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Accounting Cycle C 2 3
Recording Closing Entries § Close Credit Balances in Revenue Accounts to Income Summary. § Close Debit Balances in Expense accounts to Income Summary. § Close Income Summary account to Retained Earnings. § Close Dividends to Retained Earnings. P 4 4
NEED-TO-KNOW Use the adjusted trial balance of Magic Company to prepare its closing entries. Magic Company Trial Balance Magic Company December 31, 20 X 2 Adjusted Trial Balance Debit December 31, 2015 Cash Accounts receivable Land Accounts payable Long-term notes payable Common Stock Retained Earnings Dividends Fees earned Salaries expense Office supplies expense Totals P 4 Debit $13, 000 17, 000 85, 000 Credit $12, 000 33, 000 30, 000 45, 000 20, 000 79, 000 56, 000 8, 000 $199, 000 5
Debit $13, 000 17, 000 85, 000 Cash Accounts receivable Land Accounts payable Long-term notes payable Common stock Retained earnings Dividends 20, 000 Fees earned Salaries expense 56, 000 Office supplies expense 8, 000 Totals $199, 000 Date Dec. 31 P 4 Credit Expenses $12, 000 33, 000 30, 000 45, 000 79, 000 Closing Income summary 64, 000 Revenues Net income 15, 000 79, 000 15, 000 0 Retained earnings 12/31/2014 20, 000 Net income 12/31/2015 Dividends 45, 000 15, 000 40, 000 $199, 000 General Journal Fees earned Income summary Debit 79, 000 Credit 79, 000 Income summary Salaries expense Office supplies expense 64, 000 Income summary Retained earnings 15, 000 Retained earnings Dividends 20, 000 56, 000 8, 000 15, 000 20, 000 6
Debit $13, 000 17, 000 85, 000 Cash Accounts receivable Land Accounts payable Long-term notes payable Common Stock Retained earnings Totals $115, 000 Credit Expenses $12, 000 33, 000 30, 000 40, 000 $115, 000 Closing Income Summary 64, 000 Revenues Net income 15, 000 79, 000 15, 000 0 Dividends Retained Earnings 12/31/2014 20, 000 Net income 12/31/2015 45, 000 15, 000 40, 000 Magic Company Balance Sheet December 31, 2015 Assets Cash Accounts receivable Land Total assets P 4 $13, 000 17, 000 85, 000 $115, 000 Liabilities Accounts payable Long-term notes payable Total liabilities Equity $12, 000 33, 000 45, 000 Common stock Retained earnings Total equity Total liabilities and equity 30, 000 40, 000 75, 000 115, 000 7
Post-Closing Trial Balance § List of permanent accounts and their balances after posting closing entries. § Total debits and credits must be equal. P 5 8
Post-Closing Trial Balance P 5 9
Classified Balance Sheet Current items are those expected to come due (both collected and owed) within the longer of one year or the company’s normal operating cycle. C 3 10
NEED-TO-KNOW Use the adjusted trial balance of Magic Company to prepare its classified balance sheet as of December 31, 2015. Magic Company Adjusted Trial Balance December 31, 20 X 2 December 31, 2015 Debit Credit Cash $13, 000 Accounts receivable 17, 000 Land 85, 000 Accounts payable $12, 000 Long-term notes payable 33, 000 30, 000 Common Stock Retained Earnings 45, 000 Dividends 20, 000 Fees earned 79, 000 Salaries expense 56, 000 Trial Balance Office supplies expense 8, 000 Totals $199, 000 Debit Credit C 3 11
NEED-TO-KNOW Use the adjusted trial balance of Magic Company to prepare its classified balance sheet as of December 31, 2015. Magic Company Adjusted Trial Balance December 31, 20 X 2 December 31, 2015 Debit Credit $13, 000 Cash Accounts receivable 17, 000 Land 85, 000 Accounts payable $12, 000 Long-term notes payable 33, 000 30, 000 Common Stock Retained Earnings Dividends Fees earned Salaries expense 45, 000 20, 000 Trial Balance 56, 000 Office supplies expense 8, 000 Totals C 3 79, 000 $199, 000 Debit $199, 000 Credit Magic Company Balance Sheet December 31, 2015 Assets Current assets Cash Accounts receivable Total current assets Plant assets Land Total plant assets Total assets Liabilities Current liabilities Accounts payable Total current liabilities Long-term notes payable Total liabilities Equity Common Stock Retained Earnings Total equity Total liabilities and equity $13, 000 17, 000 30, 000 85, 000 $115, 000 $12, 000 33, 000 $45, 000 30, 000 40, 000 70, 000 $115, 000 12
Merchandiser Merchandising Companies Manufacturer C 1 Wholesaler Retailer Consumers 13
Reporting Income for a Merchandiser Merchandising companies sell products to earn revenue. Examples: sporting goods, clothing, and auto parts stores C 1 14
Inventory Systems C 2 15
Inventory Systems Ø Perpetual systems Ø continually update Ø Periodic systems Ø accounting records relating to for merchandising merchandise transactions are updated only at the end of the accounting C 2 period 16
Merchandise Purchases On November 2, Z-Mart purchased $1, 200 of merchandise inventory for cash. P 1 17
Purchase Discounts 2/10, n/30 Discount Percent P 1 Number of Days Discount Is Available Otherwise, Net (or All) Is Due in 30 Days Credit Period 18
Purchase Discounts On November 2, Z-Mart purchased $1, 200 of merchandise inventory on account, credit terms are 2/10, n/30. P 1 19
Purchase Discounts On November 12, Z-Mart paid the amount due on the purchase of November 2. Since payment was made within the discount period, a $24 discount ($1, 200 x 2%) is taken. P 1 20
Purchase Discounts After we post these entries, the accounts involved look like these: P 1 21
Purchase Returns and Allowances On November 15, Z-Mart (buyer) issues a $300 debit memorandum for an allowance from Trex for defective merchandise. P 1 22
Purchase Returns and Allowances Z-Mart purchases $1, 000 of merchandise on June 1 with terms 2/10, n/60. Two days later, Z-Mart returns $100 of goods before paying the invoice. When Z-Mart later pays on June 11, it takes the 2% discount only on the $900 remaining balance. P 1 23
Transportation Costs and Ownership Transfer P 1 24
Transportation Costs Z-Mart purchased merchandise on terms of FOB shipping point. The transportation charge is $75. P 1 Since freight terms were FOB shipping point, Z-mart is responsible for the freight charges. We increase Merchandise Inventory for the cost of the freight. 25
NEED-TO-KNOW (4 -1) Prepare journal entries to record each of the following purchases transactions of a merchandising company. Assume a perpetual inventory system. Oct. 1 Oct. 3 Oct. 7 Oct. 11 Oct. 31 Purchased 125 units of a product at a cost of $4 per unit. Terms of the sale are 2/10, n/30, and FOB shipping point; the invoice is dated October 1. Paid $30 cash for freight charges from UPS for the October 1 purchase. Returned 50 defective units from the October 1 purchase and received full credit. Paid the amount due from the October 1 purchase, less the return on October 7. Assume the October 11 payment was never made and, instead, payment of the amount due on the October 1 purchase, less the return on October 7, occurred on October 31. P 1 26
