Accounting 3/4 SAC 2

Question 1

Inventory card

Answer 1

a subsidiary accounting record that records each individual transaction involving a particular line of inventory’s movement in and out of a business

Question 2

Why is inventory counts important? Why is knowing about inventory losses or gains important?

Answer 2

Inventory losses = high theft = review security
Faithful Representation
States we want reports to accurately represent underlying economic events and be accurate/free from error. An inventory account ensures this by ensuring our inventory cards match the inventory we have physically in our store, in order to make sure our reports are accurate.

Question 3

Inventory Loss - reasons

Answer 3

• theft
• damage/breakages
• undersupply from a supplier, where a supplier has delivered less inventory than has been charged for
• oversupply to a customer, where inventory has been supplied to customers in excess of what they have been charged for

Question 4

Inventory gain - reasons

Answer 4

oversupply from the supplier from which the business has not bee charged
undersupply to the customer for where the customer has bene charged for inventory not delivered

Question 5

FIFO pros and cons

Answer 5

1. It can be applied to all types of inventory

There will be some occasions when it is not possible, practical or cost effective to use Identified Cost but, in these cases, FIFO can still be used as it does not require individual items of inventory to be marked or labelled.

2. It costs less to administer than Identified Cost

FIFO does not require the same investment of time and labour (and therefore money) to label every item of inventory, and then record each code and cost price in the Accounting records. This means lower wages and other administrative costs, and also that staff are able to attend to matters other than inventory costing.

Qualitative characteristics:
As it still uses cost prices that are Verifiable by reference to the source document, FIFO does still provide a Faithful representation of the value of inventory.

However, under FIFO there is no way of knowing if the cost prices allocated at the time of the sale were in fact the same as the price applied at the time of purchase.

This means that, compared with Identified Cost, FIFO will tend to lead to a lower Cost of Sales (and therefore higher profit and higher owner’s equity) and higher value of inventory on hand (assuming prices are rising).
However, if all inventory is sold, it will be the same

Question 6

Perpetual inventory system

Answer 6

recording inventory transactions in inventory cards, then conducting a physical inventory count at the end of the Period to verify the balances of those inventory cards, in the process detecting any inventory losses or gains

physical inventory count: Verifiability/Faithful Rep
Shows the actual inventory on hand which is important in a perpetual inventory system as the physical final count of inventory will be recorded and can be compared to the inventory cards and any
discrepancies will highlight any inventory losses or gains. Inventory is a valuable asset that is subject to fraud, error and inventory loss and inventory counts will ensure that the inventory on hand in the inventory cards are accurate and free from error.

Question 7

Perpetual inventory system - pros

Answer 7

Identify fast and slow moving lines
Drop slow moving lines
Focus or expand on fast moving lines
(identifies sleep and turnover)

More efficient reordering
can order new inventory when levels are low

Identification of inventory losses or gains

Calculate interim profits can be calculated any time, not just at the time of a stocktake

Question 8

Perpetual inventory system - cons

Answer 8

Time
We have to record continuously
We have multiple inventory cards

Training
How to use an IC (Identified cost and FIFO)

Question 9

valuation of inventory

Answer 9

choose the lower of cost price (source documents and product costs) and net realisable value (estimated SP (after damage etc.) -direct selling expenses)

direct selling expenses - (advertising/marketing/complementary products)

Question 10

the lower of cost and nrv - theory

Answer 10

Faithful representation…
states that reports should faithfully represent the underlying economic events of transactions. Therefore, we must value inventory at the lower of cost and NRV so that we do not overstate that cost price of inventory and accurately represent the future economic benefit we can receive from our inventory.

Going concern…
states that the life of the business is assumed to be continuous and reports should be kept in this manner.
Inventory should be valued at its cost price. It should not be valued at its sales price, which implies the sale will be realised today, but instead we will be able to realise the sale at a future date.
- verifiability and faithful rep
Price not guaranteed to be received, not all may be sold and at the stated SP, not supported by a source document, cannot be verified with evidence which can additionally mean that it cannot be faithfully represented and be prone to error and bias.

-obsolete
-damaged
-out of season
-superseded
-marketing reasons

Question 11

nrv

Answer 11

The estimated selling price (1) minus any selling, marketing or distribution costs. (1)

Question 12

discretion and choices in inventory valuation - ethical considerations

Answer 12

Ethical social considerations:
Jeopardises relationships
Stakeholders, Bank, Potential owners
Misleading - Overstating assets

Question 13

product vs period cost

Answer 13

was the cost incurred to get the product in a condition or location ready for sale? (one type of inventory)
no - other expense

can the price be logically allocated to individual units of inventory? (one type of inventory)
no - period cost

yes to both - product cost

Question 14

different between product and period cost

Answer 14

if inventory remains unsold or partially sold, allocating a cost as a product cost will result in a higher net profit than a period cost. This is because a product cost will only be recognised as an expense (cost of sales) when sold, whereas a period cost is recognised in full and straight away

Question 15

Inventory management

Answer 15

• Physically rotating inventory on hand (The older goods should be placed on display so they are sold first).
• Monitoring seasonal products (Towards the end of a season inventory should be run down).
• Monitoring technological obsolescence (It may be unwise to purchase volatile technologies in bulk).
• Introducing complementary products
  (Improves the chances of selling additional lines of inventory).
• Changing with the times (Managers must always be prepared to change and react to the times I.e.
  The amount and speed of change will be determined by the product and market.)
• Monitoring selling prices (One factor that management might underestimate are selling prices. In particular, by changing the mark-up, a manager can sell inventory more quickly or extract more revenue per sale.
• Ensuring adequate security (Investing in security can decrease theft and fraud, separation of duties, let work be signed off by owner or manager).

