Bank Reconciliation July 31
Unadjusted bank balance $ 870 Add: Deposits in transit 400 Less: Outstanding checks (120)
True cash balance $1,150
Unadjusted book balance $1,400
Add: Interest revenue 60
Less: NSF check (200)
Less: Bank service charges (110)
True cash balance $1,150
Accounting controls 140 Administrative controls 140 Authority manual 141 Average number of days to
sell inventory (average days in inventory) 151 Bank reconciliation 145 Bank statement 145 Bank statement credit
memo 145
Bank statement debit memo 145
Cash 143
Certified check 147 Checks 145 Consistency 139 Deposit ticket 144 Deposits in transit 146 Fidelity bond 141
First-in, first-out (FIFO) cost flow method 134
Full disclosure 139 General authority 141 Internal controls 140
Inventory cost flow methods 136 Inventory turnover 151 Last-in, first-out (LIFO) cost
flow method 134 Non-sufficient-funds (NSF)
checks 147
Outstanding checks 146 Physical flow of goods 134 Procedures manual 141 Separation of duties 140
Service charges 147 Signature card 144 Specific authorizations 141 Specific identification 134 True cash balance 145 Unadjusted bank
balance 145 Unadjusted book
balance 145
Weighted-average cost flow method 134
KEY TERMS
1. Name and describe the four cost flow methods discussed in this chapter.
2. What are some advantages and disadvantages of the spe- cific identification method of accounting for inventory?
3. What are some advantages and disadvantages of using the FIFO method of inventory valuation?
4. What are some advantages and disadvantages of using the LIFO method of inventory valuation?
QUESTIONS
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156 Chapter 4
All applicable Exercises are available with McGraw-Hill Connect Accounting.
Exercise 4-1 Effect of inventory cost flow assumption on financial statements Required
For each of the following situations, fill in the blank with FIFO, LIFO, or weighted average.
a. _____ would produce the highest amount of net income in an inflationary environment.
b. _____ would produce the highest amount of assets in an inflationary environment.
c. _____ would produce the lowest amount of net income in a deflationary environment.
d. _____ would produce the same unit cost for assets and cost of goods sold in an inflationary environment.
LO 1 LO 1 EXERCISES
5. In an inflationary period, which inventory cost flow method will produce the highest net income? Explain.
6. In an inflationary period, which inventory cost flow method will produce the largest amount of total assets on the balance sheet? Explain.
7. What is the difference between the flow of costs and the physical flow of goods?
8. Does the choice of cost flow method (FIFO, LIFO, or weighted average) affect the statement of cash flows?
Explain.
9. Assume that Key Co. purchased 1,000 units of merchandise in its first year of operations for $25 per unit. The company sold 850 units for $40. What is the amount of cost of goods sold using FIFO? LIFO? Weighted average?
10. Assume that Key Co. purchased 1,500 units of merchan- dise in its second year of operation for $27 per unit. Its beginning inventory was determined in Question 9. Assum- ing that 1,500 units are sold, what is the amount of cost of goods sold using FIFO? LIFO? Weighted average?
11. Refer to Questions 9 and 10. Which method might be pref- erable for financial statements? For income tax reporting?
Explain.
12. In an inflationary period, which cost flow method, FIFO or LIFO, produces the larger cash flow? Explain.
13. Which inventory cost flow method produces the highest net income in a deflationary period?
14. What are the policies and procedures called that are used to provide reasonable assurance that the objectives of an enterprise will be accomplished?
15. What is the difference between accounting controls and administrative controls?
16. What are several features of an effective internal control system?
17. What is meant by separation of duties? Give an illustration.
18. What are the attributes of a high-quality employee?
19. What is a fidelity bond? Explain its purpose.
20. Why is it important that every employee periodically take a leave of absence or vacation?
21. What are the purpose and importance of a procedures manual?
22. What is the difference between specific and general author- izations?
23. Why should documents (checks, invoices, receipts) be prenumbered?
24. What procedures are important in the physical control of assets and accounting records?
25. What is the purpose of independent verification of per- formance?
26. What items are considered cash?
27. Why is cash more susceptible to theft or embezzlement than other assets?
28. Giving written copies of receipts to customers can help prevent what type of illegal acts?
29. What procedures can help to protect cash receipts?
30. What procedures can help protect cash disbursements?
31. What effect does a debit memo in a bank statement have on the Cash account? What effect does a credit memo in a bank statement have on the Cash account?
32. What information is normally included in a bank statement?
33. Why might a bank statement reflect a balance that is larger than the balance recorded in the depositor’s books? What could cause the bank balance to be smaller than the book balance?
