Midterm 2 (9-17) Flashcards
Assets should end with a __ balance
DEBIT
- If it ends with credit it really changes accounts and becomes an account payable
- if cash has a credit balance at the end it is NOT an asset
Retained Earnings can have an ending debit balance
- RE = NI-Dividends
- NI = Rev - Exp
- if expenses cost more that revenues - in startup companies
- but would really be called a retained deficit or cumulative losses
Steps to Fin Systems
- Identify
- analyze
- record in journal
- post to general ledger
- prepare trial balance
- Journalize and post to ledger any necessary adjusting entries at end of period
- Prepare fin stmts
- Journalize and post Closing entries
Accrual basis accounting
Timing of revenues and expenses with 2 principles: Revenue recognition principle and matching principle
- required by GAAP bc statements are for creditors and investors
- don’t want to be able to manipulate timing of revenues and expenses
Revenue Recognition Principle (Accrual)
TIMING OF REVENUES
-Revenues are to be recognized/recorded in the period in which they are EARNED, not received
Matching principle
TIMING OF EXPENSES
- Expenses recognized in period in which those costs provide benefit to the business operations
- expenses matched against revenues they HELPED PRODUCE, not necessarily period in which cash is paid
Cash basis accounting
Used for personal income taxation
- allowed by IRS
- ability to pay concept
- there are opportunities for income manipulation
- —don’t have to pay income tax til next year bc didn’t receive income until the year after
Adjusting Entries required to comply with accrual basis accounting
- Prepaid expenses (matching)
- unearned revenue (revenue recognition)
- unpaid and unrecorded expenses (matching)
- uncollected and unrecorded revenues (recognition)
Prepaid expenses adjusting entry
Insurance purchased 12 months in advance on 10/1 (Asset)
-right to next 12 months of insurance
Entry at 10/1
Prepaid Insurance expense 1200
Cash 1200
Adjusting entry at year end (3 months)
Insurance expense 300
prepaid Ins. Exp 300
PREPAID INSURANCE EXPENSE (T chart)
10/1/X1 1200
300 12/31/X1 (Adjust)
Balance 900
-(9 months future benefit of $900)
-MATCHING PRINCIPLE (prepaid ins exp, rent exp)
If don’t fix you:
-underestimate expenses
-overestimate assets, net income, retained earnings, and owners equity
-liabilities not affected
Unearned Revenue adjusting entries
Receives 3000 in advance on 12/1/X1 for consulting services for next 2 months (liability)
Entry at 12/1/X1
Cash 3000
Unearned fee rev. 3000
Adjusting entry 12/31/X1
Unearned fee rev 1000
fee revenues 1000
UNEARNED FEE REVENUES
3000 12/1/X1
12/31/XI (adjust) 1000
2000 (balance) 12/31/X1
-(2 months times 1000 - liability of 2000 for 2 more months)
REVENUE RECOGNITION PRINCIPLE If didn't adjust -overestimate liabilities -underestimate revenues, NI, RE, OE -no affect on assets
Unpaid and unrecorded expenses adjusting
Employees work Dec. but receive wage at 1/15/X2
-must adjust for 12/31/x1 but not previously recorded
Adjusting entry at 12/31/X1
Wage expense 10000
Wage payable 10000
1/15/X2
Wage payable 10000
Cash 10000
(Utility expense
utility payable)
MATCHING PRINCIPLE
If didn’t adjust
-overestimate NI, RE, OE
-Underestimate liabilities and expenses
Uncollected and unrecorded revenues adjust
Company earned 500 interest on a loan at end of year X1, even though expect to collect loan at end of next year
Adjusting entry 12/31/X1
Interest receivable 500
Interest income (rev) 500
(consulting receivable
consulting fee revenue)
REVENUE RECOGNITION
If didn’t fix
-underestimate revenue and net income
Real vs. Nominal accounts
REAL
- All accounts on the balance sheet (A, L, OE, CS, RE)