NEED-TO-KNOW (4 -1) Oct. 1 Oct. 3 Oct. 7 Oct. 11 Oct. 31 Purchased 125 units of a product at a cost of $4 per unit. Terms of the sale are 2/10, n/30, and FOB shipping point; the invoice is dated October 1. Paid $30 cash for freight charges from UPS for the October 1 purchase. Returned 50 defective units from the October 1 purchase and received full credit. Paid the amount due from the October 1 purchase, less the return on October 7. Merchandise inventory 500 30 Oct. 7 Oct. 11 324 Date Oct. 1 Oct. 3 Oct. 7 Oct. 11 P 1 200 6 Oct. 7 Oct. 11 General Journal Merchandise inventory (125 units @ $4) Accounts payable Merchandise inventory Cash Accounts payable Oct. 1 200 300 Debit 500 Credit 500 30 30 Accounts payable (50 units @ $4) Merchandise inventory (50 units @ $4) 200 Accounts payable Merchandise inventory ($300 x. 02) Cash 300 200 6 294 27
NEED-TO-KNOW Oct. 1 Oct. 3 Oct. 7 Oct. 31 Oct. 31 Purchased 125 units of a product at a cost of $4 per unit. Terms of the sale are 2/10, n/30, and FOB shipping point; the invoice is dated October 1. Paid $30 cash for freight charges from UPS for the October 1 purchase. Returned 50 defective units from the October 1 purchase and received full credit. Assume the October 11 payment was never made and, instead, payment of the amount due on the October 1 purchase, less the return on October 7, occurred on October 31. Merchandise inventory 500 30 Oct. 7 500 330 Date Oct. 1 Oct. 3 Oct. 7 Oct. 31 P 1 200 Oct. 7 Oct. 31 Accounts payable Oct. 1 200 300 General Journal Merchandise inventory (125 units @ $4) Accounts payable Merchandise inventory Cash Debit 500 Credit 500 30 30 Accounts payable Merchandise inventory (50 units @ $4) 200 Accounts payable Cash 300 200 300 28
Sales of Merchandise Each sales transaction for a seller of merchandise involves two parts: Revenue received in the form of an asset from a customer. P 2 Recognition of the cost of merchandise sold to a customer. 29
Sales of Merchandise Z-Mart sold $2, 400 of merchandise on credit. The merchandise has a cost basis to Z-Mart of $1, 600. P 2 Two entries are required: 1) Records the revenue 2) Records the cost 30
Sales Discounts Sales discounts on credit sales can benefit a seller by decreasing the delay in receiving cash and reducing future collection efforts. P 2 31
Sales Discounts Z-Mart completes a $1, 000 credit sale with terms of 2/10, n/60. Option 1: The account was paid in full within the 60 -day period. Option 2: The account was paid in full within the 10 -day discount period. P 2 32
Sales Returns and Allowances Sales returns and allowances usually involve dissatisfied customers and the possibility of lost future sales. Sales returns refer to merchandise that customers return to the seller after a sale. P 2 Sales allowances refer to reductions in the selling price of merchandise sold to customers. 33
Sales Returns and Allowances Recall Z-Mart’s sale for $2, 400 that had a cost of $1, 600. Assume the customer returns part of the merchandise. The returned items sell for $800 and cost $600. Two entries are required: 1) Records the reduction in revenue 2) Records the return of goods to inventory P 2 34
Sales Allowances Assume that $800 of the merchandise Z-Mart sold on November 3 is defective but the buyer decides to keep it because Z-Mart offers a $100 price reduction. Contra Revenue account One entry is required: 1) Records the reduction in revenue P 2 35
NEED-TO-KNOW (4 -2) Prepare journal entries to record each of the following sales transactions of a merchandising company. Assume a perpetual inventory system. Jun. 1 Jun. 7 Jun. 8 Jun. 11 P 2 Sold 500 units of merchandise to a customer for $14 per unit under credit terms of 2/10, n/30, FOB shipping point, and the invoice is dated June 1. The merchandise had cost $10 per unit. The customer returns 20 units because those units did not fit the customer’s needs. The seller restores those units to its inventory. The customer discovers that 30 units are damaged but are still of some use and, therefore, keeps the units because the seller sends the buyer a credit memorandum for $90 to compensate for the damage. The customer discovers that 10 units are the wrong color, but keeps 8 of these units because the seller sends a $12 credit memorandum to compensate. The customer returns the remaining 2 units to the seller. The seller restores the 2 returned units to its inventory 36
NEED-TO-KNOW (4 -2) Jun. 1 Jun. 7 Date Jun. 1 Jun. 7 P 2 Sold 500 units of merchandise to a customer for $14 per unit under credit terms of 2/10, n/30, FOB shipping point, and the invoice is dated June 1. The merchandise had cost $10 per unit. The customer returns 20 units because those units did not fit the customer’s needs. The seller restores those units to its inventory. General Journal Accounts receivable Sales (500 @ $14) Debit 7, 000 Cost of goods sold (500 @ $10) Merchandise inventory 5, 000 Sales returns and allowances (20 @ $14) Accounts receivable Merchandise inventory (20 @ $10) Cost of goods sold Credit 7, 000 5, 000 280 200 37
NEED-TO-KNOW (4 -2) Jun. 8 Jun. 11 The customer discovers that 30 units are damaged but are still of some use and, therefore, keeps the units because the seller sends the buyer a credit memorandum for $90 to compensate for the damage. The customer discovers that 10 units are the wrong color, but keeps 8 of these units because the seller sends a $12 credit memorandum to compensate. The customer returns the remaining 2 units to the seller. The seller restores the 2 returned units to its inventory Date Jun. 1 Jun. 07 Jun. 08 Jun. 11 P 2 General Journal Accounts receivable Sales (500 @ $14) Debit 7, 000 Cost of goods sold (500 @ $10) Merchandise inventory 5, 000 Sales returns and allowances (20 @ $14) Accounts receivable Merchandise inventory (20 @ $10) Cost of goods sold Sales returns and allowances Accounts receivable Credit 7, 000 5, 000 280 200 90 90 Sales returns and allowances ($12 + (2 @ $14)) Accounts receivable 40 Merchandise inventory (2 @ $10) Cost of goods sold 20 40 20 38
