Perpetual Inventory System
Contains detailed records of each purchase and sale, COGS is determined each time a sale occurs
Periodic Inventory System
No detailed inventory records, COGS is determined at the end of the accounting period (periodically) by means of physical inventory
To determine the COGS under a Periodic System, these 3 steps are necessary
1) Determine the COGS on hand at the beginning of the accounting period
2) Add (+) it to the Cost of Goods Purchased
3) Subtract (-) the Cost of Goods on hand at the end of the accounting period
Which Inventory System is Preferable? Perpetual or Periodic?
Perpetual because it provides better control and it continuously shows the quantity and cost of the inventory on hand at any time, however it does cost more to maintain
When recording purchases of merchandise under the perpetual method, what do you (usually) Dr. and Cr.?
Dr. Inventory
Cr. Accounts payable
What are Freight Costs?
refers to FOB (free on board) point determines who pays
FOB Shipping Point
incurred by the BUYER, buyer pays the freight cost
FOB Destination
Incurred by the SELLER, seller pays the freight cost
When do companies record sales revenue?
When the performance obligation is satisfies (when goods are transferred from the seller to the buyer)
What are sales returns and allowances?
Transactions where the seller either accepts the goods back from a purchaser (a return) or grants a reduction in the purchase price (an allowance) so that the buyer will keep the goods
When there are Purchase Returns and Allowance, what do you Dr. and Cr.?
Dr. Accounts Payable
Cr. Inventory
When there are Purchase Discounts, what do you Dr. and Cr.?
Dr. Accounts Payable
Cr. Cash AND Cr. Inventory
When you record the sales of merchandise, how many entries do you make?
2
Dr. Accounts Receivable
Cr. Sales
Dr. COGS
Cr. Inventory
When there is a Sales Return, what do you Dr. and Cr.?
Dr. Sales Returns and Allowances
Cr. Accounts Receivable
Dr. Inventory
Cr. COGS
When there is a Sales Discount, what do you Dr. and what do you Cr.?
Dr. Cash
Dr. Sales Discounts
Cr. Accounts Receivable
Both Sales Returns and Allowances & Sales Discounts are what type os account....
Contra Revenue Accounts
Is Sales Returns and Allowances increased by a Dr. or a Cr.? (Same with Sales Discount)
Debit
Describe the Single-Step Income Statement
Only 1 step required in determining net income, all data are classified into 2 categories (revenues and expenses)
What are the 2 primary reasons for using the single-step form?
1) A company does not realize any type of profit or income until total revenues exceed total expenses, so it makes sense to divide the statement into the 2 categories
2) The form is simple and easy to read
What are the 3 steps of a Multiple-Step Income?
1) Subtract the COGS from net sales to determine Gross Profit
2) Deduct Operating Expenses from gross profit to determine income from operations
3) Add or Subtract the results of the activities not related to operations to determine net income
Why is the Multiple-step Income Statement more widely used?
More useful, shows gross profit, income from operations, and net income (highlights components of net income)
Gross Profit Equation
Sales - Cost of Goods Sold
Net Income Equation
Gross Profit - Operating Expense
Net Sales Equation
Sales - Sales Returns & Allowances - Sales Discount
T/F: Gross Profit represents the overall profit
FALSE
It represents the merchandising profit of the company
What are Nonoperating Expenses?
Various revenues and expenses/gains and losses that are unrelated to the company's main line of operations
Operating Expenses Equation
Gross Profit - Operating Expense = Income from Operations
Gross Profit Rate Equation (%)
Gross Profit/Net Sales
Whys is the Gross Profit RATE more informative than the Gross Profit Amount?
Because it expresses a more meaningful relationship between gross profit and net sales
Profit Margin Ration Equation (%)
Net Income/Net Sales
T/F: Under both GAP and IFRS, a company can choose to use EITHER a perpetual or a periodic system
True
Does IFRS mention a single-step or multiple-step approach for the income statement?
No
IFRS requires ___ years of income statement information be presented, whereas GAAP requires ___ years
IFRS--2
GAAP--3
2 important steps in the reporting of inventory at the end of the accounting period are...
classifying inventory and determining inventory amounts
What one classification is used to classify the inventory of a merchandising inventory?
Merchanidse Inventory
What are the 3 categories of classifying inventory for a manufacturing company?
1) Finished Goods Inventory--manufactured items that are complete and ready for sale
2) Work in Progress--begun production process but not complete
3) Raw Materials--the basic goods that will be used in production
Under FOB Shipping Point, when does the buyer own the goods?
When the public carrier accepts the goods from the seller (when it's in the truck)
Under FOB Destination, when does the buyer own the goods?
Ownership remains with the seller until the goods reach the buyer
What are Consigned Goods?
Goods held from other parties by a company so the company can try and sell the goods for them for a fee, but without taking ownership of the goods
What is Specific Identification?
You must know exactly which unit was sold (actual physical flow costing method)
What are the 3 Cost Flow Assumptions?
1) FIFO
2) LIFO
3) Average Cost
Which system (Periodic or Perpetual) is used in cost flow?
Periodic System
Cost of Goods Sold =
(Beginning Inventory + Purchases) - Ending Inventory
What is FIFO
First-in, First-out
Assumes that the earliest goods purchased are the first to be sold
The costs of the earliest goods purchased are the first to be recognized in determining COGS
Under FIFO, companies determine the cost of the ending inventory by taking....
the unit cost of the most recent purchase & working backwards until all of the units of inventory have been costed
What is LIFO?
