Learning Questions and Answers for Financial Accounting, Lesson 8.2 – Mastery Level

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By now, you have read sections 3, 4, and 5 of Chapter Eight using the Guided Readings cards. You should already be familiar with many of the questions below. Go through each question carefully and make sure your knowledge reconciles with the answers that follow.

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(1) – The James Company sells a stove to Mr. A for $1,100 on account. The sales contract signed by both parties indicates that the sale is “FOB destination.” What does that mean?

(2) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. James Company is using a perpetual inventory system. If the contract states that the sale is FOB shipping point, what journal entry or entries does James Company record and on what date?

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(3) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. James Company is using a periodic inventory system. If the contract states that the sale is FOB destination, what journal entry or entries does James Company record and on what date?

(4) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. If the contract states that the transfer is FOB shipping point, what journal entry or entries does Mr. A record and on what date?

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(5) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. The goods arrived safely and shipping costs were paid by James Company as stated in the contract. Is the FOB point important to either of these parties?

(6) – Ace Company buys 1,000 blue summer shirts for $20 each ($20,000). Ace expects to sell this inventory for $30 each. However, the summer season ends and Ace has not yet been able to sell these shirts. Why is that a potential financial reporting problem for Ace?

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(7) – Ace Company buys 1,000 blue summer shirts for $20 each ($20,000). Ace expects to sell this inventory for $30 each. However, the summer season ends and Ace has not yet been able to sell these shirts. At what amount should Ace report its inventory?

(8) – Ace Company buys 1,000 blue summer shirts for $20 each ($20,000). Ace originally expects to sell this inventory for $30 each. However, the summer season ends and Ace has not yet been able to sell these shirts. Ace now believes that it can sell the entire inventory to a discount retail outlet for $14,000 but will need to pay an agent $1,000 to arrange the transaction. Until the sale occurs, what does Ace report for this inventory?

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(9) – In a periodic inventory system, a physical count is taken on or near the end of the year so that inventory and cost of goods sold can be determined for financial reporting purposes. In a perpetual inventory system, inventory and cost of goods sold figures are available in the accounting system. Is a physical count necessary?

(10) – A company has a perpetual inventory system. On its records as of September 26 of the current year, the inventory account has a balance of $320,000 and cost of goods sold is $750,000. A physical inventory is taken and determines that only $310,000 in inventory is on hand. How is the $10,000 difference recorded? Clearly, the inventory account has to be reduced by a $10,000 credit so that the records are correct. The question is: What is the debit?

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(11) – What is forensic accounting?

(12) – Last year, Ace Company reported sales of $700,000 and cost of goods sold of $455,000 for a gross profit of $245,000. During the current year to date, nothing unusual has happened. The company started the year with inventory costing $150,000 and then bought merchandise costing another $210,000. Sales revenue so far this year has been $300,000. Based on this information, what is the best estimate of inventory on hand?

(13) – In the previous question, why would Ace Company go to the trouble of estimating its ending inventory?

(14) – Ace Company estimates its inventory on hand at the present time. What is the key step in making this estimate reasonably accurate?

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These questions cover the remainder of Chapter Eight. When you have gone through this series of questions and answers for a sufficient number of times so that all answers are easy and clear, you will be ready to move on to other reporting issues for inventory and cost of goods sold.

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(1) – The James Company sells a stove to Mr. A for $1,100 on account. The sales contract signed by both parties indicates that the sale is “FOB destination.” What does that mean?

The designated FOB point establishes the moment at which title to goods is legally transferred from a seller to a buyer. “FOB destination” indicates that James Company retains ownership until the stove arrives at Mr. A’s location.

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(2) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. James Company is using a perpetual inventory system. If the contract states that the sale is FOB shipping point, what journal entry or entries does James Company record and on what date?