34. What is the purpose of a bank reconciliation?
35. What is an outstanding check?
36. What is a deposit in transit?
37. What is a certified check?
38. How is an NSF check accounted for in the accounting records?
39. What information does inventory turnover provide?
40. What is an example of a business that would have a high inventory turnover? A low inventory turnover?
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Accounting for Inventories 157
Beginning inventory 70 units @ $26 Units purchased 280 units @ $30
Ending inventory consisted of 30 units. Boone sold 320 units at $40 each. All purchases and sales were made with cash.
Required
a. Compute the gross margin for Boone Company using the following cost flow assumptions:
(1) FIFO, (2) LIFO, and (3) weighted average.
b. What is the dollar amount of difference in net income between using FIFO versus LIFO?
(Ignore income tax considerations.)
e. _____ would produce the lowest amount of net income in an inflationary environment.
f. _____ would produce an asset value that was the same regardless of whether the environ- ment was inflationary or deflationary.
g. _____ would produce the lowest amount of assets in an inflationary environment.
h. _____ would produce the highest amount of assets in a deflationary environment.
Exercise 4-2 Allocating product cost between cost of goods sold and ending inventory
Ming Co. started the year with no inventory. During the year, it purchased two identical inven- tory items. The inventory was purchased at different times. The first purchase cost $2,400 and the other, $3,000. One of the items was sold during the year.
Required
Based on this information, how much product cost would be allocated to cost of goods sold and ending inventory on the year-end financial statements, assuming use of
a. FIFO?
b. LIFO?
c. Weighted average?
Exercise 4-3 Allocating product cost between cost of goods sold and ending inventory: multiple purchases
Rainey Company sells coffee makers used in business offices. Its beginning inventory of coffee makers was 200 units at $25 per unit. During the year, Rainey made two batch purchases of coffee makers. The first was a 300-unit purchase at $30 per unit; the second was a 250-unit purchase at $35 per unit. During the period, Rainey sold 700 coffee makers.
Required
Determine the amount of product costs that would be allocated to cost of goods sold and ending inventory, assuming that Rainey uses
a. FIFO.
b. LIFO.
c. Weighted average.
Exercise 4-4 Effect of inventory cost flow (FIFO, LIFO, and weighted average) on gross margin
The following information pertains to Boone Company for 2009.
LO 1, 2 LO 1, 2
LO 1, 2 LO 1, 2
LO 1, 2 LO 1, 2
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158 Chapter 4
c. Determine the cash flow from operating activities, using each of the three cost flow assump- tions listed in Requirement a. Ignore the effect of income taxes. Explain why these cash flows have no differences.
Exercise 4-5 Effect of inventory cost flow on ending inventory balance and gross margin
Ross Sales had the following transactions for DVDs in 2010, its first year of operations.
LO 1, 2 LO 1, 2
Jan. 20 Purchased 75 units @ $15 5 $1,125 Apr. 21 Purchased 450 units @ $20 5 9,000 July 25 Purchased 300 units @ $23 5 6,900 Sept. 19 Purchased 100 units @ $26 5 2,600
During the year, Ross Sales sold 850 DVDs for $60 each.
Required
a. Compute the amount of ending inventory Ross would report on the balance sheet, assum- ing the following cost flow assumptions: (1) FIFO, (2) LIFO, and (3) weighted average.
b. Compute the difference in gross margin between the FIFO and LIFO cost flow assumptions.
Exercise 4-6 Income tax effect of shifting from FIFO to LIFO The following information pertains to the inventory of the Eaton Company.
LO 1, 2 LO 1, 2
Jan. 1 Beginning Inventory 600 units @ $22 Apr. 1 Purchased 2,500 units @ $25 Oct. 1 Purchased 700 units @ $28
During the year, Eaton sold 3,300 units of inventory at $40 per unit and incurred $15,000 of operating expenses. Eaton currently uses the FIFO method but is considering a change to LIFO. All transactions are cash transactions. Assume a 30 percent income tax rate.
Required
a. Prepare income statements using FIFO and LIFO.
b. Determine the amount of income taxes Eaton would save if it changed cost flow methods.
c. Determine the cash flow from operating activities under FIFO and LIFO.
d. Explain why cash flow from operating activities is lower under FIFO when that cost flow method produced the higher gross margin.
Exercise 4-7 Effect of FIFO versus LIFO on income tax expense
Beth Porter, Inc., had sales of $225,000 for 2009, its first year of operation. On April 2, the company purchased 200 units of inventory at $210 per unit. On September 1, an additional 150 units were purchased for $230 per unit. The company had 50 units on hand at the end of the year. The company’s income tax rate is 35 percent. All transactions are cash transactions.
Required
a. The preceding paragraph describes five accounting events: (1) a sales transaction, (2) the first purchase of inventory, (3) a second purchase of inventory, (4) the recognition of cost of goods sold expense, and (5) the payment of income tax expense. Record the amounts of each event in horizontal statements models like the following ones, assuming first a FIFO and then a LIFO cost flow.
