BAT4M Grade 12 Accounting Exam

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Accounting Exam Notes:

 

What is the purpose of accounting?

  • To provide useful information for decision making
  • Qualitative characteristics of accounting information (understandability, relevance, reliability, comparability)
  • Recognition and Measurement Criteria (determine when items should be included and recognized, outline how to measure or assign amount to items)

CICA:  Canadian Institute of Chartered Accountants

IASB: International Accounting Standards Board

IFRS: International Financial Reporting Standards

 

GAAP’s

Going Concern: a company will continue to operate in the future. You continue to prepare your financial statements following the cost principle until liquidation has been confirmed and set.

Monetary Unit: only record data that has a real value in terms of money. Ex. You cannot record employees as an asset.

Economic Entity: the owner and the business should be considered separately. So the owner cannot record any personal drawings and a company’s expense

Time Period: economic life should be divided into time periods, like fiscal periods.

Cost Benefit: if the value of information exceeds the cost of providing it. This is applicable mainly for small businesses

Materiality: an item’s impact on a firm’s overall financial condition and operations. You cannot amortize a stapler, for example.

Matching: expenses should be recorded in the same period as the revenue it helped earn.

Full Disclosure: disclosure of circumstances and events that affect financial statement users should be noted.

Cost: assets should be recorded at COST, unless you get it appraised.

Revenue Recognition: revenue should be recognized in the same period it was earned

  • Point of sale: should be recognized in the same period it was earned
  • During production: revenue recognition is possible before production is completed
    • costs incurred/total estimated costs= percent complete x total revenue= revenue recognized
  • Completion of production: if you are not sure about the costs, wait till completion to recognize revenue
  • Instalment Method: payment received periodically, gross profit recognized in the period in which cash is collected
    • Cash Collection x Gross Profit Margin= Gross Profit Recognized
      • Gross Profit Margin: Gross Profit/Total Sales

 

 

Adjusting Entries

Prepaid Expenses:  examples of prepaid expenses are suppliers, advertising, insurance and rent.

 

Dec 31 _____________ Expense Xxx
          (Prepaid)_____________ Xxx
Record ______ expense for the year

 

 

Unearned Revenue: cash received before the service has been preformed are unearned revenues. Ex. Rent, magazine subscription, customer deposits. Unearned revenue is a liability. Once it has been earned, it must adjusted.

 

Dec 31 Unearned Revenue Xxx
      Earned Revenue Xxx
Record revenue for services provided

 

 

Accrued Revenues: revenues earned for services but no payment has been received.

 

Dec 31 Accounts Receivable Xxx
          Earned Revenue Xxx
Record revenue that has not been billed or collected

 

 

Accrued Expenses: expenses incurred but not yet paid or recorded. Examples are: interest, rent, property taxes and salaries. Needed to record the obligations that exist at the balance sheet date and to recognize the expenses that apply to the current accounting period.

 

Dec 31 __________ expense Xxx
           ______________ payable Xxx
Record accrued expenses.

 

 

Long Term Adjusting Entries: Amortization, allocation of the cost of capital assets to expense over their useful lives**more on amortization in later chapter**

 

Dec 31 Amortization Expense Xxx
          Accumulated Amortization Xxx
Record amortization expense for the year

 

 

Inventory:

Merchandising Company: has cost of goods sold and operating expenses. For the operating cycle, it takes longer to go from cash to cash producing revenues.

 

Perpetual Inventory

  • Continuously shows the inventory that should be on hand and the cost of goods sold, at any time. Used mainly for high unit cost, low volume turnover goods
  • Cost of goods purchased should be documented by a purchase order or a purchase invoice
  • When Inventory is bought, it is added to merchandise inventory (asset account). When merchandise is bought, it is deducted from merchandise inventory
  • Purchase Return and Allowances (contra expense): a purchaser may be dissatisfied with the merchandise and return it for a refund or credit
  • Sales revenues is recognized when earned, COGS is recognized by debiting COGS and crediting Merchandise Inventory
  • When a customer returns goods to the seller for credit/return. It is recorded by decreasing COGS and increasing Merchandise Inventory. When the merchandise is unsellable, or they choose to keep the inventory, it is recorded under sales returns and allowances (contra revenue).
  • Freight Costs incurred by the seller on outgoing merchandise are debited to Freight Out or Delivery Expense.
  • Freight in is absorbed into the cost of the merchandise inventory

