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ACCT 5131 Accounting for Administration Control

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ACCT 5131  Accounting for Administration Control

Spring 20192626

Review for Midterm Exam

Note: The objective of this review is to help you make better preparations for the midterm exam by providing a general coverage of the exam. There is no guarantee that the testing knowledge of every question is included in this review.

Chapter 1 Fraser and Ormiston

Underlying Assumptions of the Accounting Model

  • Going concern– a firm is expected to exist for the foreseeable future.
  • Ex: If the long-term existence of a company is in doubt, a building owned by the company should be recorded at its liquidation value.
  • Time Period– for accounting purposes, the life of a business assumed to divide into separate accounting periods.
  • Ex: If a ski resort has low revenue one year due to light snowfall, it cannot postpone the reporting of its income and cash flow statements and report them for a two-year period. It still must report financial statements for the current year.
  • Monetary units– accounting numbers assumed to be measured in stable monetary units (dollars in the U.S.)
  • Ex: If the market value of a building increases due to inflation, cannot increase its reported value on the balance sheet.

The objective of Financial Accounting is to provide external users financial statements.

  • Going Concern Assumption - Assumes the business entities will operate indefinitely unless there is strong evidence to the contrary.
  • Time Period Assumption - Indicates a specific time period that business firms use to report financial information. A one-year time frame is generally used with interim reporting occurring monthly and quarterly
  • Monetary Unit Assumption - Unit of measurement when preparing financial statements. Generally, the national currency of the country in which the company operates is used for financial reporting purposes.

What are the standards the audited financial statements should follow?

  • (BG) GAAP and for some companies IFRS. Depend if you are a Domestic (US) or Foreign company and if you are listed with SEC

What is “auditor’s opinion”? What are the categories of auditor’s opinion? What does each category mean?

  • (BG) “Auditor’s opinion is an independent entity reviewing company’s financial and applying tests / samples to see if the statements are materially misstated and if they are following GAAP or IFRS depending on the company. (opinion on the fairness of the company’s financial statements, and effectiveness of the company’s internal control system)
  • Unqualified - Excellent status, the auditors did not see any material issues or concerns - we want this status for public companies for investment in
  • Qualified - Maybe mostly good - Auditor could test and feel comfortable for most areas except for the qualified area which need to be reviewed and see if a concern for lenders / investors.
  • Adverse - Bad status - Major issues / concerns about the company, management is not following GAAP or other material issues.
  • Disclaimer - No opinion given, insufficient information provided by company

What information do Footnotes (or notes) to financial statements disclose?

  • The notes to the financial statement give detail and explanations on items in the financial statements and provide information not in the financial statements.
  • Summary of significant accounting policies
  • additional information to support financial statement numbers
  • information about important items not included
  • supplementary information
  • noteworthy events and transactions

What information does firm’s annual report include? (4)

  • balance sheet, income statement, statement of cash flows, and statement of stockholders’ equity

What is the main content of Statement of Stockholders’ Equity?

-          The statement of stockholders’ equity reconciles the beginning and ending balances of all accounts that appear in the stockholders’ equity section of the balance sheet. Some firms prepare a statement of retained earnings, frequently combined with the income statement, which reconciles the beginning and ending balances of the retained earnings account. Companies choosing the latter format will generally present the statement of stockholders’ equity in a footnote disclosure.

What information does Income Statement provide? What information does Balance Sheet provide?

The income or earnings statement presents the results of operations—revenues, expenses, net profit or loss, and net profit or loss per share—for the accounting period. (summarizes the profitability of a company over a period of time. Expenses and losses are subtracted from revenues and gains to produce net income)

The balance sheet or statement of financial position shows the financial position— assets, liabilities, and stockholders’ equity—of the firm on a particular date, such as the end of a quarter or a year. (assets = liabilities + equity)

Chapter 2 Fraser and Ormiston

  • Inventory accounting methods (FIFO, LIFO, weighted-average) and related computation.

