Chapter 8 Exercise Review

Question 1

Why isn’t the total in the stock card reported in the balance sheet

Answer 1

It is only one line of stock. The balance sheet will report the total value of all lines of stock on hand

Question 2

Explain the impact of GST on the recording of transactions in the stock cards

Answer 2

GST has no effect, GST does not affect the economic benefit represented by the stock, so stock cards only record the cost price of stock that is bought and sold.

Question 3

Referring to your answer to part “a”, explain the application of FIFO method of stock evaluation

Answer 3

FIFO assumes that the stock that is purchased first will be sold first. In this example, the 4 units of stock valued at $290 are assumed to be sold before any of the units valued at $300.

Question 4

Explain how the FIFO method of stock evaluation can overstate the value of stock on hand

Answer 4

FIFO assumes that the older stock is sold first, and that the newer stock is still on hand. When prices are rising, this newer stock will be more expensive, overstating stock on hand as it is possible some of the stock on hand is actually the older, cheaper stock.

Question 5

Explain the impact of FIFO on Cost of Sales and Net Profit in times of rising prices

Answer 5

FIFO assumes that the older stock is sold first. When prices are rising this older stock will be cheaper, understating Cost of Sales and overstating Net Profit as it is possible some of the stock sold is actually the newer, more expensive stock.

Question 6

Explain the role of the stock cards in the accounting system

Answer 6

Stock cards are subsidiary accounting records used to maintain a continuous/perpetual record of all movements of stock in and out of the business premises.

Question 7

Referring to one qualitative characteristic, explain the role of the physical stocktake

Answer 7

Reliability:
The stocktake ensures that the figure for Stock Control reported in the Balance Sheet is free from bias and error, by verifying the balances in the stock cards and in the process detecting any stock loss or gain.

Question 8

Apart from theft, suggest other possible reasons for stock loss

Answer 8

Damage
Oversupply to customer
Undersupply from supplier

Question 9

Explain the effect of the stock loss on the balance sheet

Answer 9

Stock Control decreases, decreasing Current Assets by $???. Stock Loss expense decreases Owner’s Equity by $???, decreasing Net profit

Question 10

Explain the effect on owners equity if memo 4 had not been recorded (stock taken home by owner worth $240)

Answer 10

No effect. Drawings would be understated by $240, but the loss of these units would be detected by the stocktake as a Stock Loss, reducing Net Profit by $240. Either way, Owner’s Equity would decrease by $240.

Question 11

Reasons for stock gain

Answer 11

Oversupply by supplier
Undersupply to customer
Recording error in stock card
Counting error in stock take

Question 12

Explain how the stock gain was valued. Identify one accounting principle to support your answer

Answer 12

Conservatism:
The stock gain is valued at the lowest price on hand in the stock card ($650) so that revenues (Stock Gain) and assets (Stock Control) are not overstated.

Question 13

Explain how memo 41 would be reported in the income statement of the firm
Memo 41: “donated 1 system to local school fete”

Answer 13

As Advertising expense under the heading Other Expenses, as it is an outflow of an economic benefit in the form of a decrease in assets (Stock Control), which leads to a decrease in owner’s equity, but it occurs after the goods are ready for sale

Question 14

Looking at a trial balance

Explain whether interest is a revenue or expense for the firm. Justify your answer

Answer 14

It is listed on the debit side of the trial balance = Expense

It is listed on the credit side of the trial balance = Revenue

Question 15

Justify your treatment of customs duty in the income statement

Answer 15

Treated as part of Cost of Goods Sold as it is incurred to bring stock into a location and condition ready for sale.

Question 16

Explain the importance of showing gross profit in the income statement of a trading firm

Answer 16

It is necessary to provide information about the average mark-up, so that the owner can take corrective action where necessary to improve profit. This could mean increasing the mark-up to generate greater profit per sale, or decreasing the mark-up to be more price competitive.

Question 17

Explain your treatment of delivery to customers in the income statement

Answer 17

Treated as an Other Expense as it is incurred to deliver stock from the business to the customer only after the stock is already sold

Question 18

Explain why Drawings is considered to be too high

Answer 18

It is higher than the Net Profit figure meaning Owner’s Equity will decrease

Question 19

Identify the special journal in which:
Details: Inv.X70 - In column
would be recorded

Answer 19

Purchases Journal

IN column means it is a purchase. ‘Inv. X70’ means it is on credit.

Question 20

State reasons for a transaction involving a memo in the stock cards

Answer 20

Advertising

Drawings

Question 21

State 2 reasons why this figure will not be the figure reported as as costs of goods sold

Answer 21

It is only for one line of stock

It doesn’t include other Cost of Goods Sold, such as buying expenses, freight in.

Question 22

Referring to one qualitative characteristic, explain the role of source documents in the accounting process

Answer 22

Reliability:
Source documents provide the verifiable evidence of each transaction to ensure that the information in the reports remains accurate and free from error and bias.

Question 23

order form

Explain your treatment of document X

Answer 23

Not recorded as no transaction has occurred – it is simply an order form.

Question 24

purchase of stock on credit for $1100 inc. GST

Explain the effect of document A on the balance sheet

Answer 24

It increases Stock Control and Current Assets by $1 000. It increases liabilities overall by $1 000: although Creditors Control increases by $1 100, GST Clearing decreases by $100.

Question 25

Memo of stocktake saying stock loss

State the effect on the accounting equation if document D was not recorded

Answer 25

Assets:Overstated (Stock Control)

Liabilities: No effect

Owner’s Equity:Overstated (Understated Stock Loss expense overstates Net Profit)

Question 26

Explain how a physical stocktake may improve reliability in reports

Answer 26

It will verify the stock on hand as recorded in the stock cards, and in the process detect any stock loss or gain, thus ensuring that the figure reported as Stock Control in the Balance Sheet is accurate and free from bias and error.

Question 27

Explain how the use of the FIFO will affect the accounting equation in times of rising prices

Answer 27

FIFO assumes that the older, cheaper stock is sold first, understating Cost of Sales and thus overstating Net Profit and Owner’s Equity. It assumes that the newer, more expensive stock is still on hand, overstating Stock Control and therefore Assets.