ACCT 2810 MILLER EXAM 2

service businesses

-Revenue activities involve providing services to customers.-Example: Family Health Care, P.C.

Retail Operations

-Merchandisers

-Revenue activities involve the buying and selling of merchandise.

-Example: Home Depot Inc.

gross profit

net sales - cost of goods sold

net sales

sales revenue -(returns and allowances and discounts)

Cost of Goods Sold

cost paid for merchandise that was sold

periodic system

Inventory records are updated "periodically".

-Inventory purchases recorded in "Purchases" account

-No entry to adjust inventory at point of sale

-Ending inventory count is used to determine COGS at the end of the period

Perpetual System

Inventory records are updated at the point of sale.

-Inventory purchases are recorded in "Inventory" account"Inventory" account is adjusted at point of sale

-Inventory account balance shows what inventory should be on hand at any point in the period. (Balance in the inventory account is kept up to date "perpetually".)

discounts

Received by buyers for making an early payment of an invoice

credit terms

2/10, n30

-Refers to the timing of when payments for merchandise are to be made, agreed on by the buyer and the seller

-If payment is required on delivery, the terms are cash or net cash

-Buyer should make the payments within a credit period

fob

free on board

FOB destination

Title passes from the seller to the buyer when the goods are delivered to the buyer.

FOB shipping point

title passes when the seller ships the inventory, not when the buyer receives it.

adjustments for retail operations

inventory shrinkage, Estimated customer refunds and allowances, Estimated customer merchandise returns

customer refunds payable

estimate is used in the adjusting process to record a liability

estimated returns inventory

inventory expected to be returned in the future

-Estimated at the end of the period as part of the adjusting process

cash sale

Seller collects the sales tax

Sale made on account

Seller charges the buyer by increasing Accounts Receivable

Inventory Shrinkage

Difference between the balance of Merchandise Inventory and the physical inventory on hand at the end of the accounting period

Multiple-Step Income Statement Format

-Cost of goods sold

-Gross profit

-Income from operations

-Selling expenses

-Administrative expenses

-Other revenue

-Other expense

Single-Step Income Statement for Retail Company

-Revenue

-expenses

-net income

Objectives of Internal Control

safeguard assets, accurate information, compliance with laws and regulations

elements of internal control

control environment, risk assessment, control activities, information and communication, monitoring

control enviroment

-Overall attitude of the management and the employees about the importance of controls

-factors that influence a company's control environment

-Management's philosophy and operating style

-Company's organizational structure

-Company's personnel policies

risk assessment

-Management should:

-Identify risks and analyze their significance

-Assess the probability of the occurrence of risks

-Take necessary actions to minimize risks

Control Procedures

-Provide reasonable assurance that business goals will be achieved

-Include:

-Competent personnel, rotating duties, and mandatory vacations

-Separating responsibilities for related operations

-Separating operations, custody of assets, and accounting

-Proofs and security measures

human element of controls

fatigue, carelessness, confusion, or misjudgment can cause human errors

Cost-benefit considerations

Costs of internal controls should not exceed their benefits

voucher

Any document that serves as a proof of authority to pay cash or issue an electronic funds transfer (EFT)

Bank account advantages

-Reduce the amount of cash on hand

-Provide an independent recording of cash transactions

-Help facilitate the transfer of funds using EFT systems

bank reconciliation

-Analysis of the items and amounts that result in the cash balance reported in the bank statement differing from the balance of the cash account in the ledger

-Actual (true) cash balance determined in the bank reconciliation is reported on the balance sheet

-Should be prepared by an employee who does not take part in or record cash transactions to avoid mistakes

Credit memo entry

Indicates an increase in the depositor's account

petty cash fund

established by cashing a check. Funds are controlled by the custodian

of the fund and kept secure.

cash

normally listed as the first asset in the Current Assets section of a balance sheet

Accounts Receivable

Credit terms extended to customers. Usually 30 to 60 days.

Notes Payable

-More formal agreement. Interest is calculated.

-includes a maker and payee

other receivables

Can include interest receivable, taxes receivable, and receivables from employees or officers

interest

Face Amount × Interest Rate × (Term/360 days)

maturity value

Face Amount + Interest

Direct Method

The Accounts Receivable account is adjusted "directly" for bad debts as they occur

allowance method

•Bad debts are estimated each period and a contra receivables account called "Allowance for Bad Debts" is used.

-bad debt expense happens before the account is written off!

percent of accounts receivable method

Accounts receivable are analyzed based on an aging schedule. The bad debt estimate represents the required ending balance that needs to be in the Allowance for Bad Debts account.

percent of sales method

Bad debt estimate is a function of total credit sales. The estimate calculated here represents the amount of Bad Debt EXPENSE that should be recorded.

bad debt expense

Credit sales × Bad debts as a percent of credit sales

precent of credit sales

An income statement approach. Focus is on the estimate of expense as it is matched to the related revenue.

Percentage of receivables (aging)

A balance sheet approach. Focus is on the estimate of the allowance (a contra asset) to get the net realizable value of accounts receivable.

merchandisers

•One classification - "Merchandise inventory"

•Cost of inventory includes all costs of ownership

-purchase price

-transportation costs

-insurance costs, etc.

manufacturers

•Every manufacturer has 3 classifications of Inventory

-Materials

-Work in Progress

-Finished Goods

Merchandise Inventory

•Merchandise on hand (not sold) at the end of the period

•Current asset

•Inventory sold becomes the cost of goods sold

Cost of Inventory

Purchase price − purchase discounts + freight - purchase returns and allowances

FIFO (first in, first out)

costs flow in the order in which the costs were incurred

-Lower cost of goods sold (COGS)

Higher gross profit

-Higher inventory values. Ending inventory amount is similar to current replacement cost

-Gross profit reduces if future costs are higher

LIFO (last in, first out)

cost flow in the reverse order in which the cost were incurred

-Higher COGS

Lower gross profit

-Lower inventory values

-Matches current costs with current revenues

Weighted average cost

cash flow is an average of cost

-Averaged gross profit

-Averaged inventory value

-Compromise between LIFO and FIFO

specific identification method

-If the merchandise can be easily tied to a specific purchase, the specific identification method can be used.

-Cost of each unit of merchandise is determined by looking at the purchase price of that particular unit.

-Only works if there is a unique characteristic of each item that makes it identifiable

•Example: VIN for an automobile

LIFO conformity rule

If a company elects to use LIFO inventory valuation for tax purposes, then the company must also use LIFO for external financial reporting

LIFO reserve

Estimated difference between the LIFO inventory and the inventory if FIFO had been used

•Noted in financial statements

Lower-of-Cost-or-Market Method

-An example of conservatism

-Applied by determining the cost, market price, and any declines for one of the following:

-Each item in the inventory

-Each major class or category of inventory

-Total inventory as a whole

Recievables

-Classified as a current asset if collection is expected within one year

Inventory Valuation

Cost is the primary basis for valuing and reporting inventories in the financial statements

market

Net realizable value of the inventory

Net realizable value

Estimated selling price − direct costs of disposal

Direct costs of disposal

include selling expenses such as special advertising or sales commissions on the sale

Accounts Receivable and Inventory

-Large current assets for many companies

-Objective in managing receivables and inventory is to convert them to cash by collecting receivables and selling inventory

-Useful measures of liquidity

-Accounts receivable turnover

-Inventory turnover

Accounts Receivable Turnover

Net Sales / Average Accounts Receivable

Days' Sales in Receivables

365 days/accounts receivables turnover

Inventory Turnover

cost of goods sold/average inventory

Days' Sales in Inventory

365 days / inventory turnover