NEED-TO-KNOW (4 -2) Partial income statement Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit on sales Date Jun. 1 Jun. 07 Jun. 08 Jun. 11 P 2 Jun. 11 $7, 000 $410 0 (410) 6, 590 4, 780 $1, 810 General Journal Accounts receivable Sales (500 @ $14) Debit 7, 000 Cost of goods sold (500 @ $10) Merchandise inventory 5, 000 Sales returns and allowances (20 @ $14) Accounts receivable Merchandise inventory (20 @ $10) Cost of goods sold Sales returns and allowances Accounts receivable Credit 7, 000 5, 000 280 200 90 90 Sales returns and allowances ($12 + (2 @ $14)) Accounts receivable 40 Merchandise inventory (2 @ $10) Cost of goods sold 20 40 20 39
Adjusting Entries for Merchandisers A merchandiser using a perpetual inventory system is usually required to make an adjustment to update the Merchandise Inventory account to reflect any loss of merchandise, including theft and deterioration. P 3 40
NEED-TO-KNOW (4 -3) A merchandising company’s ledger on May 31, its fiscal year-end, includes the following selected accounts that have normal balances (it uses the perpetual inventory system). A physical count of its May 31 year-end inventory reveals that the cost of the merchandise inventory still available is $718. (a) Prepare the entry to record any inventory shrinkage. (b) Prepare journal entries to close the balances in temporary revenue and expense accounts. Merchandise inventory Retained Earnings Dividends Sales discounts $756 2, 306 140 3, 204 94 Sales returns and allowances Cost of goods sold Depreciation expense Salaries expense Other operating expenses Merchandise inventory Retained Earnings Dividends Sales discounts Sales returns and allowances Cost of goods sold Depreciation expense Salaries expense Other operating expenses P 3 Debit $756 $130 2, 100 206 650 100 Credit $2, 306 140 3, 204 94 130 2, 100 206 650 100 41
NEED-TO-KNOW (4 -3) A merchandising company’s ledger on May 31, its fiscal year-end, includes the following selected accounts that have normal balances (it uses the perpetual inventory system). A physical count of its May 31 year-end inventory reveals that the cost of the merchandise inventory still available is $718. (a) Prepare the entry to record any inventory shrinkage. (b) Prepare journal entries to close the balances in temporary revenue and expense accounts. Merchandise inventory Retained Earnings Dividends Sales discounts Sales returns and allowances Cost of goods sold Depreciation expense Salaries expense Other operating expenses Date May 31 Debit $756 $718 P 3 $2, 306 140 3, 204 94 130 2, 100 2, 138 206 650 100 General Journal Cost of Goods Sold Merchandise inventory ($756 - $718) To adjust for inventory shrinkage. Credit Debit 38 Credit 38 42
NEED-TO-KNOW (4 -3) Merchandise inventory Retained Earnings Dividends Sales discounts Sales returns and allowances Cost of goods sold Depreciation expense Salaries expense Other operating expenses Date May 31 P 3 Debit $756 $718 General Journal Sales Income Summary Sales discounts Sales returns and allowances Cost of Goods Sold ($2, 100 + $38) Depreciation expense Salaries expense Other operating expenses Credit $2, 306 140 3, 204 94 130 2, 100 2, 138 206 650 100 Debit 3, 204 Credit 3, 204 3, 318 94 130 2, 138 206 650 100 43
Define and prepare multiple-step and single-step income statements. 44
Exhibit 4. 13 P 4 45
Single-Step Income Statement Exhibit 4. 14 P 4 46
NEED-TO-KNOW Assume Target’s adjusted trial balance on April 30, 2015, its fiscal year-end, appears below. Prepare a multiple-step income statement that includes separate categories for selling expenses and for general and administrative expenses. (b) Prepare a single-step income statement that includes these expense categories: cost of goods sold, selling expenses, and general and administrative expenses. Debit P 4 Credit 47
NEED-TO-KNOW Debit Credit TARGET Income Statement For Year Ended April 30, 2015 Sales $4, 512 Less: Sales discounts $45 Sales returns and allowances 240 285 Net sales 4, 227 Cost of goods sold 1, 490 Gross profit 2, 737 Expenses Selling expenses Sales salaries expense 640 Rent expense - Selling space 160 Store supplies expense 30 Advertising expense 260 Total selling expenses 1, 090 General and administrative expenses Office salaries expense 570 Rent expense - Office space 72 Office supplies expense 8 Total general and administrative expenses 650 Total expenses 1, 740 Net income $997 P 4 48
NEED-TO-KNOW TARGET Income Statement For Year Ended April 30, 2015 Sales $4, 512 Less: Sales discounts $45 Sales returns and allowances 240 285 Net sales 4, 227 Cost of goods sold 1, 490 Gross profit 2, 737 Expenses Selling expenses Sales salaries expense 640 Rent expense - Selling space 160 Store supplies expense 30 Advertising expense 260 Total selling expenses 1, 090 General and administrative expenses Office salaries expense 570 Rent expense - Office space 72 Office supplies expense 8 Total general and administrative expenses 650 Total expenses 1, 740 Net income $997 P 4 TARGET Income Statement For Year Ended April 30, 2015 Net sales Expenses Cost of goods sold Selling expenses General and administrative expenses Total expenses Net income $4, 227 1, 490 1, 090 650 3, 230 $997 49
Inventories and Cost of Sales
Determining Inventory Items Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where company owns and holds for sale, the goods are located when inventory is counted. Items requiring special attention include: 1) Goods in Transit C 1 2) Goods on Consignment 3) Goods Damaged or Obsolete 51
1) Goods in Transit FOB Shipping Point Public Carrier Seller Buyer Ownership passes to the buyer here. Public Carrier Seller C 1 FOB Destination Point Buyer 52
2) Goods on Consignment Merchandise is included in the inventory of the consignor, the owner of the inventory. C 1 53
3) Goods Damaged or Obsolete Damaged or obsolete goods are not counted in inventory if they cannot be sold. Cost should be reduced to net realizable value if they can be sold. C 1 54
Determining Inventory Costs Include all expenditures necessary to bring an item to a salable condition and location. Minus Discounts and Allowances Plus Import Duties C 2 Invoice Cost Plus Freight Plus Insurance Plus Storage 55
Internal Controls and Taking a Physical Ø Most companies take a physical count of inventory at least once each year. Count Ø When the physical count does not match the Merchandise Inventory account, an adjustment must be made. Good internal controls over count include: 1. Pre-numbered inventory tickets. 2. Counters have no inventory responsibility. 3. Counts confirm existence, amount, and quality of inventory item. 4. Second count is taken. 5. Manager confirms all items counted. C 2 56
Inventory Costing under a Perpetual System Inventory affects. . . Balance Sheet Income Statement The matching principle requires matching costs with sales. C 2 57
