Accounting Study Guide Chapters 5–7

Review of Chapters 5–7 covering retail operations, inventory costing methods, cash, and internal controls.

Operating Income

Calculated as: $\text{Sales} - \text{Cost of Goods Sold} - \text{Selling Expenses} - \text{Administrative Expenses}$

Gross Method

A method of recording sales discounts where an invoice is recorded at the gross sales amount.

Net Method

A method of recording sales discounts where an invoice is recorded at the gross sales amount less any discounts.

Inventory Shrinkage

The difference between the balance of the Inventory account and the physical inventory on hand; journalized as a debit to $\text{Cost of Goods Sold}$ and a credit to $\text{Inventory}$.

Gross Profit

The profitability of a business before deducting operating expenses, calculated as: $\text{Sales} - \text{Cost of Goods Sold}$

Controlling Account

A summarizing account in the general ledger that represents a specific subsidiary ledger.

Asset Turnover Ratio

A measure of how effectively a business uses its assets to generate sales, calculated as: $\text{Sales} \div \text{Average Total Assets}$

Estimated Returns Inventory

A current asset account used by retail businesses to record the cost of merchandise expected to be returned by customers.

Customer Refunds Payable

A current liability account for the amount a seller expects to refund to customers for returned products.

$$3/15, n/45$$

Credit terms indicating a $\text{3\%}$ discount if paid within $\text{15}$ days, otherwise the net amount is due in $\text{45}$ days.

Periodic Inventory System Disadvantage

A major disadvantage is that inventory shrinkage is not separately determined.

Last-in, First-out (LIFO)

An inventory costing method where the last units purchased are assumed to be sold first, and ending inventory consists of the first purchases.

First-in, First-out (FIFO)

An inventory costing method where the first units purchased are assumed to be sold first; this method yields an ending inventory closer to current prices.

Specific Identification Inventory Cost Flow Method

A method where the unit sold is identified with a specific purchase and ending inventory consists of the remaining units on hand.

Weighted Average Inventory Cost Flow Method

A method that provides similar results to the physical flow of goods when purchases are relatively uniform under the periodic system.

Lower-of-Cost-or-Market (LCM) Method

A valuation method that can be applied to each item, each major class, or the inventory as a whole.

Days' Sales in Inventory

A measure of the length of time it takes to acquire, sell, and replace inventory, calculated as: $\text{Average Inventory} \div \text{Average Daily Cost of Goods Sold}$

Gross Profit Method

An inventory estimation method useful for determining the cost of inventory destroyed by fire or other disasters.

Retail Method of Inventory Costing

A method using a ratio of cost to retail price to estimate inventory; it allows management to monitor operations and prepare monthly statements without a physical count.

Petty Cash Fund

A special cash fund used for small disbursements, replenished by debiting various expense accounts and crediting $\text{Cash}$.

Bank Service Charge

A fee that appears on a bank statement as a debit memorandum, which decreases the account balance.

Internal Control—Integrated Framework

The widely accepted standard issued by the COSO (not FASB) for designing, analyzing, and evaluating internal controls.

Sarbanes-Oxley Act

A law designed to restore public confidence in financial statements by requiring effective internal controls over transaction recording and financial statement preparation.

Days' Cash on Hand

A liquidity measure used by nonprofits and start-ups to reveal how long a business could survive using current cash balances.

Compensating Balance

A minimum cash account balance required by a bank as part of a loan or credit agreement.

Cash Equivalents

Marketable securities that are highly liquid and easily converted to cash, such as $\text{U.S. Treasury bills}$, $\text{commercial paper}$, and $\text{money market funds}$.

Cash Short and Over (Credit Balance)

Reported as income on the income statement; a debit balance is reported as an expense.

Cash Expenses

Calculated as: $\text{Total Operating Expenses} - \text{Depreciation Expense}$