Module 8

Question 1

What are Cost of Goods Sold?

Answer 1

Major expense of a retail business consisting of the cost of the goods (merchandise) that it sells during the accounting period

Question 2

What is a credit memo?

Answer 2

Business document that lists the information for a sales return or allowance

Question 3

What are general and administrative expenses?

Answer 3

Operating expenses related to the general management of a business

Question 4

What is gross profit?

Answer 4

Net sales minus cost of goods sold

Question 5

What is gross profit percentage?

Answer 5

Gross profit divided by net sales

Question 6

What are net purchases?

Answer 6

Amount of merchandise purchases adjusted for purchase returns, allowances and discounts

Question 7

What are operating expenses?

Answer 7

Expenses (other than cost of goods sold) that a business incurs in its day-to-day operations

Question 8

What is operating income?

Answer 8

All the revenues earned less the expenses incurred in the primary operating activities of a business

Question 9

What is an income statement?

Answer 9

A business’s income statement plays a key role in the decision making of users of financial information by communicating the business’s revenues, expenses and net income (or net loss) for a specific time period.
The income statement summarises the results of a business’s operating activities for a specific accounting period.

Question 10

What is the net income formula?

Answer 10

net income = revenues - expenses

Question 11

What are the uses of an income statement?

Answer 11

• A business’s income statement shows the relationship between managers’ decisions and the results of those decisions.
• This information helps both internal and external users to evaluate how well the business’s managers have ‘managed’ during the period.
• By comparing a business’s income statement information from period to period, users can also evaluate managers’ ability over the longer term.

Question 12

What are the uses of income statements for external users?

Answer 12

1. External users need accounting information that lets them compare a business’ actual operating performance with other business’s operating performance
2. Suppliers use it to compare customers income statements to determine which might represent the best credit risks

Question 13

What does GAAP do for the income statement?

Answer 13

Generally accepted accounting principles (GAAP) ensure that all businesses calculate and publish financial statement information in a similar, and thus comparable, manner

Question 14

What are temporary accounts?

Answer 14

Temporary accounts – when businesses use particular revenue and expenses accounts for only one accounting period to record the effects of its transactions on its net income

Question 15

What are permanent accounts?

Answer 15

Permanent accounts – accounts such as assets, liabilities and owner’s capital as they are used for the life of the business to record the effect of its transactions on its balance sheet.

Question 16

What consists the classified income statement?

Answer 16

1. Operating income – includes all the revenues earned and expenses incurred in the primary operating activities of the business. It has three subsections:
   a. Revenues
   b. Cost of goods sold
   c. Operating expenses
2. Other items sections - include any revenues and expenses that are not directly related to the primary operations of the business

Question 17

What is revenue?

Answer 17

income that arises during the course of the ordinary activities of a business. Most commonly recognised at the point of sale or delivery of a service

Question 18

What is sales revenue?

Answer 18

regardless of whether a customer buys goods for cash or on credit, retail businesses use a sales revenue or sales account to record the transaction (source document is a sales invoice)

Question 19

What are the three policies that affect income statement reporting?

Answer 19

1. Discount policies
2. Sales return policies
3. Sales allowance policies
   Businesses want to encourage customers to buy their merchandise or services and sales policies help them to do this.

Question 20

What are the types of discount policies?

Answer 20

Quantity discount – a reduction in the sales price of goods or a service because of the number of items purchased or because of a sales promotion.
Sales discount – a percentage reduction of the invoice price if the customer pays the invoice within a specified period.
Cash discount – discount that reduces the amount of cash received (oftentimes sales discount is also called cash discount)

Question 21

What are sales return/allowance policies?

Answer 21

Sales return – occurs when a customer returns a previously purchased merchandise. The effect of a sales return is to cancel the sale (and the related cost of goods sold)
Sales allowance – occurs when a customer agrees to keep the merchandise, and the business refunds a portion of the original sales price

Question 22

What is the impact of a sales return/allowance policy on financial statements?

Answer 22

• decreases assets on balance sheet
• decreases revenues, which decreases net income on income statement (and therefore decreases owner’s equity on balance sheet)

Question 23

What are the main types of expenses?

Answer 23

1. Cost of Goods sold

2. Operating Expenses

Question 24

What are the two types of inventory systems?

Answer 24

1. Perpetual inventory system

2. Periodic inventory system

Question 25

What is a perpetual inventory system?

Answer 25

Keeps a continuous record of the cost of inventory on hand and the cost of inventory sold.
Under this system, when a business purchases an item of inventory, it increases the asset ‘Inventory’ by the invoiced cost of the merchandise, plus any freight charges (sometimes called transportation-in) it paid to have the inventory delivered

Question 26

What is the purpose of a perpetual inventory system?