The goods were shipped on August 3, Year One. Because the sale is FOB shipping point, James records the sale on August 3 with a debit to accounts receivable for $1,100 and a credit to sales revenue for the same amount. Because a perpetual system is used, James also records a debit to cost of goods sold for $785 and a credit to inventory for $785.

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(3) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. James Company is using a periodic inventory system. If the contract states that the sale is FOB destination, what journal entry or entries does James Company record and on what date?

The goods arrived on August 9, Year One. Because the transfer is FOB destination, James records the sale on August 9. It is a debit to accounts receivable for $1,100 and a credit to sales revenue for the same amount. Because the company has a periodic inventory system, no recording is made at this time for cost of goods sold or for the reduction in inventory. Inventory and cost of goods sold will be determined at the end of the year based on physical count and a calculation.

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(4) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. If the contract states that the transfer is FOB shipping point, what journal entry or entries does Mr. A record and on what date?

The goods were shipped on August 3, Year One. Because the transaction is FOB shipping point, Mr. A records the transaction on August 3. The credit is accounts payable for $1,100, but there are three possible debits that can be recorded. If Mr. A plans to make use of the stove, the $1,100 debit should be to an account like “stove” or “equipment.” If Mr. A is going to resell the inventory and uses a perpetual inventory system, the $1,100 debit is “inventory.” If Mr. A is going to resell the inventory and uses a periodic inventory system, the $1,100 debit is “purchases of inventory.”

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(5) – The James Company sells a stove to Mr. A for $1,100 on account. The stove had originally cost James Company $785. The item was shipped by James on August 3, Year One, and arrived at Mr. A’s home on August 9, Year One. The goods arrived safely and shipping costs were paid by James Company as stated in the contract. Is the FOB point important to either of these parties?

The answer is very likely to be “No.” The FOB point has significance in three situations. First, when goods are shipped in one year but arrive in the subsequent year, an important question arises as to the timing of the recording. A company’s financial situation can appear quite different based on the reporting of such transactions. Second, if the goods are lost or damaged along the way, the FOB point determines who bears the cost if no other arrangement has been made. Third, the FOB point tells who should pay delivery costs if no other arrangement has been made. The basic rule is that the party who has ownership during the transfer pays delivery costs and absorbs any losses along the way. None of these three issues seems relevant here so the FOB point is probably not significant.

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(6) – Ace Company buys 1,000 blue summer shirts for $20 each ($20,000). Ace expects to sell this inventory for $30 each. However, the summer season ends and Ace has not yet been able to sell these shirts. Why is that a potential financial reporting problem for Ace?

The cost of this inventory is still $20,000. However, accounting rules are conservative. If the value of the shirts is now less than $20,000, then financial accounting would require the reporting company to write the inventory down to this lower number.

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(7) – Ace Company buys 1,000 blue summer shirts for $20 each ($20,000). Ace expects to sell this inventory for $30 each. However, the summer season ends and Ace has not yet been able to sell these shirts. At what amount should Ace report its inventory?

Inventory is reported at the lower of cost or net realizable value. That is a conservative approach. Net realizable value is the amount the company expects to collect from selling the items less the costs needed to make the sales happen. Notice that net realizable value for accounts receivable is what you expect to collect from customers. Net realizable value for inventory is what you can sell the items for less any costs needed to make the sale take place.

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(8) – Ace Company buys 1,000 blue summer shirts for $20 each ($20,000). Ace originally expects to sell this inventory for $30 each. However, the summer season ends and Ace has not yet been able to sell these shirts. Ace now believes that it can sell the entire inventory to a discount retail outlet for $14,000 but will need to pay an agent $1,000 to arrange the transaction. Until the sale occurs, what does Ace report for this inventory?

Inventory is reported at the lower of cost ($20,000) or net realizable value ($14,000 less $1,000 or $13,000). Ace will now report the inventory as an asset at $13,000. Ace also reports a $7,000 loss because of reducing the recorded value of the shirts from $20,000 to $13,000.

