Accounting Midterm 2 November 4 2010 Chapter 6 Merchandising Company Manufacturing Company Merchandise Inventory inventory classification for all inventory items ready for sale Finished Goods Inventory manufactured item that is complete and ready for sale Work in Process manufactured inventory that is still in the production process Raw Materials basic goods that will be used in production Just in time Inventory when companies manufacture goods just in time for use ex Dell Goods in Transit purchased goods not yet received sold goods not yet delivered FOB Shipping Point goods in transit are owned by buyer FOB Destination goods in transit are owned by seller Consigned Goods goods held for sale by one party although ownership of the goods is retained by another party Ex a car dealership selling a used car for another person PERIODIC INVENTORY Specific Identification Method items still in inventory are specifically costed to arrive at the total cost of ending inventory Cost Flow Assumptions assume flows of costs that might be unrelated to the physical flow of goods First in First out FIFO assumes that the earliest goods purchased are the first to be sold often parallels actual physical flow of merchandise Gives higher income Last in First out LIFO assumes that the latest goods purchased are the first to be sold Gives lower taxes because of lower net income Average Cost Method allocates the cost of goods available for sale on the basis of the weighted average cost incurred Cost of Goods Available for Sale Total Units Available for Sale Weighted Average Unit Cost Net Income is usually between FIFO and LIFO Consistency Principle a company uses the same accounting principles and methods from year to year Lower of Cost or Market LCM inventory is stated at the lower of either its cost or its market value as determined by current replacement cost used when calculating total inventory Journal Entry to adjust cost of total inventory Cost of Goods Sold XX Merchandise Inventory XX Conservatism the best choice among accounting alternatives in the method that is least likely to overstate assets and net income Market value is defined as current replacement cost not selling price Inventory Errors effects the computation of cost of goods sold and net income for 2 periods over 2 years the total net income is correct because the errors offset each other Income Statement Effects Sales COGS Gross Profit Gross Profit Operating Expenses Net Income Beginning Inventory Cost of Goods Purchased Ending Inventory COGS Understate Beginning Inventory COGS Understated Net Income Overstated Overstate Beginning Inventory COGS Overstated Net Income Understated Understate Ending Inventory COGS Overstated Net Income Understated Overstate Ending Inventory COGS Understated Net Income Overstated Balance Sheet Effects List of Accounts and their balances Assets should equal Liabilities and SE Overstate Ending Inventory Assets Overstated Stockholders s Equity Overstated Understate Ending Inventory Assets Understated Stockholder s Equity Understated Inventory Turnover unit less measurement of the number of times on average the inventory is sold during the period want this number to be large Inventory turnover COGS Average of Beginning and ending Inventory Days in Inventory measures the average number of days inventory is held Days in Inventory 365 Inventory Turnover Chapter 7 Fraud a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer Opportunity Financial pressure and Rationalization Sarbanes Oxley Act SOX companies must develop principles of control over financial reporting and continually verify that controls are working Internal Control consists of all the related methods and measures adopted within an organization to safeguard its assets enhance the reliability of its accounting records Increase efficiency of operations and ensure compliance with laws and regulations 1 A control environment 2 Risk Assessment 3 Control Activities 4 Information and Communication 5 Monitoring Establishment of Responsibility control is most effective when only one person is responsible for a given task Segregation of Duties related duties including physical custody and record keeping should be assigned to different individuals Documentation Procedures companies should use pre numbered documents for all documents should be accounted for Physical Controls safeguarding of assets enhance the accuracy and reliability of the accounting records Ex Safes locks computer passwords alarms time clocks Independent Internal Verification verify records periodically or on a surprise basis records verified by an employee who is independent discrepancies reported to management Human Resource Controls bond employees rotate employees duties and require vacations conduct background checks Bonding involves obtaining insurance protection against theft by employees Limitations of Internal Control Reasonable Assurance costs should not exceed benefit Human Element employee fatigue carelessness or indifference Collusion two or more employees working together to get around controls Size of the business Cash Receipts Controls Cash is the asset most susceptible to fraudulent activities Employees should not have access to both the cash receipts and the cash Mail receipts should be opened by 2 people who prepare a list and endorse the check receipts list and check should be sent to various departments to be checked entered Cash Disbursements Controls Voucher System a network of approvals by authorized individuals acting independently to ensure that all disbursements by check are proper Voucher an authorization form prepared for each expenditure Petty Cash Fund a cash fund used for relatively small amounts receipts are still necessary but vouchers are not ex lunch 1 Establish the fund Petty Cash Cash XX XX 2 Making payments from the fund NEVER credit Petty Cash No Journal entry just a collection of petty cash receipts must equal amount established for the fund 3 Replenishing the fund XX Expenses Cash to replenish fund XX If cash plus receipts does not equal established amount we need a new account CASH OVER AND SHORT If cash is short it is debited expense If cash is over it is credited revenue Use of a Bank minimizes amount of currency of hand creates a double record of bank transaction bank reconciliation Bank Reconciliation compares the bank s balance with the company s balance and explains any differences to make them
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