Financial Accounting Exam 2 – Flashcards
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Accounting for inventories is important because it can have a material effect on both the BALANCE SHEET (ENDING INVENTORY) and the INCOME STATEMENT (COST OF GOODS SOLD)
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True
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Measures the value of inventory delivered to, and billed to, customers, often referred to as the "invoice value"
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Gross Sales Revenue
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Contra-revenue account used to record customer refunds or credits given to their accounts. Represents a reduction of sales revenue for the return of (or allowance granted for) unsatisfactory goods
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Sales Returns and Allowances
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Contra-revenue account used to record discounts given to customers for early payment of their account
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Sales Discounts
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Transportation cost paid by the seller on merchandise deliverd to the customer; this is a selling expense, not a contra-revenue account; not included in net sales
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Freight-Out
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Gross Sales less all contra-revenue accounts (sales returns and allowances and sales discounts)
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Net Sales
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Measures the cost of inventory acquired as billed to the company by the supplier
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Gross Purchase Cost
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Account used to record the decrease of the purchase cost for the return of (or allowance granted for) unsatisfactory goods purchased
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Purchase Returns and Allowances
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Account used to record the decrease of the purchase cost for discounts granted by the supplier for early payment of account payable
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Purchase Discounts
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Account used to record the increase in the purchase cost of inventory due to transportation costs paid by the buying company; included in net purchases
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Freight-In
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Gross Purchase Cost - Purchase Returns and Allowances - Purchase Discounts + Freight-In
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Net Purchases
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Title passes to the buyer when the goods are placed on the common carrier and the buyer pays the shipping costs
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FOB Shipping Point
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Title passes to the buyer when the goods arrive at the buyer's location and the seller pays the shipping costs
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FOB Destination
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Expense on the income statement representing the cost of inventory sold to customers to generate Sales Revenue
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COGS
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Beginning inventory cost (BI) + Net purchase cost (P) - Ending inventory cost (EI)
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COGS Model
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Net Sales Revenue - COGS
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Gross Profit
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Net Sales Revenue - COGS / Net Sales Revenue
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Gross Profit Rate
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This inventory account maintains a continuous running record of cost of inventory on hand; facilitates inventory planning; provides data on losses due to shrinkage (theft); however, it increases bookkeeping costs
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Perpetual Inventory System
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This inventory account contains the cost of the inventory on hand at the beginning of the year and it is NOT updated for purchases; at the end of the year, the inventory account is updated by making an actual physical count of inventory on hand using the COGS model; advantages are that it minimizes bookkeeping costs and disadvantages are that it assumes all goods not accounted for by physical count have been sold ("shrinkage" [theft] buried in COGS)
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Periodic Inventory System
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This currently requires that a company's inventory be valued on the Balance Sheet at the lower-of-cost-or-market
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GAAP
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This means current replacement cost - what it would cost the company to replace the inventory it holds on the balance sheet date at prices that prevail on the balance sheet date
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"Market"
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This means either specific unit cost, first-in, first-out (FIFO) cost, or average cost. Companies must choose one of these 4 methods for measuring this.
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"Cost"
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Cost flows follow the physical flow of inventory
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Specific Unit Cost
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Selection of cost flow assumption (FIFO, LIFO, Weighted Average) determines how total THIS will be allocated between balance sheet and income statement
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Cost of Goods Available for Sale
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Any of the cost flow assumption (FIFO, LIFO, Weighted Average) methods can be used for financial reporting. However, if LIFO is used for TAX REPORTING, it MUST also be used on the company's financial statements
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LIFO Conformity Rule
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Allocates the oldest unit costs to COGS and allocates the most recent (newest) unit costs to Ending Inventory (the goods on hand)
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FIFO
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Allocates the most recent (newest) unit costs to COGS and allocates the oldest unit costs to the Ending Inventory (the goods on hand)
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LIFO
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Cost per unit is total dollars of inventory available for sale divided by the total units of inventory available for sale. Example: $165 (total)/10 units = $16.50 per unit
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Weighted Average
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When prices are increasing, it has the lowest COGS (IS), highest net income (IS), and highest ending inventory balance (BS)
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FIFO
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When prices are increasing, it has the highest COGS (IS), lowest net income (IS), and lowest ending inventory balance
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LIFO
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When prices are decreasing, it has the highest COGS (IS), lowest net income (IS), and lowest ending inventory balance
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FIFO
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When prices are decreasing, it has the lowest COGS (IS), highest net income (IS), and highest ending inventory balance (BS)
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LIFO
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Does not permit the use of LIFO; it also defines market to mean net realizable value (selling price less selling costs); allows plant assets to be valued at fair value
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IFRS
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An event where the number of units of inventory sold during the year exceeds the number of units purchased during the year so that the number of units in the ending inventory is less that the number in the beginning inventory; results in a large increase in the company's net income
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LIFO Liquidation
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Ending inventory reported on the company's balance sheet must be valued at this; when inventory is written down to market, the loss in value increases COGS
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Lower-of-Cost-or-Market
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GAAP requires that all LIFO companies present, in the notes to their financial statements, an estimate of the amount that beginning and ending inventories using FIFO exceed those using LIFO. These estimates are called "LIFO Reserves"
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LIFO Footnote
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For the end of the year, it is EI FIFO - EI LIFO. For the beginning of the year, it is BI FIFO - BI LIFO.
