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practice exam 6-7
What is the effect on the receivables turnover ratio and the average collection period if net sales decreases and accounts receivable remains constant?
Group of answer choices
The receivables turnover ratio and average collection period both decrease.
The receivables turnover ratio and average collection period both increase.
The receivables turnover ratio increases and the average collection period decreases.
The receivables turnover ratio decreases and the average collection period increases.
EXPLANATION:
RECEIVABLE TURNOVER RATIO measures how many times a company collects its accounts receivable in a period
how many times you collect money from customers in a year
receivables turnover = net sales / accounts receivable
if you sell A LOT, this number goes up (good)
if you sell LESS, this number goes down (not so good)
AVERAGE COLLECTION PERIOD
how many days it takes customers to pay you back
how long it takes to collect its account receivable
Average collection period = 365 / receivables turnover
WHAT HAPPENS IF NET SALES GO DOWN?
you are selling less lemonade = net sales decrease
but customers still owe you the same amount = accounts receivable stays the same
since receivables turnover = net sales / accounts receivable
if net sales go down, the turnover ratio goes down too
and since AVERAGE COLLECTION PERIOD = 365 / TURNOVER RATIO, if turnover goes down, the collection period GOES UP (it takes longer to collect money/receivables)
365/smaller number = larger number
selling less = turnover drops
slower collections = collection period increases
its like if your friends arent buying as much lemonade, but they still OWE you the same money, so you have to WAIT LONGER TO GET PAID
CONCLUSION: the AVG COLLECTION PERIOD INCREASES when the receivables turnover ratio decreases
NOW WE KNOW: receivables turnover ratio decreases & average collection period increases
WHY THE OTHER ANSWERS ARE WRONG:
“The receivables turnover ratio and average collection period both decrease”
incorrect because if TURNOVER DECREASES, THE COLLECTION PERIOD ACTUALLY INCREASES, not decreases
“The receivables turnover ratio and average collection period both increase”
incorrect because if TURNOVER DECREASES, COLLECTION PERIOD DOES THE OPPOSITE (IT INCREASES)
“The receivables turnover ratio increases and the average collection period decreases”
Incorrect because IF NET SALES DECREASE, TURNOVER DOES NOT INCREASE, IT DECREASES
KEY TAKEAWAYS FOR TEST:
when NET SALES DECREASE and ACCOUNTS RECEIVABLE STAYS THE SAME
RECEIVABLES TURNOVER RATIO DECREASES
AVERAGE COLLECTION PERIOD INCREASES (it takes longer to collect money from customers)
Beech Inc. is in the business of selling wooden pallets. Beech sold 12 pallets to a customer and erroneously recorded a sale of 22 pallets. What is the effect of the error on cost of goods sold and ending inventory at the end of the current accounting period?
Group of answer choices
Cost of goods sold and ending inventory are both overstated.
Cost of goods sold is understated and ending inventory is overstated.
Cost of goods sold and ending inventory are both understated.
Cost of goods sold is overstated and ending inventory is understated.
Step 1: UNDERSTANDING WHAT HAPPENED
beech inc. ACTUALLY SOLD 12 PALLETS
But they MISTAKENLY RECORDED that they sold 22 pallets instead
This means the company’s RECORDS SHOW MORE SALES THAN WHAT REALLY HAPPENED
Step 2: UNDERSTANDING COST OF GOODS SOLD (COGS)
What is COGS?:
COGS is the COST THAT A BUSINESS incurs to PRODUCE OR BUY the product that it SELLS
Every time a company makes a sale, they remove the COST of that item from the inventory and add it to the COGS on the income statement
FORMULA:
COGS = COST PER PALLET X NUMBER OF PALLETS SOLD
How does this error affect COGS?
the company actually sold 12 pallets, but they recorded 22
That means COGS IS CALCULATED AS IF 22 PALLETS WERE SOLD, even though only 12 were actually sold
This makes COGS TOO HIGH because they included costs for 10 pallets that were NOT ACTUALLY SOLD
COGS IS OVERSTATED (higher than it should be)
Step 3: UNDERSTANDING ENDING INVENTORY
What is ending inventory?
ending inveoty is the value of the produce LEFT IN STOCK at the end of the accounting period
FORMULA FOR ENDING INVENTORY:
ENDING INVENTORY = BEGINNING INVENTORY + PURCHASES - COGS
since COGS is TOO HIGH, that means MORE COSTS WERE REMOVED FROM INVENTORY THAT WHAT ACTUALLY SHOULD HAVE BEEN
HOW DOES THIS ERROR AFFECT ENDING INVENTORY?
because the company INCORRECTLY REMOVED THE COST 22 PALLETS FROM INVENTORY INSTEAD OF 12, INVENTORY NOW LOOKS SMALLER THAN IT ACTUALLY IS
There are 10 EXTRA PALLETS THAT ARE ACTUALLY STILL THERE, but they are MISSING FROM THE RECORDS
ENDING INVENTORY IS UNDERSTATED (lower than it should be)
FINAL ANSWER: COGS IS OVERSTATED (too high) & ENDING INVENTORY IS UNDERSTATED (too low)
WHY THE OTHER ANSWERS ARE WRONG:
“Cost of goods sold and ending inventory are both overstated”
wrong, COGS IS TOO HIGH, but inventory is TOO LOW, not too high
“Cost of goods sold is understated and ending inventory is overstated”
wrong, COGS is TOO HIGH, not too low. Inventory is TOO LOW, not too high
“Cost of goods sold and ending inventory are both understated”
wrong, Cogs is TOO HIGH, not too low
KEY TAKEAWAYS FOR TEST:
OVERSTATING SALES means TOO MUCH COGS IS RECORDED, making COGS TOO HIGH
Since COGS is TOO HIGH, too much is removed from INVENTORY, making INVENTORY TOO LOW
ALWAYS CHECK IF AN ERROR MAKES A NUMBER TOO HIGH OR TOO LOW
Which of the following is a contra-account?
Group of answer choices
Allowance for doubtful accounts
Unearned revenue
Cost of goods sold
Sales returns
Credit card discounts
Two of the above
Three of the above
Four of the above
Step 1: UNDERSTANDING WHAT A CONTRA-ACCOUNT IS
A CONTRA-ACCOUNT is an account that is linked to another account but has the OPPOSITE BALANCE
NORMAL ACCOUNTS have a typical balance:
Assets » NORMALLY HAVE A DEBIT BALANCE
Liabilities & revenue » NORMALLY HAVE A CREDIT BALANCE
Expenses » NORMALLY HAVE A DEBIT BALANCE
CONTRA ACCOUNTS DO THE OPPOSITE
Contra-assets » have a CREDIT BALANCE (reduce assets)
Contra-revenue » have a DEBIT BALANCE (reduce revenue)
A CONTRA-ACCOUNT reduces the value of the account it is linked to
ANALYZING EACH ANSWER CHOICE:
Allowance for doubtful accounts = CONTRA-ACCOUNT
This is a CONTRA-ASSET ACCOUNTS related to ACCOUNTS RECEIVABLE
It reduces the total value of accounts receivable by estimating UNCOLLECTIBLE DEBTS
Unearned revenue = NOT A CONTRA-ACCOUNT
unearned revenue is a LIABILITY, not a contra-account
It represents money received before a company provides goods or services
COGS = NOT A CONTRA ACCOUNT
COGS is an EXPENSE, not a contra-account
It represents the direct costs of producing goods sold by a company
Sales returns = CONTRA-REVENUE ACCOUNT
this is a CONTRA-REVENUE ACCOUNT because it REDUCES TOTAL SALES REVENUE
When a customer returns an item, sales revenue decreases
Credit card discounts = CONTRA-REVENUE ACCOUNT
this is also a CONTRA-REVENUE ACCOUNT because it REDUCES REVENUE due to credit card fees
When a company accepts credit cards, they get less money than the full sales price because of processing fees.
SELECTING THE CORRECT ANSWERS
allowance for doubtful accounts = contra-asset
Sales returns = contra revenue
Credit card discounts = contra revenue
KEY TAKEAWAYS FOR TEST:
contra-accounts have the OPPOSTIE BALANCE of their main account
Contra-assets reduce assets (allowance for doubtful accounts)
Contra-revenue accounts reduce total revenue (sales returns & credit card discounts
Unearned revenue and COGS are NOT contra-accounts
Q?: what is accounts receivable and how does it work with this?
ACCOUNTS RECEIVABLE:
accounts receivable (A/R) is AN ASSET on the balance sheet
It represents MONEY OWED TO THE COMPANY by customers who have made purchases on credit
Example: If a customer buys $1,000 worth of goods on credit, the company records $1,000 in ACCOUNTS RECEIVABLE (because they expect to receive this money later)
HOW ALLOWANCE FOR DOUBTFUL ACCOUNTS WORKS
Since some customers MIGHT NOT PAY, companies ESTIMATE bad debts using the ALLOWANCE FOR DOUBTFUL ACCOUNTS
EXAMPLE:
A company has $10,000 in ACCOUNTS RECEIVABLE (money customers owe them)
They estimate that $500 of this may never be collected
They create an ALLOWANCE FOR DOUBTFUL ACCOUNTS of $500
The balance sheet now shows:
accounts receivable: $10,000
Less: allowance for doubtful accounts: ($500)
Net accounts receivable: $9500
THE COMPANY EXPECTS TO ACTUALLY COLLECT $9500, NOT THE FULL $10,000
WHY IS ALLOWANCE FOR DOUBTFUL ACCOUNTS A CONTRA-ACCOUNT
accounts receivable is an ASSET (normally has a debit balance)
Allowance for doubtful accounts is a CONTRA-ASSET (has a credit balance)
The allowance REDUCES THE TOTAL VALUE OF ACCOUNTS RECEIVABLE to reflect the REALISTIC AMOUNT THE COMPANY EXPECTS TO COLLECT
Allowance for doubtful accounts reduces accounts receivable = so its a contra-account
Sales returns & credit card discounts, reduce REVENUE (contra-revenue account)
KEY IDEAS
Accounts receivable = money customers OWE the company (an asset)
Allowance for doubtful accounts = estimated bad debts (a contra-asset)
A contra-account has the opposite balance of the account it is linked to
Allowance for doubtful accounts reduces accounts receivable
Sequoia Co. is evaluating its inventory, computer paper, at the end of the period. The cost of each package of paper costs Sequoia $5 and there are 5,000 units in ending inventory. They sold 27,000 packages during the period. Due to increased use of the electronic cloud, the net realizable value of each package of paper is $3.50. What is the correct amount of the inventory write-down?
