Accounting 1 - Exam 2 - Lecture notes 4, 6, 7 PDF

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Lecture notes from chapters 4, 6, and 7 in respect to Exam 2 (Midterm)...

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ACCOUNTING 1 – TEST 2

CHAPTER 4 – ACCOUNTING FOR MERCHANDISING OPERATIONS

Beginning Inventory + Net Purchases = Merchandise Available for Sale = Ending Inventory + Cost of goods sold COST OF GOODS SOLD – -

Used to figure gross profit Also called cost of sales Includes the expenses of buying and preparing an item for sale Expense reported on the income sheet

PERPETUAL SYSTEMS – update accounting records for each purchase and sale of inventory PERIODIC SYSTEMS – update records for purchase and sale of inventory only at the end of the accounting period PURCHASE WITHOUT CASH DISCOUNTS – debit merchandise inventory, credit cash PURCHASE WITH CASH DISCOUNTS – debit merchandise inventory, credit accounts payable

CASH DISCOUNTS – - Sellers can grant a cash discount to encourage buyers to pay earlier. - A seller views a cash discount as a sales discount. - Cash discounts are described in credit terms. - A buyer views a cash discount as a purchase discount. - A reduced payment applies to the discount period.

SET TERMS –

PURCHASE ON CREDIT – debit merchandise inventory, credit accounts payable PURCHASE RETURN – merchandise returned by the purchaser to the supplier.

PURCHASE ALLOWANCE – a price reduction to the buyer of defective or unacceptable merchandise. Debit accounts payable, credit merchandise inventory. PURCHASE AND TRANSPORTATION COSTS – Shipping Terms

Ownership Transfers at

FOB shipping point

Shipping point

Goods in Transit Owned by Buyer

FOB destination

Destination

Seller

Transportation Costs Paid by Debit Merchandise Inventory, Credit Cash Debit Delivery Expense, Credit Cash

Gross profit = net sales – cost of goods sold SALES WITHOUT CASH DISCOUNT Revenue side journal entry – debit accounts receivable, credit sales Cost side journal entry – debit cost of goods sold, credit merchandise inventory SALES RETURNS AND ALLOWANCES

SHRINKAGE – adjustment to reflect loss of merchandise. Debit cost of goods sold, credit merchandise inventory SALES DISCOUNTS, RETURNS AND ALLOWANCES – new revenue recognition rules require reporting of sales at net amount expected. Adjusting entries required for: 1. Expected sales discounts 2. Expected returns and allowances (revenue side) 3. Expected returns and allowances (cost side) SALES DISCOUNT – contra-revenue account, increased with a debit Gross margin ratio = net sales – cost of goods sold / net sales Net income = net sales – cost of goods sold – expenses 40200 = x – 35100 - 3300 DEBIT MEMORANDUM – when a buyer returns or takes an allowance on merchandise, the buyer issues a debit memorandum to inform the seller of a debit made to the seller’s account in the buyer’s records. CREDIT MEMORANDUM – when a seller grants an allowance on a previous sale, the seller issues a credit memorandum to inform the customer of a credit made to the buyer’s Accounts Receivable in the seller’s records.

MULTI-STEP INCOME STATEMENT – it has three main parts: (1) gross profit, which is net sales minus cost of goods sold, (2) income from operations, which is gross profit minus operating expenses, and (3) net income, which is income from operation plus or minus nonoperating items. SINGLE-STEP INCOME STATEMENT – lists cost of goods sold as another expenses and shows only one subtotal for total expenses. END -

OF THE ACCOUNTING CYCLE Close expense accounts. Close revenue accounts. Close the income summary account. Close the dividends account.

ACID-TEST RATIO – measure of a merchandiser’s ability to pay its current liabilities (referred to as liquidity). = Cash and cash equivalents + Short-term investments + Current receivables / Current Liabilities PERIODIC CREDIT PURCHASE WITH CASH DISCOUNT – Debit purchases, credit accounts payable - If discount is applied: debit accounts payable, credit purchase discounts and cash - If discount expires: debit accounts payable, credit cash PERIODIC PURCHASES RETURNS – debit accounts payable, credit purchases returns and allowances PERIODIC TRANSPORTATION – debit transportation-in, credit cash PERIODIC CREDIT SALES – debit accounts receivable, credit sales PERIODIC RETURNS RECEIVED BY SELLER – debit sales returns and allowances, credit cash PERIODIC ALLOWANCES GRANTED BY SELLER – debit sales returns and allowances, credit accounts receivable ***The balance sheet mainly differs by the inclusion of merchandise inventory, inventory returns estimated, allowance for sales discounts, and sales refund payable.

