized in an earlier period.

What two journal entries are recorded when recovering a $\$300$ accounts receivable balance that was previously written off?

Step 1 (reinstate receivable): Debit Accounts Receivable for $\$300$ and credit Allowance for Doubtful Accounts for $\$300$. Step 2 (record collection): Debit Cash for $\$300$ and credit Accounts Receivable for $\$300$.

What is the formula for interest on a note receivable, and what is the interest on a $\$5,000$, $8\%$, $90$-day note assuming a $360$-day year?

$\text{Interest} = \text{Principal} \times \text{Annual Rate} \times \text{Time}$. For this note: \5,000 \times 8\% \times \frac{90}{360} = \$100$.

What are the formulas for Accounts Receivable Turnover and Days-to-Collect?

$\text{A/R Turnover} = \frac{\text{Net Credit Sales}}{\text{Average Net A/R}}$$\text{Average Net A/R} = \frac{\text{Beginning Net A/R} + \text{Ending Net A/R}}{2}$$\text{Days to Collect} = \frac{365}{\text{A/R Turnover}}$

What is the general accounting rule for capitalizing versus expensing costs incurred on long-term assets?

Capitalize all reasonable and necessary costs to acquire an asset and prepare it for its intended use (purchase price, sales tax, shipping, installation, testing, major additions/improvements). Expense routine maintenance and ordinary repairs in the period incurred.

How are costs allocated in a basket purchase of multiple assets?

The total purchase price is allocated based on each asset's relative fair value: $\text{Asset Cost} = \text{Total Price} \times \frac{\text{Asset's Fair Value}}{\text{Total Fair Value}}$.

What is the straight-line depreciation formula?

$$\text{Annual Depreciation} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$$

How is depreciation calculated using the units-of-production method?

$\text{Rate per Unit} = \frac{\text{Cost} - \text{Residual Value}}{\text{Estimated Total Units}}$$\text{Depreciation} = \text{Rate per Unit} \times \text{Actual Production Units}$

How is depreciation calculated under the double-declining-balance (DDB) method, and how is residual value handled?

$\text{DDB Rate} = \frac{2}{\text{Useful Life}}$$\text{Depreciation} = \text{Beginning Book Value} \times \text{DDB Rate}$ Residual value is ignored when computing the rate and initial depreciation, but the asset is never depreciated below its residual value.

What is the two-step process for asset impairment under U.S. GAAP for long-lived assets held and used?

Step 1 (Recoverability test): Compare the asset's carrying amount to its expected undiscounted future cash flows. Step 2 (Measurement): If carrying amount exceeds undiscounted cash flows, record an impairment loss equal to $\text{Carrying Amount} - \text{Fair Value}$.

How is the gain or loss on the disposal of a long-term asset calculated?

$\text{Book Value} = \text{Asset Cost} - \text{Accumulated Depreciation}$$\text{Gain or Loss} = \text{Cash Received} - \text{Book Value}$ A positive difference is a gain; a negative difference is a loss.

How does the accounting treatment of finite-lived intangible assets differ from indefinite-lived intangible assets?

Finite-lived intangible assets (e.g., patents, copyrights) are amortized over their useful lives using straight-line amortization. Indefinite-lived intangible assets (and goodwill) are not amortized, but are tested for impairment at least annually.

How is goodwill calculated in a business acquisition, and how is it accounted for post-acquisition under U.S. GAAP for public companies?

$\text{Goodwill} = \text{Purchase Price} - \text{Fair Value of Identifiable Net Assets}$ Identifiable net assets equal the fair value of identifiable assets acquired minus liabilities assumed. Goodwill is not amortized; it is tested for impairment at least annually or when triggering events occur.