FOB Shipping Point: buyer pays the freight cost

FOB Destination Point: seller must pay the freight cost

 

Purchases under the Perpetual Inventory
Merchandise Inventory X
       AP X
Purchased merchandise on account
Merchandise Inventory X
       Cash X
Paid for freight on goods purchased
AP x
       Merchandise Inventory x
Returned unsatisfactory goods
AP X
       Merchandise Inventory X
Received an allowance for damaged goods
AP X
       Cash X
       Purchase discounts X
Made payment within discount period
COGS X
       Merchandise Inventory X
Record difference  between inventory records and physical units on hand
Sales under Perpetual
AR X
       Sales Revenue X
Sold goods on account
COGS X
       Merchandise Inventory X
Value of goods sold
Sales Returns and Allowances X
       AR X
Customer returned damaged goods
Merchandise Inventory X
       COGS X
Value of goods returned
Cash X
Sales Discounts X
       AR X
Customer paid within discount period.

 

 

Selling expenses: delivery and shipping expenses that help complete the sale. Ex. Salaries, advertising, amortization, freight out.

Administrative Expenses: relate to general expenses management, accounting. Ex. Salaries, rent, utilities, insurance.

Non Operating Activities

  • Other revenue gains
    • Interest revenue
    • Dividend revenue from investments
    • Rent revenue
  • Other expenses and losses
    • Interest revenue on notes and loans payable
    • Casualty losses from recurring causes such as accidents and vandalism
    • Loss from the sale of capital assets
    • Loss from strikes

Periodic Inventory

  • Inventory is only updated periodically
  • Ownership of goods must be determined before they are included in the inventory
    • Goods in transit (FOB shipping points belong to the buyer, FOB destination belong to the seller)
    • Goods on approval belong to vendor
    • Goods on consignment belong to the consigner and are not included in the holder’s inventory.
  • Freight in is recorded separately as well as purchase returns and allowances.

 

Purchases under the Periodic System s
Purchases X
       AP X
Purchased merchandise on account
Freight In X
       Cash X
Paid for freight on goods purchased
AP X
       Purchase returns and allowances X
Returned unsatisfactory goods
AP X
       Purchase Returns and Allowances X
Received an allowance for damaged goods
AP X
       Cash X
       Purchase discounts X
Made payment within discount period
Sales under the periodic inventory
AR X
       Sales Revenue X
Sold goods on account
Sales Return and Allowances X
       AR X
Customer returned damaged goods
Cash X
Sales discounts X
       AR X
Customer paid within discount period

 

 

Beginning Inventory + Purchases – Purchase Returns and Allowances= Net Purchases + Freight In = Cost of goods Available for Sale – Ending Inventory= COST OF GOODS SOOOOLLLD!!!

 

Two more closing entries in periodic inventory system: beginning inventory is removed and ending inventory is inserted

 

Capital X
       Merchandise Inventory X
To close beginning inventory
Merchandise Inventory X
       Capital X
To close ending inventory

 

 

First in, first out: the first items purchased in the year are the first to be dols. This method closely resembles how most companies sell their inventory. This method is better for the balance sheet because it has better inventory representation

Last In, Last Out: this method is no longer acceptable in Canada. Considers the most recently purchased inventory is to be sold first. Better for income statement because it matches current expenses with current revenue.

Average Cost: average unit cost of all goods available for sale during the period should be used to cost inventory.

Specific identification: matches each item sold with its specific cost. Mainly used for companies who sell expensive products.

 

Effect of Cost Flow Assumptions on the Financial Statements

 

Prices COGS GP and NI Merchandise inventory

 

 

 

LIFO FIFO LIFO FIFO LIFO FIFO
Rising Highest Lowest Lowest Highest Lowest Highest
Falling Lowest Highest Highest Lowest. Highest Lowest

 

 

Inventory errors

 

Item Error Goods Available for Sale COGS Gross Profit and Net Income
Beginning Inventory OR Cost of goods purchased Understated Under Under Over
Overstated Over Over Under
Ending Inventory Understated Over Over Under
Overstated Under over

 

 

Lower of cost and market (LCM)

When the market value of the inventory falls below its cost, it is written down to market value. Market value=net realizable value. Loss is reported in the Other Expenses section of the Income Statement.