Inventory Cost Flow Assumptions Management decisions in accounting for inventory involve the following: 1. Items included in inventory and their costs. 2. Costing method (specific identification, FIFO, LIFO, or weighted average). 3. Inventory system (perpetual or periodic). 4. Use of market values or other estimates. C 2 58
NEED-TO-KNOW A master carver of wooden birds operates her business out of a garage. At the end of the current period, the carver has 17 units (carvings) in her garage, three of which were damaged by water and cannot be sold. The distributor also has another five units in her truck, ready to deliver per a customer order, terms FOB destination, and another 11 units out on consignment at several small retail stores. How many units does the carver include in the business’s period-end inventory? Units in ending inventory Key point – How many units does she own at year-end? Units in storage 17 Less damaged (unsalable) units (3) Plus units in transit (FOB Destination) 5 Plus units on consignment 11 Total units in ending inventory 30 A distributor of artistic iron-based fixtures acquires a piece for $1, 000, terms FOB shipping point. Additional costs in obtaining it and offering it for sale include $150 for transportation-in, $300 for import duties, $100 for insurance during shipment, $200 for advertising, a $50 voluntary gratuity to the delivery person, $75 for enhanced store lighting, and $250 for sales staff salaries. For computing inventory, what cost is assigned to this artistic piece? Cost of inventory Key point – What are the necessary costs to get the asset ready for its intended purpose? Cost Transportation-in (FOB shipping point) Import duties Insurance cost Inventory cost $1, 000 150 300 100 $1, 550
Inventory Cost Flow Assumptions First-In, First-Out (FIFO) Assumes costs flow in the order incurred. Last-In, First-Out (LIFO) Assumes costs flow in the reverse order incurred. Weighted Average Assumes costs flow at an average of the costs available. P 1 60
Inventory Costing Illustration Here is information about the mountain bike inventory of Trekking for the month of August. P 1 61
1) Specific Identification P 1 62
First-In, First-Out (FIFO) P 1 Oldest Costs Cost of Goods Sold Recent Costs Ending Inventory 63
2) First-In, First-Out (FIFO) P 1 64
Last-In, First-Out (LIFO) P 1 Recent Costs Cost of Goods Sold Oldest Costs Ending Inventory 65
3) Last-In, First-Out (LIFO) P 1 66
4) Weighted Average When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Units on hand Available for ÷ on the date of Sale sale P 1 67
Weighted Average P 1 68
NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Beginning inventory Purchase Sales Purchase Units Acquired at Cost Units Sold at Retail 5 units @ $3. 00 = $15. 00 10 units @ $4. 50 = $45. 00 8 units @ $7. 00 13 units @ $5. 00 = $65. 00 18 units @ $8. 00 8 units @ $5. 30 = $42. 40 36 units $167. 40 26 units The company uses a perpetual inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents. ) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. P 1 69
NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Units Acquired at Cost Beginning inventory 5 units @ $3. 00 = $15. 00 Purchase 10 units @ $4. 50 = $45. 00 Sales Purchase 13 units @ $5. 00 = $65. 00 Sales Purchase 8 units @ $5. 30 = $42. 40 36 units $167. 40 Units Sold at Retail 8 units @ $7. 00 18 units @ $8. 00 26 units The company uses a perpetual inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents. ) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Regardless of the method used, the cost of 26 units are included in Cost of Goods Sold, and the cost of 10 units are included in Ending Inventory P 1 70
NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Units Acquired at Cost Beginning inventory 5 units @ $3. 00 = $15. 00 Purchase 10 units @ $4. 50 = $45. 00 Sales Purchase 13 units @ $5. 00 = $65. 00 Sales Purchase 8 units @ $5. 30 = $42. 40 36 units $167. 40 Units Sold at Retail 8 units @ $7. 00 18 units @ $8. 00 26 units The company uses a perpetual inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents. ) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Specific Identification Method Not an inventory assumption - Actual Cost of Goods Sold represents the actual cost of the units selected by the customer. Ending Inventory represents the actual cost of the units that remain in ending inventory. P 1 71
NEED-TO-KNOW Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Units Acquired at Cost Beginning inventory 5 units @ $3. 00 = $15. 00 Purchase 10 units @ $4. 50 = $45. 00 Sales 13 units @ $5. 00 = $65. 00 Purchase Sales Purchase 8 units @ $5. 30 = $42. 40 36 units $167. 40 Units Sold at Retail 8 units @ $7. 00 18 units @ $8. 00 26 units Ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Specific Identification – Cost of exact units sold are expensed as Cost of Goods Sold. Date Dec. 01 Dec. 08 Dec. 19 Dec. 30 Activities Beginning inventory Purchase Units Acquired at Cost 5 @ $3. 00 = $15. 00 10 @ $4. 50 = $45. 00 13 @ $5. 00 = $65. 00 8 @ $5. 30 = $42. 40 36 units $167. 40 Cost of Goods Sold 5 @ $3. 00 = $15. 00 8 @ $4. 50 = $36. 00 13 @ $5. 00 = $65. 00 26 units $116. 00 Cost of Ending Inventory 2 @ $4. 50 = $9. 00 8 @ $5. 30 = $42. 40 10 units $51. 40 Cost of Goods Sold $116. 00 Ending inventory 51. 40 Goods available for sale $167. 40 P 1 72
NEED-TO-KNOW Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Units Acquired at Cost Beginning inventory 5 units @ $3. 00 = $15. 00 Purchase 10 units @ $4. 50 = $45. 00 Sales 13 units @ $5. 00 = $65. 00 Purchase Sales Purchase 8 units @ $5. 30 = $42. 40 36 units $167. 40 Units Sold at Retail 8 units @ $7. 00 18 units @ $8. 00 26 units Perpetual FIFO – Cost of Goods Sold is calculated at the time of the sale. The first items in are the first items out – expensed as Cost of Goods Sold. Date Dec. 1 Dec. 8 Goods Purchased 10 @ $4. 50 Dec. 9 Dec. 19 5 @ $3. 00 3 @ $4. 50 P 1 } = $28. 50 13 @ $5. 00 Dec. 24 Dec. 30 Cost of Goods Sold 7 @ $4. 50 11 @ $5. 00 } = $86. 50 8 @ $5. 30 Cost of Goods Sold $115. 00 Ending inventory 52. 40 Goods available for sale $167. 40 Inventory Balance 5 @ $3. 00 = $15. 00 5 @ $3. 00 } = $60. 00 10 @ $4. 50 7 @ $4. 50 13 @ $5. 00 2 @ $5. 00 8 @ $5. 30 = $31. 50 } = $96. 50 = $10. 00 } = $52. 40 $115. 00 73