- Balance of account is a CUMULATIVE running balance
- reflecting all transactions since inception of the business
NOMINAL
- all INCOME statement accounts (rev/exp/dividends)
- do not maintain cumulative running balance since inception but accumulates period by period (yr by yr)
- nominal accounts are closed at end of account period and their amounts are transferred to RE, then start at 0 again for new period
Closing entries
- All rev, exp, and divined accounts must be reset to 0 to start next accounting period
- Retained earnings account must be updated to include the amount of net income (R-E) less dividends for the current year
SALES REVENUES
0 1/1/X4
550,000 X4 transactions
550,000 12/31/X4
Closing entry 550,000
0 1/1/X5
Closing entry at 12/31/X4
Sales revenues 550,000
retained earnings 550,000
Retained earnings
RETAINED EARNINGS
10000 1/1/X2
15,000 NI
Dividends 5,000
20,000 12/31/X2 (balance)
- alternative to closing entries is stmt of retained earnings
- close all income stmt accounts to RE (cost of goods, expenses, revenues)
- less any dividends
DIVIDENDS entry
Retained earnings 5000
dividends 5000
Closing entries 2
DEBIT HAS TO EQUAL CREDIT
- sales revenue would close on debit side
- cost and expenses would close on credit side
- difference in the entry would be the retained earnings (whether a loss or gain)
Retained earnings
6,800 X1
net loss 2,200
dividends 500
4,100 (Balance X2)
Dividends
Can pay dividends in a net loss with retained earnings from last year
-can’t pay dividends unless you have retained earnings to do it
Inventory example
- inventory 1/1/X3 25,000
- inventory 12/31/x3 23,000
- cost of goods sold x3 - 100,000
INVENTORY Balance
1/1/X3 25,000
100,000 cost
(FIND = 98,000)
12/31/X3 23,000
Inventory 98,000
Cash 98,000
Cost of goods 100,000
inventory 100,000
Problem with wages
Dec. 31 is Tues - wages paid Fri and weekly payroll (5 days) is $4000. What should adjust on 12/31/
12/31/X1 adjust
Wage expense 1,600
Wage payable 1,600
(been 2 days - owe two days of wages - bc next 3 are in new year)
Revenues
The amount of inflowing assets from the sale of goods/services to customers - ant usually reflected in the sales price charged to customers
timing - revenues are recognized when they are EARNED not when cash is received from customers
-typically earned when goods sold have been delivered to customer or services to be provided have been rendured
Complicating revenue transactions
- Providing of sales or cash discounts to credit customers to encourage early payment on account
- acceptance of merchandise returns from customers
- the uncollectibility of customer accounts receivable
- the acceptance of payment of credit cards
Sales (cash) discount adjust
Company sells merchandise costing $600 to a customer on account for $1,000 with terms of 2/10, N/30
2/10, N/30 means customer may take 2% discount of all or portion of price paid within 10 days of sale. Any portion of price not paid within the 10 day discount period is due within the next 20 days (30 days from date of sale) in full
- 2 = amount of discount (2%)
- 10 = how long discount period lasts
- N/30 = portion that has not been paid off must be paid by then
to encourage customer to pay A/R early
Entries of NOT paid within discount period
AT DATE OF SALE
Accounts receivable 1000
sales revenue 1000
cost of goods sold 600
inventory 600
AT DATE OF COLLECTION
Cash 1000
A/R 1000
if a penalty or interest is charged to credit customer for payments received AFTER 30 days
Cash XXX
interest revenue XXX
Calculate discount in terms of 2/10, N/20
1000 X 2% = $20 discount available
calculate amount of interest
Interest rate X principle amount X time period = interest amt.
