Chapter 6: Inventories and Cost of Goods Sold
Key Concepts:
1. Inventory Systems:
○ Periodic Method: Inventory updated at the end of the accounting period.
○ Perpetual Method: Inventory updated continuously.
2. Cost Flow Assumptions:
○ FIFO (First-In, First-Out): Oldest inventory costs are used first.
○ LIFO (Last-In, First-Out): Newest inventory costs are used first.
○ Weighted Average Cost: Costs are averaged to compute cost of goods sold.
Goods in Transit:
● Included if terms are FOB Shipping Point (ownership transfers when shipped).
● Excluded if terms are FOB Destination (ownership transfers when delivered).
Lower-of-Cost-or-Net Realizable Value (NRV):
○ If inventory cost exceeds its NRV, it must be written down.
Inventory Errors:
○ Errors in ending inventory affect:
■ Cost of Goods Sold (COGS) and Net Income (two periods).
■ Assets, Liabilities, and Equity on the balance sheet.
○ Impact of Errors:
■ Understated inventory: COGS overstated, Net Income understated.
■ Overstated inventory: COGS understated, Net Income overstated.
Formulas:
● Cost of Goods Sold (COGS):
COGS = Beginning Inventory + Purchases - Ending Inventory
● Weighted Average Cost per Unit:
WAC = Total Cost of Inventory / Total Units Available for Sale
● Inventory Turnover:
Inventory Turnover = Cost of Goods Sold / Average Inventory
● Days in Inventory:
Days in Inventory = 365 / Inventory Turnover
● Net Realizable Value (NRV):
NRV = Selling Price - Cost to Complete and Sell
Steps:
Periodic Inventory System (Example: FIFO):
1. Organize inventory by purchase date.
2. Identify the oldest costs for goods sold first.
3. Calculate ending inventory using remaining costs.
Perpetual Inventory System (Example: LIFO):
1. Record every purchase and sale immediately.
2. Use the newest costs to calculate each sale.
3. Maintain updated inventory records.
Chapter 7: Bank Reconciliation
Key Concepts:
● Bank Reconciliation: Matching the company’s cash account balance with the bank
statement balance.
Steps:
1. Start with the bank statement balance.
2. Add: Deposits in transit.
3. Subtract: Outstanding checks.
4. Adjust for errors: Add/subtract corrections for discrepancies.
5. Compare the adjusted bank balance with the cash account balance.
6. Journalize adjustments: E.g., service charges, NSF checks.
Chapter 9: Depreciation Schedule
Key Concepts:
1. Depreciation: Allocation of an asset’s cost over its useful life.
2. Methods:
○ Straight-Line: Equal depreciation each year.
○ Units of Activity: Based on usage or output.
○ Declining-Balance: Accelerated depreciation method.
Formulas:
● Straight-Line Depreciation:
(Cost - Salvage Value) / Useful Life
● Units-of-Activity Depreciation:
Depreciation Expense per Unit = (Cost - Residual Value) / Total Estimated Activity
Annual Depreciation Expense = Depreciation Expense per Unit X Activity During the Year
● Declining-Balance Depreciation:
Depreciation Expense = Book Value at Beginning of Year X Declining-Balance Rate
Steps:
1. Determine the method.
2. Calculate depreciation for each year.
3. Update book value annually.
Plant Assets:
● Recorded at historical cost (all costs to acquire and prepare for use).
● Examples: Land, Buildings, Equipment.
● Costs include:
○ Purchase price.
○ Installation and preparation expenses.
● Disposals
○ Sale, retirement, or exchange.
○ Gain/loss recorded based on proceeds vs. book value.
● Natural Resources
○ Depletion: Cost allocated over extracted units.
● Intangible Assets
○ Types: Patents, Copyrights, Trademarks, Goodwill.
○ Amortization applied to limited-life intangibles.