LO 1, 2 LO 1, 2
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Accounting for Inventories 159
b. Compute net income using FIFO.
c. Compute net income using LIFO.
d. Explain the difference, if any, in the amount of income tax expense incurred using the two cost flow assumptions.
e. How does the use of the FIFO versus the LIFO cost flow assumptions affect the statement of cash flows?
Exercise 4-8 Features of a strong internal control system Required
List and describe nine features of a strong internal control system discussed in this chapter.
Exercise 4-9 Internal controls for equipment Required
List the internal control procedures that pertain to the protection of business equipment.
Exercise 4-10 Features of internal control procedures for cash Required
List and discuss effective internal control procedures that apply to cash.
Exercise 4-11 Internal controls to prevent theft
Sarah Black worked as the parts manager for Country Automobiles, a local automobile dealer- ship. Sarah was very dedicated and never missed a day of work. Since Country was a small operation, she was the only employee in the parts department. Her duties consisted of order- ing parts for stock and as needed for repairs, receiving the parts and checking them in, dis- tributing them as needed to the shop or to customers for purchase, and keeping track of and taking the year-end inventory of parts. Country decided to expand and needed to secure addi- tional financing. The local bank agreed to a loan contingent on an audit of the dealership.
One requirement of the audit was to oversee the inventory count of both automobiles and parts on hand. Sarah was clearly nervous, explaining that she had just inventoried all parts in the parts department and supplied the auditors with a detailed list. The inventory showed parts on hand worth $225,000. This seemed a little excessive, and the accountants decided they needed to verify at least a substantial part of the inventory. When the auditors began their counts, a pattern began to develop. Each type of part seemed to be one or two items short when the actual count was taken. This raised more concern. Although Sarah assured the audi- tors the parts were just misplaced, the auditors continued the count. After completing the count of parts on hand, the auditors could document only $155,000 of actual parts. Suddenly, Sarah quit her job and moved to another state.
Required
a. What do you suppose caused the discrepancy between the actual count and the count that Sarah had supplied?
b. What procedures could be put into place to prevent this type of problem?
LO 3 LO 3
LO 3 LO 3
LO 4 LO 4
LO 3 LO 3
Event Statement of
No. Balance Sheet Income Statement Cash Flows Cash 1 Inventory 5 C. Stk. 1 Ret. Earn. Rev. 2 Exp. 5 Net Inc.
Effect of Events on Financial Statements Panel 1: FIFO Cost Flow
Panel 2: LIFO Cost Flow
Event Statement of
No. Balance Sheet Income Statement Cash Flows Cash 1 Inventory 5 C. Stk. 1 Ret. Earn. Rev. 2 Exp. 5 Net Inc.
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160 Chapter 4
Exercise 4-12 Internal control procedures
Dick Haney is opening a new business that will sell sporting goods. It will initially be a small operation, and he is concerned about the security of his assets. He will not be able to be at the business all of the time and will have to rely on his employees and internal control proce- dures to ensure that transactions are properly accounted for and assets are safeguarded. He will have a store manager and two other employees who will be sales personnel and stock personnel and who will also perform any other duties necessary. Dick will be in the business on a regular basis. He has come to you for advice.
Required
Write a memo to Dick outlining the procedures that he should implement to ensure that his store assets are protected and that the financial transactions are properly recorded.
Exercise 4-13 Treatment of NSF check
The bank statement of Gear Supplies included a $300 NSF check that one of Gear’s custom- ers had written to pay for services that were provided by Gear.
Required
a. Show the effects of recognizing the NSF check on the financial statements by recording the appropriate amounts in a horizontal statements model like the following one.
LO 3 LO 3
LO 5 LO 5
Assets 5 Liab. 1 Equity Rev. 2 Exp. 5 Net Inc. Cash Flow Cash 1 Accts. Rec.
b. Is the recognition of the NSF check on Gear’s books an asset source, use, or exchange transaction?
c. Suppose the customer redeems the check by giving Gear $325 cash in exchange for the bad check. The additional $25 paid a service fee charged by Gear. Show the effects on the financial statements in the horizontal statements model in Requirement a.
d. Is the receipt of cash referred to in Requirement c an asset source, use, or exchange transaction?
Exercise 4-14 Adjustments to the balance per books Required
Identify which of the following items are added to or subtracted from the unadjusted book balance to arrive at the true cash balance. Distinguish the additions from the subtractions by placing a 1 beside the items that are added to the unadjusted book balance and a 2 beside those that are subtracted from it. The first item is recorded as an example.
LO 5 LO 5
Book Balance Added or Reconciling Items Adjusted? Subtracted?