36% X $1,000 X 1 year = $360 annual interest
$360 annual interest = $1 interest per day
10th day - borrow $980 from bank (to pay off with discount)
- 10% X $980 X 20/360 = $5
- pay back bank $985 on 30th day
Entries if paid within discount period
AT DATE OF SALE
Accounts receivable 1000
sales revenue 1000
cost of goods sold 600
inventory 600
AT DATE OF COLLECTION WITHIN 10 DAYS
Cash 980
Sales discounts 20
A/R 1000
Sales discounts is a contra-revenue account (reduction of revenue account) - nominal and must be closed to RE at end of period
Income statement
sales revenues 1000
Less: sales discounts (20)
Net sales revenues $980
-Net sales revenues is gross sales revenues less any contra-revenues
Sales return adjust
Company sells 10 bikes which cuts $100 each to a customer on account at a price of $150 each
-2 days later the customer returns on bike for credit on his account bc he only needs 9 bikes
ENTRY AT DATE OF SALE
Accounts receivable 1500
sales revenues 1500
Cost of goods sold 1000
inventory 1000
ENTRY AT DATE OF RETURN
Sales returns and allowances 150
accounts receivable 150
Inventory 100
cost of goods sold 100
Sales returns and allowances are contra-revenue account
Net sales revenues
Sales revenues less any contra-revenues
Gross Margin
Net sales revenues less cost of goods sold
- not net income bc that includes ALL expenses
- this only includes cost of goods sold
Gross Margin tells us our markup - how much we have marked up the price above the cost of goods sold
Income stmt for revenues and gross margin
Sales revenues $1500
Less: Sales discounts 0
Sales returns/allowances (150)
Net sales revenues $1350
Less: cost of goods sold (900)
Gross Margin (profit) $450
(9 bikes X $50 profit/bike)
Markup
Net sales price per unit $150
Cost of goods sold per unit ($100)
Gross margin/markup per unit $50
9X$50 = $450 = total gross margin or markup on sale
Gross margin/markup as a % of sales
450/1350 = 50/150 = 33.3%
Gross margin/markup as a percent of cost
450/900 = 50/100 = 50% (more accurace)
What would be sales price at?
100% markup on cost? $100 X 100% = $200
200% markup on cost? $100 X 200% = $300
Sales return ex continued
What was cost of company’s return policy which allowed for return of one unit?
- Gross margin before return = 10 X $50/unit = $500
- Gross margin after return = 9 X $50/unit = $450
- cost of return = $50
-worth it? decrease margin but increase customer loyalty
If returned merchandise has no future value once returned ENTRY AT DATE OF SALE A/R 1500 Sales revenues 1500 Cost of goods 1000 inventory 1000
ENTRY AT DATE OF RETURN
Sales returns and allowances 150
accounts receivable 150
-skip cost of goods credit and inventory debit bc it is no longer an asset bc no future benefit
Why use contra-revenue accounts instead of just debiting sales revenues?
-better information for management
Sales return example 2
Cost of goods is 70% its selling price
.7 X 100,000 = $70,000
4/3 JOURNAL ENTRY
A/R 100,000
Sales revenue 100,000
Cost of goods 70,000
inventory 70,000
4/13 journal entry
Cash 49,000
Sales discount 1,000
A/R 50,000
5/2 journal entry
Cash 34,000
A/R 34,000
sales returns and allowances 16,000
A/R 16,000
inventory 11,200
cost of goods sold 11,200
-return = 16,000 X .7 = 11,200 (inventory returned)
Gross margin = 24,200
% markup on cost = 41% (24,200/58,800 = gross margin/cost of goods sold)
Income stmt if returned goods were unusable
Net sales revenues 83,000
Less: cost of goods (70,000) - full cost bc returned goods cannot be resold
Gross Margin $13,000
% markup on cost = 1.9% (13,000/70,000)
Accounting for uncollectible accounts receivable
Business makes a sale on account and gives them 30 days to repay - usually B2B
-always a risk that these sales will go bad and you won’t be repaid bc customer is unable to pay
Subsidiary ledger
A set of accounts that provide detail for a general ledger
- customer by customer - more detail to keep track on each transaction