Depreciation Expense = (Cost - Residual Value) / Useful Life (in years)
Depletion:
Depletion Cost per Unit = Total Cost of Resource / Estimated Total Units
Depletion Expense = Depletion Cost per Unit * Units Extracted
Amortization for Intangible Assets:
Annual Amortization Expense = Cost of Asset / Useful Life
Chapter 13: Cash Flow Statements (Indirect Method)
Key Concepts:
1. Cash Flow Statement: Shows cash inflows and outflows.
2. Sections: Operating, Investing, Financing Activities.
Steps:
1. Start with net income.
2. Adjust for non-cash items: Add back depreciation/amortization.
3. Adjust for changes in current assets/liabilities:
○ Increase in assets = Subtract.
○ Decrease in assets = Add.
○ Increase in liabilities = Add.
○ Decrease in liabilities = Subtract.
4. List investing and financing activities separately.
Formula:
● Operating Activities Cash Flow:
Net Income + Non-Cash Adjustments ± Changes in Working Capital
Chapter 14: Financial Statement Ratio Analysis
Key Ratios:
1. Current Ratio: Purpose: Assess liquidity and financial health.
Current Assets / Current Liabilities
2. Acid-Test Ratio: Purpose: Evaluate quick liquidity.
(Current Assets - Inventory) / Current Liabilities
3. Accounts Receivable Turnover: Purpose: Gauge collection efficiency
Net Credit Sales / Average Accounts Receivable
4. Inventory Turnover: Purpose: Assess inventory management
COGS / Average Inventory
5. Profit Margin: Purpose: Evaluate profitability.
Net Income / Net Sales
6. Asset Turnover: Purpose: Assess asset efficiency.
Net Sales / Average Total Assets
7. Return on Assets: Purpose: Evaluate overall profitability.
Net Income / Average Total Assets
8. Return on Ordinary Shareholders’ Equity: Purpose: Assess shareholder returns
(Net Income - Preferred Dividends) / Average Ordinary Shareholders’ Equity
9. Earnings Per Share: Purpose: Gauge profitability per share.
(Net Income - Preferred Dividends) / Weighted Average Ordinary Shares
Outstanding
10.Price-Earnings Ratio: Purpose: Evaluate stock price relative to earnings.
Market Price per Share / Earnings Per Share
11.Payout Ratio: Purpose: Measure dividend policy
Cash Dividends / Net Income
12.Debt to Asset Ratio: Purpose: Assess financial risk
Total Liabilities / Total Assets
13.Times Interest Earned Ratio: Purpose: Evaluate debt-servicing ability.
(Net Income + Interest Expense + Tax Expense) / Interest Expense
Steps for Analysis:
1. Gather data from financial statements.
2. Compute the ratios using the above formulas.
3. Compare ratios to industry benchmarks or historical data for insights.
Practice Final Exam - ACT 201
Chapter 6: Inventories
Solve and Explain:
1. A company has the following inventory data: 100 units at $10, 200 units at $12, and 150
units at $11. Calculate the weighted average cost per unit.
Solution: Weighted Average Cost = [(100 × $10) + (200 × $12) + (150 × $11)] / (100 +
200 + 150) = $11.17/unit
2. Estimating Cost of Goods Sold (FIFO): A company has the following inventory data:
○ Beginning Inventory: 100 units at $10 each
○ Purchases: 200 units at $12 each
○ Sales: 150 units
3. Calculate the cost of goods sold using FIFO. Solution:
○ First 100 units sold at $10 = $1,000
○ Next 50 units sold at $12 = $600 Cost of Goods Sold (FIFO) = $1,600
4. Estimating Cost of Goods Sold (LIFO): Using the same data:
○ Beginning Inventory: 100 units at $10 each
○ Purchases: 200 units at $12 each
○ Sales: 150 units
5. Calculate the cost of goods sold using LIFO. Solution:
○ First 150 units sold at $12 = $1,800 Cost of Goods Sold (LIFO) = $1,800
Chapter 7: Bank Reconciliation
Multiple Choice Questions:
