Financial Accounting Exam II Questions (Ch 4-7)
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| Describe merchandising activities and identify income components for a merchandising company | Merchandisers buy products and resell them. Examples of merchandisers include Walmart, Home Depot, The Limited, and Barnes & Noble. A merchandiser's costs on the income statement include an amount for cost of goods sold. Gross profit, or gross margin, equals sales minus cost of goods sold.
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| Describe merchandising activities and identify income components for a merchandising company | Merchandisers buy products and resell them. Examples of merchandisers include Walmart, Home Depot, The Limited, and Barnes & Noble. A merchandiser's costs on the income statement include an amount for cost of goods sold. Gross profit, or gross margin, equals sales minus cost of goods sold.
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| Analyze and record transactions for merchandise purchases using a perpetual system. For a perpetual inventory system, purchases of inventory (net of trade discounts) are added to the Merchandise Inventory account. Purchase discounts and purchase returns and allowances are subtracted from Merchandise Inventory, and transportation-in costs are added to Merchandise Inventory. |
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| Analyze and record transactions for merchandise sales using a perpetual system | A merchandiser records sales at list price less any trade discounts. The cost of items sold is transferred from Merchandise Inventory to Cost of Goods Sold. Refunds or credits given to customers for unsatisfactory merchandise are recorded in Sales Returns and Allowances, a contra account to Sales. If merchandise is returned and restored to inventory, the cost of this merchandise is removed from Cost of Goods Sold and transferred back to Merchandise Inventory. When cash discounts from the sales price are off
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| Prepare adjustments and close accounts for a merchandising company | With a perpetual system, it is often necessary to make an adjustment for inventory shrinkage. This is computed by comparing a physical count of inventory with the Merchandise Inventory balance. Shrinkage is normally charged to Cost of Goods Sold. Temporary accounts closed to Income Summary for a merchandiser include Sales, Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold.
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| Define and prepare multiple-step and single-step income statements | Multiple-step income statements include greater detail for sales and expenses than do single-step income statements. They also show details of net sales and report expenses in categories reflecting different activities.
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| Compute the acid-test ratio and explain its use to assess liquidity | The acid-test ratio is computed as quick assets (cash, short-term investments, and current receivables) divided by current liabilities. It indicates a company's ability to pay its current liabilities with its existing quick assets. An acid-test ratio equal to or greater than 1.0 is often adequate.
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| Compute the gross margin ratio and explain its use to assess profitability | The gross margin ratio is computed as gross margin (net sales minus cost of goods sold) divided by net sales. It indicates a company's profitability before considering other expenses.
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| Record and compare merchandising transactions using both periodic and perpetual inventory systems | A perpetual inventory system continuously tracks the cost of goods available for sale and the cost of goods sold. A periodic system accumulates the cost of goods purchased during the period and does not compute the amount of inventory or the cost of goods sold until the end of a period. Transactions involving the sale and purchase of merchandise are recorded and analyzed under both the periodic and perpetual inventory systems. Adjusting and closing entries for both inventory systems are illustrated and expl
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| Identify the items making up merchandise inventory | Merchandise inventory refers to goods owned by a company and held for resale. Three special cases merit our attention. Goods in transit are reported in inventory of the company that holds ownership rights. Goods on consignment are reported in the consignor's inventory. Goods damaged or obsolete are reported in inventory at their net realizable value.
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| Identify the costs of merchandise inventory. Costs of merchandise inventory include expenditures necessary to bring an item to a salable condition and location. This includes its invoice cost minus any discount plus any added or incidental costs necessary to put it in a place and condition for sale. |
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| Compute inventory in a periodic system using the methods of specific identification, FIFO, LIFO, and weighted average | Periodic inventory systems allocate the cost of goods available for sale between cost of goods sold and ending inventory at the end of a period. Specific identification and FIFO give identical results whether the periodic or perpetual system is used. LIFO assigns costs to cost of goods sold assuming the last units purchased for the period are the first units sold. The weighted average cost per unit is computed by dividing the total cost of beginning inventory and net purchases for the period by the total nu
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| Analyze the effects of inventory methods for both financial and tax reporting | When purchase costs are rising or falling, the inventory costing methods are likely to assign different costs to inventory. Specific identification exactly matches costs and revenues. Weighted average smooths out cost changes. FIFO assigns an amount to inventory closely approximating current replacement cost. LIFO assigns the most recent costs incurred to cost of goods sold and likely better matches current costs with revenues.
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| Compute the lower of cost or market amount of inventory | Inventory is reported at market cost when market is lower than recorded cost, called the lower of cost or market (LCM) inventory. Market is typically measured as replacement cost. Lower of cost or market can be applied separately to each item, to major categories of items, or to the entire inventory.
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| Analyze the effects of inventory errors on current and future financial statements | An error in the amount of ending inventory affects assets (inventory), net income (cost of goods sold), and equity for that period. Since ending inventory is next period's beginning inventory, an error in ending inventory affects next period's cost of goods sold and net income. Inventory errors in one period are offset in the next period.