Interest revenue Yes 1
Deposits in transit Debit memo Bank service charge Charge for checks NSF check from customer
Note receivable collected by the bank Outstanding checks
Credit memo
Exercise 4-15 Adjustments to the balance per bank Required
Identify which of the following items are added to or subtracted from the unadjusted bank balance to arrive at the true cash balance. Distinguish the additions from the subtractions by LO 5
LO 5
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Accounting for Inventories 161 placing a 1 beside the items that are added to the unadjusted bank balance and a 2 beside
those that are subtracted from it. The first item is recorded as an example.
Bank Balance Added or Reconciling Items Adjusted? Subtracted?
Deposits in transit Yes 1
Debit memo Credit memo Certified checks Petty cash voucher NSF check from customer Interest revenue
Bank service charge Outstanding checks
Exercise 4-16 Adjusting the cash account
As of May 31, 2010, the bank statement showed an ending balance of $18,500. The unadjusted Cash account balance was $16,950. The following information is available.
1. Deposit in transit, $2,630.
2. Credit memo in bank statement for interest earned in May, $25.
3. Outstanding check, $4,208.
4. Debit memo for bank service charge, $53.
Required
Determine the true cash balance by preparing a bank reconciliation as of May 31, 2010, using the preceding information.
Exercise 4-17 Determining the true cash balance, starting with the unadjusted bank balance
The following information is available for Marble Company for the month of August.
1. The unadjusted balance per the bank statement on August 31 was $57,800.
2. Deposits in transit on August 31 were $2,900.
3. A debit memo was included with the bank statement for a service charge of $20.
4. A $5,620 check written in August had not been paid by the bank.
5. The bank statement included a $1,000 credit memo for the collection of a note. The prin- cipal of the note was $950, and the interest collected was $50.
Required
Determine the true cash balance as of August 31. (Hint: It is not necessary to use all of the preceding items to determine the true balance.)
Exercise 4-18 Determining the true cash balance, starting with the unadjusted book balance
Smith Company had an unadjusted cash balance of $8,550 as of April 30. The company’s bank statement, also dated April 30, included a $100 NSF check written by one of Smith’s customers. There were $920 in outstanding checks and $250 in deposits in transit as of April 30. According to the bank statement, service charges were $75, and the bank collected a $700 note receivable for Smith. The bank statement also showed $12 of interest revenue earned by Smith.
Required
Determine the true cash balance as of April 30. (Hint: It is not necessary to use all of the preceding items to determine the true balance.)
LO 5 LO 5
LO 5 LO 5
LO 5 LO 5
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162 Chapter 4
Exercise 4-19 Performing ratio analysis using real-world data
Safeway, Inc., operated 1,743 stores as of December 29, 2007. The following data were taken from the company’s annual report. All dollar amounts are in millions.
LO 6 LO 6
Fiscal Years Ending December 29, 2007 December 30, 2006
Revenue $42,286.0 $40,185.0
Cost of Goods Sold 30,133.1 28,604.0
Net Income 888.4 870.6
Merchandise Inventory 2,797.8 2,642.5 Required
a. Compute Safeway’s inventory turnover ratio for 2007 and 2006.
b. Compute Safeway’s average days to sell inventory for 2007 and 2006.
c. Based on your computations in Requirements a and b, did Safeway’s inventory manage- ment get better or worse from 2006 to 2007?
PROBLEMS
All applicable Problems are available with McGraw-Hill Connect Accounting.
Problem 4-20 Effect of different inventory cost flow methods on financial statements The accounting records of Brooks Photography, Inc., reflected the following balances as of January 1, 2012:
LO 1, 2 LO 1, 2
CHECK FIGURES
a. Cost of Goods Sold—FIFO:
$28,450
b. Net Income—LIFO: $4,935
Cash $19,000
Beginning inventory 6,750 (75 units @ $90) Common stock 7,500
Retained earnings 18,250 The following five transactions occurred in 2012.
1. First purchase (cash) 100 units @ $92 2. Second purchase (cash) 175 units @ $100 3. Sales (all cash) 300 units @ $170 4. Paid $15,000 cash for operating expenses.
5. Paid cash for income tax at the rate of 30 percent of income before taxes.
Required
a. Compute the cost of goods sold and ending inventory, assuming (1) FIFO cost flow, (2) LIFO cost flow, and (3) weighted-average cost flow.
b. Use a vertical model to prepare the 2012 income statement, balance sheet, and statement of cash flows under FIFO, LIFO, and weighted average. (Hint: Record the events under an accounting equation before preparing the statements.)
Problem 4-21 Using internal control to restrict illegal or unethical behavior Required
For each of the following fraudulent acts, describe one or more internal control procedures that could have prevented (or helped prevent) the problems.
a. Paula Wissel, the administrative assistant in charge of payroll, created a fictional employee, wrote weekly checks to the fictional employee, and then personally cashed the checks for her own benefit.
LO 3, 4 LO 3, 4
o
p r
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