The factor which determines whether or not goods should be included in a physical count of inventory is
legal title
Which of the following should not be included in the physical inventory of a company?
Goods held on consignment from another company
The difference between inventory reported using LIFO and inventory using FIFO.
LIFO reserve
Tracks the actual physical flow for each inventory item available for sale.
Specific identification method
Goods that are only partially completed in a manufacturing company.
Work in process
Cost of goods sold consists of the most recent inventory purchases.
Last-in, first-out (LIFO) method
Goods ready for sale to customers by retailers and wholesalers.
Merchandise Inventory
Title to the goods transfers when the public carrier accepts the goods from the seller.
FOB shipping point
Ending inventory valuation consists of the most recent inventory purchases.
First-in, first-out (FIFO) method
The same unit cost is used to value ending inventory and cost of goods sold.
Average cost method
Title to goods transfers when the goods are delivered to the buyer.
FOB destination
Measures the number of times the inventory sold during the period.
Inventory turnover ratio
Two companies report the same cost of goods available for sale but each employs a different inventory costing method. If the price of goods has increased during the period, then the company using
FIFO will have the highest ending inventory
The manager of Weiser is given a bonus based on net income before taxes. The net income after taxes is $35,700 for FIFO and $29,400 for LIFO. The tax rate is 30%. The bonus rate is 20%. How much higher is the manager's bonus if FIFO is adopted instead of
$1,800
The lower of cost or market basis of valuing inventories is an example of
conservatism
All of the following requirements about internal controls were enacted under the Sarbanes Oxley Act of 2002 except:
independent outside auditors must eliminate redundant internal control
Which one of the following is not a primary component of an internal control system?
Rationalization
Each of the following is a feature of internal control except
generic design of documents
Which of the following is not a limitation of internal control?
Collusion
A very small company would have the most difficulty in implementing which of the following internal control activities?
separation of duties
Mrs. Smith has worked for Bosco Inc. for 20 years without taking a vacation. An internal control feature that would address this situation would be
human resource controls
What is the rationale for the internal control principle, segregation of duties?
The work of one employee should, without duplication of effort, provide a reliable basis for evaluating the work of another employee.
Which of the following was not a result of the Sarbanes-Oxley Act?
Companies must file financial statements with the Internal Revenue Service.
Which internal control principle is most important in a control system for handling cash receipts?
Segregation of duties
A NSF check should appear in which section of the bank reconciliation?
Deduction from the balance per books
A bank reconciliation should be prepared
to explain any difference between the depositor's balance per books with the balance per bank
If a check correctly written and paid by the bank for $491 is incorrectly recorded on the company's books for $419, the appropriate treatment on the bank reconciliation would be to
subtract $72 from the book's balance
Outstanding checks
deducted from cash balance per bank
Bank debit memorandum for service charge
deducted from cash balance per book
Bank credit memorandum for collecting a note for the depositor
added to cash balance per books
Deposit in transit
added to cash balance per bank
Collier Company has implemented a just-in-time system, which relies on suppliers to deliver goods for resale as needed. This implementation is most consistent with which of the following basic principles of cash management?
Keeping inventory levels low
Which of the following is not one of the sections of a cash budget
Cash from operations section
A $100 petty cash fund has cash of $16 and receipts of $86. The journal entry to replenish the account would include a
credit to Cash Over and Short for $2
A debit balance in Cash Over and Short is reported as a
miscellaneous expense
Advanced $1,000 to a trusted employee
Other Receivables
Accepted a $2,000 promissory note from a customer as payment on account
Notes Receivables
Determined that a $10,000 income tax refund is due from the IRS.
Other Receivables
Sold goods to a customer on account for $5,000
Accounts Receivables
Recorded $500 accrued interest on a note receivable due next year
Other Receivables
Loaned a company officer $4,000.
Other Receivables
Accounts receivable are valued and reported on the balance sheet
at cash realizable value
If an account is collected after having been previously written off
there will be both a debit and a credit to accounts receivable
Nichols Company uses the percentage of receivables method for recording bad debts expense. The accounts receivable balance is $200,000 and credit sales are $1,000,000. Management estimates that 4% of accounts receivable will be uncollectible. What adjusti
Bad Debt Expense
6,000
Allowance for Doubtful Accounts
6,000
Using the percentage-of-receivables method for recording bad debt expense, estimated uncollectible accounts are $45,000. If the balance of the Allowance for Doubtful Accounts is $11,000 debit before adjustment what is the amount of bad debt expense for th
$56,000
Using the percentage-of-receivables method for recording bad debt expense, estimated uncollectible accounts are $30,000. If the balance of the Allowance for Doubtful Accounts is $4,000 credit before adjustment what is the amount of bad debt expense for th
$26,000
One might infer from a debit balance in Allowance for Doubtful Accounts that
more accounts have been written off than had been estimated
Under the allowance method of accounting for bad debts, why must uncollectible accounts receivable be estimated at the end of the accounting period?
To match bad debt expense to the period in which the revenues were earned.