Group of answer choices
$7,500
$40,500
$17,500
$33,000
Step 1: UNDERSTANDING AN INVENTORY WRITE-DOWN
An inventory write-down happens when the value of inventory DROPS BELOW ITS ORIGINAL COST
this usually happens due to DAMAGE, OBSOLESCENCE, OR MAKRET PRICE DROPS
Companies must follow the LOWER OF COST OR NET REALIZABLE VALUE (NRV) RULE MEANING:
If inventory’s ORIGINAL COST is HIGHER than what it can be sold for (NRV), the company must WRITE IT DOWN
Step 2: IDENTIFY KEY INFO
original cost per unit = $5.00
Net realizable value (NRV) per unit (what it can be sold for) = $3.50
Units in ending inventory = 5,000
WRITE DOWN FORMULA:
WRITE DOWN = (COST PER UNIT - NRV PER UNIT) X UNITS IN INVENTORY
(5.00-3.50) X 5,000
1.50 X 5,000 = 7,500
WRITE DOWN AMOUNT = $7,500
WHY THE OTHER ANSWERS ARE WRONG:
“$40,500”
likely calculated using total sales (27,000 units), but write-down only applies to unsold inventory (5,000 units)
“$17,500”
possible miscalculation, does not match the correct formula
“$33,000”
incorrectly inflating the write-down amount
KEY TAKEAWAYS:
write-down happens when inventory’s market value drops below cost
Only apply the write-down to ENDING INVENTORY, NOT SOLD INVENTORY
Formula: (COST PER UNIT - NRV PER UNIT) x UNITS IN ENDING INVENTORY
Locust Co. determined that $4,500 of its accounts receivable were uncollectible. The beginning accounts receivable balance was $70,000 and the ending for the period was $67,000. What is the appropriate journal entry to record the write-off of the accounts receivable?
Group of answer choices
Dr. Allowance for doubtful accounts $4,500; Cr. Accounts receivable $4,500
Dr. Accounts receivable $4,500; Cr. Allowance for doubtful accounts $4,500
Dr. Accounts receivable $3,000; Cr. Allowance for doubtful accounts $3,000
Dr. Allowance for doubtful accounts $3,000; Cr. Accounts receivable $3,000
Step 1: UNDERSTANDING WHATS HAPPENING
locust co. Determined that $4,500 of its accounts receivable were uncollectible
Meaning that the company has customers who OWE THEM MONEY BUT WONT PAY
To properly reflect this in their accounting records, they need to WRITE OFF these UNCOLLECTIBLE AMOUNTS
Step 2: HOW WRITE OFFS WORK
Most companies use the ALLOWANCE METHOD for BAD DEBTS
under this method, the company estimates BAD DEBTS in advance and creates a CONTRA-ASSET ACCOUNT called ALLOWANCE FOR DOUBTFUL ACCOUNTS (ADA)
When a specific account is CONFIRMED UNCOLLECTIBLE, the company writes it off by reducing BOTH ACCOUNTS RECEIVABLE AND THE ALLOWANCE FOR DOUBTFUL ACCOUNTS
Step 3: THE CORRECT JOURNAL ENTRY FOR THE WRITE-OFF
When we write off an uncollectible account, we:
DEBIT (REDUCE) THE ALLOWANCE FOR DOUBTFUL ACCOUNTS, because we are now using part of the estimated bad debts
CREDIT (REDUCE) ACCOUNTS RECEIVABLE because we are removing this uncollectible amount form out records
JOURNAL ENTRY:
Dr. Allowance for doubtful account… 4,500
Cr. Accounts receivable… 4,500
WHY THE OTHER ANSWERS ARE WRONG
“Dr. Accounts receivable $4,500; Cr. Allowance for doubtful accounts $4,500”
wrong, this would INCREASE accounts receivable, which is incorrect. We need to REMOVE THE UNCOLLECTIVLE AMOUNT FROM ACCOUNTS RECEIVABLE
“Dr. Accounts receivable $3,000; Cr. Allowance for doubtful accounts $3,000”
wrong, the write off amount is $4,500, not $3,000
“Dr. Allowance for doubtful accounts $3,000; Cr. Accounts receivable $3,000”
wrong, the correct write-off amount is $4,500, not 3,000
KEY TAKEAWAYS FOR TEST:
when writing off bad debts, always DEBIT (REDUCE) the ALLOWANCE FOR DOUBTFUL ACCOUNTS AND CREDIT (REDUICE) ACCOUNTS RECEIVABLE
A write-off does NOT affect the income statement because we already estimated bad debts earlier
Never debit accounts receivable when writing off bad debts— doing so would increase the amount owed, which is incorrect
Q?: can you explain debits and credits
UNDERSTANDING THE BASICS
DEBITS (Dr.) AND CREDITS (Cr.) Are the two sides of every financial transaction
Debits are not always “good,” and credits are not always “bad”
depends on the type of account
Every transaction affects ATLEAST TWO ACCOUNTS and must stay balanced (this is called DOUBLE ENTRY ACCOUNTING)
TYPE OF ACCOUNT
ASSETS (cash, inventory, accounts receivable)
increases with debit
Decreases with credit
LIABILITIES (loans, accounts payable)
increases with credit
Decreases with debit
EQUITY (owners capital, retained earnings)
increases with credit
Decreases with debit
REVENUE (sales, service fees)
increases with credit
Decreases with debit
EXPENSES (rent, wages, cost of goods sold)
increases with debit
Decreases with credit
EXAMPLE 1: BUYING EQUIPMENT WITH CASH
You buy $1,000 worth of equipment for your business using CASH
equipment is an ASSET » INCREASES (DEBIT)
Cash is an ASSET » DECREASES (CREDIT)
JOURNAL ENTRY:
Dr. Equipment….1,000
Cr. Cash ….1,000
EXAMPLE 2: BORROWING MONEY FROM THE BANK
You take a $5,000 loan form the bank
cash (ASSET) increases » DEBIT
Loan payable (LIABILITY) increases » credit
JOURNAL ENTRY
Dr. Cash… 5,000
Cr. Loan payable….5,000
EXAMPLE 3: MAKING A SALE ON CREDIT
A customer buys $500 WORTH OF PRODUCTS ON CREDIT
accounts receivable (asset) increases » debit
Sales revenue (revenue) increases » credit
JOURNAL ENTRY:
Dr. Accounts receivable …500
Cr. Sales Revenue… 500
EXAMPLE 4: PAYING RENT
You pay $800 in rent for your business
rent expense (expense) increases » debit
Cash (asset) decreases » credit
JOURNAL ENTRY:
Dr. Rent expense…800
Cr. Cash…800
WHY DEBITS AND CREDITS MUST ALWAYS BALANCE
total debits must always equal total credits
If they don’t, the books are OUT OF BALANCE, and there is an error
EXAMPLE:
you take $2,000 loan and deposit it in the bank
Cash (asset) increases by 2,000 » debit
Loan payable (liability) increases by 2,000 » credit
$2,000 debit = $2,000 credit, so they are BALANCED
KEY TAKEAWAYS:
debits increase assets and expenses but decrease liabilities and revenue
Credits increase liabilities, equity, and revenue but decrease assets and expense
Each transaction must always balance (TOTAL DEBITS = TOTAL CREDITS)
Contra-accounts (like allowance for doubtful accounts) have opposite normal balances
TIPS: THE “DEAD CLER”
Debits increase Expenses, Assets, and Dividends
Credits Increase Liabilities, Equity, and Revenue
Q2?: HOW DO YOU KNOW IF ITS DEBITED OR CREDITED
goal: figure out which accounts are changing and whether each one is increasing or decreasing
EXAMPLE: paying rent » affects CASH AND RENT EXPENSE
EXAMPLE: selling goods on credit » affects ACCOUNTS RECEIVABLE AND SALES REVENUE
ASK YOURSELF:
WHAT TYPE OF ACCOUNT IS IT (every account falls into one of these 5 main categories)
ASSETS (cash, A/R, inventory)
Normal balance: DEBIT
Liabilities (loans, A/P)
Normal balance: CREDIT
Equity (owners capital, retained earnings)
Normal balance: CREDIT
revenue (sales, service revenue)
Normal balance: CREDIT
Expenses (rent, salaries, utilities)
normal balance: DEBIT
IS THE ACCOUNT INCREASING OR DECREASING?
Once you identify the type of account, determine if its going up or down
if it INCREASES, use its NORMAL BALANCE SIDE
If it DECREASES, use the OPPOSITE SIDE
EXAMPLE:
if CASH INCREASES, is an ASSET, and assets normally have a DEBIT BALANCE, so we DEBIT CASH
If CASH DECREASES, we do the OPPOSITE AND CREDIT CASH
IS THE COMPANY RECEIVING OR GIVING SOMETHING?
if the company RECEIVES SOMETHING (CASH, EQUIPMENT, SUPPLIES), the account is DEBITED (because assets increase with DEBITS)
If the company GIVES OR PAYS SOMETHING (cash payment, rent, loan repayment), the account is CREDITED (because assets decrease with credits)
DOES THIS TRANSACTION AFFECT REVENUE OR EXPENSES?
if REVENUE INCREASES, CREDIT REVENUE (because revenue increases with credits)
If EXPENSES INCREASE, DEBIT EXPENSES (because expenses increase with debits)
EXAMPLES:
#1: PAYING RENT
TRANSACTION: the company pays $1,000 in RENT with CASH
ACCS AFFECTED:
RENT EXPENSE (EXPENSE) » INCREASES » DEBIT
CASH (ASSET) » DECREASES » CREDIT
ENTRY:
Dr. Rent expense…1000
Cr. Cash…1000
#2: BUYING EQUIPMENT WITH CASH
TRANSACTION: the company buys equipment for $5,000 using cash
ACCS AFFECTED:
EQUIPMENT (ASSET) » INCREASES » DEBIT
CASH (ASSET) » DECREASES » CREDIT
ENTRY:
Dr. Equipment …5000
Cr. Cash …5,000
#3: SELLING GOODS ON CREDIT
TRANSACTION: the company sells $2,000 of goods on credit (customer promises to pay later)
ACCS AFFECTED:
ACCOUNTS RECEIVABLE (ASSET) » INCREASES » DEBIT
SALES REVENUE (REVENUE) » CREDIT
ENTRY:
Dr. Account receivable…2000
Cr. Sales Revenue…2000
#4: BORROWING MONEY FROM THE BANK
TRANSACTION: the company takes $10,000 loan from teh bank
ACCS AFFECTED:
CASH (ASSET) » INCREASES » DEBIT
LOAN PAYABLE (LIABILITY) » INCREASES » CREDIT
ENTRY:
Dr. Cash…10,000
Cr. Loan Payable…10,000
FINAL CHEAT SHEET:
QUESTION
is an asset increasing?
Yes - debit
No - credit
Is it an expense increasing?
Yes - debit
No - credit
Is it a liability increasing?
Yes - credit
No - debit
Is it revenue increasing?
Yes - credit
No - debit
Is it cash decreasing?
Yes - credit
No - debit
INCREASING ASSETS AND EXPENSES = DEBITS
INCREASING LIABILITIES, EQUITY, AND REVENUE = CREDITS
always identify the 2 accounts affected (sometimes more than2)
Ask: what type of account is it? Is it increasing or decreasing?
Larch Inc. is preparing the adjusting journal entry to record the estimate of uncollectible accounts receivable for the year ended 2021. Larch uses the aging of accounts receivable method. Given the following information, which is the correct adjusting journal entry Larch must book?