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| Assess inventory management using both inventory turnover and days' sales in inventory | We prefer a high inventory turnover, provided that goods are not out of stock and customers are not turned away. We use days' sales in inventory to assess the likelihood of goods being out of stock. We prefer a small number of days' sales in inventory if we can serve customer needs and provide a buffer for uncertainties.
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| Compute inventory in a perpetual system using the methods of specific identification, FIFO, LIFO, and weighted average | Costs are assigned to the cost of goods sold account each time a sale occurs in a perpetual system. Specific identification assigns a cost to each item sold by referring to its actual cost (for example, its net invoice cost). Weighted average assigns a cost to items sold by dividing the current balance in the inventory account by the total items available for sale to determine cost per unit. We then multiply the number of units sold by this cost per unit to get the cost of each sale. FIFO assigns cost to it
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| Define internal control and identify its purpose and principles | An internal control system consists of the policies and procedures managers use to protect assets, ensure reliable accounting, promote efficient operations, and urge adherence to company policies. It can prevent avoidable losses and help managers both plan operations and monitor company and human performance. Principles of good internal control include establishing responsibilities, maintaining adequate records, insuring assets and bonding employees, separating recordkeeping from custody of assets, dividing
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| Define cash and cash equivalents and explain how to report them | Cash includes currency, coins, and amounts on (or acceptable for) deposit in checking and savings accounts. Cash equivalents are short-term, highly liquid investment assets readily convertible to a known cash amount and sufficiently close to their maturity date so that market value is not sensitive to interest rate changes. Cash and cash equivalents are liquid assets because they are readily converted into other assets or can be used to pay for goods, services, or liabilities.
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| Apply internal control to cash receipts and disbursements | Internal control of cash receipts ensures that all cash received is properly recorded and deposited. Attention focuses on two important types of cash receipts
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| Explain and record petty cash fund transactions | Petty cash disbursements are payments of small amounts for items such as postage, courier fees, minor repairs, and supplies. A company usually sets up one or more petty cash funds. A petty cash fund cashier is responsible for safekeeping the cash, making payments from this fund, and keeping receipts and records. A Petty Cash account is debited only when the fund is established or increased in amount. When the fund is replenished, petty cash disbursements are recorded with debits to expense (or asset) accoun
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| Prepare a bank reconciliation | A bank reconciliation proves the accuracy of the depositor's and the bank's records. The bank statement balance is adjusted for items such as outstanding checks and unrecorded deposits made on or before the bank statement date but not reflected on the statement. The book balance is adjusted for items such as service charges, bank collections for the depositor, and interest earned on the account.
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| Compute the days' sales uncollected ratio and use it to assess liquidity | Many companies attract customers by selling to them on credit. This means that cash receipts from customers are delayed until accounts receivable are collected. Users want to know how quickly a company can convert its accounts receivable into cash. The days' sales uncollected ratio, one measure reflecting company liquidity, is computed by dividing the ending balance of receivables by annual net sales, and then multiplying by 365.
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| Describe accounts receivable and how they occur and are recorded | Accounts receivable are amounts due from customers for credit sales. A subsidiary ledger lists amounts owed by each customer. Credit sales arise from at least two sources
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| Apply the direct write-off method to account for accounts receivable | The direct write-off method charges Bad Debts Expense when accounts are written off as uncollectible. This method is acceptable only when the amount of bad debts expense is immaterial.
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| Apply the allowance method and estimate uncollectibles based on sales and accounts receivable | Under the allowance method, bad debts expense is recorded with an adjustment at the end of each accounting period that debits the Bad Debts Expense account and credits the Allowance for Doubtful Accounts. The uncollectible accounts are later written off with a debit to the Allowance for Doubtful Accounts. Uncollectibles are estimated by focusing on either (1) the income statement relation between bad debts expense and credit sales or (2) the balance sheet relation between accounts receivable and the allowan
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| Describe a note receivable, the computation of its maturity date, and the recording of its existence | A note receivable is a written promise to pay a specified amount of money at a definite future date. The maturity date is the day the note (principal and interest) must be repaid. Interest rates are normally stated in annual terms. The amount of interest on the note is computed by expressing time as a fraction of one year and multiplying the note's principal by this fraction and the annual interest rate. A note received is recorded at its principal amount by debiting the Notes Receivable account. The credit
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| Record the honoring and dishonoring of a note and adjustments for interest | When a note is honored, the payee debits the money received and credits both Notes Receivable and Interest Revenue. Dishonored notes are credited to Notes Receivable and debited to Accounts Receivable (to the account of the maker in an attempt to collect), and Interest Revenue is recorded for interest earned for the time the note is held.
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| Explain how receivables can be converted to cash before maturity | Receivables can be converted to cash before maturity in three ways. First, a company can sell accounts receivable to a factor, who charges a factoring fee. Second, a company can borrow money by signing a note payable that is secured by pledging the accounts receivable. Third, notes receivable can be discounted at (sold to) a financial institution.
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| Compute accounts receivable turnover and use it to help assess financial condition | Accounts receivable turnover is a measure of both the quality and liquidity of accounts receivable. The accounts receivable turnover measure indicates how often, on average, receivables are received and collected during the period. Accounts receivable turnover is computed as net sales divided by average accounts receivable.
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