The collection of an account that had been previously written off under the allowance method of accounting for uncollectibles
does not affect income in the period it is collected
An aging of a company's accounts receivable indicates that $4,500 are estimated to be uncollectible. If Allowance for Doubtful Accounts has a $1,200 credit balance, the adjustment to record bad debts for the period will require a
debit to Bad Debt Expense for $3,300
Bad Debt Expense is considered
a necessary risk of doing business on a credit basis
The interest on a $10,000, 6%, 60-day note receivable is
$100
ABC Company accepted a national credit card for a $7,000 purchase. The cost of the goods sold is $5,600. The credit card company charges a 3% fee. What is the impact of this transaction on net operating income?
Increase by $1,190
The retailer considers Visa and MasterCard sales as
cash sales
Classifying Inventory
How a company classifies its inventory depends on
the business (operating cycle) type
A merchandizing company uses only one inventory
classification, merchandise inventory, to describe the
many different items
- which are owned by the company and ready for sale.
- We are focusing on this merchandise inventory
A manufacturing company uses three categories;
finished goods, work in progress, and raw materials
- Finished goods: manufactured and ready for sale items
- Work in progress: under the manufacturing process items
- Raw materials: purchased but not processed yet items
All companies have to count, weight, or measure
their inventory at the end of accounting period.
- Perpetual system companies count their inventory
� to check the accuracy of their inventory records
� to determine the inventory loss due to damage or theft
- Periodic system companies count their inventory
� to determine the ending balance of inventory
The timing of counting inventory
� Perpetual system counts inventory whenever there is a change
in inventory.
� Periodic system just waits until the end of period.
Determining ownership of goods
Inventory should legally belong to the company.
Goods in transit
- Legal title is determined by the terms of the sale, and
transferred to buyer
� when the public carrier accepts the goods from the seller (FOB
shipping points) or
� when the goods reach the buyer (FOB destination).
Consigned goods
- Consigned goods are ones that legally belong to an
owner but are sold by a dealer for a fee.
� This inventory should not be included in the dealer's financial
statements, but be included in the owner's statements.
The inventory costing is the systematic and
consistent process of
- determining the cost of ending inventory and
- allocating COGS to match with Sales in that period.
Three main variables related to this process are
- 1. the amount of inventory purchased
- 2. the price of inventory purchased
- 3. the date of purchases and sales, if a company uses
perpetual system.
What is the incentive for managers to report high
earnings?
� Because they want to maintain or improve stock price
performance, which is closely related to managers' salary,
bonus, reputation, and job security or opportunity.
� And inventory comprises major portion of operating cost for
most companies, and is easy
The overstatement of ending inventory
� decreases the cost of goods sold,
� therefore, increases gross profit and net income,
� which increases tax expense at the same time.
Specific identification is a way to allocate
inventory cost by matching goods in inventory
with goods sold one by one.
- Theoretically correct, but only possible if there are a
few inventory to monitor, such as expensive antiques.
- Easy for managers to manipulate net income by selling
low cost inventory first or high cost inventory last.
What is the difference between specific
identification and perpetual system?
Perpetual system does not keep track of individual
goods and does not match goods purchased with
goods sold one by one.
It is not possible, or impractical to match goods in
inventory with actual goods sold.
- Therefore, we assume a specific flow of cost, which may
differ from actual physical flows of goods.
� Which means that companies treat all physical inventory same
regardless of their cost, once they are purchased and placed in
warehouse.
� Which means t
First-in, First-out (FIFO)
- FIFO method assumes that the first goods purchased
are the first to be sold.
� The ending balance is calculated by taking the unit cost of the
most recent purchase and working backward until all units of
inventory have been costed.
� The COGS is calcula
Last-in, Fast-out (LIFO)
- LIFO method assumes that the last goods purchased
are the first to be sold.
� The ending balance is calculated by taking the unit cost of the
beginning inventory balance and working forward until all
units of inventory have been costed.
� The COGS is ca
Average cost
- Average cost method allocates the cost of goods
available for sale on the basis of weighted-average unit
cost incurred.
� The ending balance is calculated by applying the weighted average
unit cost to the units on hand
� The COGS is calculated by subtra
In periods of changing prices, the cost flow
assumption can have a significant impact
on COGS, net income, and evaluations based on NI
In the period of inflation (rising prices),
- FIFO reports highest ending inventory, lowest COGS,
and highest net income (tax) among three methods,
� because the lowest unit costs of the first units purchased are
matched against revenues.
- LIFO reports lowest ending inventory, highest COGS,
and lo
Inventory is accounted for at cost, not market value
- Cost includes all expenditures necessary to acquire
goods and place them in a condition ready for sale.
� E.g., freight-cost, storage space cost, insurance cost, legal fee.
Do companies always have to record inventory at
cost if there is great depreciation in value? NO!
- The value of inventory can drop quickly in tech, food,
and fashion industry
� due to technology advancements, expiration, and new trends.
- The second exception to historical cost principles.
� The first one is the fair value reporting requirement for
a
The Lower-of-cost-or-market (LCM) allows
companies to use current replacement cost
instead of historical cost.