Sales revenue | $500,000 |
Accounts receivable | $100,000 |
Current credit balance in allowance for doubtful accounts (before any adjusting entry) | $500 |
Days past due | A/R balance | % estimated uncollectible |
Current | $50,000 | 2% |
<30 days | $25,000 | 3% |
<60 days | $15,000 | 5% |
<90 days | $7,000 | 10% |
>90 days | $3,000 | 40% |
Total | $100,000 |
|
Group of answer choices
Dr. Allowance for doubtful accounts $3,900; Cr. Bad debt expense $3,900
Dr. Bad debt expense $3,900; Cr. Allowance for doubtful accounts $3,900
Dr. Allowance for doubtful accounts $4,400; Cr. Accounts receivables $4,400
Dr. Accounts receivable $4,400; Cr. Allowance for doubtful accounts $4,400
Step1: UNDERSTANDING THE AGING OF ACCOUNTS RECEIVABLE METHOD
The AGING METHOD: estimates how much of the company’s accounts receivable will not be collected based on how long the debts have been outstanding
each category of accounts receivable has a DIFFERENT PROBABILITY OF BECOMING UNCOLLECTIBILE, with older debts being less likely to be paid
Step 2: IDENTIFY THE GIVEN INFO
AGING SCHEDULE: the table with the days past due
TOTAL ACCOUNTS RECEIVABLE = $100,000
CURRENT ALLOWANCE FOR DOUBTFUL ACCOUNTS = $500 (credit balance)
Step 3: CALCULATE THE TOTAL ESTIMATED UNCOLLECTIBLE AMOUNT
for each category, multiply the A/R BALANCE by the % ESTIMATED UNCOLLECTIBLE
FORMULA:
UNCOLLECTIBLE AMOUNT = A/R BALANCE x UNCOLLECTIBLE
A/R BALANCE: $50,000
% UNCOLLECTIBLE: 2%
50,000 x .02 = $1000 ESTIMATED BAD DEBT
Find the ESTIMATED BAD DEBT FOR EACH ONE
add all of the bad debt up
TOTAL ESTIMATED BAD DEBT EXPENSE = $3,900
Step 4: DETERMINE THE ADJUSTING ENTRY
the current balance in allowance for doubtful accounts is $500 (credit balance)
We need to ADJUST IT TO $3,900 based on our calculation
Since we use the AGING METHOD, we DO NOT subtract the existing allowance balance—we adjust the total amount
ADJUSTING JOURNAL ENTRY:
Dr. Bad debt expense…3900
Cr. Allowance for Doubtful accounts …3900
WHY THE OTHER ANSWERS ARE WRONG
“Dr. Allowance for doubtful accounts 3900; Cr. Bad debt expense 3900”
wrong, this reverses the correct entry. We are INCREASING the allowance, not reducing it
“Dr. Allowance for doubtful accounts 4400; Cr. Accounts receivable 4400”
wrong, this would be a write-off, not an adjusting entry
“Dr. Accounts receivable 4400; Cr. Allowance for Doubtful accounts 4400”
wrong, this would also be a write off—we are not removing specific bad debts, just adjusting our estimate
KEY TAKEAWAYS
the aging method estimates total uncollectible accounts based on past due categories
The adjusting entry should INCREASE THE ALLOWANCE FOR DOUBTFUL ACCOUNT to the NEW ESTIMATED AMOUNT
BAD DEBT EXPENSE IS DEBITED TO RELFECT THE NEW EXPECTED LOSSES
The allowance for doubtful accounts is CREDITED TO REDUCE NET ACCOUNTS RECEIVABLE
Q?: explain why we debit bad debt expense and credit allowance for doubtful accounts in this
WHAT ARE WE DOING IN THIS TRANSACTION?
we are using the AGING OF ACCOUNTS RECEIVABLE METHOD to ESTIMATE how much money we wont be able to collect from customers. This is an ADJUSTING ENTRY, not a WRITE OFF
The goal of this entry » increase the allowance for doubtful accounts to mach our new estimated uncollectible amount
IDENTIFY THE 2 ACCOUNTS AFFECTED
BAD DEBT EXPENSE (expense account)
This represents the COST OF UNCOLLECTIBLE ACCOUNTS (money we expect not to receive)
When expenses increase = debited
ALLOWANCE FOR DOUBTFUL ACCOUNTS (CONTRA-ASSET ACCOUNT)
This is a CONTRA-ASSET that reduces ACCOUNTS RECEIVABLE on the balance sheet
This keeps the books accurate by showing that not all receivables will actually be collected
When CONTRA ASSETS INCREASE = credited
ASK YOURSELF THESE 2 QUESTIONS
IS BAD DEBT EXPENSE INCREASING OR DECREASING?
We are RECORDING A NEW EXPENSE to reflect estimated bad debts
INCREASE IN EXPENSE = DEBIT
We debit bad debt expense
IS ALLOWANCE FOR DOUBTFUL ACCOUNTS INCREASING OR DECREASING?
We are INCREASING this account because we not expect MORE BAD DEBTS
INCREASE IN CONTRA-ASSETS = CREDIT
We credit allowance for doubtful accounts
CREATE THE JOURNAL ENTRY
We determined:
bad debt expense is increase = debit
Allowance for doubtful accounts increases = credit
ENTRY:
Dr. Bad debt expense..3900
Cr. Allowance for doubtful accounts …3900
WHY WE CREDIT INSTEAD OF DEBIT FOR THE ALLOWANCE
many people get confused because ALLOWANCE FOR DOUBTFUL ACCOUNTS IS A CONTRA-ASSET (not a regular expense or liability)
NORMALLY WHEN ASSETS INCREASE THEY ARE DEBITED, BUT CONTRA-ASSETS WORK THE OPPOSITE WAY
Since allowance for doubtful accounts REDUCES accounts receivable (an asset), we INCREASE WITH A CREDIT
THINK:
NORMAL ASSETS GO UP WITH DEBITS
CONTRA-ASSETS GO UP WITH CREDITS
FINAL SUMMARY: HOW TO ALWAYS KNOW IF ITS DEBITED OR CREDITED
Is the account INCREASING or DECREASING?
What TYPE OF ACCOUNT is it?
What is the NORMAL BALANCE of this account
FOR THIS ENTRY:
Bad debt is an EXPENSE » this example, bad debt is INCREASING » DEBITED
Allowance for doubtful accounts is a CONTRA-ASSET » this example, the account is INCREASING » CREDITIED
KEY TAKEAWAYS:
bad debt is always debited (increases expenses)
Allowance for doubtful accounts is always credited when estimating bad debts (its a contra-assets)
Contra-assets go up with credits, while normal assets go up with debits
DEBITS = LEFT SIDE, CREDIT = RIGHT SIDE (ALWAYS KEEP THEM BALANCED)
Aspen Co. has $400,000 in credit sales for the year. The credit card company charges a 2% fee. Beginning net accounts receivable were $38,000 and ending net accounts receivable were $42,000. What is the average days sales in receivables ratio?
Group of answer choices
36.50 days
39.11 days
37.24 days
35.38 days
Step 1: UNDERSTAND THE FORMULA
The AVERAGE DAYS SALES IN RECEIVABLES RATIO (also called DAYS SALES OUTSTANDING (DSO))
measures how long, on average, it takes a company to collect its account receivable
FORMULA:
AVERAGE DAYS SALES IN RECEIVABLES = (AVG ACCOUNTS RECEIVABLE / NET CREDIT SALES) x 365
Average accounts receivable =
BEGINNING A/R + ENDING A/R / 2
Net credit sales = total credit sales minus any discounts or deductions
Step 2: IDENTIFY THE GIVEN INFO
total credit sales = $400,000
Credit card fee = 2% of $400,000 = $8,000
Net credit sales = $400,000 - $8,000 = $392,000
Beginning net accounts receivable = $38,000
Ending net accounts receivable = $42,000
Step 3: CALCULATE AVERAGE ACCOUNTS RECEIVABLE
Average A/R = Beginning A/R + Ending A/R / 2
= 38000 + 42000 / 2
80000 / 2 = 40,000
Step 4: APPLY THE FORMULA
AVERAGE DAYS SALES IN RECEIVABLES = 40,000 / 392,000 × 365
= 0.102 × 365
= 37.24 days
Step 5: WHY THIS MATTERS
This means it takes the company an AVERAGE OF 37.24 DAYS to collect payments from customers after a sale
IF THIS NUMBER IS HIGH, it may mean slow collections or customers taking too long to pay
IF THIS NUMBER IS LOW, it means the company is collecting payments quickly, which helps CASH FLOW
KEY TAKEAWAYS:
use the correct formula:
AVERAGE A/R / NET CREDIT SALES x 365
net credit sales = credit sales - discounts or returns
Average A/R = (beginning A/R + Ending A/R) / 2
Lower days = faster collections; higher days = slower collections
Birch Inc. is an appliance seller. Birch sold a washing machine, dryer, and a 3-year warranty to a customer for $5,000. The sales price of each item $2,500, $2,000, and $1,500, respectively. What amount of revenue should Birch Inc. book at the time of the sale?
Group of answer choices
$6,000
$3,500
$3,000
$5,000
$3,750
Step 1: UNDERSTANDING REVENUE RECOGNITION FOR MULTIPLE-ELEMENT SALES
When a company sells multiple items together (like a washing machine, dryer, and warranty), it must recognize revenue ONLY FOR ITEMS DELIVERED AT THE TIME OF THE SALE
PRODUCTS (WASHING MACHINE & DRYER): revenue is recognized IMMEDIATELY because they are DELIVERED
WARRANTY (3-YEAR SERVICE CONTRACT): revenue is DEFERRED because the service is provided over time
we need to exclude the warranty from the immediate revenue and only recognize the revenue for the washing machine and dryer
Step 2: IDENTIFY THE GIVEN INFO
total sale price = $5,000
Washing machine price = $2500
Dryer price = $2,000
Warranty price = $1500
Step 3: DETERMINE RECOGNIZABLE REVENUE
at the time of sale, Birch Inc. should recognize revenue ONLY FOR THE WASHING MACHINE & DRYER:
FORMULA:
RECOGNIZED REVENUE = WASHING MACHINE + DRYER
= 2500 + 2000
= 4500
However the total transaction price is $5,000, which includes the warranty
to allocate revenue properly, we calculate the % of the total value for each item
Step 4: CALCULATE REVENUE ALLOCATION
The sum of the standalone prices is:
2500 + 2000 + 1500 = 6000
Now find the propportion of each products standalone price to the total standalone price
Washing machine
2500/6000 = 0.4167
Dryer:
2000/6000 = 0.3333
Warranty:
1500/6000 = 0.25
Now, allocate revenue based on the total ACTUAL SALE PRICE ($5,000)
Washing machine:
5000 × 0.4167 = 2,083.33
Dryer:
5000 x .3333 = 1,666.67
Warranty (deferred revenue):
5000 × 0.25 = 1,250
Now, TOTAL REVENUE RECOGNIZED AT THE TIME OF SALE
2,083.33 + 1,666.67 = $3750
WHY THE OTHER ANSWERS ARE WRONG
“$6,000”
wrong, this would be recognizing the FULL STANDALONE PRICES, but the ACTUAL SALE PRICE WAS ONLY $5,000
“$3,500”
wrong, this number is too low, its not calculated based on the fair value allocation
“$3,000”
wrong, this likely ignores part of the product revenue
“$4,000”
wrong, this incorrectly assumes the warranty revenue can be recognized immediately, which is incorrect
KEY TAKEAWAYS:
revenue is only recognized when goods are delivered or services are performed
Warranties are recognized over time, so they must be EXCLUDED from IMMEDIATE REVENUE
Use the FAIR VALUE ALLOCATION method to proportionally distribute the sale price
FORMULAS:
ALLOCATED REVENUE = (STANDALONE PRICE OF ITEM/TOTAL STANDALONE PRICE) x TOTAL SALES PRICE
use this to determine how much REVENUE TO RECOGNIZE for each product at the TIME OF SALE
TOTAL STANDALONE PRICE
before you allocate revenue, first add up all the individual product prices
TOTAL STANDALONE PRICE = WASHING MACHINE PRICE + DRYER PRICE + WARRANTY PRICE
RECOGNIZED REVENUE AT THE TIME OF SALE
to find how much REVENUE IS RECOGNIZED IMMEDIATELY, sum up the allocated amounts for items DELIVERED IMMEDIATELY (washing machine & dryer)
RECOGNIZED REVENUE = ALLOCATED REVENUE FOR WASHING MACHINE + ALLOCATED REVENUE FOR DRYER
DEFERRED REVENUE FOR WARRANTY
since the warranty service is PROVIDED OVER TIME, this amount is recorded as DEFERRED REVENUE (a liability), and it is recognized as revenue GRADUALLY over the warranty period:
DEFERRED REVENUE = ALLOCATED REVENUE FOR WARRANTY
Recognize it per year by:
ANNUAL WARRANTY REVENUE = DEFERED REVENUE/WARRANTY PERIOD (YEARS)
KEY TAKEAWAYS FOR TEST
use the fair value allocation formula to distribute total sales price
Only recognize revenue for items delivered immediacy
Deferred revenue is recorded separately for future recognition
Understand the difference between product sales (immediate revenue) and service contracts (deferred revenue)
Given the following information, determine the amount of inventory purchases for the period.
