ACCT 284 Exam 2 Review
Ch. 4
Why do we need adjusting entries?
 They make the accounting records reflect the actual situation
 They are necessary if cash changes hands at a different time than revenues
are earned or expenses incurred
 Deferral: cash comes before the recognition of revenue or expense
o Ex: unearned revenue, prepaid expenses
 Accrual: cash comes after the recognition of revenue or expense
Rules for Adjustments:
1.) Adjustments never involve cash
2.) Adjustments always affect both the balance sheet (A or L) and the income
statement (R or E)
Types of Adjustments:
 Deferred Expense (A and E): when an asset is purchased and paid for that
last multiple periods
o Prepaid expense (asset) –
o Expense +
 Deferred Revenue (L and R): when we receive cash in advance of earning
revenue
o Unearned revenue (liability) –
o Revenue +
 Accrued Expense (E and L): when an expense is incurred before it is paid
o Expense +
o Payable (liability) –
 Accrued Revenue (A and R): when revenue is earned before cash is received
o Receivable (asset) +
o Revenue –
Contra-Account: an account that is an offset to, or deduction from, the primary
account
Depreciation: an adjusting entry
 A deferred expense
 Capitalize the fixed asset purchased (buildings, equipment, etc)
 Apply matching principle: record a portion of the asset’s cost as depreciation
expense each accounting period
 New account: accumulated depreciation
Closing Entries: RED
 Revenues, expenses, dividends (temporary)

NOT balance sheets; they never close (permanent)
Accounting Cycle:
Analyze Transactions
Prepare and post journal entries
Unadjusted trial balance
Prepare and post adjusting entries
Adjusted trial balance
Prepare financial statements
Prepare and post closing entries
Post-closing trial balance
Ch. 5
Internal Statement Users: (use managerial accounting)
 Managers
 Board of Directors
External Statement Users: (use financial accounting)
 Creditors
 Investors
 Government
Sarbanes-Oxley Act: created stiffer penalties for fraud and increased internal
control requirements
 Fraud Triangle:
o Incentive
o Opportunity
o Personality/Rationalization
Financial Statements:
 Comparative Financial Statements: separate columns for each period’s
results side by side
 Statement of Stockholder’s Equity: on actual financial statements the
Statement of Retained Earnings is a column on this statement.
o The other equity accounts make up the additional columns on this
statement
Multistep Income Statement:
Gross Profit – Income from Operations – Income Before Taxes – Income Tax
Expense
= Net Income
Gross Profit = Net Sales – COGS
Income from Operations = Selling Expenses + General & Administrative Expenses
Income Before Taxes = Other Revenue and Expenses
- Operating Expenses:
Selling Expenses
General and Administrative Expenses
EPS: earnings per share ratio
Important subtotals:
 Gross Profit = Sales – COGS (markup)
 Income from operations
 Income before taxes
Disclosure Process:
 Press releases: where earnings are usually first announced
 Annual report: audited and released annually
 Form 10K: yearly report filed with SEC that gives more detailed information
on the business
 Quarterly Statements: are unaudited and usually include an income
statement only
 Form 10Q: the quarterly report filed with the SEC
 Form 8K: a report that must be filed with the SEC anytime a major event
occurs in the business
Annual Report Contents:
 5 or 10 year summary of financial data
 MD&A
 Management report on internal control
 Auditor’s report
 4 basic financial statements
 Notes to the statements
 Recent stock price information
 Unaudited quarterly data
 List of directors, officers, and relevant addresses
International Financial Reporting Standards (IFRS): accounting rules
established by the IASB for use in over 100 countries around the world
Qualitative Characteristics of Accounting Information
 Cross Sectional Analysis
 Time-Series Analysis ???
Ratio Analysis:
 Steps to ratio analysis:
o Obtain financing
o Invest in assets
o Generate revenues
o Produce net income
 Debt-to-assets ratio = Total Liabilities / Total Assets
 Asset Turnover Ratio = Sales Revenue / Average Total Assets
 Net Profit Margin Ratio = Net Income / Sales Revenue
Ch. 6
Types of Business
 Service
o Services provided
o Do not sell products
o No inventory
 Merchandising
o Sell already made products
 Manufacturing
o Make their inventory
o Sell to merchandisers
What do you need to keep your assets safe and records accurate?
 Establish responsibility
 Segregate duties
 Restrict access
 Document procedures
 Independently verify
o Need good set of internal controls
Bank Reconciliation
 Adjustment to Books: (on bank statement we didn’t know about)
o Bank Service Charges
o NSF Checks
o EFT
o Interest
 Adjustments to Bank: (in our books; bank didn’t know about)
o Outstanding checks
o Deposits in transit
Cash and Cash Equivalents
 Cash equivalents: short-term, highly liquid investments with three months
or less to maturity
o Represented as a single item on the balance sheet
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
COGS = BI + P - EI
Inventory Shrinkage: loss of inventory due to stealing/damage
Buy Inventory
Sell Inventory
Count Inventory
Perpetual System
Increase Inventory
Increase COGS Reduce
Inventory
Adjust balance to count
Periodic System
Increase Purchases
No entry
Record inventory, close
purchases, and create
COGS
Sales Adjustments
Gross Sales – Sales Returns and Allowances – Sales Discounts = Net Sales
Gross Profit % = Gross Profit / Net Sales
Ch. 7
Inventory:
 Usually company’s largest expenses and biggest assets
o Affects assets on balance sheet
o Affects expenses on income statement
 Management is crucial
o Satisfy customer needs
o Minimize carrying costs of inventory
 4 types of inventory:
o Merchandise inventory (retailers)
o Raw materials inventory (manuacturers)
o Work-in-progress inventory(manuacturers)
o Finished goods inventory (manuacturers)
 Merchandiser:
o Merchandise Inventory (Asset at first)
o When sold becomes COGS (turns into Expense)
 Manufacturer:
o See slides
Consignment inventory: belongs to the owner
Goods in transit: belong to the owner
 FOB Shipping Point: belongs to the buyer
 FOB Destination: belongs to the seller
Inventory Costing Methods:
 Specific Identification
 FIFO
 LIFO
o LIFO Conformity Rule: if we use LIFO on tax return, we must use LIFO
on our financial statements
o IFRS does not use LIFO
 Weighted Average
LIFO
Highest COGS
Lowest net income
Lowest ending inventory cost
FIFO
Lowest COGS
Highest net income
Highest ending inventory cost
Lower of Cost or Market (LCM): choosing the lower priced item between cost or
market; always write inventory as lowest amount
- May be applied to the entire inventory or to each item separately
- Write down the inventory and increase cost of goods sold
- By doing this, normal margins can be made when the product is sold
o Inventory (A) –
o COGS (E) +
Net Purchases =
Gross Purchases
+ Transportation in
- Purchase returns and allowances
- Purchase discounts
Inventory Errors:
OVERSTATED
This year
Next Year
INVENTORY
COGS
Understated
Overstated
Net Income
Overstated
Understated
*OPPOSITES
UNDERSTATED
INVENTORY
COGS
Net Income
This year
Next year
Overstated
Understated
Understated
Overstated
Ratio Analysis: Inventory
Inventory Turnover = COGS / Average Inventory
- Average Inventory = (BI + EI) / 2
Days to Sell = 365 / Inventory Turnover