- must post to BOTH general and subsidiary ledgers - should = each others ending balance
Uncollectable accounts receivable example
Jones Wholesale candy started business on Jan X4
-revenues were $120,000 - 20% were cash sales and rest were on account - cost of goods was $70,000
Cash (20% X 120,000) 24,000
A/R 96,000
Sales revenue 120,000
Cost of goods 70,000
inventory 70,000
Made collections of A/R 85,000
Cash 85,000
A/R 85,000
ACCOUNTS RECEIVABLE
1/1/X4 0
96,000
85,000
12/31 balance 11,000
-not known if these 11,000 are uncollectible - however it is known that $920 is uncollectible
-need to reduce assets (A/R) bc there is no probable future benefit
20X5
Bad debt expense 920
A/R 920
-BUT THIS GOES AGAINST MATCHING PRINCIPLE
—-expenses must be accounted for at time they helped make revenue - revenue earned in 20x4 but this bad debt expense is in 20x5 - didm’t know this A/R would go bad
Allowance method for bad debt
Uses estimation of uncollecible A/R to reflect bad debt expense in the proper period and is required under GAAP
-we hope all accounts will go through but we must estimate a percentage that will in order to comply with the matching principle (therefore it is already accounted for)
Prepare adjusting entry for 12/31/X4 assuming 10% of the 12/31/x4 balance of A/R will be uncollectible
10% X 11,000 = 1,100
12/31/X4
Bad debt expense 1,100
Allowance/reserve for uncollectible A/R 1,100
- is a contra-asset account to reflect estimated amount of uncollectible A/R
- can’t just credit A/R bc then you have to go update subsidiary ledger on a specific customer account - and it is an estimate so you can’t guess which specific customer will be uncollectible
Balance sheet adjustment fir bad debt expense
Current assets:
A/R 11,000
Less: allowance for (1,100)
uncollectible A/R
Net realizable value 9,900
Net realizable value - net we think we are going to collect
Allowance for uncollectible A/R is a real account - increase with credit entries and ends with a credit balance
Uncollectible A/R example continued for following year
in 20x5 revenues = 210,000, 70% on account and rest in cash
-cost of goods sold = 60% of total sales rev
Cash (30% X 210,000) 63,000
A/R 147,000
Sales revenue 210,000
cost of goods sold 126,000
inventory 126,000
Collections in 20x5 of the 11,000 12/31/X4 balance totaled 10,080 (all but the 920 we knew was uncolletible)
-and collections of 117,000 of sales on account in 20x5
Cash 10,080
A/R 10,080
Cash 117,600
A/R 117,600
920 was proven uncollectible and must be written off books
-not bad debt expense bc you already estimated this and would be double counting the expense
Allowance for uncollectible A/R 920
A/R 920
-was credited by an estimate bc you don’t know who will go bad, now you know so must debit this account
ALLOWANCE FOR UNCOLLECTIBLE A/R
1,100 12/31/X4
write-off bad 920
180 (balance - overestimated uncollectible
Accounts receivable
12/31/X4 11,000
147,000
10,080 (Collect from X4)
117,600 (Collect in X5)
Balance
before write-off 30,320
920 (Write-off)
Balance 29,400
what is affect of a write-off of A/R on the balance sheet
0 affect on balance sheet (Reduce asset and contra-asset)
also 0 affect on income stmt
-just cleans up the books - the effect was in old entries
Allowance for uncollectible A/R
- If it ends in CREDIT = Overestimated uncollectibles
- ends in DEBIT = underestimated uncollectibles
- can fix over/under estimate by compensating for prior year in estimation of current year
- —overstated bad debt expense in 20x4 by $180, so understate it by $180 in 20x5
Prepare adjusting entry at 12/31/X5 for estimated bad debt expense with 8% of the balance of A/R
- ending balance of A/R was $29,400
- –8% of 29,400 = 2,352 - 180 (overestimate) = 2,172
12/31/X5 ADJUSTMENT
Bad debt expense 2,172
Allowance for uncollectible A/R 2,172
But the ledger for Allowance would have ending balance at 12/31/X5 OF 2,352 (8% X 29,400) - it would be compensated by the adjustment
Aging of accounts receivable to estimate uncollectibles