Beginning inventory - $57,000
Ending inventory - $64,000
Cost of goods sold - $361,000
Account write-offs - $5,000
Group of answer choices
$373,000
$363,000
$368,000
$358,000
Step 1: USE THE INVENTORY FORMULA
The INVENTORY PURCHASES FORMULA is based on the COST OF GOODS AVAIBLE FOR SALE equation:
BEGINNING INVENTORY + PURCHASES = COGS + ENDING INVENTORY
Rearrange the equation to solve for PURCHASES
PURCHASES = COGS + ENDING INVENTORY - BEGINNING INVENTORY
Step 2: IDENTIFY THE GIVEN INFO
beginning inventory = $57,000
Ending inventory = $64,000
Cost of goods sold (COGS) = $361,000
Account write offs = $5,000 (irrelevant in this case because its related to receivables, not inventory purchases
Step 3: PLUG THE VALUES INTO THE FORMULA
PURCHASES = 361,000 + 64,000 - 57,000
= 361,000 + 7,000
= $368,000
WHY THE OTHER ANSWERS ARE WRONG:
“$373,000”
wrong, likely includes an extra $5,000 from the write-offs which do not belong in inventory calculations
“$363,000”
possibly a subtraction mistake or missing part of the inventory equation
“$358,000”
I incorrectly reducing the inventory balance too much
FORMULAS:
PURCHASES = COGS + ENDING INVENTORY - BEGINNING INVENTORY
COGAS (cost of goods avaible for sale) = BEGINNING INVENTORY + PURCHASES
COGS = COGAS - ENDING INVENTORY
KEY TAKEAWAY FOR TEST
use the correct formula to determine purchases
COGS + ending inventory - beginning inventory = purchases
Ignore account write-offs when calculating inventory purchases — write offs affect accounts receivable, not inventory
Purchases are what the company buys during the period, not the same COGS (which is what is sold)
Ending inventory is what remains unsold, so it must be added back when calculating total purchases
Cottonwood Co. received an order for 80 cotton shirts from a customer. Each shirt sells for $15. The customer paid with a credit card. Cottonwood’s fee to the credit card company is 2%. What is the net amount of sales revenue?
Group of answer choices
$1,176
$1,200
$1,224
$1,152
Step 1: UNDERSTAND THE NET SALES REVENUE FORMULA
when a customer pays with a credit card, the credit card company CHARGES A PROCESSING FEE
The ent revenue that the company actually receives is calculated as:
NET SALES REVENUE = TOTAL SALES - CREDIT CARD FEE
since the credit card fee is a PERCENTAGE OF TOTAL SALES, we can express the formula as:
NET SALES REVENUE = TOTAL SALES x (1-CREDIT CARD FEE)
Step 2: IDENTIFY THE GIVEN INFO
number of shirts sold = 80
Price per shirt = $15
Credit card fee = 2% (or 0.02 in decimal form)
Step 3: CALCULATE TOTAL SALES BEFORE FEES
TOTAL SALES = NUMBER OF SHIRTS x PRICE PER SHIRT
= 80 × 15
= 1200
Step 4: APPLY THE NET SALES REVENUE FORMULA
NET SALES REVENUE = 1200 x (1- 0.02)
= 1200 × 0.98
= $1,176
WHY THE OTHER ANSWERS ARE WRONG
“$1,200”
this is the GROSS SALES AMOUNT, not the net amount after deducting the 25 fee
“$1,224”
this is higher than the total sales, which is impossible
“$1,152”
likely a miscalculation or incorrect fee percentage
FORMULA TO REMEMBER
TOTAL SALES FORMULA:
TOTAL SALES = NUMBER OF UNITS SOLD x SELLING PRICE PER UNIT
NET SALES REVENUE FORMULA (AFTER CREDIT CARD FEE):
NET SALES REVENUE = TOTAL SALES x (1 - CREDIT CARD FEE)
CREDIT CARD FEE CALCULATION:
CREDIT CARD FEE = TOTAL SALES x FEE
KEY TAKEAWAYS FOR TEST:
always calculate total sales first before applying the credit card fee
Subtract the credit card fee from total sales to get net revenue
Net revenue is always lower than gross revenue when there’s a fee
Multiply total sales by (1 - fee %) to get the correct net amount
Sycamore Inc. detailed their accounts receivable and allowance for doubtful accounts for the year ended 2022, prior to year-end adjusting entries.
Accounts receivable | |||
Beginning bal. | $210,000 | $425,000 | Cash collected |
Credit sales | $475,000 | ??? | Write-offs |
Ending bal. | $250,000 |
|
|
Allowance for doubtful accounts | |||
|
| $2,000 | Beginning bal. |
Write-offs | ??? | ??? | Bad debt exp. |
|
| ??? | Ending bal. |
3% of credit sales are estimated uncollectible, Sycamore uses the percentage of sales method to estimate bad debt expense
After recording the bad debt expense adjusting entry, what is the net realizable value of Sycamore’s accounts receivable for the year ended 2022?
Group of answer choices
$243,750
$235,650
$245,750
$248,000
HOW TO DETERMINE THE NET REALIZABLE VALUE (NRV) OF ACCOUNTS RECEIVABLE:
Step 1: UNDERSTAND THE NRV OF ACCOUNTS RECEIVABLE
the net realizable value (NRV) of accounts receivable is the amount the company EXPECTS TO COLLECT after accounting for estimated uncollectible accounts
FORMULA:
NET REALIZABLE VALUE (NRV) = ENDING ACCOUNTS RECEIVABLE - ALLOWANCE FOR DOUBTFUL ACCOUNTS (AFTER ADJUSTMENT)
Step 2: IDENTIFY GIVEN INFO
Beginning accounts receivable = $210,000
Credit sales = $475,000
Cash collected = $425,000
Ending accounts receivable = $250,000
Beginning allowance for doubtful accounts = $2,000
Write-offs = ?
Bad debt expense = ? (Calculated using % of sales method)
3% of credit sales are estimated to be uncollectible
Step 3: CALCULATE WRITE-OFFS
we use ACCOUNTS RECEIVABLE FORMULA TO DETERMINE WRITE OFFS:
ENDING A/R = BEGINNING A/R + CREDIT SALES - CASH COLLECTED - WRITE OFFS
250,000 = 210,000 +475,000 -425,000 - writeoffs
Write-offs = 10,000
Step 4: CALCULATE BAD DEBT EXPENSE
bad debt expense is based on the 3% of credit sales
BAD DEBT EXPENSE = 475,000 × 0.03
= 14,250
Step 5: CALCULATE ENDING ALLOWANCE FOR DOUBTFUL ACCOUNTS
ENDING ALLOWANCE = BEGINNING ALLOWANCE + BAD DEBT EXPENSE - WRITE OFFS
= 2,000 + 14,250 - 10,000
= 6,250
Step 6: CALCULATE NT REALIZABLE VALUE (NRV)
NRV = ENDING A/R - ENDING ALLOWANCE
= 250,00 - 6,250
= $243,750
KEY FORMULAS:
Accounts receivable formula:
ENDING A/R = BEGINNING A/R + CREDIT SALES - CASH COLLECTED - WRITE OFFS
Allowance for doubtful account formula:
ENDING ALLOWANCE = BEGINNING ALLOWANCE + BAD DBET EXPENSE - WRITE OFFS
Net realizable value formula:
NRV = ENDING A/R - ALLOWANCE FOR DOUBTFUL ACCOUNTS
KEY TAKEAWAYS FOR TEST:
write-offs reduce both accounts receivable and the allowance for doubtful accounts
Bad debt expense is based on credit sales percentage when using the percentage of sales method
Net realizable value tells you how much money teh company expect to actually collect
Use the correct formulas to calculate each step
Weeping Willow Co. is a greeting card wholesaler. Below is the inventory information for the month of December.
|
| # of units | Cost per unit |
12/1/2021 | Beginning inventory | 100 | $14 |
12/13/2021 | Sale | 40 |
|
12/17/2021 | Purchase | 200 | $15 |
12/20/2021 | Sale | 230 |
|
Each unit of greeting cards sell for $20. What is Weeping Willow’s ending inventory for December assuming a periodic LIFO inventory cost system?