Answer 26

• In this way, the business will have inventory and cost of good sold accounts that are always up to date  always know the physical quantity of inventory that it should have on hand
• This can help make decisions about operations  when to buy inventory, compare the revenues and costs of recent sales

Question 27

What is a periodic inventory system?

Answer 27

Does not keep a continuous record of the inventory on hand and sold, but instead determines the inventory at the end of each accounting period by physically counting it.

Question 28

Why do some business use a periodic inventory system?

Answer 28

1. Any businesses that use a periodic inventory system are small enough to manage their inventory without perpetual records.
2. many businesses sell a high volume of similar, inexpensive goods. If these items are not expensive, perpetual records may not be as important for keeping day-to-day physical control over the inventory.
3. Cost is not worth the benefits

Question 29

How do you calculate the Cost of Goods Sold?

Answer 29

Cost of Goods Sold = Cost of beginning inventory + Cost of net purchases - Cost of ending inventory

Question 30

What are net purchases?

Answer 30

amount of merchandise purchases adjusted for purchase returns, allowances and discounts

Question 31

What are the types of operating expenses?

Answer 31

1. Selling expenses
2. General and administrative expenses
3. Financial expenses

Question 32

What are selling expenses?

Answer 32

operating expenses related to the sales activities of a business
o Salaries expenses
o Advertising
o Delivery

Question 33

What are financial expenses?

Answer 33

relate to the financing of the business and its operations and debt collection 
o	Bank charges 
o	Interest expense
o	Discounts allowed to customers
o	Bad debts
o	Debt collectors’ fees

Question 34

What is depreciation?

Answer 34

Depreciation is an allocation of the cost of an asset over its useful life. It measures the portion of the cost (less residual value) of a fixed asset that has been consumed during an accounting period.

Question 35

How is depreciation recorded in financial statements?

Answer 35

The depreciation expense is recorded on the income statement and the corresponding accumulated depreciation amount is recorded on the balance sheet, directly under the asset it relates to.

Question 36

What are the main concerns for creditors when evaluating the income statement?

Answer 36

A business’s financial statements help you decide whether to loan money to the business and, if so, under what loan arrangements
o The interest rate to charge
o The amount of time to allow before the loan must be repaid
o The restrictions to place on the business’s ability to borrow additional money

Question 37

What are the main concerns of investors when evaluating the income statement?

Answer 37

A business’s financial statements help you estimate the return you may expect on your investment and to decide whether you want to become or continue to be an owner. They also help evaluate:

a. risk
b. operating capability
c. financial flexibility

Question 38

What is risk?

Answer 38

estimating the chances that the business will not earn a satisfactory profit. Refers to the uncertainty about the future earnings potential of a business

Question 39

What is operating capability?

Answer 39

refers to a business’s ability to continue a given level of operations in the future

Question 40

What is financial flexibility?

Answer 40

refers to a business’s ability to adapt to change in the future

Question 41

What are the main concerns for managers when evaluating the income statement?

Answer 41

Managers use the income statement for internal decision making such as planning, operating and evaluation decisions. They will evaluate a business’s risk, operating capability and financial flexibility

Question 42

What are ratios?

Answer 42

consists of calculations in which an item on the business’s financial statements is divided by another related item

Question 43

What are ratios used for?

Answer 43

To evaluate a business’s operating performance, managers and external users may perform ratio analysis. • The ratios are benchmarks that are used to compare a business’s performance with that of previous periods and with that of other businesses.

Question 44

What is a statement of comprehensive income?

Answer 44

the Australian Accounting Standards Board AASB 101 Presentation of Financial Statements requires that entities present a statement of comprehensive income, which is effectively the income statement plus all other comprehensive income.

Question 45

What is comprehensive income?

Answer 45

comprises items of income and expense that are not recognised in profit or loss as required or permitted by other Australian Accounting Standards

Question 46

What is a statement of changes in owner’s equity?

Answer 46

summarises the transactions that affected owner’s equity during the accounting period

Question 47

What are closing entries?

Answer 47

entries made by a business to transfer the ending balances from its temporary revenue and expense accounts into its permanent account for owner’s capital.

Question 48

Why does a business use closing entries?

Answer 48

so that when a new accounting period starts:

1. The revenue and expense accounts (temporary accounts) have zero balances
2. The accounting system keeps the revenue and expense transactions of the current period separate from the revenue and expense transactions of other periods
3. The permanent (balance sheet) accounts are up-to-date (i.e. net income has been added to the previous balance of the owner’s capital account)