-look at subsidiary ledgers to see how old each A/R are - oldest are more likely to go bad
current A/R = 15,000 (5% estimated uncollect) = 750
past due:
0-30 days = 8,000 (8% estimated) = 640
30-60 days = 3,000 (10% estimated) = 300
-keep multiplying by % and add up the estimates)
= $2,270 (vs. the guessed 2.352)
-aging is a better estimate from business experience than guessing the 8% previously
ALLOWANCE FOR UNCOLLECTIBLE A/R LEDGER
1,100 12/31/X4
Writeoffs 1,280
Underestimated 180
2,450 adjust
2,270 (12/31/X5 balance)
Bad debt expense 2,450
Allowance for uncollectible A/R 2450
-make sure you don’t use the 2,270 we found!! have to do the adjustment including the overestimate/underestimate
Sales price =
Cost + markup
X + (% x X
Net realizable value =
A/R less contra-assets
- A/R - final balance of Allowance for uncollecible A/R
- (not A/R less the adjustment you used in the journal entry, it is the total A/R ending balance)
Writeoff entry
Allowance for uncollectible A/R XXX
A/R XXX
Company wrote off then ended up getting it
A/R 500
Allowance 500
Cash 500
A/R 500
T/F allowance for uncollectible A/R will ALWAYS end with credit balance
TRUE
T/F allowance account will be closed to RE
False
-balance sheets are real accounts - never closed - cumulative running balance
T/F management’s estimate of uncollectible A/R at year end will always = the amount of bad debt expense for the year
FALSE
-could have over or underestimated in prior year and must compensate for this in next year
T/F matching principle requires the “bad debt expense” be accounted for on an estimated basis rather than when uncollectibility of an A/R is actually determined
TRUE
Credit Card sales
- Customer makes charges on card and must pay customer’s bank
- customer swipes at restauraunt, immediately sends credit card verification to customer’s bank
- once approved, then restaurants bank credits the restaurant’s account, but bank charges fee to restaurant
- customers bank then electronically transfers funds to restaurants bank to cover the amount charged on card
- then customer pays charges to their own bank
- restaurant gets money like cash (not A/R), but with a charge for accepting the card
Credit card sales adjust entry
Company sells merchandise costing 1000 to a customer for 2000
- customer pays with VISA
- company has agreed to pay 4% fee on all VISA sales for the right to accept VISA as payment
ENTRY AT DATE OF SALE
Cash 1920
credit card expense 80
Sales revenues 2000
cost of goods sold 1000
inventory 1000
-company pays fee for allowing customers to pay with card
Amount to charge to new $100 cash in a credit sale
Cash 97
Credit card fee 3
sales revenues 100
(X) x (97%) = 100
X = 103.09
Two ways to estimate bad debt
- The % aging of A/R method
2. % of credit sales method
A/R information
A/R ledger Beginning balance (Debit) -debit (+ credit sales) -credit (- cash collections, write-offs) ending balance (Debit)
Allowance ledger Beginning balance (Credit) -debit (- write-offs) -credit (+ estimate bad debt expense) Ending balance (Credit)
Journal entries
1. record credit sales on account (A/R increases)
A/R XXX
sales revenue XXX
- Cash collections on A/R (A/R decreases)
Cash XXX
A/R XXX - Write-offs on A/R (A/R decreases)
Allowance XXX
A/R XXX - estimate bad debt expense (ALWAYS)
Bad debt expense XXX
allowance for bad debt XXX
Estimating bad debt expense - % of A/R Aging method
USES BALANCE SHEET
Allowance ledger
beginning credit balance
write-offs
XXX
(CALC THIS #) - ending balance of A/R
EX. Aging - added percentages = 54,100
Allowance ledger
50,000 beginning
w/off 42,000
8000 (overestimate)
46,100 adjust
54,100 ending balance
JOURNAL ENTRY
Bad debt expense 46,100
Allowance for uncollectible A/R 46,100
-this method calculates the ending balance $ and you solve for the adjusting # to put in the journal entry
Estimating bad debt expense - % of credit sales method
USES INCOME STATEMENT
Allowance ledger
beginning credit balance
Write-off
