Accounting Test 2

Here’s a detailed breakdown of Chapters 4, 5, and 6 in note form to help you study for your exam:

Chapter 4: Merchandising Activities

Inventory Systems

1. Perpetual Inventory System

   • Continuously updates inventory records after each purchase/sale.

   • All transactions (purchases, sales, returns) directly affect the Inventory account.

2. Periodic Inventory System

   • Updates inventory only at the end of the accounting period.

   • Uses a formula to determine COGS:

     • COGS = Beginning Inventory + Net Purchases - Ending Inventory

Merchandise Purchases Entries (Perpetual System)

• Purchase of Inventory on Account

  • Dr. Inventory

  • Cr. Accounts Payable

• Freight Costs (FOB Shipping Point – Buyer Pays)

  • Dr. Inventory

  • Cr. Cash

• Purchase Returns & Allowances

  • Dr. Accounts Payable (or Cash)

  • Cr. Inventory

• Purchase Discounts (e.g., 2/10, n/30)

  • If paid within the discount period:

    • Dr. Accounts Payable

    • Cr. Cash (Amount Paid)

    • Cr. Inventory (Discount Amount)

Merchandise Sales Entries (Perpetual System)

1. Recording a Sale

   • Dr. Accounts Receivable (or Cash)

   • Cr. Sales Revenue

2. Recording Cost of Goods Sold (COGS)

   • Dr. COGS

   • Cr. Inventory

3. Sales Returns (If customer returns goods)

   • Reverse the original sale:

     • Dr. Sales Returns & Allowances

     • Cr. Accounts Receivable (or Cash)

   • Restore inventory:

     • Dr. Inventory

     • Cr. COGS

4. Sales Discounts (If customer pays early and receives a discount)

   • Dr. Cash (Amount Paid)

   • Dr. Sales Discounts (Discount Amount)

   • Cr. Accounts Receivable

Financial Statements for Merchandising Companies

1. Multi-Step Income Statement

   • More detailed than a single-step income statement.

   • Key sections:

     • Net Sales = Sales Revenue - Sales Discounts - Sales Returns & Allowances

     • Gross Profit = Net Sales - COGS

     • Operating Income = Gross Profit - Operating Expenses

     • Net Income = Operating Income ± Other Revenues/Expenses

2. Classified Balance Sheet

   • Separates current and long-term assets/liabilities.

   • Key sections:

     • Current Assets: Cash, Accounts Receivable, Inventory, Prepaid Expenses.

     • Long-term Assets: Equipment, Land, Buildings, Accumulated Depreciation.

     • Current Liabilities: Accounts Payable, Unearned Revenue, Short-term Debt.

     • Long-term Liabilities: Notes Payable (long-term), Bonds Payable.

     • Equity: Common Stock, Retained Earnings.

Key Ratios

1. Acid-Test (Quick) Ratio

   • Measures a company’s ability to pay short-term obligations without relying on inventory.

   • Formula: Cash+Short-Term Investments+ReceivablesCurrent Liabilities\frac{\text{Cash} + \text{Short-Term Investments} + \text{Receivables}}{\text{Current Liabilities}}

2. Gross Margin Ratio

   • Measures profitability of sales before expenses.

   • Formula: Net Sales−COGSNet Sales\frac{\text{Net Sales} - \text{COGS}}{\text{Net Sales}}

Chapter 5: Inventory Valuation & Cost Flow Methods

Determining Inventory Items

• Includes goods in transit:

  • FOB Shipping Point: Buyer owns inventory once shipped.

  • FOB Destination: Seller owns inventory until received by the buyer.

• Consigned Goods: Inventory held by another company but still owned by the consignor.

Inventory Costing Methods

1. Specific Identification

   • Tracks exact cost of each unit sold.

   • Used for unique, high-value items (e.g., cars, jewelry).

2. FIFO (First-In, First-Out)

   • Oldest costs → COGS

   • Newest costs → Ending Inventory

   • Effect: Higher profits, higher taxes in inflation.

3. LIFO (Last-In, First-Out)

   • Newest costs → COGS

   • Oldest costs → Ending Inventory

   • Effect: Lower taxable income in inflation.