 

Loss due to decline in Net Realizable Value of inventory X
     Merchandise inventory X

 

 

Multi-Step Income Statement now includes:

  • Net sales: sales revenue-sales discounts- sales returns and allowances
  • Gross profit: net sales-COGS
  • Operating Income: gross profit- operating expenses

 

Internal Control: optimizes resources, prevent and detect errors, safeguard assets, maintain reliable control systems

  1. Authorization of transactions and activities
  2. Segregation of duties
  3. Documentation procedures
  4. Safeguarding assets and records (physical, mechanical and electronic controls)
  5. Independent verification (by both internal and external auditors)
  6. Other Controls: bonding employees who handle cash, rotating duties and requiring employees to take vacations (easy way to catch any cons going on)

Limitations

  • Reasonable assurance rests on the premise that the costs must not exceed its benefit.
  • Human element (fatigue, carelessness and indifference)
  • Size of business

Petty Cash: used to pay small expenses

  • To establish fund, DR Petty Cash and CR Cash
  • Replenishing: DR all the necessary expenses and CR what cash is needed

Bank Reconciliation P8-4A 

 

Bank Books
+ deposits in transit + collections by bank on our behlf
– outstanding cheques + Interest earned
+/- errors – interest and other bank charges
– NSF cheques
+/- errors

 

 

 

Cash X
Bank Charges X
       Notes Receivable X
       Interest Revenue X
Record collection of note receivable by bank
Cash X
       AP X
Correct error in recording cheque
AR X
       Cash X
To record NSF
Bank Service Charge X
       Cash X
Record bank charges/cheque printing charges

 

 

Receivables:

  • Accounts receivable (owned by customers on account)
  • Notes receivables: basically you lent out money. It would be due in 30-90 days
  • Other receivables: GST recoverable, interest receivable, loans to company officers, advances to employees, and recoverable income taxes.

Valuing Accounts Receivables: sometimes customers do not pay back their loans on time. Credit losses are debited to bad debts expenses. When bad debts are too low, their credit policy is too strict and they may be losing business.

  1. Direct Write off method: when the account is determined to be uncollectible, the loss is charged to bad debts expense. If they pay in the future, they can reverse the entry.

 

Bad Debts Expense X
       AR X
To write off an uncollectible account

 

 

  1. Allowance Method:  uncollectible accounts receivables are estimated. It is treated as an expense and is matched against sales. Estimated uncollectibles are debited to bad debts expense and credited to Allowance for Doubtful Accounts (contra asset) through and adjusting entry at the end of each period.

 

Bad Debts Expense (operating expense) X
       Allowance for Doubtful Accounts X
Record estimate of uncollectible accounts
Allowance for Doubtful Accounts X
       AR X
To write off account
AR X
       Allowance for Doubtful Accounts X
To reverse the write off
Cash X
       AR X
To record collection of account

 

 

  1. Percentage of Sales: management indicated what percentage of sales will be uncollectible. (Multiply percent by the total sales). That is ADDED to the total amount in the accounts receivables.
  2. Percentage of Receivables: increasing percents for each credit term period for which the receivable has not been written off.  The amount of bad debt adjusting entry is the difference between the required balance and the existing  balance in the allowance account

Credit Card Sales: major advantages are that the issuer does the credit investigation, maintains customer accounts, they undertake any losses and the retailer receives cash quicker.

 

Cash X
Credit Card Expenses (credit card service fee) X
       Sales X
To record credit card sales
AR- American Express X
Credit Card Expense X
       Sales X
Record American Express  (non-bank) credit card sales
Cash X
       AR- American Express X
Record redemption of credit card billing

 

Note Receivable:  credit may also be granted in exchange for a promissory note. It is used when individuals and companies lend or borrow money.