(CALC THIS # - % of CR sales)
ending balance
EX. sales were 874,000 (estimates 5% will go bad)
874,000 X .05 = 43,700
Allowance ledger
50,000 beginning
W/off 42,000
43,700 adjust
51,700 Ending
JOURNAL ENTRY
Bad debt expense 43,700
allowance for bad debt 43,700
-this method calculates the adjusting entry # which you use in the journal entry - then you add for the ending balance #
Perpetual inventory accounting
Means every transaction involving an inflow and outflow of inventory is recorded as it happens with a debit/credit to inventory account
-as a result, inventory account in general ledger will maintain a running balance of the amount of inventory on hand at any point in time
- most perpetual inventory accounting systems utilize a subsidiary ledger
- item by item
Effect of computerized systems in accounting for inventory
- Especially useful in managing SEASONAL INVENTORIES
- see how much is left, whether to discount day of holiday - Can help us discovery GEOGRAPHIC and DEMOGRAPHIC rends relative to sales
- Can help us identify relationships btwn different products purchased by similar costumers (snacks and diapers)
Example of perpetual inventory accounting given factors of purchase discounts/returns
11/1/X2 Joe buys inventory of 20 bikes for $100 on terms 2/10, N/30
- 2 days later Joe returns one defective bike for credit
- on 11/9/x2 joe pays balance due net of the discount
DATE OF PURCHASE
Inventory 2000
accounts payable 2000
DATE OF RETURN
Accounts payable 100
inventory 100
PAYOFF WITH DISCOUNT (2% X 1900 = $38)
Accounts payable 1900
Cash (1900-38) 1862
inventory 38
decreased the cost of the inventory by paying with discount - don’t use contra-inventory account
Accounting for inv. perpetually required accounting for the inflow and outflow of the # of units as any increase of decrease in the cost of those units
- original cost of bicycles (20 @ $100 each)
- true cost (20 @ $98 each)
- true inventory balance (19 @ $98 each = 1862)
Inventory ledger
2000
100 (return 1 unit)
38 (discount of 2% X 1900)
1862 (ending balance)
Inventory cost flows complications
Start used car business and buy 3 cars for resale
-buy old VW bug (2000), camaro (4000), pinto (6000)
Journal
- debit all inventory
- credit all cash
One car sold for 7000
Cash 7000
sales revenues 7000
cost of goods ?
inv. ?
-don't know which car sold?
If Pinto
cost of goods 6000
inventory 6000
-Gross margin/profit = rev-cost of goods sold = 1000
If VW bug
Cost 2000
inv. 2000
-gross margin = (7000-2000) = 5000
Inventory jellybean example
Start business that sells jellybeans purchases 3 times
- 10 lbs. @ $2/lb. = $20 (first purchase, bottom of jar)
- 10 lbs. @ $2.50/lb. = $25 (middle of jar)
- 10 lbs. @ $3/lb. = $30 (top of jar)
- total inventory is 75
if customer buys 1 lb. of jellybeans we don’t know what the cost is bc they could be jellybeans from any of the 3 purchases - price kept increasing from supplier
LIFO (Last in first out) - customer scoops in and takes 1 lb. from top of jar - would be form the last purchase ($3/lb.)
ENTRY
Cost of goods 3
inv. 3
FIFO (First in first out) - customer reaches to bottom of jar
Entry
Cost of goods 2
Inv. 2
AVERAGE COST - customer mixes around and takes a mixture of the 3 inventory costs
(75 / 30 lbs. = $2.50 per pound)
ENTRY
Cost of goods 2.50
inv. 2.50
Depending on which method has a significant impact on PROFITABILITY IN INCOME STMT
Comparing btwn methods in jellybean example
LIFO
- net sales rev. $4
- Less: cost of goods sold (3)
- Gross margin = $1
- ending inventory balance = $72
FIFO
- net sales rev. $4
- Less: cost of goods sold (2)
- gross margin = 2
- ending inv. balance = $73
Average
- net sales rev. $4
- Less: cost of goods sold (2.50)
- gross margin = 1.50
- ending inv. balance = 72.50
THERE WOULD BE NO DIFFERENT IN AMOUNT OF COST OF GOODS SOLD BTWN METHODS IF ALL THE INVENTORY WAS SOLD
at supermarket they try to sell at FIFO and we try to buy at LIFO
What method of inventory accounting would you choose?