The current replacement cost is the cost of purchasing
the same goods at the present time form the usual
suppliers in the usual quantities
LCM is an example of accounting conservatism
which requires companies to report lower number
US GAAP does not allow companies to reverse
inventory write-downs
- even after inventory increases in value subsequently.
- But IFRS permits companies to reverse it in some cases
Inventory is accounted for at cost, not market value.
- Cost includes all expenditures necessary to acquire
goods and place them in a condition ready for sale.
� E.g., freight-cost, storage space cost, insurance cost, legal fee.
45% of US companies use FIFO.
- 24% and 16% of US companies use LIFO and Averagecost
method, respectively.
Some critiques argue that LIFO provides an unfair
tax dodge, because LIFO usually reports lower NI.
But proponents argue that LIFO reflects real, current cost of production and reduces the possibility of paper profit under FIFO
IFRS does not allow the use of
LIFO
LIFO conformity
Tax regulations require that if companies use LIFO for tax purposes they must also use it for financial reporting purposes
LIFO reserve
- companies using LIFO are required to report the difference between inventory reported using LIFO and inventory using FIFO
- this amounts to referred to as the LIFO reserve
Fraud
a dishonest act that results in personal benefit at a cost to a company
Fraud triangle
fraud is usually predicted or explained by three factors
- opportunity
- financial pressure
- rationalization
Sarbanes-Oxley Act
- internal control system: companies have to maintain adequate internal control system, managers are required to assess and report the effectiveness and reliability of internal control system, violations can result in fines up to $5million and prison pena
internal control
- Internal control is all measures adopted to safeguard assets, enhance the reliability of accounting records,increase efficiency of operations, and ensure compliance with laws and regulations.
5 components of internal control
- A control environment: general attitudes toward fraud
- Risk assessment: identification of risk factors
- Control activities: policies and procedures to address identified risk
- Information and communication:
- Monitoring: on the regular and random bas
Internal control activities
- The specific control activities used by a company vary, depending on
� management's assessment of the risks faced
� the size and nature of the company.
6 principles of control activities
- Establishment of responsibility
- Segregation of duties
- Documentation procedures
- Physical controls
- Independent internal verification
- Human resource controls
Establishment of responsibility
- Control is most effective when only one person is responsible for a given task
� which makes it possible to identify responsible person.
Segregation of duties
- The work of one employee should provide a reliable, verifiable basis for evaluating another's work.
� The responsibility for record-keeping for an asset should be separate from the physical custody of that asset.
Divide and control
� Companies should assign related sales activities to different individuals; e.g., ordering, delivery, cash collection activities should be assigned to different employees.
Documentation procedures
- Documents provide evidence that transactions and events have occurred
- Companies should use pre-numbered (traceable) documents, and account for all documents recorded,
� which helps to ensure timely recording of the transaction and contributes to the a
Physical controls
- Physical controls relate to the safeguarding of assets; e.g., safes, locked warehouses, and other advanced security systems such as fingerprint scanner, security camera, and motion detectors.
Independent internal verification
- This principle involves the review of data prepared by employees
� It is useful in comparing recorded transactions with existing assets
Human resource controls
- This principle includes 1. bonding employees, 2. rotating employees' duties, 3. conducting background check
� Bonding is to obtain insurance protection against theft by employees
Documentation procedures
- Documents provide evidence that transactions and events have occurred
- Companies should use pre-numbered (traceable) documents, and account for all documents recorded,
� which helps to ensure timely recording of the transaction and contributes to the a
limitation of internal control
- Companies design their internal control systems to provide reasonable assurance of proper safeguarding of assets and reliability of the accounting records.
� The cost of control system < the expected benefit
- The human element can deteriorate the effec
Cash is the most liquid, vulnerable assets.
- Control activities should apply to both cash receipts and disbursements process
- Generally, the control over cash is the stronger when individuals have less control over cash.
Voucher system
- A voucher is an authorization form prepared for all types of cash expenditure,
� which is similar to a check, but includes more detailed transaction information based on invoice and receipts.
� which enables establishment of individual responsibilities
Petty Cash Fund
- Using checks to pay small amounts as those for postage due, taxi fares, and lunches is both impractical and not cost-effective
- Petty cash fund is the stipulated amount of cash allocated to each responsible custodian
establishing fund
- A company establishes the petty cash fund by issuing a check payable to the custodian
� The custodian cashed the check and places the proceeds in a cash box
Making payments from petty cash
- The custodian has the authority to make payments that conform to prescribed management policies.
- The custodian keeps the receipts in exchange for cash; the sum of receipts and cash in the box should equal the established amount.
Replenishing the petty cash fund
- A company should replenish a fund
� when a fund reaches a minimum level, or at the end of the accounting period
- If receipts + cash remaining in the box < initial fund:
� Debit "Cash over and short" for this difference in order to report that amount of
Banks facilitate a company's control over cash
by safeguarding cash and by providing an independent cash transaction record
the need for reconciliation
time lag of recording, errors