 

Note Receivable X
       AR X
Record acceptance of Company A note
Cash X
       Notes Receivable X
       Interest Revenue X
Record collection of note
AR X
       Notes Receivable X
       Interest Revenue (other revenue and gains) X
Record the dishonouring of the note

 

  • Note may be sold to a third party prior to maturity in order to immediately receive cash on the note.

 

Capital Assets

  • Subdivided into property, plant and equipment (land improvements, buildings, equipment, land) and natural resources

Determining the costs of capital assets:

  • Land= purchase price + closing losts (ex. Legal fees, accrued property tax, and other liens) + costs that come from preparing the land for use.
  • Building= purchase price + closing costs +  costs of making the building ready for its intended use, costs related to construction of a building= contract price + architect’s fees, building permits, excavation costs, interests cost
  • Equipment= purchase piece + freight charges + insurance + assembling/installing/testing costs
  • When capital assets are purchased assets are purchased for a single price, it is called a basket price. To figure out how much you record in the accounts, you look at the fair market value and give the same percentage to how much you paid for it.

Amortization Methods

  1. Straight Line, matches expenses with revenues: Cost – Residual Value = Amortizable Cost/ Useful Life = Annual Amortization Expense
    1. Amortization expense/Amortizable Cost = Straight Line Rate of Amortization
  2. Declining Balance produces a decreasing annual amortization expense over the asset’s useful life. The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year. Residual value does limit the total amortization that can be taken respects matching principle (higher amortization expense in earlier years when the higher benefits are received)
    1. Net book Value at Beginning of the Year x (2 x Straight Line Rate) = Annual Amortization.
  3. Units of Activity: useful life is expressed as the total units of activity or production expected from the asset. Best used to assets like machinery, delivery equipment, planes.
    1. Cost – Residual Value = Amortizable Cost / Total Units of Activity = Amortizable Cost per Unit x Units of Activity during the year = Annual Amortization Expense

Revising Periodic Amortization: sometimes estimates are off and the residual value or useful life could change. Then you would have to revise the amortization schedule

  • Current Net Book Value – Revised Residual Value = Revised amortizable cost/remaining useful life = revised annual amortization

Expenditures over useful life: ordinary repairs are small but frequent expenses that are debited to expense account. Additions and improvements improve efficiency and/or increase useful life of the asset (called capital expenditures) are debited to capital asset account

 

Disposals:

  • Disposal of an asset that if fully amortized gives you no gain or loss. If the asset is still useful even after full amortization, you must leave it at its residual value and not amortize anymore. The accumulate amortization of an asset must never exceed its cost.
  • If you retire an asset before it is fully amortized, there will be a loss on disposal (other expenses).
  • Gain on disposal (other revenue)  occurs when you sell the asset for more than the net book value.
  • Loss on disposal occurs when you sell an asset for less than the net book value

 

Accum. Amortization X
       Printing Equipment X
Record retirement of a fully amortized printing equipment
Accum. Amortizaion- Printing Equipment X
Loss on Disposal X
       Delivery Equipment X
Record retirement of printing equipment at a loss
Cash X
Accum. Amortization X
       Delivery equipment X
       Gain on Disposal X
Record sale of delivery equipment at a gain
Cash X
Accum. Amortization X
Loss on Disposal X
       Delivery Equipment X
Record Sale of delivery equipment at a loss

 

 

Intangible Assets: amortized typically on a straight line basis. Amortized over the useful or legal life of asset.

  • Patents: initial cost is the cash paid to acquire it; legal costs to successfully defend the patent are added to the patent account. The cost of the patent should be amortized over its 20-year legal life or its useful life, whichever one is shorter.
  • Copyrights: cost of copyright consists of the cost of acquiring and defending it. Copyright legal life is the life of the creator plus 50 years
  • Trademark/Trade names: indefinite life, therefore no amortization. If it is purchased, its cost is the purchase price. If it was designed internally, the cost of securing it is the cost.
  • Franchises and Licences: you could or could not amortize it depending on if the franchises/licence is granted for an indefinite amount of time, or not.
  • Goodwill: largest intangible asset. Includes: exceptional management, desirable location, good customer relations, etc. good will is the excess of cost over the fair market value of the net assets acquired. It is also not amortized
  • Research and Development: not intangible assets. All research costs should be expense, certain development costs with reasonable assured benefits can be capitalized (added to capital account)