GAAP ALLOWS ANY METHOD
-but method must be consistently used over time
to impress investors:
-lowest cost and highest market (FIFO in ex.)
to pay less income tax
-highest expense and lowest margin (LIFO in ex.)
Whatever method you use for fin. reporting to creditors/investors you must also use for income tax reporting
- if the ex. was actually in a deflationary env. (supply cost kept decreases) - the methods of FIFO and LIFO would product the opposite results
- if there are stable prices in the env, there is no change btwn LIFO and FIFO
in the case of cars identification is required by GAAP in cost bc that is more accurate in the gross margin in the end
-any methods can be used in jellybean example because the jellybeans all appear to be alike
Effects of LIFO and FIFO
Inflation environment -cost increases as time goes on -first costs have lower price (FIFO) -last costs have higher price (LIFO) LIFO -higher cost of goods sold -lower net income and taxes FIFO -lower cost of goods sold -higher net income and taxes
Deflation env. -cost decreases with time -first costs have higher price (FIFO) -last costs have lower price (LIFO) LIFO -lower cost -higher net income and taxes FIFO -higher costs -lower net income and taxes
Which inventory cost flow method would product the highest tax liability in a period of deflation?
LIFO
Which inv. cost flow method would result in a higher ending inventory balance in a period of inflation
FIFO
Which will result in ending inventory that utilizes the most recent costs?
FIFO
Affect on net income in stable prices
no difference between methods
-no difference on net income of all inventory is sold
FIFO example
Inventory ledger
- (1000 X $20) = 20,000 - beginning balance of inv.
- (300 X $21) = 6,300 - purchased 300 inv. @ $21 each
- sold 400 units (go to First in, so the ones that cost $20 per unit = 400 $20 = $8000 cost of goods sold - and now there are 600 left of the $20 ones
- so when sell 500 = 500 X 20 = 10,000 cost - now 100 left of the $20 ones
- sell 500 - (100 X $20) + (300 X $21) + (100 X 22) = 10,500 cost of goods - used up all $20 and $21 inv.
LIFO example
Inventory ledger
(1000 X $20) = 20,000 beginning balance
(300 X $21) = 6,300 - 300 purchased at $21 each
-sold 400 units - go to last in = (300 X $21) + (100 X $20) - now have none of the 21 left and 900 of the $20 left
-just continue using the latest inventory costs in
Moving weighted average example
Inventory ledger (1000 X $20) = 20,000 beginning inventory balance (300 X 21) = 6,300 MWA = (26,300 / 1,300) = 20.23 per unit -sold 400 (400 X 20.23) = 8,092 -purchased 400 @ $22 per unit = 8,800 MWA = (900 left X 20.23) = 18,207 + 8,800 (27,007 / 1300) = 20.77 per unit -sold 500 (500 X 20.77) = 10,385 cost -purchased 600 @ $23 each = 13,800 MWA = (800 left X 20.77) = 16,616 + 13,800 (30,416 / 1400) = 21.73 per unit -sold 500 (500 X 21.73) = 10,863
ending balance = 19,560
The three methods change:
cost of goods sold
- therefore changing gross margin
- also changing % markup (gross margin/ cost)
Physical inventory
Go out and actually count inventory
- periodic physical inv. necessary even tho we maintain subsidiary ledger bc errors can be made
- most important reason is THEFT or pilferage
- —never will be able to be determined by accounting
- can’t always rely on accounting, must look at discrepancies through physical inventory
Entry
Pilferage expense XXX
inventory XXX
-most businesses use PERPETUAL acct. system
Subtitles in income stmt
INCOME STMT
For year ending 12/31/X1
Sales revenues
Less: sales discounts
sales returns/allowances
NET SALES REVENUES
Less: cost of goods sold
GROSS MARGIN
Less: operating expenses
salaries expense
utility expense
payroll tax expense
OPERATING INCOME
Other revenues and expenses
interest revenue
interest expense
INCOME BEFORE INCOME TAX
income tax expense
NET INCOME/LOSS
EPS
