Accounting Basics Merchandising and Special Topics Syllabus

Under LIFO, which costs are assigned to COGS and which to ending inventory?

LIFO assumes the newest (most recent) costs flow to COGS, so ending inventory consists of the oldest purchase costs.

In a period of rising prices (inflation), which method yields the highest net income and which yields the lowest?

FIFO yields the highest net income (older, lower costs in COGS) and the highest ending inventory. LIFO yields the lowest net income (newest, higher costs in COGS) and the lowest ending inventory.

In a period of rising prices, which inventory method minimizes income taxes, and why?

LIFO minimizes taxes because it charges the highest (most recent) costs to COGS, producing the lowest taxable net income.

Give the formula for the weighted-average unit cost under a periodic system.

$$\text{Weighted-Average Unit Cost} = \frac{\text{Cost of Goods Available for Sale}}{\text{Total Units Available for Sale}}$$

What does the Lower of Cost or Market (LCM) rule require?

Inventory must be reported at the lower of its historical cost or its market value (replacement cost / net realizable value). If market has fallen below cost, inventory is written down to market. It is an application of the conservatism principle.

Under LCM, what is the entry to record a write-down of inventory to market?

Debit Cost of Goods Sold (or Loss on Inventory Write-down) and credit Inventory for the amount by which cost exceeds market. Inventory is never written up above cost.

List the six principles of internal control activities.

1) Establishment of responsibility, 2) Segregation of duties, 3) Documentation procedures, 4) Physical controls, 5) Independent internal verification, 6) Human resource (personnel) controls.

What are the two main applications of the principle of segregation of duties?

1) Different individuals should be responsible for related activities (e.g., ordering vs. paying). 2) The responsibility for recordkeeping for an asset should be separate from physical custody of that asset.

What are the two primary objectives of a system of internal control?

1) Safeguard assets and enhance the reliability/accuracy of accounting records. 2) Increase efficiency of operations and ensure compliance with laws and management policies.

Why is a bank reconciliation prepared?

To reconcile (explain) the difference between the cash balance per the company's books and the cash balance per the bank statement, because of timing differences and errors, and to determine the correct adjusted cash balance.

On a bank reconciliation, how are deposits in transit and outstanding checks treated?

Deposits in transit are ADDED to the bank balance. Outstanding checks are SUBTRACTED from the bank balance. Both are timing differences already recorded on the books.

On the book side of a bank reconciliation, how are bank collections/interest earned versus service charges and NSF checks treated?

Bank credit memoranda (collections, interest earned) are ADDED to the book balance. Debit memoranda (service charges, NSF/bounced checks) are SUBTRACTED from the book balance. These items require adjusting journal entries.

After a bank reconciliation, which reconciling items require journal entries on the company's books?

Only the items adjusting the BOOK balance (e.g., bank service charges, NSF checks, interest earned, notes collected by the bank, book errors). Bank-side items (deposits in transit, outstanding checks) need no entry.

What is a petty cash fund used for, and what type of internal control account is it?

A petty cash fund is an imprest fund used to pay small, routine expenditures (postage, minor supplies) where writing a check is impractical. It is an imprest system maintained at a fixed established amount.

What is the journal entry to establish a petty cash fund?

Debit Petty Cash and credit Cash for the amount of the fund. This entry is made only once (at establishment).

When a petty cash fund is replenished, what accounts are affected, and is Petty Cash debited?

Debit the various expense accounts documented by the receipts and credit Cash for the amount needed to restore the fund. Petty Cash itself is NOT debited on replenishment (only when established or when the fund size is changed).

How is a Cash Over and Short account used during petty cash replenishment?

If receipts plus remaining cash don't equal the imprest amount, the shortage/overage is recorded in Cash Over and Short: debit it for a shortage (expense) or credit it for an overage (revenue) to balance the replenishment entry.

Define accounts receivable and note where they are classified on the balance sheet.

Accounts receivable are amounts owed by customers from credit sales of goods/services, typically due within 30–60 days. They are classified as a current asset, reported at net realizable value.

What is net realizable value of accounts receivable?

$$\text{Net Realizable Value} = \text{Accounts Receivable} - \text{Allowance for Doubtful Accounts}$$ It is the net amount the company expects to actually collect.

Contrast the direct write-off method and the allowance method for uncollectible accounts.

Direct write-off: bad debt expense is recorded only when a specific account is deemed uncollectible (not GAAP-compliant; violates matching). Allowance method: bad debts are estimated and expensed in the period of sale via a contra-asset (Allowance for Doubtful Accounts), satisfying the matching principle.

Under the allowance method, what entry records the estimate of uncollectible accounts?

Debit Bad Debt Expense and credit Allowance for Doubtful Accounts for the estimated amount. The allowance is a contra-asset that reduces net receivables.

Under the allowance method, what is the entry to write off a specific uncollectible account, and does it affect net receivables?

Debit Allowance for Doubtful Accounts and credit Accounts Receivable. It has no effect on net realizable value or total assets, since both the allowance and gross receivables decrease by the same amount.

Contrast the two bases for estimating bad debts: percentage-of-sales vs. percentage-of-receivables.

Percentage-of-sales (income-statement approach) applies a rate to net credit sales to directly compute Bad Debt Expense. Percentage-of-receivables (balance-sheet approach, often an aging schedule) computes the required ending Allowance balance; the entry is the amount needed to adjust the allowance to that target.

State the formula for computing interest on a note receivable.

$$\text{Interest} = \text{Face Value (Principal)} \times \text{Annual Rate} \times \text{Time}$$ where Time is expressed as a fraction of a year (e.g., $\frac{90}{360}$).