 

Corporations

  • Separate legal existence
  • Limited liability of shareholders
  • Transferable ownership rights
  • Ability to acquire capital
  • Continuous life
  • Corporation management (board of directors)
  • Government regulation
  • Income tax
    • Corporations must pay taxes as a separate legal entity, but there are deductions that can reduce the substantial tax rate. Shareholders do not pay tax on corporate earnings until they are distributed in dividends.
  • To form a corporation, you have to file an application with provincial/federal authorities. They file articles of incorporation to incorporate a company. The costs incurred are called organization costs and are expensed in the year they occur.
  • Shares are divided up into different classes (common, preferred, class A and class B).
    • Common shares allow you to: a vote, dividends, purchase more shares, residual claim on assets in the event of liquidation, pre-emptive right (keep the same percentage of ownership even when more shares are issued)
    • Preferred shares: higher priority, do not have voting rights but have higher priority over dividends and assets in event of liquidation. You can convert your shares into common shares at a specific ratio that would not result in a gain or loss to the corporation. Callable preferred shares means the company can buy the shares back from you, retractable preferred shares means you can sell it back to the corporation.

Share Issue Considerations:

  • Authorized Share Capital: amount of shares a corporation is authorized to issue is indicated in its articles of incorporation. No journal is needed until they issue the shares
  • Issuance of shares: first issue is known as the IPO, then they trade on the secondary market. They buy and sell from each other on the stock exchange
  • Market Value of Shares: established by the interaction between buyers and sellers. Follows earnings trend generally.

 

Corporate Capital:

  • Contributed Capital: total amount of cash/assets paid to the corporation by shareholders in exchange for shjares
  • Retained Earnings: cumulative net income/loss that has been retained (not given out in dividends). Net income is closed out to retained earnings
  • Owner’s equity is now Shareholder’s equity

 

Types of Shares:

  • Par value: assigned a specific value in the corporate charter and will not change, represents the legal capital per share that must be kept in the business for the protection of the share holders. Not really used anymore
  • No par value: not been assigned a calue in the corporate charter, entire proceeds received become legal capital
  • Stated Value: does not indicate market value, board of director’s assigns it and can change it.
  • You can issue shares in exchange for services or non cash assets.

 

Cash 1000
       Common Shares 1000
To record issue of 1000 no apr value shares (@ $1 per share) *same for preferred shares, except “preferred shares” is credited instead.
Cash 5000
       Common Shares (1000 x 1) 1000
       Contributed Capital in Excess of Stated Value (1000×4) 4000
Record issue of 1000 common shares ($1/per share stated value, but sold for $5/per share)**similar of par value**
Land X
       Common Shares X
Record 10000 no par value shares for land

 

 

 

 

Financial Ratios:

 

Current Ratio Current Assets/Current Liabilities Measures short term debt paying ability, best is 2:1. Anything over 1:1 is fine.
Quick Ratio (Cash+temp investments+receivables)/ Current Liabilities Measures immediate short-term liquidity. Again, 1:1 and over is fine
Receivables Turnover Net Credit Sales/Average Net Receivables Measures liquidity of receivables. Again, a high number is good
Inventory Turnover COGS/Average Inventory Measures liquidity of inventory. How many times the inventory is sold during the fiscal period.
Day Sales in Inventory 365/Inventory Turnover Measures days’ stock is on hand. Varies for each industry. Gorcery stores should be low, but car dealerships may be higher
Collection Period 365/Receivables turnover Measures number of days receivables are outstanding. Lower the number the better
Return on Assets (Net Income/ Total Average Assets) x100 Efficiency ratio, overall profitability of assets, higher the number the better
Asset Turnover (Net sales/Average Total Assets) x100 Measures how efficiently assets are being used to generate sales, higher the better
Profit Margin Net income/Net Sales Measures net income generated by each dollar of sales. Higher the better
Gross Profit Margin Gross Profit/Net Sales Measures gross profit generated by each dollar of sales, see above
Cash Return on Sales Net Cash/Net Sales Measures the net cash flow generated by each dollar of sales