The three cost flow assumptions most frequently used by U.S. companies are FIFO (first in, first out), LIFO (last in, first out), and average cost. As the terms imply, the FIFO method assumes the first units purchased are the first units sold during an accounting period, LIFO assumes that the items bought last are sold first, and the average cost method uses an average purchase price to determine the cost of products sold.

Weighted Average Total= (total cost of all units/#of units in inventory)x #of units sold

  • How to compute LIFO reserve?- LIFO Reserve = FIFO Valuation - LIFO Valuation
  • In times of rising prices, which method (FIFO, LIFO, weighted-average) leads to higher ending inventory, which leads to less income tax?

LIFO= Reduced Tax Bill, Lowest Ending Valuation of Inventory. LIFOLEVI

FIFO= Pays MORE TAX, Higher Ending Valuation of Inventory. FIFOHEVI

  • Depreciation methods, such as straight-line method and double declining method. Related computation.

Straight line depreciation: An accounting procedure under which equal amounts of expense are apportioned top each year of an asset’s life.

( [Depreciable base - (salvage value)]/ Depreciation period) = Depreciation expense $50,000 - $0/5 years = $10,000

Double-declining balance method: An accounting procedure for depreciation under which the straight-line rate if depreciation is doubled and applied to the net book value of the asset.

Cost less accumulated depreciation x twice the straight-line rate = Depreciation expense $50,000 x (2 x 0.2) = $20,000

  • What accounts (or items) belong to Current Liabilities? What accounts (or items) belong to Current Assets?

Current Liabilities:

Current liabilities include accounts and notes payable, the current portion of long-term debt, accrued liabilities, unearned revenue, and deferred taxes.

Current Assets: Cash equivalents, inventory, prepaid expenses.

  • When and how should goodwill be recorded?

When: Goodwill must be evaluated annually to determine whether there has been a loss of value. If there is no loss of value, goodwill remains on the balance sheet at the recorded cost indefinitely.

How: Goodwill arises when one company acquires another company (in a business combination accounted for as a purchase) for a price in excess of the fair market value of the net identifiable assets (identifiable assets less liabilities assumed) acquired. This excess price is recorded on the books of the acquiring company as goodwill.

  • What is the account “Allowance for doubtful accounts”?
  • The balance sheet account that measures the amount of outstanding accounts receivable expected to be uncollected. P.275
  • Management must estimate—based on such factors as past experience, knowledge of customer quality, the state of the economy, the firm’s collection policies—the dollar amount of accounts they expect will be uncollectible during an accounting period. Actual losses are written off against the allowance account, which is adjusted at the end of each accounting period.
  • Money the company accepted as credit that won’t likely be collected.
  • What accounts belong to Stockholders’ Equity? How to compute total stockholders’ equity?

Stockholders’ Equity: Claims against assets by the owners of the business; represents the amount owners have invested including income retained in the business since inception. P.281

Found in the Stockholders Equity: Common stock, additional paid-in capital, retained earnings.

Lastly, you will need to subtract the company's total liabilities from the company’s total assets to find the shareholders' equity in the business. For example, if a company has $100,000 in total assets and $50,000 in liabilities, the shareholders ‘equity is $50,000

Chapter 3 Fraser and Ormiston

  • What is the structure of Income Statement? How to generate net income?
  • also called statement of earnings, presents revenues, expenses, net income, and earnings per share for an accounting period, generally a year or a quarter
  • Multi-step: provides several intermediate profit measures - gross profit, operating profit, and earnings before income tax - prior to the amount of net earnings for the period
  • Single Step: groups all items of revenue together, then deducts all categories of expense to arrive at a figure for net income
  • What is gross profit margin? How to compute it?
  • difference between net sales and cost of goods sold
  • gross profit = net sales - cost of goods sold
  • gross profit margin = gross profit/net sales
  • it’s the average % markup a firm is able to charge on its goods

What are the components of Comprehensive income? foreign currency translation effects, unrealized gains and losses on available for sale securities, additional pension liabilities, and unrealized gains and losses on cash flow hedges

  • In the income statement, what items are included in “other revenue and gains”?
  • Common examples are interest revenue, gains from investments, gains from the sale of property, plant and equipment, unusual or infrequent gains, equity earnings
  • When should revenue be recognized (revenue recognition principle)?