Last-in, First-out
Assumes that the latest goods purchased are the first to be sold
The costs of the latest goods purchased are the first to be recognized in determining COGS
Under LIFO, companies determine the cost of the ending inventory by taking...
the unit cost of the earliest goods available for sale & working forward until all units of inventory have been costed
What is Average-Cost?
Allocated the cost of goods available for sale on the basis of the weighted-average unit cost
What is the Average-Cost Equation?
Cost of goods available for sale/Total units available for sale
Which Cost Flow Assumption results in lower income taxes?
LIFO, because under LIFO you have lower net income
Which Cost Flow Assumption results in higher net income?
FIFO
Income Statement Effects of LIFO/FIFO
In periods of inflation and rising prices, FIFO produces higher net income; LIFO enables companies to avoid "phantom profits
Balance Sheet Effects of LIFO/FIFO
Under FIFO, cost of ending inventory will approximate current costs
Tax Effects of LIFO/FIFO
LIFO results in the lowest income taxes
Inventory Turnover Equation
COGS/Average Inventory
What does Inventory Turnover indicate?
liquidity of inventory by measuring the number of times the average inventory "turns over" (is sold) during the year
Days in Inventory Equation
365/Inventory Turnover
What does Days in Inventory tell us?
the average number of days inventory is held
What is LIFO Reserve?
the difference between inventory reported using LIFO and inventory using FIFO
LIFO Inventory + LIFO Reserve =
FIFO Inventory
Which Cost Flow Assumption does IFRS prohibit?
LIFO
T/F: Do GAAP and IFRS determine market in the lower-of-cost-or-market inventory valuation differently?
Yes
In the lower-of-cost-or-market, IFRS defines market as....
net realizable value
The write down may be reversed under which (IFRS or GAAP)?
IFRS
What is Fraud?
A dishonest act by an employee that results in personal benefit to the employee at a cost to the employer
What are the 3 factors in the "Fraud Triangle
Opportunity
Financial Pressure
Rationalization
Which element is most important in the Fraud Triangle?
Opportunity
What doe internal control do?
safeguard assets, enhance reliability of records, increase efficiency of operations, and ensure compliance with laws and regulations
What are the five primary components of internal control systems?
1) A Control Environment
2) Risk Assessment
3) Control Activities
4) Information & Communication
5) Monitoring
What are the 6 principles of internal control activities?
-Establishment of responsibility
-Segregation of duties
-Documentation procedures
-Physical Controls
-Independent internal verification
-Human resource controls
Explain Establishment of Responsibility
Control is most effective when only one person is responsible for a given task
Explain Segregation of Duties
Different individuals should be responsible for related activities
The responsibility for record-keeping (ex) for an asset should be separate from the physical custody of that asset
Explain Documentation Procedures
Companies should use prenumbered documents and all documents should be accounted for
The control system should require that employees promptly forward source documents for accounting entries to the accounting department
Explain Physical Controls
Relate to the safeguarding of assets & enhance the accuracy and reliability of the accounting records
(Ex: safes, locks, fingerprint scanners)
Explain Independent Internal Verification
Involves the review of data prepared by employees
Companies should verify records periodically or on a surprise basis
Explain Human Resources Controls
Involves bonding employees who handle cash (obtaining insurance protection against theft by employees)
Rotate employees and require vacations
Conduct thorough background checks
What is Reasonable Assurance?
The costs of establishing control procedures should not exceed their expected benefit
Why is the human element an important factor in every system of internal control?
Because a good system can be ineffective as a result of employee fatigue, carelessness, or indifference
What is a Collusion?
When 2+ employees work together to get around prescribed controls
What asset is most susceptible to fraudulent activity?
Cash
Internal control over cash disbursements is more effective when companies pay by.....
Check or electronic funds transfer (EFT) rather than cash
What is a Voucher System?
A network of approvals by authorized individuals, acting independently to ensure that all disbursements by check are proper
What is a Voucher?
An authorization form prepared for each expenditure in a voucher system
How many journal entries does a Voucher System involve?
2- one to record the liability when the voucher is issued, and another to pay the liability that relates to the voucher
What is a Petty Cash Fund?
A cash fund used to pay relatively small amounts
What is a Bank Reconciliation?
the process of comparing the bank's balance with the company's balance, and explaining the differences to make them agree
What is an NFS check
A Non Sufficient Funds check is a check not paid by a bank because of insufficient funds
What does "Reconciling the Bank Account" mean?
Making the balance per books and balance per bank agree with the correct or true amount
What are the 2 causes for a need of reconciliation?
Time Lags
Errors
What are some examples of time lags?
-Deposits in transit
-Outstanding checks
-Bank Memorandum
-Errors
Who should prepare the reconciliation?
An employee who has no other responsibilities related to cash
What are deposits in transit?
Deposits recorded by the depositor that have not been recorded by the bank
What are outstanding checks?
Issued checks recorded by the company that have not been paid by the bank
What are Cash Equivalents?
Short-term, highly liquid investments that are readily convertible to known amounts of cash and so near their maturity that their market value is relatively insensitive to changes in interest rates
What is Restricted Cash?
Cash that is not available for general use but is restricted for a special purpose
What are the 5 basic principles of cash management?
1) increase the speed of receivables collection
2) Keep inventory levels low
3) Monitor payment of liabilities
4) Plan the timing of major expenditures
5) Invest idle cash
What is a liquid investment?
One with a market in which someone is always willing/there to buy or sell the investment