Group of answer choices
$900
$450
$840
$420
HOW TO DETERMINE THE ENDING INVENTORY USING THE PERIODIC LIFO INVENTORY COST SYTEM
Step 1: UNDERSTANDING LIFO (LAST IN, FIRST OUT)
LIFO (LAST-IN, FIRST-OUT) means that THE MOST RECENT PURCHASES ARE SOLD FIRST
The remaining inventory at the end consists of the OLDEST items
Since this is a PERIODIC INVENTORY SYSTEM, we are calculating ENDING INVENTORY AT THE END OF THE PERIOD, rather than tracking costs during each sale
Step 2: IDENTIFY THE GIVENT INFO
total purchases during the period = 200 units at $15 each
Total sales during the period = 40 units + 230 units = 270 units
Total available inventory before sales = beginning inventory (100) + purchases (200) = 300 units
Step 3: DETERMINE ENDING INVENTORY UNDER LIFO
since we use LIFO, we assume that the MOST RECENT purchases at $15 were sold first
Total units available = 300
Total units sold = 270
Remaining inventory = 300 - 270 = 30 units (this is our ending inventory)
Under LIFO, the OLDEST inventory remains at the end. The OLDEST INVENTORY is from the beginning balance, which was PURCHASED AT $14 PER UNIT
ENDING INVENTORY = 30 UNITS x 14 (costs per unit)
= $420
KEY FORMULAS:
ENDING INVENTORY = OLDEST REMAINING UNITS x COST PER UNIT
TOTAL AVAILABLE INVENTORY = BEGINNING INVENTORY + PURCHASES
TOTAL UNITS SOLD = FIRST SALE UNITS + SECOND SALE UNITS
TOTAL ENDING INVENTORY UNITS = TOTAL AVAILABLE - TOTAL SOLD
KEY TAKEAWAYS:
LIFO (LAST IN, FIRST OUT) means the most recent purchases are sold FIRST
Under a periodic system, ending inventory is calculated at the end of the period
The oldest inventory remains, which means we use the oldest cost per unit for ending inventory
Always check total units available vs total units sold to determine what remains
Given the following information, determine the ending balance of accounts payable for the period.
Beginning inventory - $30,000
Ending inventory - $40,000
Cost of goods sold - $56,000
Beginning accounts payable - $25,000
Cash paid to suppliers - $60,000
All inventory purchases are made on account
Group of answer choices
$6,000
$31,000
$56,000
$26,000
DETERMINE HOW TO CALCULATE THE ENDING BALANCE OF ACCOUNTS PAYABLE
Step 1: UNDERSTAND THE ACCOUNTS PAYABLE FORMULA
FORMULA:
ENDING ACCOUNTS PAYABLE = BEGINNING ACCOUNTS PAYABLE + INVENTORY PURCHASES - CASH PAID TO SUPPLIERS
since all inventory purchases are made on account, the inventory purchases amount is important
Step 2: CALCULATE INVENTORY PURCHASES
we use the COGS (COGS) FORMULA to find TOTAL PURCHASES:
FORMULA:
COGS = BEGINNING INVENTORY + PURCHASES - ENDING INVENTORY
Rearrange to solve for PURCHASES
PURCHASES = COGS + ENDING INVENTORY - BEGINNING INVENTORY
PURCHASES = 56,000 + 40,000 - 30,000
= 66,000
So INVENTORY PURCHASES = $66,000
Step 3: CALCULATE ENDING ACCOUNTS PAYABLE
Apply the accounts payable formula:
ENDING A/P = 25,000 + 66,000 - 60,000
= $31,000
WHY THE OTHER ANSWERS ARE WRONG
“6,000”
Likely a miscalculation where cash paid is incorrectly subtracted from purchases directly
“$56,000”
this is the cost of goods sold, not the ending accounts payable
“$26,000”
possibly an incorrect subtraction mistake in the formula
KEY FORMULAS:
COGS = BEGINNING INVENTORY + PURCHASES - ENDING INVENTORY
Purchases formula (solving for inventory purchases):
PURCAHSES = COGS + ENDING INVENTORY - ENDING INVENTORY
ENDING A/P = BEGINNING A/P + PURCHASES - CASH PAID TO SUPPLIERS
KEY TAKEAWAYS FOR TEST:
PURCAHSES are made on account, so they are added to accounts payable
Cash paid to suppliers reduces accounts payable
Use the correct formula to find inventory PURCAHSES before calculating accounts payable
Understand the relationship between inventory, purchases, and accounts payable
Q?: what’s the relationship between inventory purchases and accounts payable
the relationship is direct because businesses often buy inventory on CREDIT rather than paying cash upfrom
When a company PURCAHSES inventory on account, it increases both inventory (asset) and accounts payable (liability)
When the company pays its suppliers, accounts payable decreases
Purchasing inventory on account (increases accounts payable)
the company RECEIVES INVENTORY but has not yet paid for it
This creates a liability because the company owes money to suppliers
Journal entry for purchase on account:
Dr. Inventory ….xxx
Cr. Accounts payable… xxx
effect: increases BOTH inventory and accounts payable
Paying off accounts payable (decreases accounts payable)
when he company pays cash to its suppliers it reduces its accounts payable
Journal entry for payment to suppliers:
Dr. Accounts payable … xxx
Cr. Cash … xxx
effect: decreases both ACCOUNTS PAYABLE AND CASH
EXAMPLE OF THE RELATIONSHIP:
A company:
buys $10,000 of inventory on account (doesn’t pay immediately)
This increases accounts payable by $10,000 because they OWE MONEY TO SUPPLIERS
Later they pay $6,000 IN CASH to the suppliers
This REDUCES ACCOUNT PAYABLE B $6,000, leaving a balance of $4,000 STILL OWED
FORMULA TO CALCULATE ENDING ACCOUNTS PAYABLE:
ENDING A/P = BEGINNING A/P + PURCHASES ON ACCOUNT - CASH PAID TO SUPPLIERS
Where:
beginning A/P = amount owed to suppliers at the start
Purchases on account = total inventory bought on credit
Cash paid to suppliers = payments made to reduce accounts payable
Ending A/P = the final amount still owed to suppliers
KEY TAKEAWAYS FOR TEST:
when inventory is purchased on account, accounts payable increases
When payments are made to suppliers, accounts payable decreases
Ending accounts payable depends on beginning A/P, purchases, and cash paid to suppliers
Use teh formula
ENDING A/P = BEGINNING A/P + INVENTORY PURCHASES - CASH PAID
If the ending inventory balance is less than the beginning balance, which of the following is true?
Group of answer choices
Cost of goods sold was less than current period inventory purchases.
Cost of goods sold exceeded current period purchases.
Cash payments for inventory were less than current period inventory purchases.
Cash payments for inventory exceeded current period purchases.
Step 1: UNDERSTANDING INVENTORY CHANGES
Inventory follows this basic equation:
ENDING INVENTORY = BEGINNING INVENTORY + PURCHASES - COGS
if ending inventory is lower than beginning inventory, it means more inventory was sold that was purchased
IN OTHER WORDS:
the company USED UP MORE INVENTORY THAN IT BOUGHT during the period
This happens COGS is greater than PURCAHSES, meaning the company HAD TO DIP INTO ITS BEGINNING INVENTORY TO MEET DEMAND
Step 2: WHAT HAPPENS WHEN ENDING INVENTORY IS LESS THAN BEGINNING INVENTORY ?
the company started with a certain amount of inventory (beginning inventory)
They PURCHASED NEW INVENTORY during the period
They SOLD INVENTORY (COGS)
Since ENDING INVENTORY IS LOWER THAN BEGINNING INVENTORY, it means that sales (COGS) were high enough to REDUCE THE OVERALL INVENTORY BALANCE
This means that COGS must have been larger than the purchases made during the period
COGS EXCEEDED PURCHASES
WHY THE OTHER ANSWERS ARE WRONG
“COGS was less than current period inventory purchases.”
if this were true, then inventory would have increased, not decreased
“Cash payments for inventory were less than current period inventory purchases.”
cash payment are unrelated to whether COGS EXCEEDS PURCHASES
A company can buy inventory on credit, meaning CASH PAID DOES NOT NECESSARILY EQUAL PURCHASES
The question is about INVENTORY LEVELS, NOT CASH PAYAMENTS
“Cash payments for inventory exceeded current period purchases.”
again, cash payments are NOT THE KEY FACTOR in determining inventory levels
Even if a company paid more for past PURCAHSES, it DOESNT MEAN THAT COGS EXCEEDED PURCHASES
The key factor is inventory movement, not cash payments
KEY TAKEAWAYS FOR TEST
If ending inventory is lower than beginning inventory, it mean more inventory was sold than puchased
COGS must have been higher than purchases because the company had to use beginning inventory
Inventory balances are determined by purchases and sales (COGS), not cash payments
Formula to remember:
ENDING INVENTORY = BEGINNING INVENTORY + PURCHASES - COGS
if ending inventory decreases, COGS must have been greater than purchases
Fir Co. uses the aging of accounts method to estimate bad debt expense. Fir’s estimate of uncollectible accounts receivable from the aging method is $500. The beginning balance in the allowance for doubtful accounts was a $200 credit balance. Write offs of bad debts were $150. What amount would be recorded as bad debt expense?
Group of answer choices
$450
$550
$700
$650
DETERMINE THE CORRECT BAD DEBT EXPENSE USING THE AGING OF ACCOUNTS RECEIVABLE METHOD
Step 1: UNDERSTANIDNG THE AGING METHOD ESTIMATING BAD DEBT
the aging method estimates the DESIRED ENDING BALNCE in the ALLOWANCE FOR DOUBTFUL ACCOUNTS to match the new estimate
Step 2: IDENTIFY GIVEN INFO
estimated uncollectible accounts (from aging method) = $500
Beginning balance in allowance for doubtful accounts = $200 (credit balance)
Write-offs = $150
Bad debt expense = ?? (What we need to find)
Step 3 : USE THE ALLOWANCE FOR DOUBTFUL ACCOUNTS FORMULA
BAD DEBT EXPENSE FORMULA IS:
ENDING ALLOWANCE FOR DOUBTFUL ACCOUNTS = BEGINNING ALLOWANCE + BAD DEBT EXPENSE
we need the ending allowance to match the ESTIMATED UNCOLLECTIBLE AMOUNT ($500)
500 = 200 + BAD DEBT EXPENSE - 150
Step 4: SOLVE FOR BAD DEBT EXPENSE
500 = 200 + bad debt expense - 150
500 = 50 + bad debt expense
Bad debt expense = 500 - 50
Bad debt expense = 450
Correct answer = $450
KEY FORMULAS:
Allowance for doubtful account formula:
ENDING ALLOWANCE = BEGINNING ALLOWANCE + BAD DEBT EXPENSE - WRITE OFFS
Bad debts expense formula (solving for BDE):
BAD DEBT EXPENSE = ENDING ALLOWANCE - BEGINNING ALLOWANCE + WRITE OFFS
KEY TAKEAWAYS:
the aging method estimates the ending allowance for doubtful accounts, NOT the bad debt expense directly
Bad debt expense is calculated as the amount needed to adjust the allowance account to the correct ending balance
Write-offs reduce the allowance for doubtful accounts but do NOT affect bad debt expense directly
Always solve for bad debt expense by adjusting for the beginning balance and write-offs
Ash Inc. sold materials to its customer on August 11, 2021, for $75,000. Ash offers all its customers credit terms of 2/10, n/30. The customer paid for the materials on August 23rd.
If the materials cost Ash 70% of the original selling price to make, what amount of gross profit will Ash report from the above transaction?