ADJUSTING ENTRIES

ALLOWANCE FOR SALES DISCOUNTS – contra asset account and is reported on the balance sheet as a reduction to the Accounts Receivable asset account.

EXPECTED RETURNS AND ALLOWANCES – two adjusting entries are made: one for the revenue side and one for the cost side. Current Asset -> Inventory Returns Estimated Cost side - Debit inventory returns estimated, credit cost of goods sold

Current Liability -> Sales Refund Payable Revenue Side - Debit sales returns and allowances, credit sales refund payable

NET METHOD - Assuming all discounts will be taken and later adjusting - Sales is the same DISCOUNTS LOST ACCOUNT – expense account reported on the income statement GROSS METHOD - assuming discounts will NOT be taken and later adjusting - Sales is the same

CASH, FRAUD, AND INTERNAL CONTROL INTERNAL CONTROL SYSTEM – policies and procedures used to: - Protect assets - Ensure reliable accounting - Uphold company policies - Promote efficient operations COMMITTEE OF SPONSORING ORGANISATIONS (COSO) - Control environment - Risk assessment - Control activities - Information and communication - Monitoring PRINCIPLES INTERNAL CONTROL -

Establish responsibilities o Tasks should be clearly established o Tasks should be assigned to one person o Can then determine who is at fault

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Maintain adequate records o Protect assets o Helps managers monitor company activities  Detailed records  Use of chart of accounts  Preprinted forms  Prenumbered sales slips  Computerized point-of-sale systems

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Insure assets and bond key employees o Assets should be insured against losses o Employees handling a lot of cash and other assets should be bonded o Bonded means the company has purchased an insurance policy against theft by that employee

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Recordkeeping from custody of assets o Person who control or has access to assets must not have access to that asset’s accounting records o Reduces ricks of theft or waste of an asset o Employees would need to collude, agree in secret to commit fraud under this control

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Divide responsibility for related transactions o Responsibility for a transaction should be divided between two or more individuals o Ensures work of one person acts as a check on the other to prevent fraud o Called separation of duties

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Apply technological controls o Cash register o Time clocks o Personal scanners limits

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Perform regular and independent reviews o Helps ensure that procedures are followed o Done by auditors o Evaluate efference of internal controls

LIMITATIONS OF INTERNAL CONTROL – human error and human fraud CASH, CASH EQUIVALENTS, AND LIQUIDITY – cash and similar assets are called liquid assets because they can be readily used to pay current liabilities CASH – currency, coins, and deposits in bank accounts. Also includes items such as customer checks, cashier checks, certified check, and money orders CASH EQUIVALENTS – short-term, highly liquid investments that are: 1. Readily convertible to a known cash amount – 3 months 2. Close to maturity date and not sensitive to changes CONTROL OF CASH – an effective system of internal control that protect cash and equivalents should meet three basic guidelines: - Handling cash is separated from recordkeeping for cash - Cash receipts are promptly deposited in a bank - Cash disbursements are made by check CASH MANAGEMENT – plan cash receipts to meet cash payments when due, keep a minimum level of cash necessary to operate. - Encourage collection of receivables - Delay payment of liabilities - Keep only necessary assets - Plan expenditures - Invest excess cash APPLY INTERNAL CONTROL TO CASH RECEIPTS AND PAYMENTS

OVER-THE-COUNTER CASH RECEIPTS – none of the people involve can make a mistake or divert cash without the difference being revealed. - The clerk and the cashier have access to cash, but not to the accounting records. - Clerks should be required to give the customer a receipt for each sale. CASH OVER AND SHORT – account showed in the income statement. When errors occur between the cash register and the record of the amount of cash receipts. - Overage: credit cash over and short - Shortage: debit cash over and short CONTROL OF CASH PAYMENTS – require all payment to be made by check; limit access to check except for those who have authority to sign checks. VOUCHER SYSTEM OF CONTROL – established procedures for: - Verifying, approving, and recording liabilities for eventual cash payments - Issuing checks for payment of verified, approved, and recorded liabilities