The Revenue Recognition Principle requires that four conditions be met for a transaction to be recorded as a revenue item. the four conditions are (1) the revenues must be earned (the sale is complete), (2) the amount of the revenue must be measurable, (3) the costs of generating the revenue can be determined, and (4) the revenue must be realizable.  (Fraser)

  • How to recognize investment income when a firm A owns a significant amount of voting stock of another company B? (e.g. How to record firm A’s investment income when company B reports its net income)
  • The two companies financial statements are consolidated. The company that owns >50% of the voting stock is the parent company and the other is the subsidiary company.
  • What is “earnings per share”? How to compute it? shows return to common stock shareholders for each share owned.
  • net earnings / average common shares outstanding
  • What is operating expense? Examples of it. costs related to purchase or manufacture inventory, sell the product, and collect the cash
  • salaries and related costs, contracted services, aircraft fuel
  • What is a common-size income statement?

Common-Size Income Statement
As discussed in Chapter 2, common-size financial statements are a useful analytical tool to compare firms with different levels of sales or total assets, facilitate internal or structural analysis of a firm, evaluate trends, and make industry comparisons. The common-size income statement expresses each income statement item as a percentage of net sales. The common-size income statement shows the relative magnitude of various expenses relative to sales, the profit percentages (gross profit, operating profit, and net profit margins), and the relative importance of “other” revenues and expenses. Exhibit 3.3 presents the common-size income statement for Sage Inc. that will be used in this chapter and Chapter 5 to analyze the firm’s profitability.
 (Fraser)

Chapter 4 Fraser and Ormiston

  • What information does Statement of Cash Flow provide? Understand the three sections in this Statement. Understand the importance of the section of “Cash flow from operating activities”.
  • Classify various cash flow activities into three categories: cash flow from operating, cash flow from investing, and cash flow from financing. Related computation and recording in this aspect.

Statement of Cash Flows: The financial statement that provides information about the cash inflows and outflows from operating, financing, and investing activities during an accounting period. P.281

I.             Three Categories of Cash Flows in the Cash Flow Statement
  1. Operating activities normally include transactions and events that enter into the determination of net income. Included under operating activities are:

-       selling goods and providing services;

-       purchasing inventory, paying wages, paying rent, and paying other operating expenses;

-       receipt of interest and dividends;

-       payments of interest;

-       payment of income taxes; and

-       payments for the purchase of and receipts from the sale of trading securities (in some cases).

Information associated with operating activities is often found in the income statement, under current assets in the balance sheet, and under current liabilities in the balance sheet. 

  1. Investing activities primarily (but not always) include the purchases and sales of long-term assets. Included in investing activities are:

-       purchases and sales of land, buildings, equipment, and other assets not generally held for resale;

-       purchases and sales of non-trading securities;

-       loans to other entities;

-       receiving the principal on loans to other entities; and

-       some non-trade notes receivables.

Information associated with investing activities is often found under non-current assets in the balance sheet.

  1. Financing activities include events and transactions whereby cash is obtained from or repaid to owners (equity financing) and creditors (debt financing). Includes:

-       the issuance of stock;

-       borrowing money;

-       paying cash dividends;

-       paying off loans; and

-       repurchasing stock (treasury stock).

Information related to financing activities is often found in the under long-term liabilities and equity parts of the balance sheet.

