accounting exam 2

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business that sells merchandise or goods to customers

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merchandise inventory

The amount of goods on hand for sale to customers

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buys goods from a manufacturer and sells them to retailers.

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buys merchandise from manufacturers or a wholesaler and then sells the goods to consumers

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the operating cycle

  1. company purchases inventory from an individual or business, called a vendor.

  2. the company sells the inventory to a customer

  3. the company collects cash from customers

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what does the income statement of a merchandiser report

sales revenue, cost of goods sold, gross profit, and operating expenses.

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cost of goods sold

cost of merchandise sold to customers

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gross profit

net sales - cost of goods sold

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operating expenses

expenses other than cost of goods sold.

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periodic inventory system

requires a physical count of inventory to determine inventory on hand.

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perpetual inventory system

keeps a running computerized record of merchandise inventory.

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the sellers request for payment from the purchaser. Also called bills. Sellers and purchasers have these.

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purchase returns

exists when sellers allow purchasers to return merchandise that is defective, damaged, or otherwise unsuitable.

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purchase allowances

amounts granted to purchasers as an incentive to keep goods that are not "as ordered"

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purchase discounts

discount that businesses offer to purchasers as an incentive for early payment.

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credit terms

the payment terms of purchase or sale as stated on the invoice. most express the discount, the discount time period, and the final due date.

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FOB shipping point

the buyer takes ownership (title) to the goods after the goods leave the seller's place of business (shipping point) the buyer usually pays the freight.

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FOB destination

the buyer takes ownership (title) to the goods at the delivery destination point. the seller usually pays the freight.

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freight in

the transportation cost to ship goods into the purchasers warehouse, thus, it is freight on purchased goods.

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freight out

the transportation cost to ship goods out of the sellers warehouse and tho the customer; thus, it is freight on goods sold to a customer.

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net cost of inventory purchased

allows a business to determine the actual cost of the merchandise purchased.

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net cost inventory purchased equation

purchase cost of inventory - purchase returns and allowances - purchase discounts + freight in

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sales revenue

amount a business earns from selling merchandise inventory

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Two entries required to record sale transactions in a perpetual inventory system

  1. records sales revenue (sales revenue and cash received)

  2. records inventory sold (cost of goods sold and the reduction of merchandise inventory)

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sales return

reduce the future cash collected from the customer or require a refund be made to the customer

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estimated returns inventory

asset account used to estimate the cost of merchandise inventory a company will receive in returns.

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refunds payable

liability account used to estimate the amount of refunds that will be paid to customers in the future

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sales allowance

occurs when the seller reduces the amount owed by a customer, but the customer does not return merchandise inventory. The company also reduce the estimated refunds payable account.

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sales discount

reduction in the amount of revenue earned on sales for early payment. sales are recorded at the net amount or the amount of the sale less any discounts.

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inventory shrinkage

loss of inventory occurring from theft, damage ,and errors. Businesses take a physical count of inventory at least once a year.

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4 steps to closing the accounts of a merchandiser

  1. make revenue accounts equal zero through the income summary account

  2. make expense account equal zero via the income summary account

  3. make the income summary account equal zero via the owner capital account

  4. make the owner withdrawals account equal zero via the owner capital account.

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single step income statement

groups all revenues together and lists and deducts all expenses together without calculating any subtotals.

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multi-step income statement

contains subtotals to highlight significant relationships.

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how are single step and multi step income statements different

lists several important subtotals; gross profit, operating income, total other income and expenses, and net income.

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selling expenses

related to marketing and selling the company's goods and services.

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administrative expenses

include expenses not related to marketing the company's goods and services.

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operating income equation

gross profit - operating expenses

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other income and expenses

reports revenues or expenses that are outside the normal, day-to-day operations of a business, such as interest revenue, sales discounts forfeited, interest expense, gains and losses on the sale of plant assets.

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two new asset accounts on balance sheet for a merchandiser

merchandise inventory and estimated returns inventory

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gross profit percentage

measures the profitability of each sales dollar above the cost of goods sold.

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gross profit percentage equation

gross profit/net sales revenue

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performance obligation

contractual promise with a customer to transfer a distinct good or service

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four accounting principles associated with merchandise inventory

  • consistency

  • disclosure

  • materiality

  • accounting conservatism

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consistency principle

states that a business should use the same accounting methods and procedures from period to period

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disclosure principle

financial statements should report enough information for outsiders to make knowledgeable decisions about the company. information should be relevant and represented faithfully.

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materiality concept

states that a company must perform strictly proper accounting only for items that are significant to the business's financial situation. Information is significant when it would cause someone to change a decision.

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a business should report the least favorable figures in the financial statements when two or more possible options are presented. Anticipate no gains, but provide for all losses. choose the value that undervalues rather than overvalues your business.

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ending merchandise inventory equation

number of units on hand x unit cost

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cost of goods sold equation

number of units sold x unit cost

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inventory costing method

approximates the flow of inventory costs in a business that is used to determine the amount of cost of goods sold and ending merchandise inventory

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Four basic inventory costing methods are allowable by GAAP:

  1. specific identification

  2. first in, first out (FIFO)

  3. last in, first out (LIFO)

  4. weighted average

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specific identification method

inventory costing method that matches each unit of inventory with its actual cost. used for automobiles, jewels, real estate.

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FIFO method

assumes the first units purchased are the first to be sold. cost of goods sold is based on the oldest purchases

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cost of goods available for sale

total cost spent on inventory that was available to be sold during a period.