Question 16

inventory turnover

Answer 16

ITO = Average Inventory
––––––––––––––––––– x 365
Cost of Goods Sold

Question 17

Managing accounts receivable

Answer 17

Granting credit to customers - how can a business guarantee they will be paid back?

• Offering discounts to customers (NOT INCREASING DISCOUNT)
• Sending emails to Accounts Receivable.
• Sending regular statements to overdue accounts.
• Threatening/taking legal action.
• Engaging a debt collector.

Question 18

accounts receivable turnover

Answer 18

ARTO = Average Accounts Receivable
––––––––––––––––––– x 365
Net Credit Sales (Plus GST)

Question 19

Managing Accounts Payable

Answer 19

Why would a business purchase on credit?
- Gives a business time to sell inventory and turn it into cash.
- Trade credit is basically interest free finance.

strategies to improve APTO
- pay earlier for discount
- pay later to retain more cash
- generate more cash

Question 20

accounts payable turnover

Answer 20

APTO = Average Accounts Payable
––––––––––––––––––– x 365
Net Credit Purchases (Plus GST)

Question 21

Bad debt theory

Answer 21

bad debt = negative current asset

Verifiability: adjustments an estimate, estimating adjustment for bad debts

Faithful Rep: more accurate representation of economic benefit

Understandability: why negative current asset? formatting the BS, makes it easier to understand, connecting the two numbers

Period assumption:
Matching the revenue and expense for a particular period of time
Balance reflects amount unlikely to be recurred in a future period

Accrual basis: - BDA’s
Revenues earned vs. expenses incurred
We must match and estimate bad debts expense we will incur from a given period’s credit sales (we want to match revenues earned against expenses incurred)

The accrual accounting assumption states that revenues earned should be matched against
expenses incurred. Therefore, the allowance for doubtful debts account allows us to record the bad debts expense which is predicted to be incurred from the net credit sales in May. This allows us to match the revenues to the expenses that will be incurred to help calculate a more accurate net profit.

Why allowance for doubtful debts?
business needs to recognise an amount in the accounting reports that is not being collected from accounts receivable, allowance recognises the expected loss of economic benefits

Question 22

Examples of useful non-financial information

Answer 22

Relationship with customers
Quality of inventory
Relationship with suppliers
Relationship with employees
State of the economy

Question 23

recording bad debts

Answer 23

1. create allowance for doubtful debts
2. write off bad debt (AR, GST and allowance)
3. balance day adjustment
   calculate allowance from this month
   (if BD exceeded previous allowance, add to new allowance
   if BD is lower than previous allowance, minus from new allowance)

general ledger - allowance for doubtful debts
you need:
starting balance, write off (AR), calculated allowance(= target closing balance for allowance general ledger) and bad debt(CR).
bad debt is new allowance minus difference between balance and write off)

Question 24

cash cycle

Answer 24

ITO + ARTO

Question 25

how can ethical and nonfinancial information inform the management of accounts receivable

Answer 25

Ethical considerations refers to the social and environmental implications of a firms decisions. Non financial information: if the economy has declined, the spending power of accounts receivable may decrease, decreasing how much money is being generated from accounts receivable and if so, the business would be more lenient to accounts receivable in their ability to pay the business back in time. Further, he business should act in an ethical manner, understanding that customers may not be able to pay back the business in time and be more lenient with customers which would improve the business's goodwill and reputation in the long term for acting in a more ethical manner to their accounts receivable.

Question 26

QCs, Elements, Assumptions

Answer 26

notes

Question 27

Doubtful debt + bad debt

Answer 27

debts arising from credit sales in the current period that are likely to be uncollectable at some point in the future a debt that is deemed uncollectable or unredeemable Bad debts means less cash is collected from AC, but does not mean less revenue Bad debts are not incurred at point of sale but sometimes later when AC cannot pay and are classified as an expense

Question 28

ethical consideration

Answer 28

This is an ethical consideration that affects a social/environmental outcome. Social: - Relationships and trust - Not trying to intentionally manipulate reports to overstate (AR, AP) profit and assets - We must make the adjustment for bad debts to rec and expense + negative asset - Decisions made regarding product/period costing - Must write down inventory when appropriate - We must buy inventory of sufficient quality/ we should buy from buy from suppliers who operate in a morally responsible way By compromising on inventory quality to achieve a lower price, this could impact the relationship between the business and their customers. If inventory is of a low quality, it may be unfit to fulfil its intended purpose. If this is the case, customers may no longer trust the business and sales may decrease. Additionally, purchasing from a business who undercuts their prices may be from exploiting their own employees or the environment which may further damage the reputation of the business. - Overseas suppliers - overseas suppliers will have a negative impact in the local economy, potentially resulting in job losses. This can also tarnish a businesses reputation and result in a reduction of sales. Environmental - Purchasing from overseas will also increase CO2 emissions, and negatively impact the environment.

Question 29

Financial considerations

Answer 29

Profit, $$, Assets Changing to FIFO or IC solely to make your reports looks better that month, should use consistent methods over time - comparability QC changing cost assignment methods in rising and falling prices Rising - FIFO Falling - IC