  • Should be able to tell which cash flow activities lead to cash inflow and which lead to cash outflow, and should be able to classify these different cash inflow or outflow activities into different categories (operating, investing, and financing).
    • When determining inflows and outflows of cash:
    • Inflows: Decrease in an asset account, increase in a liability account, increase in an equity account
    • Outflows: Increase in an asset account, decrease in liability account, decrease in equity account
  • Flexibly apply indirect method to generate cash flow from operating activities (starting with net income and then make adjustments).

Indirect Method: On the statement of cash flows, a method of calculating cash flow from operating activities that adjusts net income for deferrals, accruals, and noncash and nonoperating items. P.278

           

  • How to compute ending balance of cash? (Ending balance of cash = Beginning balance of cash + net cash flow from operating, investing, and financing activities over the period)
  • How to disclose (or record) significant noncash transactions.

Noncash Transactions: Investing or financing activity that does not affect the cash inflows or outflows, but involves only owners' equity or long-term assets and liabilities. If it represents a significant amount, a noncash transaction is disclosed in the notes (footnotes) to the cash flow statement.

 Normally, transactions involving the generation or use of cash are recorded in the statement of cash flows, but since we're looking at non-cash transactions, we cannot use the exact same technique.

Instead, to record a non-cash investing and financing activity, you should include a footnote on the bottom of the statement of cash flows or in the notes of the financial statements. You can also disclose the non-cash investing and financing activity in a separate schedule or list.

Chapter 1 Datar and Rajan

  • The primary users of managerial accounting information and financial accounting information.
  1. 2-3

Management Accounting: Managers of the organization

  • Measures, analyzes, and reports financial and nonfinancial information that helps managers make decisions to fulfill goals of an organization.

Financial Accounting: External users such a investors, banks, regulators, and suppliers

  • Measures and records business transactions and provides financial statements that are based on GAAP.
  • What is the cost-benefit approach managers should apply (one of the Key Management Accounting Guidelines)
  • Managerial Accounting information is used for an organization’s planning and control. What is “planning”? What is “control”?
  • Understand using value-chain and supply-chain analysis to improve the organization’s performance What are the business functions in the value-chain analysis?

Chapter 2 Datar and Rajan

  • What is period cost (including selling costs and administration cost)? How to record period cost? Examples of period cost, selling cost, and administration cost.

All costs in the income statement other than inventoriable costs are period costs.

All costs other than cost of goods sold, for example, marketing and distribution costs, are period costs. These costs are matched against revenues in the period in which they occur.

Period costs are all costs in the income statement other than cost of goods sold. Period costs, such as marketing, distribution, and customer service costs, are treated as expenses of the accounting period in which they are incurred because managers expect those costs to benefit revenues in only that period and not in future periods.

For manufacturing-sector companies, period costs in the income statement are all nonmanufacturing costs (for example, design costs and costs of shipping products to customers). For merchandising-sector companies, period costs in the income statement are all costs not related to the cost of goods purchased for resale. Examples of these period costs are labor costs of sales floor personnel and advertising costs. Because there are no inventoriable costs for service-sector companies, all costs in the income statement are period costs.

Newcomers to cost accounting frequently assume that indirect costs such as rent, telephone, and depreciation are always costs of the period in which they are incurred and are not associated with inventories. When these costs are incurred in marketing or in corporate headquarters, they are period costs. However, when these costs are incurred in manufacturing, they are manufacturing overhead costs and are inventoriable.

The manufacturing costs of finished goods include direct materials, other direct manufacturing costs such as direct manufacturing labor, and manufacturing overhead costs such as supervision, production control, and machine maintenance. All these costs are inventoriable: They are assigned to work-in-process inventory until the goods are completed and then to finished goods inventory until the goods are sold. All nonmanufacturing costs, such as R&D, design, and distribution costs, are period costs.

Treated as expenses of the accounting period in which they are incurred

All costs that are attached to purchasing materials that are held and directly tied to revenue are inventoriable costs. All other cost direct or indirect are period costs (R&D, Design, Distribution, Sales People, Supervision, Marketing, Corporate Functions, Rent, Telephone, Depreciation, Shipping)

  1. Selling costs, marketing costs, selling and distribution costs, marketing and distribution costs – Costs required to obtain customer orders and to provide the customer with the finished product.