Calculate the interest on a $\$6{,}000$, $8\%$, 90-day note (using a 360-day year).

$$\text{Interest} = 6{,}000 \times 0.08 \times \frac{90}{360} = \$120$$

What is the maturity value of a note receivable?

$$\text{Maturity Value} = \text{Principal (Face Value)} + \text{Interest}$$ It is the total amount due at the note's due date.

What entry does the payee make to record accrued interest on a note at year-end (before maturity)?

Debit Interest Receivable and credit Interest Revenue for the interest earned from the note's issue date through the balance sheet date. This satisfies the revenue recognition and matching principles.

Define accounts payable and current liabilities.

Accounts payable are amounts owed to suppliers for goods/services purchased on credit. Current liabilities are obligations expected to be paid within one year or the operating cycle (whichever is longer) from existing current assets or by creating other current liabilities.

When a company borrows via a note payable, how is the interest portion handled at year-end if unpaid?

Accrue it: debit Interest Expense and credit Interest Payable for interest incurred but not yet paid, computed as $\text{Principal} \times \text{Rate} \times \text{Time}$. This records the expense in the period incurred.

How is sales tax collected from customers recorded by the seller, and why is it a liability?

At the sale, debit Cash (or A/R) for the total, credit Sales Revenue for the selling price, and credit Sales Taxes Payable for the tax. The tax is a current liability because it is collected on behalf of the government and later remitted, not revenue to the seller.

How is the current portion of long-term debt reported?

The portion of long-term debt (principal) due within the next year is reclassified from long-term liabilities to current liabilities as 'Current portion of long-term debt' on the balance sheet.

What costs are included in the cost of a plant asset (the cost principle)?

All expenditures necessary to acquire the asset and make it ready for its intended use — e.g., purchase price, freight, installation, sales taxes, and site preparation. Recurring costs like ordinary repairs and insurance after use begins are expensed.

Define depreciation. Is it a process of valuation or of cost allocation?

Depreciation is the systematic allocation of the cost of a plant asset (less salvage value) to expense over its useful life. It is a process of cost allocation, NOT a process of valuing the asset at market.

State the straight-line depreciation formula.

$$\text{Annual Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life (years)}}$$

State the units-of-activity (units-of-production) depreciation formula.

First, $$\text{Depreciable Cost per Unit} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Total Estimated Units}}$$ Then $$\text{Depreciation Expense} = \text{Cost per Unit} \times \text{Units of Activity this period}$$

How is the double-declining-balance depreciation rate and expense determined?

The rate is twice the straight-line rate: $$\text{Rate} = 2 \times \frac{1}{\text{Useful Life}}$$ Expense $=$ Rate $\times$ beginning book value. Salvage value is ignored in the calculation, but the asset is not depreciated below salvage value.

Define book value (carrying value) of a plant asset.

$$\text{Book Value} = \text{Cost} - \text{Accumulated Depreciation}$$ It is the asset's undepreciated cost, not its market value.

Which depreciation method produces the highest expense in the early years of an asset's life?

Double-declining-balance (an accelerated method) produces the highest depreciation expense in the early years and lower expense in later years, though total depreciation over the life equals that of straight-line.

Distinguish a capital expenditure from a revenue expenditure for plant assets.

A capital expenditure increases the asset's capacity or useful life (an addition/improvement) and is debited to the asset account (capitalized). A revenue expenditure maintains the asset in operating condition (ordinary repairs) and is expensed immediately.

What is the first step required before recording any disposal of a plant asset?

Update (record) depreciation up to the date of disposal, so that Accumulated Depreciation and book value are current. Only then is the gain or loss on disposal computed.

How is a gain or loss on the sale of a plant asset determined?

Compare cash proceeds to book value: if proceeds > book value, record a gain; if proceeds < book value, record a loss. $$\text{Gain/Loss} = \text{Proceeds} - \text{Book Value}$$

What is the journal entry to retire (discard) a fully depreciated plant asset with no salvage value?

Debit Accumulated Depreciation and credit the asset account for its full cost. No gain or loss results because book value is zero.

When a plant asset is discarded before it is fully depreciated (scrapped for nothing), what is recorded?

Debit Accumulated Depreciation for the amount recorded, debit Loss on Disposal for the remaining book value, and credit the asset account for its cost. The loss equals the book value at disposal.

Distinguish gross pay from net pay in payroll accounting.

Gross pay (gross earnings) is total compensation earned before deductions (regular + overtime). Net pay is the amount actually paid to the employee: $$\text{Net Pay} = \text{Gross Pay} - \text{Total Deductions}$$

Distinguish employee payroll deductions from employer payroll taxes.

Employee deductions (withheld from gross pay) include federal/state income tax withholding, the employee share of FICA (Social Security and Medicare), and voluntary deductions. Employer payroll taxes are additional expenses to the employer: the employer's matching FICA, plus federal (FUTA) and state (SUTA) unemployment taxes.

How is overtime pay generally calculated for hourly employees under standard rules?

Hours worked beyond 40 in a week are paid at 1.5 times the regular rate. $$\text{Overtime Pay} = \text{Overtime Hours} \times (1.5 \times \text{Regular Rate})$$

What is the journal entry to record an employer's payroll (recognizing wages owed)?

Debit Salaries and Wages Expense for gross pay; credit the withholding liabilities (FICA Taxes Payable, Federal/State Income Taxes Payable, other deductions) and credit Salaries and Wages Payable for net pay.