4. Weighted Average

   • Averages cost per unit for inventory.

   • Formula: Total Cost of Inventory AvailableTotal Units Available\frac{\text{Total Cost of Inventory Available}}{\text{Total Units Available}}

Financial Statement Effects of Inventory Costing Methods

• FIFO: Higher income, higher inventory value (good in inflation).

• LIFO: Lower income, lower inventory value (good for tax savings).

• Weighted Average: Smooths out cost fluctuations.

Lower of Cost or Market (LCM) Rule

• Inventory is recorded at the lower of cost or market value (replacement cost).

Key Ratios

1. Inventory Turnover Ratio

   • Measures how quickly inventory is sold.

   • Formula: COGSAverage Inventory\frac{\text{COGS}}{\text{Average Inventory}}

2. Days’ Sales in Inventory Ratio

   • Measures how long inventory stays before being sold.

   • Formula: Ending InventoryCOGS×365\frac{\text{Ending Inventory}}{\text{COGS}} \times 365

Chapter 6: Internal Controls & Cash Management

Purpose of Internal Controls

• Protect assets, ensure reliable financial reporting, promote efficiency, and enforce compliance.

Principles of Internal Controls

1. Establish Responsibilities

2. Maintain Adequate Records

3. Separate Duties

4. Apply Technological Controls

5. Perform Regular Reviews

Limitations of Internal Controls

• Human error & fraud (collusion, management override).

Cash Management & Controls

1. Control Over Cash Receipts

   • Immediate deposit of cash.

   • Use of cash registers and receipts.

2. Control Over Cash Payments

   • Dual authorization.

   • Use of pre-numbered checks.

Bank Reconciliation

• Compares bank statement to cash ledger.

• Adjustments needed for:

  • Outstanding checks (deduct from bank).

  • Deposits in transit (add to bank).

  • Bank fees, NSF checks, errors (adjust books).

Journal Entries for Reconciling Bank Statement (Books Only)

• Bank Fees:

  • Dr. Miscellaneous Expense

  • Cr. Cash

• NSF Check (Bounced Check):

  • Dr. Accounts Receivable

  • Cr. Cash

Petty Cash

• Small fund for minor expenses.

• Replenished when funds are low.

Key Ratio: Days’ Sales Uncollected

• Measures how long it takes to collect receivables.

• Formula: Accounts ReceivableNet Sales×365\frac{\text{Accounts Receivable}}{\text{Net Sales}} \times 365

Exam Format

✅ 25 multiple-choice questions
✅ In-person exam
✅ Scantron provided
✅ Bring a calculator (no cell phones allowed)

This is a detailed yet organized version of your topics. Let me know if you need more breakdowns! 😊📚

Here’s a breakdown of all the accounts mentioned in your study topics and whether they are debit (Dr.) or credit (Cr.) accounts.

Merchandising & Inventory Accounts

Accounts Receivable & Payable

Financial Statement Accounts

Internal Controls & Cash Management Accounts

Key Ratios & Their Accounts

Journal Entry Cheat Sheet (Dr. vs. Cr.)

✅ Increase (Dr.):

• Assets (Cash, Inventory, A/R, Equipment, etc.)

• Expenses (COGS, Salaries, Rent, Misc. Expense, etc.)

• Contra-Revenues (Sales Discounts, Sales Returns & Allowances)

✅ Increase (Cr.):

• Liabilities (A/P, Notes Payable, Bonds Payable, etc.)

• Equity (Common Stock, Retained Earnings)

• Revenues (Sales Revenue, Service Revenue, etc.)

• Contra-Assets (Accumulated Depreciation)

Let me know if you need more details! 🚀📚

Balancing & Correcting Bank Statements (Bank Reconciliation)

Bank reconciliation is the process of comparing the bank statement balance to the company’s cash ledger balance and making adjustments to correct differences.

Steps to Reconcile a Bank Statement

Step 1: Compare the Bank Statement & Cash Ledger

• The bank statement shows what the bank records for the company’s cash account.