Ex: Salespersons’ commissions, shipping cost of finished product, storage costs of finished product, customer service costs, advertising costs

  1. Administration costs– Executive, organizational, and clerical costs that cannot be considered manufacturing or selling costs.

Ex: CEO’s salary, depreciation on administrative office equipment, rent on administrative offices, accountant’s salary

  • What is direct material? What is direct labor? What is manufacturing overhead? Examples of each cost.

Direct materials inventory. Direct materials in stock and awaiting use in the manufacturing process (for example, computer chips and components needed to manufacture cellular phones).

Direct material costs are the acquisition costs of all materials that eventually become part of the cost object (work in process and then finished goods) and can be traced to the cost object in an economically feasible way. Acquisition costs of direct materials include freight-in (inward delivery) charges, sales taxes, and customs. Material Costs are all costs associated with the acquisition and movement of an item. EX. Freight-In Charges, Sales Tax, Customs

Direct manufacturing labor costs include the compensation of all manufacturing labor that can be traced to the cost object (work in process and then finished goods) in an economically feasible way. Examples include wages and fringe benefits paid to machine operators and assembly-line workers who convert direct materials purchased to finished goods.

Indirect manufacturing costs are all manufacturing costs that are related to the cost object (work in process and then finished goods) but cannot be traced to that cost object in an economically feasible way. Examples include supplies, indirect materials such as lubricants, indirect manufacturing labor such as plant maintenance and cleaning labor, plant rent, plant insurance, property taxes on the plant, plant depreciation, and the compensation of plant managers. This cost category is also referred to as manufacturing overhead costs or factory overhead costs. We use indirect manufacturing costs and manufacturing overhead costs interchangeably in this book.

Indirect Manufacturing Costs, Manufacturing Overhead Costs, Factory Overhead Costs: 3 terms used interchangeably to describe costs incurred that cannot be directly tied to a specific product. EX. Indirect Supplies, Labor, Maintenance, Cleaning, Rent, Insurance, Property Tax, Plant Depreciation, Compensation.

  • Flexibly apply schedule of Cost of Goods Manufactured and Schedule of Cost of Goods Sold

         Schedule of Cost of Goods Manufactured

Beginning direct materials inventory

+ Direct material purchased

Cost of direct materials available for use

            - Ending direct materials inventory

            Direct materials used in production

            + Direct manufacturing labor

            + Manufacturing overhead

            Total manufacturing costs

            + Beginning work-in-process inventory

            Total manufacturing costs to account for

            - Ending work-in-process inventory

            Cost of goods manufactured (COGM)

Schedule of Cost of Goods Sold

Beginning finished goods inventory

+ Cost of goods manufactured

Cost of goods available for sale

- Ending finished goods inventory

Cost of goods sold

  • How to determine employees’ compensation when they work overtime or at regular time? The related costs should be classified as direct labor cost or manufacturing overhead?

OT=Premium rate paid for excess work categorized as Indirect Labor Cost or Overhead cost. Due to overall heavy volume of work.

Direct Labor= labor that can be directly traced to a specific product.

Idle Time= Wages paid for unproductive work because of: Breakdowns, Scheduling, Lack of Orders. Indirect Labor Cost

  • Characteristics of fixed cost and variable cost. How to compute fixed cost per unit?
  • A variable cost changes in total in proportion to changes in the related level of total activity or volume. A fixed cost remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume. The cost per unit of a variable cost is constant.
  • Fixed costs become smaller and smaller on a per-unit basis as the number assembled increases. Costs are fixed when total costs remain unchanged despite significant changes in the level of total activity or volume.
  • What is relevant range? Understand the importance of relevant range in the characteristics of fixed costs and variable costs.
  • Difference between direct cost and indirect costs. Examples of each type.

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