NEED-TO-KNOW Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Units Acquired at Cost Beginning inventory 5 units @ $3. 00 = $15. 00 Purchase 10 units @ $4. 50 = $45. 00 Sales 13 units @ $5. 00 = $65. 00 Purchase Sales Purchase 8 units @ $5. 30 = $42. 40 36 units $167. 40 Units Sold at Retail 8 units @ $7. 00 18 units @ $8. 00 26 units Perpetual LIFO – Cost of Goods Sold is calculated at the time of the sale. The last items in are the first items out – expensed as Cost of Goods Sold. Date Dec. 1 Dec. 8 Goods Purchased 10 @ $4. 50 Dec. 9 Dec. 19 8 @ $4. 50 P 1 = $36. 00 13 @ $5. 00 Dec. 24 Dec. 30 Cost of Goods Sold Inventory Balance 5 @ $3. 00 = $15. 00 5 @ $3. 00 } = $60. 00 10 @ $4. 50 5 @ $3. 00 } = $24. 00 2 @ $4. 50 5 @ $3. 00 2 @ $4. 50 = $89. 00 13 @ $5. 00 2 @ $3. 00 = $6. 00 } 3 @ $3. 00 2 @ $4. 50 13 @ $5. 00 } = $83. 00 8 @ $5. 30 Cost of Goods Sold $119. 00 Ending inventory 48. 40 Goods available for sale $167. 40 2 @ $3. 00 8 @ $5. 30 } = $48. 40 $119. 00 74
NEED-TO-KNOW Date Dec. 01 Dec. 08 Dec. 09 Dec. 19 Dec. 24 Dec. 30 Activities Units Acquired at Cost Beginning inventory 5 units @ $3. 00 = $15. 00 Purchase 10 units @ $4. 50 = $45. 00 Sales 13 units @ $5. 00 = $65. 00 Purchase Sales Purchase 8 units @ $5. 30 = $42. 40 36 units $167. 40 Units Sold at Retail 8 units @ $7. 00 18 units @ $8. 00 26 units Weighted Average – Cost of Goods Sold is calculated at the time of the sale. Average cost is equal to cost of goods available at the time of the sale divided by number of units available at the time of the sale. Date Goods Purchased Cost of Goods Sold Inventory Balance Dec. 1 5 @ $3. 00 = $15. 00 Dec. 8 10 @ $4. 50 5 @ $3. 00 } = $60. 00 10 @ $4. 50 $60 / 15 units = $4. 00 avg. cost Dec. 9 Dec. 19 8 @ $4. 00 = $32. 00 13 @ $5. 00 Dec. 24 Dec. 30 P 1 18 @ $4. 65 = $83. 70 8 @ $5. 30 Cost of Goods Sold $115. 70 Ending inventory 51. 70 Goods available for sale $167. 40 7 @ $4. 00 = $28. 00 7 @ $4. 00 } = $93. 00 13 @ $5. 00 $93 / 20 units = $4. 65 avg. cost 2 @ $4. 65 = $9. 30 2 @ $4. 65 } = $51. 70 8 @ $5. 30 $51. 70 / 10 units = $5. 17 avg. cost $115. 70 75
Financial Statement Effects of Costing Methods Because prices change, inventory methods nearly always assign different cost amounts. A 1 76
Financial Statement Effects of Costing Methods Advantages of Methods First-In, First-Out Last-In, First-Out Weighted Average Ending inventory approximates current replacement cost. Better matches current costs in cost of goods sold with revenues. Smoothes out price changes. A 1
Tax Effects of Costing Methods The Internal Revenue Service (IRS) identifies several acceptable inventory costing methods for reporting taxable income. If LIFO is used for tax purposes, the IRS requires it be used in financial statements. A 1 78
Consistency in Using Costing Methods The consistency principle requires a company to use the same accounting methods period after period so that financial statements are comparable across periods. A 1 79
Lower of Cost or Market 80
Lower of Cost or Market Inventory must be reported at market value when market is lower than cost. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. P 2 Can be applied three ways: (1) (2) (3) separately to each individual item. to major categories of assets. to the whole inventory. 81
Lower of Cost or Market A motor sports retailer has the following items in inventory: P 2 82
NEED-TO-KNOW A company has the following products in its ending inventory. (a) Compute the lower of cost or market for its inventory when applied separately to each product. (b) If the LCM amount is less than the recorded cost of the inventory, then record the December 31 LCM adjustment to the Merchandise Inventory account. Road bikes Mountain bikes Town bikes Total Date Dec. 31 P 2 Units 5 4 10 Per Unit Cost Market $1, 000 $800 500 600 450 General Journal Cost of Goods Sold Merchandise Inventory Total Cost Market $5, 000 $4, 000 2, 400 4, 000 4, 500 $11, 000 Debit 1, 000 LCM By item $4, 000 2, 000 4, 000 $10, 000 Credit 1, 000 83
Financial Statement Effects of Inventory Errors A 2 84
Financial Statement Effects of Inventory Errors A 2 85
NEED-TO-KNOW A company had $10, 000 of sales in each of three consecutive years 20 X 1 -20 X 3, and it purchased merchandise costing $7, 000 in each of those years. It also maintained a $2, 000 physical inventory from the beginning to the end of that three-year period. In accounting for inventory, it made an error at the end of year 20 X 1 that caused its year-end 20 X 1 inventory to appear on its statements as $1, 600 rather than the correct $2, 000. (a) Determine the correct amount of the company’s gross profit in each of the years 20 X 1– 20 X 3. (b) Prepare comparative income statements to show the effect of this error on the company’s cost of goods sold and gross profit for each of the years 20 X 1– 20 X 3. Correct Amounts Year 20 X 1 Sales $10, 000 Cost of goods sold Beginning inventory $2, 000 Cost of purchases 7, 000 Goods available for sale 9, 000 Ending inventory 2, 000 Cost of goods sold 7, 000 Gross profit $3, 000 Inventory error Year 20 X 1 Sales $10, 000 Cost of goods sold Beginning inventory $2, 000 Cost of purchases 7, 000 Goods available for sale 9, 000 Ending inventory 1, 600 Cost of goods sold 7, 400 Gross profit $2, 600 A 2 Year 20 X 2 $10, 000 $2, 000 7, 000 9, 000 2, 000 Year 20 X 3 $10, 000 Total $30, 000 $2, 000 7, 000 9, 000 2, 000 7, 000 $3, 000 21, 000 $9, 000 Year 20 X 2 $10, 000 Year 20 X 3 $10, 000 Total $30, 000 $1, 600 7, 000 8, 600 2, 000 $2, 000 7, 000 9, 000 2, 000 6, 600 $3, 400 7, 000 $3, 000 21, 000 $9, 000 86
Cash and internal control
Internal Control System Policies and procedures managers use to: o Protect assets. o Ensure reliable accounting. o Urge adherence to company policies. o Promote efficient operations. C 1 88
Sarbanes-Oxley Act (SOX) The Sarbanes-Oxley Act requires managers and auditors of public companies to document and certify the system of internal controls. Section 404 of SOX requires that managers document and assess the effectiveness of all internal control processes that can impact financial reporting. C 1 89
Principles of Internal Control Internal control principles common to all companies: 1. Establish responsibilities. 2. Maintain adequate records. 3. Insure assets and bond key employees. 4. Separate recordkeeping from custody of assets. 5. Divide responsibility for related transactions. 6. Apply technological controls. 7. Perform regular and independent reviews. C 1 90
Technology and Internal Control Reduced Processing Errors More Extensive Testing of Records Limited Evidence of Processing Crucial Separation of Duties Increased E-Commerce C 1 91