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LIFO method

as inventory is sold, the cost of the newest item in inventory is assigned to each unit as the cost of goods sold.

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weighted average method

computes a new weighted average cost per unit after each purchase.

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weighted average cost per unit equation

cost of goods available for sale/units available for sale

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Lower cost or market rule

requires that inventory be reported in the financial statements at the lower of the inventory's original cost or its market value. market value generally means the current replacement cost.

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inventory turnover equation

cost of goods sold/average merchandise inventory

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average merchandise inventory equation

(beginning merchandise inventory + ending merchandise inventory) / 2

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what does inventory turnover ratio measure

how rapidly inventory is sold. High turnover rate indicates ease of selling.

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days sales in inventory equation

365 days / inventory turnover

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what does days sales in inventory measure

the average number of days inventory is held by the company.

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average cost per unit

cost of goods available for sale (entire period) /number of units available

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accounting information system (AIS)

provides information that is useful for decision makers. records, stores, and processes accounting data to produce information that is useful for decision makers.

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five things an effective accounting information system provides

  1. control

  2. compatibility

  3. flexibility

  4. relevance

  5. positive cost/benefit relationship

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three basic components of accounting information systems

source documents and input devices, processing and storage, and outputs.

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special journal

an accounting journal deigned to record one specific type of transaction

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the four special journals

  • sales journal

  • cash receipts journal

  • purchases journal

  • cash payments journal

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two common subsidiary ledgers

accounts receivable subsidiary ledger and accounts payable subsidiary ledger

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subsidiary ledger

contains the details related to a given general ledger account

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Accounts Receivable subsidiary ledger

lists customer names and account balances, amounts sold, received, and still due.

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control account

account whose balance equals the sum of the balances in a group of related accounts in a subsidiary ledger.

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what does the accounts payable subsidiary ledger list

vendors in alphabetical order, amounts paid, amounts owed.

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sales journal

credit sales are entered into the sales journal. sales for cash are NOT

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cash receipts journal

records the collection of cash receipts. every transaction is cash receipts, no payments are recorded.

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purchase journal

a special journal used to record only purchases of merchandise on account

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cash payments journal

all cash and check payments are recorded here. also called the check register and the cash disbursements journal.

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general journal

used to record all other transactions, like adjusting entries for depreciation, expiration of prepaid insurance, accrual of salaries payable, adjustment for sales returns and allowances and purchase returns and allowances.

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two basic components to computerized accounting information system

  1. hardware (electronic equipment)

  2. software (set of programs that drives the computer)

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two popular computerized accounting information systems for small businesses

  1. quickbooks

  2. sage 50 accounting

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advantages to enterprise resource planning systems

  • reduce operating costs

  • help companies adjust to change

  • integrate separate software systems

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disadvantages to enterprise resource planning systems

  • major installations are expensive

  • implementation requires a large commitment of time and people.

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Internal Control

The organizational plan and all the related measures adopted by an entity to safeguard assets, encourage employees to follow company policies, promote operational efficiency, and ensure accurate and reliable accounting records.

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Committee of Sponsoring Organizations (COSO)

provides thought leadership related to enterprise risk management, internal control, and fraud deterrence. mission is to develop frameworks and guidance to help companies improve their internal controls and reduce fraud deterrence.

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public companies

companies that sell stock to the general public- are required by the US congress to maintain a system of internal controls.

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Sarbanes-Oxley Act (SOX)

requires companies to review internal control and take responsibility for the accuracy and completeness of their financial reports.

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SOX provisions

1.Public companies must issue an internal control report -An auditor must evaluate internal controls. 2.The Public Company Accounting Oversight Board (PCAOB), oversees the work of auditors of public companies. 3.Accounting firms are not allowed to audit a public company and also provide certain consulting services for the same client. 4.Stiff penalties await violators—25 years in prison for securities fraud and 20 years for an executive making false sworn statements.

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a business can achieve its internal control objectives by addressing five components: (CRIME)

  • control procedures

  • risk assessment

  • information system

  • monitoring of controls

  • environment

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how are internal controls monitored

internal auditors (employees of the company) and external auditors (outside accountants)

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internal control procedures

  • competent, reliable, and ethical personnel

  • assignment of responsibilities

  • separation of duties

  • audits

  • documents

  • electronic devices

  • e-commerce

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separation of duties

division of responsibilities between two or more people to limit fraud and promote accuracy of accounting records.

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rearranges plain text messages by a mathematical process

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limit access into a local network

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occurs when two or more people work together to circumvent internal controls and defraud a company

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steps of cash receipts by mail

step 1: all incoming mail is opened by a mailroom employee, and sends all customer checks to the treasurer and remittance advices to accounting department. step 2: treasurer has the cashier deposit checks in the bank. cashier receives a deposit receipt. step 3: the accounting department uses the remittance advices to record the journal entries to cash and customer accounts. step 4: as a final control, the controller compares the following records for the day; Bank deposit amount from the treasurer Debit to cash from the accounting department.

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remittance advice

optional attachment to a check that tells the business the reason for the payment.

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lock box system

system in which customers send their checks to a post office box that belongs to a bank.

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Evaluated receipts settlement (ERS)

procedure that compresses the payment approval process into a single step by comparing the receiving report to the purchase order.

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Electronic data interchange (EDI)

a streamlined process that bypasses paper documents altogether. Computers of customers communicate directly with the computers of suppliers to automate routine business transactions.

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