PETTY CASH SYSTEM OF CONTROL – asset reported on the income sheet. Small payments for items such as shipping fees, minor repairs and low-cost supplies. - To establish a petty cash fund: petty cash is debited to increase, cash is credited to decrease BANK SERVICES - To withdraw money from an account, the depositor can use a check. - Each bank deposit is supported by a deposit ticket. - A bank account is a record set up by a bank for a customer. - A bank reconciliation is a report explaining any differences between the checking account balance according to the depositor’s records and the balance reported on the bank statement

BANK RECONCILIATION - The bank reconciliation is useful in proving the accuracy of the Cash account in the general ledger. - Timing differences between the bank statement and the depositor's records are reflected in the bank reconciliation. - We must reconcile the balance of the bank's records and the Cash account in the general ledger and explain or account for any differences in the two.

OUTSTANDING CHECK – a check written by the depositor that has not yet been received by the bank for payment DEPOSIT IN TRANSIT – deposit made and recorded by the depositor, but not yet recorded on the bank statement NSF CHECK – a check written by a customer who does not have enough money in his account to cover the check BANK CHARGES – service fees charged by the bank CREDIT MEMORANDUM – bank notifies the depositor of each increase to the account with a credit memorandum

DAYS’ SALES UNCOLLECTED – used to estimate how much time is likely to pass before the current amount of accounts receivable is received in cash. It is used to determine if cash is being collected quickly enough to pay upcoming obligations.

RECEIVING REPORT – used within the company to report to purchasing and accounting that ordered goods were received and to describe their quantity and condition.

DIRECT WRITE-OFF METHOD – some customers may not pay their account. Uncollectible amounts are referred to as bad debts. - Two methods of accounting for bad debts: direct write-off and allowance method. - Debit bad debts expense, credit accounts receivable. – Note specific customer o When the payment is received: debit accounts receivable, credit bad debts expense; debit cash, credit accounts receivable ALLOWANCE METHOD – records estimated bad debts in the period, reports accounts receivable on the balance sheet at the estimated amount of cash to be collected. - To establish the account: Debit bad debts expense, credit allowance for doubtful accounts (contra asset account, reported together in the balance sheet with accounts receivable) - For a bad debt: debit allowance for doubtful accounts, credit accounts receivable. o When payment is received: debit accounts receivable, credit allowance for doubtful accounts; debit cash, credit accounts receivable.

ESTIMATE UNCOLLECTIBLES BASED ON SALES AND ACCOUNTS RECEIVABLE 1. Percentage of Sales Method 2. Accounts Receivable Methods a. Percentage of Sales Method b. Percentage of Receivables Method c. Aging of Receivables Method PERCENTAGE OF SALES METHOD – current period sales * bad debt% = estimated bad debts expense PERCENTAGE OF RECEIVABLES METHOD – total estimated bad debts expense – previous balance in allowance account = current bad debts expense AGING OF RECEIVABLES METHOD – classify each receivable by how long it is past due; each age group is multiplied by its estimated bad debts percentage; estimated bad debts for each group are totaled.

NOTES RECEIVABLE – written promise to pay a specified amount of money, usually with interest, either on demand or at a stated future date.

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Maturity date day that the note must be paid. Interest Computation principal of the note * interest rate * time in fraction of year

REALIZABLE VALUE – accounts receivable – allowance for doubtful accounts PROMISSORY NOTE – Written promise to pay a specified amount of money PRINCIPAL – Amount that the signer agrees to pay back, not including interest Amount that the signer agrees to pay back, not including interest INTEREST – Charge from using money loaned from one entity to another Charge from using money loaned from one entity to another MAKER – One who signed the note and promised to pay at maturity PAYEE – The person to whom the note is payable MATURITY DATES – Day that the principal and interest must be paid Day that the principal and interest must be paid...