Group of answer choices
$22,050
$52,500
$22,500
$51,450
HOW TO CALCULATE GROSS PROFIT CORRECTLY
Step 1: UNDERSTANDING GROSS PROFIT
Gross profit: the amount a company earns from sales after subtracting the COGS
GROSS PROFIT FORMULA :
GROSS PROFIT = SALES REVENUE - COGS
Step 2: IDENTIFY THE GIVEN INFO
sales price = $75,000
COGS is 70% of sales price
PAYMENT WAS MADE ON AUGUST 23
The customer had 2/10, n/30 terms, meaning they would get a 2% discount if they paid within 10 days
August 11 » august 23 is 12 days, so they did NOT qualify for the discount
This means THEY PAID THE FULL $75,000
Step 3: CALCULATE COGS
COGS is 70% OF THE SALES PRICE:
COGS = 75,000 × 0.70
= 52,500
Step 4: CALCULATE GROSS PROFIT
Now subtract COGS from SALES REVENUE:
GROSS PROFIT = 75,000 - 52,500
= $22,500
WHY THE OTHER ANSWER ARE WRONG
“$22,050”
wrong, this would only be correct if the customer took the 2% discount (75,000 x .98 = 73,500 and 73500 - 52500 = 22050)
However the customer paid after the discount period, so the discount does not apply
“$52,500”
this is the COGS, not the gross profit
“$51,450”
likely incorrect calculation involving the discount, but the customer did not get a discount
KEY FORMULAS:
Gross profit formula:
GROSS PROFIT = SALES REVENUE - COGS
COGS = SALES PRICE X COGS PERCENTAGE
Sales discount (if applicable):
NET SALES = SALES PRICE x (1 - DISCOUNT PRICE)
only applies if payment is made within the discount period
KEY TAKEAWAYS:
gross profit is sales revenue minus COGS
If the customer pays after the discount period, they pay the full amount
The COGS percentage tells us how much the product cost to make
Always check if the discount applies before calculating gross profit
Spruce Inc. is a wooden baseball bat retailer. Below is the inventory information for the month of April.
|
| # of units | Cost per unit |
4/1/2021 | Beginning inventory | 600 | $80 |
4/3/2021 | Sale | 200 |
|
4/7/2021 | Purchase | 300 | $85 |
4/15/2021 | Sale | 200 |
|
4/17/2021 | Sale | 200 |
|
4/23/2021 | Purchase | 200 | $90 |
4/27/2021 | Sale | 200 |
|
Each bat sells for $150. What is Spruce’s gross margin, assuming perpetual LIFO inventory cost system is used?
Group of answer choices
$44,100
$52,500
$55,000
$53,000
DETERMINE HOW TO CALCULATE GROSS MARGIN USING THE PERPETUAL LIFO INVENTORY SYSTEM
Step 1: UNDERSTANDING GROSS MARGIN CALCULATION
Gross margin (gross profit) formula:
GROSS MARGIN = SALES REVENUE - COST OF GOODS SOLD
sales revenue = total units sold x selling price per unit
COGS = the cost of the inventory sold, determined using LIFO (last in, first out) PERPETUAL METHOD
Step 2: IDENTIFY INFO
selling price per unit = $150
Total units sold = 200 + 200 + 200 +200 = 800 units
Step 3: CALCULATE SALES REVENUE
SALES REVENUE = TOTAL UNITS SOLD x SELLING PRICE PER UNIT
= 800 x 150
= 120,000
Step 4: CALCULATE COGS USING PERPETUAL LIFO
in LIFO (last-in, first-out) perpetual, we use the MOST RECENT INVENTORY COSTS FIRST WHEN SELLING UNITS
FIRST SALE: 4/3/2021 (200 UNITS SOLD)
since the most recent inventory before this sale is the BEGINNING INVENTOY ($80), we use:
200 × 80 = 16,000
SECOND SALE: 4/15/2021 (200 UNITS SOLD)
the most recent inventory before this sale includes NEW PURCHASE OF 300 AT $85
We take 200 UNITS FROM $85 INVENTORY:
200 × 85 = 17,000
THIRD SALE: 4/17/2021 (200 UNITS SOLD)
The most recent inventory before this sale includes:
Remaining 100 units from $85 purchase
100 units from beginning inventory ($80)
100 × 85 = 8500
100 × 80 = 8000
Total for this sale:
8500 + 8000 = 16500
FOURTH SALE: 4/27/2021 (200 UNITS SOLD)
the most recent inventory before this sale includes NEW PURCHASE OF 200 AT $90
So we take 200 UNITS FORM $90 INVENTORY:
200 ×90 = 18000
Step 5: CALCULATE TOTAL COGS
16,000 + 17,000 +16,500 + 18,000 = 67,500
Step 6: CALCULATE GROSS MARGIN
GROSS MARGIN = SALES REVENUE - COGS
= 120,000 - 67,500
= 52,500
KEY FORMULAS:
Gross margin formula:
GROSS MARGIN = SALES REVENUE - COGS
Sales revenue formula:
SALES REVENUE = TOTAL UNITS SOLD x SELLING PRICE PER UNIT
COGS (perpetual LIFO method):
use the MOST RECENT INVENTORY PURCHASES when selling goods
Track EACH SALE SEPERATLY, adjusting inventory at the time of each transaction
KEY TAKEAWAYS:
perpetual LIFO sells the most recently purchased inventory first
COGS is calculated at teh time of each sale, not at the end of the period
Always track the latest inventory purchases before assigning cost per unit to sales
Use LIFO correctly to ensure you subtract the newest inventory first when calculating COGS
Which of the following is false regarding the LIFO reserve?
Group of answer choices
The LIFO reserve is the excess of FIFO inventory over LIFO inventory.
The LIFO reserve helps investors compare companies that use different inventory methods.
The LIFO reserve is the difference between FIFO and LIFO in physical units.
The difference between beginning and ending LIFO reserve is the difference in cost of goods sold if FIFO was used.
WHY THIS IS FALSE: THE LIFO RESERVE IS THE DIFFERENCE BETWEEN FIFO AND LIFO IN PHYSICAL UNITS
Step 1: UNDERSTANDING THE LIFO RESERVE
the LIFO reserve is an accounting adjustment used to show the different between INVENTORY COSTS under the FIFO (first in, first out) method and LIFO (last in, first out) method
FORMULA:
LIFO RESERVE = FIFO INVENTORY VALUE - LIFO INVENTORY VALUE
FIFO usually reports a HIGHER inventory value because older, cheaper costs are assigned to COGS
LIFO usually reports a LOWER inventory value bceause the newest, most expensive cots are assigned to COGS
The LIFO RESERVE helps investors compare companies using different inventory methods
Step 2: WHY THE 3RD OPTION IS FALSE
“The LIFO RESERVE is the difference between FIFO and LIFO in physical units”
wrong, the LIFO reserve does not measure physical units; it measures the difference in cost between FIFO and LIFO inventory values
FIFO and LIFO assign different costs to the same number of inventory units, so the LIFO reserve is a -COST-BASED difference, not a QUANTITY-BASED difference
WHAT IS TRUE?: the LIFO reserve represents a DOLLAR different, not a difference in physical inventory units
WHY THE OTEHRS ARE TRUE
“The LIFO reserve is teh excess of FIFO inventory over LIFO inventory”
FIFO usually reports a higher inventory balance than LIFO
The LIFO reserve measures how much higher FIFO inventory is compared to LIFO inventory
“The LIFO reserve helps investors compare companies that use different inventory methods”
investors and analysts use the LIFO reserve to adjust financial statements and make fair comparisons between companies using FIFO vs LIFo
“The difference between beginning and ending LIFO reserve is the difference in COGS if FIFO was used
THE CHANGE IN LIFO RESERVE OVER TIME AFFECTS REPORTED PROFITS because FIFO and LIFO result in different COgs amounts
This allowas companies to ADJUST NET INCOME to reflect FIFO if needed
KEY TAKAWAYS FOR TEST:
the LIFO reserve is dollar difference, NOT a difference in physical units
It helps compare companies that use FIFO vs LIFO
FIFO inventory is typically higher than LIFO inventory, creating the LIFO reserve
The change in LIFO reserve affects reported cost of goods sold
LIFO reserve is used for financial adjustments and tax planning
Using the following information, calculate the receivables turnover ratio.
Sales revenue | $350,000 |
Credit card discount | $4,000 |
Bad debt expense | $5,000 |
Cost of goods sold | $175,000 |
Utilities expenses | $35,000 |
Sales returns | $5,000 |
Depreciation expense | $15,000 |
Beginning accounts receivable and allowance for doubtful accounts were $75,000 and $3,000, respectively
Ending accounts receivable and allowance for doubtful accounts were $88,000 and $5,000, respectively
Group of answer choices
4.40
4.52
4.18
4.45
CALCULATE THE RECEIVABLES TURNOVER RATIO CORRECTLY:
The receivable turnover ratio measures how efficiently a company collects cash from its credit sales. It tells us how many times accounts receivable are collected during a period
Tell us how HOW MANY TIMES A COMPANY COLLECTS MONEY FROM CUSTOMERS IN A YEAR
High ratio = customers are paying quickly (which is good!)
Low ratio = customers are taking too long to pay (which is bad)
Step 2: IDENTIFY INFO
sales revenue = $350,000
Credit card discount = $4,000
Sales returns = $5,000
Beginning accounts receivable = $75,000
Ending accounts receivable = $88,000
FORMULA:
RECEIVABLE TURNOVER RATIO = NET CREDIT SALES / AVERAGE ACCOUNTS RECEIVABLE
Find net credit sale:
NET CREDIT SALES = TOTAL SALES REVENUE - SALES RETURNS - CREDIT CARD DISCOUNTS
$350,000 - $5,000 - $4,000 =$341,000.00 $341,000
Net credit sales = $341,000
Find average accounts receivable
AVERAGE ACCOUNTS RECEIVABLE = (BEGINNING A/R + ENDING A/R) / 2
(75,000-3,000) + (88,000-5,000) / 2
= $77,500
Calculate the receivables turnover ratio
RECEIVABLES TURNOVER RATIO = NET CREDIT SALES / AVERAGE ACCOUNTS RECEIVABLE
$341,000 / 77,500 =$4.40 4.40
the company collects money from customers about 4.4 times per year
KEY FORMULA:
Receivables turnover ratio:
NET CREDIT SALES / AVERAGE ACCOUNTS RECEIVABLE
Net credit sales:
TOTAL SALES - SALES RETURNS - CREDIT CARD DISCOUNTS
Average accounts receivable
BEGINNING A/R + ENDING A/R / 2
KEY TAKEAWAYS:
the receivables turnover ratio shows how many time A/R is collected in a period
Subtract sales returns and credit card discount from total sales to get net credit sales
Use the average of beginning and ending A/R to get an accurate ratio
A higher ratio means faster collection; a lower ratio means slower collections
Which of the following statements is true?
Group of answer choices
When costs are decreasing, a LIFO cost assumption will result in a higher net income than a FIFO cost assumption.
When costs are decreasing, a LIFO cost assumption will result in a higher COGS than a FIFO cost assumption.
When costs are increasing, a LIFO cost assumption will result in a higher inventory balance than a weighted average cost assumption.
When costs are increasing, a LIFO cost assumption will result in a higher net income than a weighted average cost assumption.