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(9) – In a periodic inventory system, a physical count is taken on or near the end of the year so that inventory and cost of goods sold can be determined for financial reporting purposes. In a perpetual inventory system, inventory and cost of goods sold figures are available in the accounting system. Is a physical count necessary?

Even with a perpetual inventory system, companies continue to take physical counts of their inventory to verify the accuracy of the accounting records. However, if the records have typically been accurate, these physical counts may be less frequent and performed at convenient times rather than at the end of the year.

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(10) – A company has a perpetual inventory system. On its records as of September 26 of the current year, the inventory account has a balance of $320,000 and cost of goods sold is $750,000. A physical inventory is taken and determines that only $310,000 in inventory is on hand. How is the $10,000 difference recorded? Clearly, the inventory account has to be reduced by a $10,000 credit so that the records are correct. The question is: What is the debit?

If the difference is relatively small, the company will probably debit cost of goods sold and assume an accounting error took place along the way that needs to be rectified. If the difference is larger, the company should investigate the reason for the discrepancy. If the company determines that the reduction was the result of an event (a theft or breakage, for example), a loss should be recorded rather than an increase in cost of goods sold. Whether a loss is recorded or an increase in cost of goods sold, reported net income is reduced by $10,000 by the drop in the reported inventory balance.

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(11) – What is forensic accounting?

Forensic accounting is the use of accounting information for investigation purposes. For example, an insurance company might use forensic accounting to determine the amount of inventory loss resulting from a fire or flood. Law enforcement might apply forensic accounting techniques to determine the amount of money stolen from a company in a robbery. The term “forensic accounting” describes a situation where financial information is used in hopes of determining numbers or other amounts that are not otherwise available.

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(12) – Last year, Ace Company reported sales of $700,000 and cost of goods sold of $455,000 for a gross profit of $245,000. During the current year to date, nothing unusual has happened. The company started the year with inventory costing $150,000 and then bought merchandise costing another $210,000. Sales revenue so far this year has been $300,000. Based on this information, what is the best estimate of inventory on hand?

Last year, the gross profit (markup) was 35 percent of the sales price ($245,000/$700,000). Assuming that was a normal year, the company probably expects the same percentage for the current year. This year, the company started with $150,000 in inventory but bought another $210,000 for a total of $360,000. Nevertheless, some of this merchandise was sold. The key question is: What was cost of the goods sold so far in the current year? The sales figure is $300,000 and the typical markup appears to be 35 percent or $105,000. If sales were $300,000 and the markup is $105,000, then the cost of the goods sold this year is $195,000 ($300,000 less $105,000). The inventory total was $360,000 but $195,000 has been sold. The best guess at the cost of the ending inventory at the present time is $165,000 ($360,000 less $195,000).

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(13) – In the previous question, why would Ace Company go to the trouble of estimating its ending inventory?

There are several reasons why Ace might make this computation. As explained previously, the company could have suffered a loss and not know the extent of the event. If a fire happens and only $20,000 in inventory remains, an estimation can be made to determine the loss. As a second reason, the company might be producing interim financial statements (financial statements for less than a year – for a quarter, for example, or a month) and need to determine inventory and cost of goods sold but does not want to incur the cost necessary to count the merchandise. As a third possibility, an auditor might estimate the quantity of inventory on hand to verify the accuracy of the company’s physical inventory count.

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(14) – Ace Company estimates its inventory on hand at the present time. What is the key step in making this estimate reasonably accurate?

Ace Company used its past results to estimate the current markup. If the markup was 35 percent last year, company officials might assume 35 percent to be appropriate for this year. In reality, a markup-percentage can change over time. The accuracy of the estimate depends on officials looking into the current operations and economic conditions and assessing whether there are differences from past years and, if so, by how much.

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Take your time. This is not an assignment where the amount of time exerted is important. Go through the questions as often as you need. Stay calm and keep working. Never leave these questions and answers without knowing that you can answer them all. You want to develop that level of confidence.

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