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LIFO Reserve
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COGS LIFO - COGS FIFO; this equals (EI FIFO - EI LIFO) - (BI FIFO - BI LIFO)
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Change in the LIFO Reserve
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Pretax income using LIFO + Increase (or - Decrease) in LIFO Reserve
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Pretax Income using FIFO
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After tax: Net income (after tax) using LIFO + [Increase (or - Decrease) in LIFO Reserve x (1.0 - Tax Rate)]
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Net Income using FIFO
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________ in the LIFO reserve X tax rate determines the amount of income taxes the company saved during the current year by using LIFO
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Increase
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________ in the LIFO reserve X tax rate determines the amount of additional taxes the company paid during the current year by using LIFO
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Decrease
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________ in the LIFO reserve X tax rate determines the cumulative tax saving since the company began using LIFO
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Year-End Balance
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Indication of how well a company manages its inventories. Again the higher the turnover, the more efficient inventory management; therefore the better management is performing
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Inventory Turnover
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COGS / Average Inventory/2 ([Beginning + Ending])
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Inventory Turnover
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Indicates the average number of days that goods remain unsold (in inventory). Lower the number of days, the better job the company is doing; 360/Inventory Turnover
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Average Holding Period
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Impact both a company's income statement and balance sheet. Generally have one effect in one year and have the opposite effect in the second year
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Inventory Errors
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On the Income Statement, if beginning inventory is understated and ending inventory is overstated, COGS is understated and NI is overstated. If beginning inventory is overstated and ending inventory is understated, COGS is overstated and NI is understated
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True
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On the Balance Sheet, if the ending inventory error is overstated, assets are overstated, liabilities do not change, and equity is overstated. If the ending inventory error is understated, assets are understated, liabilities do not change, and equity is understated.
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True
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Method used to make an estimated inventory on hand
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Gross Profit
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Long-lived assets usually called PPE or Fixed Assets
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Plant Assets
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Long-lived assets without physical substance. These assets convey various benefits, often contractual in nature, to the company
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Intangible Assets
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Cash and cash equivalents paid to acquire the asset and make it ready for its intended use. Also referred to as Historical Cost or Original Cost
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Acquisition Cost
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Acquisition cost of depreciable plant assets less accumulated depreciation - referred to as book value or carrying value
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Net Plant Assets
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When more than one plant asset is acquired for a single amount, the original cost of each asset acquired is based on the relative market values of each of the individual assets acquired
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Basket Purchase
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An expenditure on a plant asset that improves its economic capacity, efficiency, or extends its useful life. The expenditure is recorded as an addition to the cost of the asset, included on the balance sheet, and depreciated; aka changing an engine
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Capital Expenditure
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An expenditure on a plant asset that maintains the asset in its normal operating condition. The expenditure is recorded as an expense and reported on the income statement in the period incurred (or "immediate expense"); aka an oil change
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Revenue Expenditure
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Systematic process of allocating the cost of a fixed asset to expense over the asset's productive life
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Depreciation
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This is a permanent contra-asset account and is increased by crediting it. It is NOT an amount of cash set aside to replace the asset at the end of its useful life. It is offset against the cost of the asset, thus reducing the asset to its carrying value or book value
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Accumulated Depreciation
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This "value" does NOT measure the asset's worth if sold, or cost if it were to be replaced
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Book Value
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Also called residual value; the amount the company expects to receive from selling the asset at the end of its service life
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Salvage Value
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The original acquisition cost of a depreciable asset minus its salvage value. This is the amount in accumulated depreciation at the end of the asset's useful life
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Depreciable Cost
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Allocates the same amount of depreciable cost (original cost minus salvage value) to each accounting period. Used for those plant assets whose services are used up approximately equally over the asset's useful life; Cost - Salvage Value / Useful Life (n)
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Straight-Line Method
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Allocates the same dollar amount of depreciation expense to each unit of output. The amount allocated to each accounting period equals the amount of depreciation per unit of output times the number of units of output occurring in the current accounting period. Used for those assets that depreciate mainly because of wear and tear (physical factors); (Asset cost - Salvage value) / Total output = Cost per unit x Current output = Depreciation
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Units-of-Production Method
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This method is a special case of several methods referred to as accelerated depreciation methods. These methods share the property that depreciation expense is largest in the first year of the asset's life and becomes progressively smaller with each succeeding year of the asset's life. It is used for those assets that depreciate mainly because of obsolescence; (Cost - Accumulated Depreciation at BOY) x (2/Useful Life)
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Double-Declining Balance Method
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Some companies prefer to use an accelerated depreciation method because the higher depreciation deductions during the early years of the asset's life results in the company paying less tax, giving the companies a cash flow advantage over straight-line called Modified Accelerated Cost Recovery System