Limitations of Internal Control Human Error Human Fraud Negligence Fatigue Misjudgment Confusion Intent to defeat internal controls for personal gain Human fraud triple-threat: Opportunity, Pressure, and Rationalization C 1 92
Limitations of Internal Control The costs of internal controls must not exceed their benefits. C 1 93
NEED-TO-KNOW Identify the following phrases/terms as best linked with the (a) purposes of an internal control system, (b) principles of internal control, or (c) limitations of internal control. 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) C 1 Protect assets Establish responsibilities Human error Maintain adequate records Apply technological controls Ensure reliable accounting Insure assets and bond key employees Human fraud Separate recordkeeping from custody of assets Divide responsibility for related transactions Cost-benefit principle Promote efficient operations Perform regular and independent reviews Urge adherence to company policies 94
NEED-TO-KNOW C 1 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) Protect assets Establish responsibilities Human error Maintain adequate records Apply technological controls Ensure reliable accounting Insure assets and bond key employees Human fraud Separate recordkeeping from custody of assets Divide responsibility for related transactions Cost-benefit principle Promote efficient operations Perform regular and independent reviews Urge adherence to company policies a) Purposes of internal controls Protect assets. Promote efficient operations. Ensure reliable accounting. Urge adherence to company policies. a) Purpose of internal controls 95
NEED-TO-KNOW C 1 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) Protect assets Establish responsibilities Human error Maintain adequate records Apply technological controls Ensure reliable accounting Insure assets and bond key employees Human fraud Separate recordkeeping from custody of assets Divide responsibility for related transactions Cost-benefit principle Promote efficient operations Perform regular and independent reviews Urge adherence to company policies a) Purpose of internal controls b) Principles of internal controls a) Purposes of internal controls Protect assets. Promote efficient operations. Ensure reliable accounting. Urge adherence to company policies. b) Principles of internal controls Establish responsibilities. Maintain adequate records. Insure assets and bond key employees. Separate recordkeeping from custody of assets. Divide responsibility for related transactions. Apply technological controls. Perform regular and independent reviews. b) Principles of internal controls a) Purpose of internal controls b) Principles of internal controls a) Purpose of internal controls 96
NEED-TO-KNOW C 1 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) Protect assets Establish responsibilities Human error Maintain adequate records Apply technological controls Ensure reliable accounting Insure assets and bond key employees Human fraud Separate recordkeeping from custody of assets Divide responsibility for related transactions Cost-benefit principle Promote efficient operations Perform regular and independent reviews Urge adherence to company policies a) Purpose of internal controls b) Principles of internal controls c) Limitations of internal controls b) Principles of internal controls c) Limitations of internal controls a) Purpose of internal controls b) Principles of internal controls a) Purposes of internal controls Protect assets. Promote efficient operations. Ensure reliable accounting. Urge adherence to company policies. c) Limitations of internal controls Human elements include: Human error. Human fraud. Cost-benefit principle. b) Principles of internal controls Establish responsibilities. Maintain adequate records. Insure assets and bond key employees. Separate recordkeeping from custody of assets. Divide responsibility for related transactions. Apply technological controls. Perform regular and independent reviews. 97
Control of Cash An effective system of internal control that protects cash and cash equivalents should meet three basic guidelines: Handling cash is separated from recordkeeping for cash. C 2 Cash receipts are promptly deposited in a bank. Cash disbursements are made by check. 98
Cash, Cash Equivalents, and Liquidity Cash and similar assets are called liquid assets because they can be readily used to settle such obligations. Cash Currency, coins, and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders. C 2 Cash Equivalents Short-term, highly liquid investments that are: 1. Readily convertible to a known cash amount. 2. Close to maturity date and not sensitive to interest rate changes. 99
Cash Management The goals of cash management are twofold: 1. Plan cash receipts to meet cash payments when due. 2. Keep a minimum level of cash necessary to operate. Effective cash management involves applying the following cash management principles: § Encourage collection of receivables. § Delay payment of liabilities. § Keep only necessary levels of assets. § Plan expenditures. § Invest excess cash. C 2 100
Over-the-Counter Cash Receipts This graphic illustrates that none of the people involved can make a mistake or divert cash without the difference being revealed. P 1 101
Cash Over and Short Sometimes errors in making change are discovered from differences between the cash in the cash register and the record of the amount of cash receipts. If a cash register’s record shows $550 but the count of cash in the register is $555, we would prepare the following journal entry: P 1 102
Cash Over and Short Sometimes errors in making change are discovered from differences between the cash in the cash register and the record of the amount of cash receipts. On the other hand, if a cash register’s record shows $625 but the count of cash in the register is $621, the entry to record cash sales and its shortage is: P 1 103
Cash Receipts by Mail Preferably, two people are assigned the task of opening the mail P 1 The cashier deposits the money in a bank The recordkeeper records the amounts received in the accounting records 104
Control of Cash Disbursements Control of cash disbursements is especially important as most large thefts occur from payment of fictitious invoices. Keys to Controlling Cash Disbursements • Require all expenditures to be made by check. • Limit access to checks except for those who have the authority to sign checks. P 1 105