Step 1: UNDERSTANIDNG LIFO VS FIFO
LIFO (last-in, first-out):
The most recent (newest) inventory costs are used first when calculating COGS
This means that when prices are rising, COGS is HIGHER, and NET INCOME IS LOWER
When prices are falling, COGS IS LOWER, and NET INCOME IS HIGHER
FIFO (first-in, first-out)
The oldest inventory costs are used first when calculating COGS
This means that when prices are rising, COGS is lower, and net income is higher
When prices are falling, COGS is higher, and net income is lower
Conclusion: LIFO RESULTS IN HGIHER NET INCOME THAN FIFO WHEN COSTS ARE DECREASING
What happens when COSTS ARE DECREASING
this means NEWER INVENTORY is CHEAPER than OLDER INVENTORY
If we use LIFO, we sell the NEWER, CHEAPER ITEMS FIRST
Leaving the OLDER, MORE EXPENSIVE ITEMS IN INVENTORY
This makes COGS LOWER because the cheaper items were sold
LOWER COGS = HIGHER NET INCOME (because you’re reporting lower expenses)
If COGS is lower, that means EXPENSES ARE LOWER and when expenses lower, net income (profit) is HIGHER
If it costs you $1,000 less to make something, and you still sell the same amount, you will earn more money!
WHY THE OTHERS ARE WRONG:
“When costs are decreasing, a LIFO cost assumption will result in a higher COGS than a FIFO cost asumption
wrong, when costs are DECREASING, a LIFO assigns CHEAPER (NEWER) INVENTORY to COGS, making COGS LOWER, NOT HIGHER THAN FIFO
“When costs are increasing, a LIFO cost assumption will result in a higher inventory balance than a weighted average cost assumption”
under LIFO, the OLDEST, CHEAPEST inventory remains in stock, resulting in a LOWER inventory balance compared to the weighted average method
FIFO typically results in the HIGHEST inventory balance in a rising-cost environment
“When costs are increasing, a LIFO cost assumption will result in a higher net income than a weighted average cost assumption”
wrong, when costs INCREASE, LIFO assigns HIGHER COSTS TO COGS, making NET INCOME LOWER, NOT HIGHER
FIFO or weighted average would result in HIGHER NET INCOME than LIFO in this scenario
KEY TAKEAWAYS:
when costs are decreasing, LIFO results in lower COGS and higher net income than FIFO
Costs are decrease, LIFO sells the cheaper inventory first, making COGS lower = higher net income
When costs are increasing, LIFO results in higher COGS and lower net income than FIFO
LIFO sells the newest inventory, which will be the more expensive inventory (bc COGS is higher) so = net income goes DOWN
LIFO generally leads to lower inventory balances compared to FIFO and weighted average
LIFO is usually preferred for tax benefits when costs are rising (because it lowers taxable income)
How to remember LIFO vs FIFO
FIFO = FIRST IN FIRST OUT
first in = oldest stuff = gets sold first
Think: “oldest inventory goes first”
Vending machine: first one loaded into the machine isn’t he first one sold
LIFO = LAST IN, FIRST OUT
last in = newest stuff = get sold first
Think: “newest inventory goes first”
The last pancake added to the stack is the first one you take
Assume that Weeping Willow used a perpetual FIFO inventory cost system. What would the cost of goods sold be?
|
| # of units | Cost per unit |
12/1/2021 | Beginning inventory | 100 | $14 |
12/13/2021 | Sale | 40 |
|
12/17/2021 | Purchase | 200 | $15 |
12/20/2021 | Sale | 230 |
|
Group of answer choices
$3,950
$4,050
$3,780
$4,010
HOW TO CALCULATE COGS USING PERPETUAL FIFO INVENTORY
Step 1: Understanding FIFO (First-In, First-Out)
FIFO (First-In, First-Out) means that the oldest inventory is sold first.
You always sell the OLDEST TOYS FIRST before selling the newer ones
If you had 100 teddy bears from last year, you sell those BEFORE selling the 200 new teddy bears you just bought
This is exactly how we will calculate COGS
Under Perpetual FIFO, we update inventory and COGS each time a sale happens, rather than waiting until the end of the period.
Understanding the data:
What we have at the START (beginning inventory)
100 units of toys costing $14 each
What happens?
DEC 13 SALE » sold 40 units
since we use FIFO, we sell 40 units from the 100 OLD UNITS AT $14 EACH
DEC 17 PURCHASE » we BOUGHT 200 MORE units at $15 EACH
now our inventory looks like this
60 OLD UNITS AT $14
200 NEW UNITS AT $15
DEC 20 SALE » sold 230 units
we sell the OLDEST INVENTORY FIRST (FIFO)
Sell 60 units from the oldest batch ($14 each)
Sell 170 units from the new batch ($15 each)
CALCULATE COGS:
1st sale Dec 13:
40 units x 14 = $560
2nd sale Dec 20:
Sell 60 units at $14
60 × 14 = $840
Sell 170 new units at $15
170 × 15 = $2,550
TOTAL COGS = $560 + $840 + $2,550 =$3,950.00 $3,950
FIFO PERPETUAL INVENTORY COGS CALCULATION:
sells oldest inventory first (update after each sale)
Track purchases and remaining inventory balance carefully
TOTAL COGS FORMULA:
COGS = (COST OF FIRST SALE) + (COST OF SECOND SALE)
KEY TAKEAWAYS:
FIFO = SELL OLD STUFF FIRST!
Always TRACK HOW MANY UNITS YOU HAVE LEFT before moving to newer purchases
Under perpetual FIFO, inventory is updated immediately after each sale
Track inventory costs at each sale to ensure the correct FIFO layers are used
Use correct cost layers for each sale to avoid mistakes in COGS calculation
Periodic inventory accounting differs from perpetual inventory accounting in that periodic inventory accounting:
Group of answer choices
a. is used more widely today with the advent of computers
b. can determine the balance of inventory only after a physical inventory count
c. ignores inventory inflows and outflows at the time of any sales or sales returns
d. both a and b
e. both b and c
f. all of the above
Step 1: Understanding Periodic vs. Perpetual Inventory Systems
There are two primary inventory accounting systems:
1. Perpetual Inventory System
Continuously updates inventory records after every purchase and sale.
COGS is recorded immediately when a sale occurs.
Commonly used today due to computerized systems.
2. Periodic Inventory System
Does not update inventory after each transaction.
Inventory levels and COGS are determined only at the end of the period using a physical count.
Inventory inflows and outflows are ignored during the period.
Step 2: Analyzing the Answer Choices
“Is used more widely today with the advent of computers” (False)
Perpetual inventory is more widely used today because of computers that allow real-time tracking.
Periodic inventory is becoming less common for this reason.
“Can determine the balance of inventory only after a physical inventory count” (true)
Under the Periodic System, inventory balances are not updated until a physical count is done at the end of the period.
“Ignores inventory inflows and outflows at the time of any sales or sales returns” (true)
In the Periodic System, purchases and sales are not recorded in real time; they are only recorded at the end of the period.
COGS is not calculated until the period ends.
“Both A and B” (false)
B is correct, but A is false (perpetual, not periodic, is more widely used today)
“Both B & C” (correct answer)
B is true (Periodic inventory is only updated after a physical count).
C is true (Periodic ignores inventory inflows/outflows during the period).
“All of the above.”(false)
Since A is false, we cannot say all of the above are correct.
KEY TAKEAWAYS:
periodic inventory only updates at the end of the period using a physical count
COGS is not recorded during the period—only at the end
Inventory inflows & outflows are ignored in real-time under periodic
Perpetual inventory is more widely used today because of computers
Which of the following appropriately describes the presentation of accounts receivable on the financial statements?
Group of answer choices
Gross accounts receivable less bad debt expense in the asset section of the balance sheet.
Gross accounts receivable less allowance for doubtful accounts in the asset section of the balance sheet.
Gross accounts receivable in the asset section of the balance sheet and the allowance for doubtful accounts in the expense section of the income statement.
Gross accounts receivable plus allowance for doubtful accounts in the asset section of the balance sheet.
Step 1: Understanding Accounts Receivable Presentation
Accounts receivable represents money owed to the company by customers.
They take toys home but haven’t paid yet
Is an asset because we expect get cash later
Some of these receivables may not be collected (bad debts), so companies use an account called Allowance for Doubtful Accounts to estimate these losses. (For money we might never get)
The net amount that a company expects to collect is called Net Accounts Receivable.
FORMULA:
NET ACCOUNTS RECEIVABLE = GROSS ACCOUNTS RECEIVABLE - ALLOWANCE FOR DOUBTFUL ACCOUNTS
Gross Accounts Receivable = the total money customers owe
Allowance for Doubtful Accounts: Contra-asset account that reduces A/R to reflect estimated uncollectible amounts.
the estimated amount we WONT COLLECT
Net accounts receivable = the amount we actually expect to receive
Step 2: Why the Correct Answer Is Right
“Gross accounts receivable less allowance for doubtful accounts in the asset section of the balance sheet” (correct Answer)
This is the proper GAAP presentation.
Net Accounts Receivable is reported in the Asset section of the Balance Sheet.
The Allowance for Doubtful Accounts is deducted from Gross Accounts Receivable.
Step 3: Why the Other Answers Are Wrong
“Gross accounts receivable less bad debt expense in the asset section of the balance sheet.”
Incorrect, Bad Debt Expense is reported on the Income Statement, not the Balance Sheet.
The correct reduction on the Balance Sheet is the Allowance for Doubtful Accounts, not Bad Debt Expense.
“Gross accounts receivable in the asset section of the balance sheet and the allowance for doubtful accounts in the expense section of the income statement”
Incorrect, The Allowance for Doubtful Accounts is a contra-asset on the Balance Sheet, not an expense.
Only Bad Debt Expense appears on the Income Statement.
“Gross accounts receivable plus allowance for doubtful accounts in the asset section of the balance sheet.”
Incorrect. The Allowance for Doubtful Accounts is subtracted, not added to Gross A/R.
Net A/R should reflect only what the company expects to collect.
KEY TAKEAWAYS:
accounts receivable is reported net of allowance for doubtful account on the balance sheet
Allowance for doubtful accounts is a contra-asset, not an expense; it is like a safety cushion for uncollected money, it stays on the balance sheet as a contra-asset
Bad debt expense appears on the income statement, not the balance sheet
Net accounts receivable = gross accounts receivable - allowance for doubtful accounts
Which of the following regarding inventory is true?
Group of answer choices
Inventory is recorded as an asset in the amount that it will sell for.
Inventory is marked up to its fair market value at the end of each period.
Inventory is written down if its historical cost is less than its net realizable value.
Inventory is the cost of goods available for sale less cost of goods sold.
Step 1: Understanding Inventory Accounting
Inventory is reported on the Balance Sheet as an asset and represents the cost of goods that a company has available for sale but has not yet sold.
inventory is the stuff a business has to sell - like toys on a shelf
The formula for ending inventory is:
ENDING INVENTORY = COST OF GOODS AVAILABLE FOR SALE - COGS
Cost of Goods Available for Sale (COGAS) includes: = beginning inventory + new purchases
Beginning Inventory
Inventory Purchases
Cost of goods sold (COGS) includes: = the cost of items the store actually sold
The cost of inventory that was actually sold during the period.
