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Final

ACC 100 Study Guide - Final Guide: Subledger, Cash Flow Statement, Inventory Turnover


Department
Accounting
Course Code
ACC 100
Professor
Anthony Chan
Study Guide
Final

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Chapter 6
Taking a physical inventory:
Internal Control Consists of policies and procedures to optimize resources, prevent and detect errors,
safe guard assets, and enhance the accuracy and reliability of accounting records
Counting should be done by employees who do not have responsibility for the custody or record
keeping
Each counter should check the validity of each inventory item
Second count by another employee or auditor
Pre-numbered inventory tags should be used
Determining ownership of goods:
Goods in transit
Goods in transit should be included in the inventory of the company that has legal title of the
goods
o FOB shipping point Belongs to seller up until it is shipped
o FOB destination Belongs to sell until it reaches the destination
Consigned goods Hold goods belonging to other parties and sell them, for a fee, without even
taking ownership of the goods
o Holder of the goods = consignee
o Lender of the goods = consignor
Other Situation
o Goods on approval - Belong to the store lending them out Like an employee taking
home a stapler, included in inventory
o Goods are sold but the seller is holding them, not included in inventory
o Damaged good should NOT be included
Inventory costing A way of allocating the purchase cost to each item in inventory and each item that
has been sold
Specific identification method
o Tracks the actual physical flow of goods
o Each item of inventory is marked, tagged or coded with its specific unit cost
o Items still in inventory at the end of the year are specifically costed to determine the
total cost of the ending inventory
o Most practical when company sells limited number of items with high unit cost
o Ideal method for determining costs

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o Reports ending inventory at actual cost and matches the actual cost of goods sold
against sales revenue
o Disadvantage is that management can manipulate net earnings
o Expensive and Rare
Cost flow assumptions - Assume flows of costs may not be the same as the actually physical flow
of goods
o FIFO First In First Out
First goods in are first goods sold
Generally good business practice to sell the older items first
Often matches the physical flow of goods
Commonly Used
o Average
Assumes that the goods are homogenous or nondistinguishable
Uses weighted average unit cost
Formula: Cost of goods available for sale / Total Units available for sale
Commonly Used
o LIFO Last In First Out
Last goods in are the first to go out
Rarely matches with physical flow of goods
Illegal in Canada because of tax purposes, only used sometimes to harmonize
with the US
Earnings can be manipulated with last minute purchasing
Rarely Used, used more in the USA
LIFO is best valuation because it matches current costs with current revenues
since under LIFO, the cost of goods sold is assumed to be the cost of the most
recently acquired goods
Statement of earnings effect
Period of rising prices (Inflation)
o FIFO higher net earnings because the lower unit costs of the first units purchased are
matched against revenues
Balance Sheet: am advantage is that in a period of inflation, the costs allocated
to ending inventory will approximate their current cost
o Average in between
o LIFO rising prices = lower net earnings/ most accurate
Balance Sheet: A major limitation is that in a period of inflation, the costs that
are allocated to ending inventory may be significantly understated in terms of
current cost of inventory
Period of falling prices
o FIFO - lower net earnings/ most accurate
o Average In Between

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o LIFO - higher net earnings
Prices Stable
o All 3 Assumptions will report the same results
Period of rising prices
FIFO
LIFO
Cost of goods sold
Lowest
Highest
Gross profit/net earnings
Highest
Lowest
Pre-tax cash flow
Same
Same
Ending inventory
Highest
Lowest
Inventory errors
o Statement of earnings effect
If beginning inventory is understated then cost of goods sold will also be understated
Understating ending inventory will overstate cost of goods sold
An understatement in cost of goods sold will produce an overstatement in gross profit
and net earnings
An overstatement in cost of goods sold will produce an understatement in gross profit
and net earnings
An error on ending inventory of the current period will have a reverse effect on net
earnings of the next period
o Balance sheet effect
Overstated ending inventory will lead to overstated assets and shareholders’ equity
Understated ending inventory will lead to understated assets and shareholders’ equity
Lower of Cost and Market (LCM)
o Inventory decreases in value over time sometimes
o Cash basis accounting no longer followed
o When the value of inventory is lower than its cost, inventory is written down to its market value
o Used because of conservatism
o Used because it is least likely to overstate assets and net earnings
o It can mean replacement cost or net realizable value
o Debit loss due to decline in net realizable value
o Used after specific identification or cost follow assumption has been used to determine cost
o Credit merchandise inventory
Dr. Loss to decline in Net Resizable value of inventory XXX
Cr. Merchandise Inventory XXX
- Decline in inventory
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