Voucher System of Control A voucher system establishes procedures for: 1. Verifying, approving, and recording obligations for eventual cash disbursements. 2. Issuing checks for payment of verified, approved, and recorded obligations. P 1 106
Voucher System of Control P 1 107
NEED-TO-KNOW A good system of internal control for cash provides adequate procedures for protecting both cash receipts and cash disbursements. Which of the following statements are true regarding the control of cash receipts and disbursements? 1. Over-the-counter cash receipts from sales should be recorded on a cash register at the time of each sale. True – All sales should be recorded on a cash register. 2. Custody over cash should be separate from the recordkeeping of cash. True – Segregation of duties 3. For control of cash receipts that arrive through the mail, two people should be assigned the task of, and be present for, opening that mail. True – Segregation of duties 4. One key to controlling cash disbursements is to require that no expenditures be made by check; instead, all expenditures should be made from petty cash. False – Only small amounts should be paid from petty cash. 5. A voucher system of control should be applied only to purchases of inventory and never to other expenditures. False – A voucher system should be applied to all purchases. P 1 108
Petty Cash System of Control Small payments required in most companies for items such as postage, courier fees, repairs, and supplies. P 2 109
Operating a Petty Cash Fund P 2 110
Operating a Petty Cash Fund P 2 111
Operating a Petty Cash Fund P 2 112
NEED-TO-KNOW Bacardi Company established a $150 petty cash fund with Eminem as the petty cashier. When the fund balance reached $19 cash, Eminem prepared a petty cash payment report, which follows. Receipt No. 12 13 15 16 Account Charged Delivery Expense Merchandise Inventory (Omitted) Miscellaneous Expense Total $29 18 32 41 $120 Approved by Eminem (Omitted) Received by A. Smirnoff J. Daniels C. Carlsberg J. Walker Required: 1. Identify four internal control weaknesses from the payment report. Petty cash ticket no. 14 is missing. All petty cash tickets should be pre-numbered and all numbers should be accounted for. Since total cash on hand is only $19, $131 has been withdrawn ($150 - $19). Only $120 in expenditures has been documented. Management should investigate the $11 cash shortage. The petty cashier did not sign petty cash receipt no. 16. Was the expense approved, or was this an oversight? Petty cash receipt no. 15 does not indicate the account to be charged. If possible, management should determine the correct account; if impossible, Miscellaneous Expense should be charged. P 2 113
NEED-TO-KNOW Bacardi Company established a $150 petty cash fund with Eminem as the petty cashier. When the fund balance reached $19 cash, Eminem prepared a petty cash payment report, which follows. Receipt No. 12 13 15 16 Account Charged Delivery Expense Merchandise Inventory (Omitted) Miscellaneous Expense Total $29 18 32 41 $120 Approved by Eminem (Omitted) Received by A. Smirnoff J. Daniels C. Carlsberg J. Walker 2. Prepare general journal entries to record the establishment of the fund and the reimbursement of the fund. (Assume that management was unable to verify the account number for receipt no. 15. ) Date Establish General Journal Petty cash Cash Reimburse Delivery expense Merchandise inventory Miscellaneous expense Cash short and over Cash ($150 - $19) P 2 Debit 150 Credit 150 29 18 73 11 131 114
NEED-TO-KNOW Bacardi Company established a $150 petty cash fund with Eminem as the petty cashier. When the fund balance reached $19 cash, Eminem prepared a petty cash payment report, which follows. Receipt No. 12 13 15 16 Account Charged Delivery Expense Merchandise Inventory (Omitted) Miscellaneous Expense Total $29 18 32 41 $120 Approved by Eminem (Omitted) Received by A. Smirnoff J. Daniels C. Carlsberg J. Walker 3. What is the Petty Cash account balance immediately before reimbursement? $150 Immediately after reimbursement? $150 The balance in Petty cash remains constant unless the amount of the fund is changed. P 2 115
Basic Bank Services Signature Cards Deposit Tickets Bank Accounts Bank Statements Checks Electronic Funds Transfer P 2 116
Bank Statement Usually once a month, the bank sends each depositor a bank statement showing the activity in the account. P 2 117
Bank Reconciliation A bank reconciliation is prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on company’s books. P 3 118
Bank Reconciliation The balance of a checking account reported on the bank statement rarely equals the balance in the depositor’s accounting records. Cash Balance per Bank Cash Balance per Book + Deposits in Transit + Collections & Interest - Outstanding Checks - Uncollectible items +/- Errors Adjusted Cash Balance = Adjusted Cash Balance Adjusting entries are recorded for the reconciling items on the book side of the reconciliation. P 3 119
Bank Reconciliation We follow nine steps in preparing the bank reconciliation. Cash Balance per Bank + Deposits in Transit - Outstanding Checks +/- Errors Adjusted Cash Balance P 3 120
Bank Reconciliation We follow nine steps in preparing the bank reconciliation. Cash Balance per Book + Collections & Interest - Uncollectible items +/- Errors Adjusted Cash Balance P 3 121
Bank Reconciliation We follow nine steps in preparing the bank reconciliation. Adjusting entries are recorded for the reconciling items on the book side of the reconciliation. P 3 122
Bank Reconciliation Only the items reconciling the book balance require adjustment. P 3 123
NEED-TO-KNOW The following information is available to reconcile Gucci’s book balance of cash with its bank statement cash balance as of December 31. Prepare the bank reconciliation for this company as of December 31. a. The December 31 cash balance according to the accounting records is $1, 610, and the bank statement cash balance for that date is $1, 900. b. Gucci’s December 31 daily cash receipts of $800 were placed in the bank’s night depository on December 31, but do not appear on the December 31 bank statement. c. Check No. 6273 for $400 and Check No. 6282 for $100, both written and entered in the accounting records in December, are not among the canceled checks. Two checks, No. 6231 for $2, 000 and No. 6242 for $200, were outstanding on the most recent November 30 reconciliation. Check No. 6231 is listed with the December canceled checks, but Check No. 6242 is not. d. When the December checks are compared with entries in the accounting records, it is found that Check No. 6267 had been correctly drawn for $340 to pay for office supplies but was erroneously entered in the accounting records as $430. e. A credit memorandum indicates that the bank collected $500 cash on a note receivable for the company, deducted a $30 collection fee, and credited the balance to the company’s Cash account. Gucci had not recorded this transaction before receiving the statement. f. Two debit memoranda are enclosed with the statement and are unrecorded at the time of the reconciliation. One debit memorandum is for $150 and dealt with an NSF check for $140 received from a customer, Prada Inc. , in payment of its account. The bank assessed a $10 fee for processing it. The second debit memorandum is a $20 charge for check printing. Gucci had not recorded these transactions before receiving the statement. P 3 124