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MACRS
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The process of allocating the cost of natural resources to expense over the resource's estimate useful life
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Depletion
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The cost of the asset is allocated to expense over the life of the asset as the benefits embodied in the asset get used up
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Amortization
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This of intangible assets with estimable useful lives are almost always zero
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Salvage Value
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Intangible assets without estimate useful lives are not amortized, but are instead tested for this; companies are required to periodically test whether the FMV of the asset is less than the recorded amount
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Asset Impairment
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Amount paid - FMV of company's net assets
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Goodwill
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A potential liability, the existence of a liability is in doubt and depends upon the occurrence of a future event. Examples include: Litigation claims, premium claims (rebates, jewelry), product warranties
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Contingent Liabilities
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If the likelihood for this future event is this, we record the liability as a dollar amount as reasonably amount. We disclose in the notes if it is not reasonably estimable
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Probable
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If the likelihood for this future event is this, we disclose this event in the notes
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Reasonably Possible
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If the likelihood for this future event is this, no disclosure is required
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Remote
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The amount of money on some future date; these values get larger because they include accumulated interest; maturity value
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Future Value
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The amount of money today; these values get smaller because they exclude accumulated interest
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Present Value
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Computes interest on the amount of the initial principal only. Interest = Principal x Rate x Time
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Simple Interest
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Computes interest on the principal plus all accumulated interest to date that has not been paid or received; this is the norm for investments over one year in duration
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Compound Interest
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Series of equal periodic cash receipts or payments, separated by equal intervals of time
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Annuity
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Number of interest periods during which interest is being earned (for a single cash flow); number of cash flows (for an annuity)
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N
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Used in annuity calculations. Represents the amount of the equal periodic cash flow being received or paid out; coupons payments = face value x STATED rate
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R
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A fixed amount at a specified maturity date in the future
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Face Value
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Payments every 6 months (or every year) between the issue date and the maturity date
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Coupon Interest Payment
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Unsecured bonds
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Debentures
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Bonds that can be exchanged for other securities of the borrowing company
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Convertible Bonds
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Bonds that the issuer can retire prior to their scheduled maturity at a fixed contract price
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Callable Bonds
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The interest rate that lenders must earn if they are to buy the bonds; this is also the interest rate lenders use to discount the cash flows promised by the borrowing company to present value which equals the selling price of the bonds
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Market Rate
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The amount received for the bonds might equal the Face Value of the bonds in which case the bonds are said to be issued at:
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Par
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If the amount received is less than the Face Value, the bonds are issued at a:
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Discount
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If the amount received is more than the Face Value, the bonds are issued at a:
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Premium
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On each interest payment date, the difference between the amount of interest expense and the amount of the stated interest paid in cash will reduce the Bond Discount or Premium account. This method of reducing the Bond Discount or Premium accounts is called:
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Effective-Interest Method
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Bond Payable (aka Face Value) - Discount [or + Premium]
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Bond Carrying Value
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A lease that transfers most of the risks and rewards of asset ownership from the lessor (the party having legal title to the asset) to the lessee (the party that uses the asset but does not own it)
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Capital Lease
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This type of lease contains these: 1) Transfers ownership 2) Bargain purchase option 3) Lease term 4) Present value of the payment
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Capital Lease
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If the lease agreement does not contain any of these: 1) Transfers ownership 2) Bargain purchase option 3) Lease term 4) Present value of the payment It is an:
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Operating Lease
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When accounting for this, the asset must be depreciated over its useful life and the lessee thus records interest expense each year that the lease is outstanding
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Capital Lease
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When accounting for this, most companies prefer to structure their lease contracts so that it would be accounted for this
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Operating Lease
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Requires that weekly or monthly wages earned by employees be reported as expenses during the period that employees work for the company
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Matching Principle
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Total Liabilities / Total Assets; the higher the ratio, the greater the likelihood of default
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Debt Ratio
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Operating Income / Income Expense; the higher the ratio, the greater is the company's ability to meet maturing interest payments on its long-term debt
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Times-Interest-Earned
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