- operating expenses are also selling and administrative expenses
- operating income reveals the true profit from operating the business
- “other revenues and expenses” = loans and expenses not part of normal operations (loaning to employees)
- interest expense is lower than operating expense bc it is not a cost of operating the business it is a cost of FINANCING the business
- interest expense is common to be large
Operating expenses
Common is salaries and wages
- not as simple as “Wage expense”
- major complicating factor is PAYROLL TAXES
Two kinds of payroll taxes
- employee’s payroll tax withholding
- employer’s payroll taxes
Employee payroll tax withholdings
- FICA taxes (social security and medicare)
- federal income taxes
- state income taxes
- union dues, contributions to retirement or investment plans, charitable contributions
- these are EMPLOYEES taxes that the employer takes out of his/her paycheck
EX. Employee’s gross wage for a month is $1000
-employer withholds $70 FICA, $170 federal income taxes and $60 state income taxes
-check for their net pay of $700
ENTRY
Wage expense 1000
Cash 700
Employee FICA payable 70
Employee FIT payable 170
Employee SIT payable 60
-desensitizes people bc employers pay the taxes on their behalf - employees don’t know how much taxes they pay
Employer’s payroll taxes
(tax for letting them have employees)
- FICA taxes (equal to employee amounts)
- Federal unemployment insurance (FUI)
- State unemployment insurance (SUI)
Ex. Employer record’s employer’s payroll tax liability arising from the $1000 employee payroll in previous ex
-FUI = 10 and SUI = 5
ENTRY
Payroll tax expense 85
employer’s FICA payable 70
employer’s FUI payable 10
employer’s SUI payable 5
Employer’s have two payroll related costs
- employee’s salary/wage expense
- employer’s payroll tax expense
State sales taxes
amount charged to consumers when they buy products from a business
Ex. Joe sells burger for $.99 but collects $1.05 including state sales tax of $.06
Cash 1.05
Sales Revenue .99
Sales tax payable .06
-liability bc you didn’t earn the 6 cents, you are obligated to pay it to the state gov.
ENTRY ON REMITTANCE OF SALES TAX TO STATE
Sales tax payable .06
Cash .06
Whose rev. is the sales tax? - state gov.
Whose expense is the sales tax? - customers
Other operating expenses
Required by matching principle to be accounted for in timing of the revenues
-Prepaid property tax expense
-utilities expense for Dec. has not yet been received/recorded but last months bill was $1500
Utilities expense 1500
utilities payable 1500
(sometimes you need to estimate)
Internal controls
Policies and procedures implemented by a business that are designed to safeguard assets and ensure accurate accounting records
- fencing around inventory/supplies
- computer passwords
- shoplifting detection procedures
Key internal controls in safeguarding cash (most attractive asset)
- Separation of duties (who collects cash, accounts for it)
- Authorization procedures (all signed by 2 ppl)
- Adequate documentation and records
- Independent checks on performance (bank reconciliation)
Who is responsible for internal controls?
Management
- if businesses don’t know who to protect and establish internal controls use SPA
- CPA expertise in the area of internal controls
- publicly held businesses are required to include in their annual report a letter that mentions a fin. report, including internal controls
Management is responsible to prepare fin. stmts. in accordance with GAAP
- checked and audited by CPAs
- many companies hire internal auditors to check internal controls
Important parts of internal control
- assets are physically safeguarded
- only authorized transactions occur
- complete and accurate records are kept
In fraud triangle, why are internal controls important?
Reduce opportunity
Fraud triangle
-opportunity, pressure, rationalization