NEED-TO-KNOW Bank statement balance Gucci Bank Reconciliation December 31 Book balance Add: Items already added to the book balance that have not yet been added to the bank balance. Add: Items already added to the bank balance that have not yet been added to the book balance. Deduct: Items already subtracted from the book balance that have not yet been subtracted from the bank balance. Deduct: Items already subtracted from the bank balance that have not yet been subtracted from the book balance. Adjusted bank balance Adjusted book balance In the case of an error, whichever party made the error (book or bank) will show the correction as an adjustment. P 3 125
NEED-TO-KNOW Gucci Bank Reconciliation December 31 $1, 900 Book balance Add: 800 Bank statement balance Add: Deposit of December 31 Deduct: Checks No. 6273 6282 6242 Adjusted bank balance $400 100 200 $1, 610 Deduct: Adjusted book balance a. The December 31 cash balance according to the accounting records is $1, 610, and the bank statement cash balance for that date is $1, 900. b. Gucci’s December 31 daily cash receipts of $800 were placed in the bank’s night depository on December 31, but do not appear on the December 31 bank statement. c. Check No. 6273 for $400 and Check No. 6282 for $100, both written and entered in the accounting records in December, are not among the canceled checks. Two checks, No. 6231 for $2, 000 and No. 6242 for $200, were outstanding on the most recent November 30 reconciliation. Check No. 6231 is listed with the December canceled checks, but Check No. 6242 is not. P 3 126
NEED-TO-KNOW Gucci Bank Reconciliation December 31 $1, 900 Book balance Add: 800 Error (Ck 6267) $90 2, 700 Proceeds of note less $30 fee 470 Bank statement balance Add: Deposit of December 31 Deduct: Checks No. 6273 6282 6242 Adjusted bank balance $400 100 200 700 $2, 000 Deduct: NSF check Printing fee Adjusted book balance $150 20 $1, 610 560 2, 170 $2, 000 d. When the December checks are compared with entries in the accounting records, it is found that Check No. 6267 had been correctly drawn for $340 to pay for office supplies but was erroneously entered in the accounting records as $430. e. A credit memorandum indicates that the bank collected $500 cash on a note receivable for the company, deducted a $30 collection fee, and credited the balance to the company’s Cash account. Gucci had not recorded this transaction before receiving the statement. f. Two debit memoranda are enclosed with the statement and are unrecorded at the time of the reconciliation. One debit memorandum is for $150 and dealt with an NSF check for $140 received from a customer, Prada Inc. , in payment of its account. The bank assessed a $10 fee for processing it. The second debit memorandum is a $20 charge for check printing. Gucci had not recorded these transactions before receiving the statement. P 3 127
NEED-TO-KNOW Gucci Bank Reconciliation December 31 $1, 900 Book balance Add: 800 Error (Ck 6267) $90 2, 700 Proceeds of note less $30 fee 470 Bank statement balance Add: Deposit of December 31 Deduct: Checks No. 6273 6282 6242 Adjusted bank balance Date Dec. 31 P 3 $400 100 200 700 $2, 000 Deduct: NSF check Printing fee Adjusted book balance General Journal Cash Office supplies 560 2, 170 $150 20 Debit 90 170 $2, 000 Credit 90 Cash Collection expense Notes receivable 470 30 Accounts receivable - Prada Inc. Cash 150 Miscellaneous expenses Cash $1, 610 500 150 20 20 128
1) Return on Assets Return on assets (ROA) is stated in ratio form as net income divided by the average of total assets invested. Return on assets = A 2 Net income Average total assets 129
2) Debt Ratio Total Liabilities Debt Ratio = Total Assets Evaluates the level of debt risk. A higher ratio indicates that there is a greater probability that a company will not be able to pay its debt in the future. A 2 130
3) Profit Margin The profit margin ratio measures the company’s net income to net sales. Profit Net Income = Margin Net Sales Limited Brands, Inc. A 1 131
4) Current Ratio Helps assess the company’s ability to pay its debts in the near future Current ratio = Current assets Current liabilities Limited Brands, Inc. A 2 132
5) Acid-Test (Quick) Ratio Acid-test ratio Quick assets = Current liabilities Acid-test Cash + short term investments+ Receivables = Current liabilities ratio A common rule of thumb is the acid-test ratio should have a value of at least 1. 0 to conclude a company is unlikely to face liquidity problems in the near future. A 1 133
6) Gross Margin Ratio Gross Net sales - Cost of goods sold margin = Net sales ratio Percentage of dollar sales available to cover expenses and provide a profit. A 2 134
7) Inventory Turnover Shows how many times a company turns over its inventory during a period. Indicator of how well management is controlling the amount of inventory available. Inventory turnover Average Inventory A 3 = Cost of goods sold Average inventory = (Beg. Inv. + End Inv. ) ÷ 2 135
8) Days’ Sales in Inventory Reveals how much inventory is available in terms of the number of days’ sales. Ending inventory Days‘ sales in 365 × = inventory Cost of goods sold A 3 136
9) Days’ Sales Uncollected Indicates how much time is likely to pass before we receive cash receipts from credit sales. Days’ Accounts receivable = sales Net sales uncollected A 1 × 365 137
Homework assignment • Prepare Chapter 7 “Accounting for Receivables. ” Receivables • Prepare chapters 4, 5, and 6 for EXAM # 2 on 3/21, all Homework are due by max. 3/20 at 11: 59 PM. Happiness is having all homework up to date Atef Abuelaish 138
Thank you and See You Wednesday at the Same Time, Take Care Atef Abuelaish 139
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