Thus, the correct statement is that inventory is calculated as COGAS minus COGS.
What ever is LEFT OVER after sales is the REMAINING INVENTORY
Why “inventory is the cost of goods available for sale less cost of goods sold”
this means: TOTAL INVENTORY YOU HAD - STUFF YOU ALREADY SOLD = WHATS LEFT in inventory
Think of it like a candy jar:
If you start with 100 candies and buy 50 MORE, you have 150 in total
If you sell 120 candies, how many do you still have?
150 (COGAS) - 120 (COGS) = 30 candies left (inventory)
Why the Other Answers Are Wrong
“Inventory is recorded as an asset in the amount that it will sell for.”
Incorrect.
Inventory is always recorded at its cost (how much the company paid for it), not at its selling price.
The selling price includes markup (profit), while inventory accounting
If a toy store buys a teddy bear for $10 and plans to sell it for $25, it still records the inventory at $10, not $25
Businesss ONLY RECORD the ACTUAL COST THEY PAID FOR INVENTORY, not what they hope to sell it for
“Inventory is marked up to its fair market value at the end of each period.”
businesses DO NOT INCREASE INVENTORY VALUE just because market prices go up
If an iPhone originally cost $500 in inventory, an apple raises the selling price to $800, the business STILL KEEPS IT RECORDED AT $500
The only time we adjust inventory value is when it LOSES VALUE (a write-down), not when it GAINS VALUE
Incorrect, Inventory is recorded at historical cost, unless it is written down due to impairment.
Companies do not mark up inventory to market value under GAAP.
“Inventory is written down if its historical cost is less than its net realizable value.”
Incorrect wording.
Statement is backwards! Inventory is WRITTEN DOWN when its COST IS MORE than what it can actually be sold for.
Example: if a store buys 10 tshirt for $20 each but can now only sell them for $10, the store must LOWER (write-down) the inventory value to reflect reality
BUT if the cost is LOWER THAN THE SELLING PRICE, we do nothing - we only adjust when the value drops
Inventory is written down if net realizable value (NRV) is less than historical cost, not the other way around.
The Lower of Cost or Net Realizable Value (LCNRV) rule applies when inventory is worth less than what it was originally purchased for.
KEY TAKEAWAYS:
Inventory is recorded at cost, not selling price or fair market value
Inventory is calculated as COGAS minus COGS
Under GAAP, inventory is written down if its net realizable value is lower than cost
Ending inventory is what remains after subtracting COGS from COGAS
Businesses don’t record inventory at selling price (only at cost, what they paid for)
Inventory is not increased if the market value goes up (only adjusted if value DROPS)
Write-downs happen only when cost is MORE THAN SELLING PRICE, NOT the other way around
What is the correct journal entry to record an estimated $5,600 of bad debt expense, assuming the company had not made any adjusting entries for the period?
Group of answer choices
Dr. Accounts receivable $5,600; Cr. Bad debt expense $5,600
Dr. Accounts receivable $5,600; Cr. Allowance for doubtful accounts $5,600
Dr. Bad debt expense $5,600; Cr. Accounts receivable $5,600
Dr. Bad debt expense $5,600; Cr. Allowance for doubtful accounts $5,600
What’s happening?
we EXPECT $5,600 worth of customers WONT PAY THEIR BILLS.
This isn’t actually removing money from accounts YET; we are setting aside a rainy day fund for bad debts
So, we DONT TOUCH ACCOUNTS RECEIVABLE DIRECTLY, but instead, we RECORD AN EXPENSE AND INCREASE the “ALLOWANCE FOR DOUBTFUL ACCOUNTS” (a special account that holds expected losses)
Step 1: Understanding Bad Debt Expense and Allowance for Doubtful Accounts
When companies estimate uncollectible accounts (bad debts), they use the Allowance Method rather than directly writing off accounts receivable.
Bad Debt Expense (BDE): Represents estimated uncollectible accounts.
Allowance for Doubtful Accounts (AFDA): A contra-asset account that reduces Accounts Receivable on the Balance Sheet.
Key Rule:
Instead of reducing Accounts Receivable directly, we record an expense and increase the Allowance for Doubtful Accounts.
Step 2: The Correct Journal Entry
bad debts expense: this is the cost of doing business
Allowance for doubtful accounts: a “holding account” for expected bad debts)
Dr. Bad debt expense….5600 (record the EXPECTED LOSS)
Cr. Allowance for doubtful accounts… 5600 (set money aside for future bad debts)
This follows the GAAP allowance method.
Step 3: Why the Other Answers Are Wrong
“Dr. Accounts Receivable $5,600; Cr. Bad Debt Expense $5,600”
Incorrect.
We do not reduce Accounts Receivable when estimating bad debts.
This would be incorrect unless we were directly writing off a specific bad debt.
“Dr. Accounts Receivable $5,600; Cr. Allowance for Doubtful Accounts $5,600”
Incorrect.
We never debit (increase) Accounts Receivable when recording bad debts.
Instead, we debit Bad Debt Expense to recognize the cost.
“Dr. Bad Debt Expense $5,600; Cr. Accounts Receivable $5,600”
Incorrect.
We only credit Accounts Receivable when actually writing off a specific bad debt.
This journal entry would be used for a direct write-off, not an estimated expense.
KEY TAKEAWAYS:
Bad debt expense is estimated using the allowance for doubtful accounts (contra-asset account)
We do NOT directly reduce accounts receivable when estimating bad debts
We don’t credit accounts receivable YET because we are not actually removing a SPECIFIC customers balance: we are just estimating future losses
Allowance for doubtful accounts acts as a safety net: so later, when customers don’t pay, we can reduce accounts receivable from this account instead of taking a sudden big loss
The correct journal entry for estimated bad debts is:
Dr. Bad debt expense…xxx
Cr. Allowance for doubtful accounts…xxx
direct write-offs happen only when a specific account is confirmed uncollectible
To record estimated bad debts, we increase Bad Debt Expense and increase the Allowance for Doubtful Accounts:
Given the following information, compute the total bad debt expense using percentage of sales method:
Net credit sales: $240,000
Historical percentage of credit losses: 3.5%
Beginning allowance of doubtful accounts credit balance: 3,100
Accounts receivable < 30 days, 2% deemed uncollectible: 45,000
Accounts receivable <60 days, 7% deemed uncollectible: 30,000
Accounts receivable >90 days, 20% deemed uncollectible: 20,000
Group of answer choices
$4,800
$8,400
$16,800
$48,000
calculate bad debt expense using the percentage of sales method
Step 1: what is bad debt expense?
bad debt expense is money we EXPECT TO NEVER COLLECT from customers who bought on credit
Imagine you let kids take TOYS NOW AND PAY LATER..but some never pay you back
To plan for this, businesses ESTIMATE how much they’ll lose based on past experience
Understanding the Percentage of Sales Method
The Percentage of Sales Method estimates bad debt expense based on a fixed percentage of net credit sales.
Unlike the Aging of Accounts Receivable Method, which focuses on the Allowance for Doubtful Accounts balance, this method directly calculates bad debt expense based on past trends.
Formula for Bad Debt Expense using the Percentage of Sales Method:
BAD DEBT EXPENSE = NET CREDIT SALES x HISTORICAL PERCENTAGE OF CREDIT LOSSES
From the problem:
Net Credit Sales = $240,000
Historical Percentage of Credit Losses = 3.5% (0.035)
Beginning Allowance for Doubtful Accounts = $3,100 (not needed for this method)
Accounts Receivable Balances & Their Uncollectible Percentages → (not needed for this method because we are using % of sales, not aging method).
Since this problem asks for the percentage of sales method, we ignore the aging of accounts receivable and directly apply the percentage to net credit sales.
Step 3: Calculate Bad Debt Expense
BAD DEBT EXPENSE = NET CREDIT SALES X HISTORICAL OF CREDIT LOSSES
240,000 X 0.035 = 8,400
= $8400 (CORRECT ANSWER)
KEY FORMULAS:
Percentage of sales method (used here):
BAD DEBT EXPENSE = NET CREDIT SALES x ESTIMATED OF CREDIT LOSSES
Aging of accounts receivable method (not used here):
ENDING ALLOWANCE FOR DOUBTFUL ACCOUNTS = THE SUM (A/R CATAGORY x ESTIMATED UNCOLLECTIBLE)
Key Takeaways for Your Accounting Test
The Percentage of Sales Method focuses on credit sales, not accounts receivable balances.
Ignore beginning allowance and accounts receivable aging when using this method.
Apply the historical percentage of bad debts directly to net credit sales.
The Allowance for Doubtful Accounts balance is not adjusted first in this method—bad debt expense is calculated independently.
Percentage of sales method Step = just multiply total sales by the bad debt percentage
Given the following information, calculate the inventory turnover ratio.
Inventory, beginning of year - $15,000
Cost of goods sold - $133,000
Inventory purchases $143,000
Ending accounts payable - $175,000
Group of answer choices
6.65
7.15
8.75
5.32
inventory turnover ratio
Step 1: Understanding the Inventory Turnover Ratio
The inventory turnover ratio measures how efficiently a company sells and replaces its inventory during a period.
basically tells us HOW MANY TIMES WE SOLD AND REPLACED OUR INVENTORY in a year
imagine you have a shelf full of toys:
if you sell all the toys and restock the shelf 6 times in a year, your turnover ratio is 6
If the toys JUST SIT THERE, your turnover ratio is LOW (which is bad for business)
Formula for Inventory Turnover Ratio:
INVENTORY TURNOVER RATIO = COGS / AVERAGE INVENTORY
We know:
beginning inventory = $15,000
Purchases = $143,000
Cost of goods sold = $133,000
Ending accounts payable = $175,000 (not needed for this calculation)
Ending inventory = ?? (We need to FIND)
FORMULA:
ENDING INVENTORY = BEGINNING INVENTORY + PURCAHSES - COGS
15,000 + 143,000 - 133,000 =25,000 $25,000 (ENDING INVENTORY)
Now we calculate AVERAGE INVENTOYRY
FORMULA:
AVERAGE INVENTORY = BEGINNING INVENTORY + ENDING INVENTORY / 2
= (15000+25000)/2
Average inventory = $20,000
Step 5: CALCULATE INVENTORY TURNOVER RATIO
FORMULA:
INVENTROY TURNOVER RATIO = COGS / AVERAGE INVENTORY
= 133,000 / 20,000
= 6.65 (correct answer)
That means we SOLD AND REPLACED OUR INVENTORY 6.65 TIME IN THE YEAR!
KEY FORMULAS:
ENDING INVENTORY = BEGINNING INVENTORY + PURCHASES - COGS
KEY TAKEAWAYS:
The inventory turnover ratio measures how efficiently inventory is sold and replaced.
Use COGS, NOT purchases, in the formula.
Ending Inventory must be calculated if not given.
HIGH TURNOVER = GOOD! (Selling a lot, making money)
LOW TURNOVER = BAD (toys sitting on shelves, no sales)
The correct formula is:
COGS / AVERAGE INVENTORY
FINAL ANSWER: 6.65 (inventory turnover ratio = 133,000 / 20,000)
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