• The company’s cash ledger (books) tracks the company’s cash transactions.

• Differences arise due to timing or errors, so adjustments are necessary.

Step 2: Identify & Adjust Differences

A. Adjustments to the Bank Statement Balance

(These are things that the bank has not yet recorded but will affect the final balance.)

1. Outstanding Checks (Subtract 🡓)

   • Checks issued by the company but not yet cleared by the bank.

   • Example: A $500 check written on Feb 25 isn’t cashed yet.

2. Deposits in Transit (Add 🡑)

   • Deposits made by the company but not yet recorded by the bank.

   • Example: A $1,200 deposit made late on Feb 28 won’t appear in February’s bank statement.

B. Adjustments to the Book (Company’s Ledger) Balance

(These are things that the company hasn’t recorded but should.)

1. Bank Service Fees & Charges (Subtract 🡓)

   • Fees charged by the bank (e.g., monthly maintenance fees, wire transfer fees).

   • Example: A $15 bank service fee deducted from the account.

2. NSF (Non-Sufficient Funds) Checks (Subtract 🡓)

   • Checks received from customers that bounced due to insufficient funds.

   • Example: A $200 customer check was deposited but later bounced.

3. Bank Collections on Company’s Behalf (Add 🡑)

   • The bank collects payments for the company, such as receivables or loan payments.

   • Example: The bank collected a $500 accounts receivable payment for the company.

4. Errors (Can be an increase or decrease 🡑🡓)

   • The company or bank might make mistakes in recording transactions.

   • Example: The company recorded a check as $450 instead of the actual $540.

Step 3: Adjust the Books with Journal Entries

After identifying the necessary adjustments, the company updates its books with journal entries.

Common Journal Entries for Adjustments

1. Bank Fees (Decreasing Cash)

   Dr. Miscellaneous Expense  15  
   Cr. Cash                   15  
   

2. NSF Check (Reversing a Customer Payment)

   Dr. Accounts Receivable   200  
   Cr. Cash                  200  
   

3. Bank Collection (Increasing Cash)

   Dr. Cash                 500  
   Cr. Accounts Receivable  500  
   

4. Correcting an Error (If underreported expense)

   Dr. Expense Account   XX  
   Cr. Cash             XX  
   

Final Step: Verify the Adjusted Balances

• After adjustments, the adjusted bank balance and adjusted book balance should match.

• If they don’t, check for errors or missing transactions.

Example of a Bank Reconciliation Statement

✅ Final Check: The adjusted bank balance = adjusted book balance ($5,700). The reconciliation is complete!

Key Takeaways

✔ Bank reconciliation ensures cash records are accurate and up to date.
✔ It detects fraud, errors, and timing differences.
✔ Adjustments are needed to bring the books in line with the bank’s records.
✔ Journal entries correct the books for any bank-related transactions.

Would you like a practice problem on this? 😊

Great question! "Varies" is used because bank errors & book errors can either increase or decrease the balance, depending on the situation. Let me break it down:

Why Bank & Book Errors Vary?

1. Bank Errors (Could be Add or Subtract 🡑🡓)

   • If the bank accidentally deducted too much, you ADD it back.

   • If the bank forgot to deduct something, you SUBTRACT it.

   ✅ Example:

   • The bank mistakenly deducted $50 extra from your account → ADD $50 back to the bank balance.

   • The bank forgot to clear a $30 automatic payment → SUBTRACT $30 from the bank balance.

2. Book (Company) Errors (Could be Add or Subtract 🡑🡓)

   • If the company under-recorded expenses, you SUBTRACT to correct it.

   • If the company over-recorded expenses, you ADD to fix it.

   ✅ Example:

   • You recorded a check for $500 but it was actually $550 → SUBTRACT $50 from the books.

   • You recorded a deposit as $900, but it was actually $1,000 → ADD $100 to the books.

Final Cheat Code:

💡 Bank & Book Errors = "Check for Mistakes" (Fix the Wrong Direction!)

• If too little was recorded → Add 🡑

• If too much was recorded → Subtract 🡓

Would you like a quick practice problem on this? 😊