1. Which of the following is added to the bank statement balance in a bank reconciliation?
a) Outstanding Checks
b) Deposits in Transit
c) Bank Service Charges
d) NSF Checks
Answer: b) Deposits in Transit
2. A bank reconciliation helps to: a) Detect fraud
b) Ensure accuracy of financial records
c) Adjust the cash book
d) All of the above
Answer: d) All of the above
Broader Question: Prepare a bank reconciliation statement given the following details:
● Bank statement balance: $15,000
● Deposits in transit: $4,000
● Outstanding checks: $6,000
● Bank service charge: $200
● NSF check: $500
● Book balance: $12,700
Solution:
1. Adjust the bank statement balance:
○ Bank Statement Balance: $15,000
○ Add: Deposits in Transit: $4,000
○ Less: Outstanding Checks: $6,000
Adjusted Bank Balance = $13,000
2. Adjust the book balance:
○ Book Balance: $12,700
○ Less: Bank Service Charge: $200
○ Less: NSF Check: $500
Adjusted Book Balance = $12,000
Reconciled Balance = $13,000 (Error found, adjust books accordingly)
Chapter 9: Depreciation Schedule
Multiple Choice Questions:
1. Straight-line depreciation is calculated as: a) (Cost - Salvage Value) / Useful Life
b) Cost / Useful Life
c) Salvage Value / Useful Life
d) None of the above
Answer: a) (Cost - Salvage Value) / Useful Life
2. Units of activity depreciation is most suitable for: a) Equipment with consistent usage
b) Equipment with variable usage
c) Buildings
d) Land
Answer: b) Equipment with variable usage
Broader Question: Prepare a depreciation schedule using the following data:
● Cost: $50,000
● Salvage Value: $5,000
● Useful Life: 10 years
Solution:
1. Straight-Line Method: Depreciation = (Cost - Salvage Value) / Useful Life
Annual Depreciation = ($50,000 - $5,000) / 10 = $4,500/year
Year Straight-Line Depreciation Accumulated Book
Depreciation Value
1 $4,500 $4,500 $45,500
2 $4,500 $9,000 $41,000
... ... ... ...
Chapter 13: Cash-Flow Statement (Indirect Method)
Multiple Choice Questions:
1. Which of the following is added to net income in the operating activities section of a cash
flow statement? a) Depreciation Expense
b) Increase in Accounts Receivable
c) Purchase of Equipment
d) Decrease in Accounts Payable
Answer: a) Depreciation Expense
2. Cash flows from financing activities include: a) Purchase of equipment
b) Repayment of bonds
c) Payment of dividends
d) Both b and c
Answer: d) Both b and c
Broader Question: Prepare a cash flow statement using the following data:
● Net Income: $80,000
● Depreciation Expense: $10,000
● Increase in Accounts Receivable: $5,000
● Decrease in Inventory: $3,000
● Increase in Accounts Payable: $4,000
● Purchase of Equipment: $20,000
● Issuance of Bonds: $50,000
Solution:
1. Operating Activities: Net Income: $80,000
Add: Depreciation Expense: $10,000
Less: Increase in Accounts Receivable: ($5,000)
Add: Decrease in Inventory: $3,000
Add: Increase in Accounts Payable: $4,000
Net Cash from Operating Activities = $92,000
2. Investing Activities: Less: Purchase of Equipment: ($20,000)
Net Cash from Investing Activities = ($20,000)
3. Financing Activities: Add: Issuance of Bonds: $50,000
Net Cash from Financing Activities = $50,000
Net Increase in Cash = $122,000
Chapter 14: Financial Ratios
Multiple Choice Questions:
1. The current ratio is calculated as: a) Total Assets / Total Liabilities
b) Current Assets / Current Liabilities
c) Cash / Total Liabilities
d) Total Liabilities / Current Assets
Answer: b) Current Assets / Current Liabilities
2. The acid-test ratio excludes: a) Accounts Receivable
b) Inventory
c) Cash
d) Marketable Securities
Answer: b) Inventory
3. The accounts receivable turnover ratio measures: a) How efficiently a company uses its
assets
b) How quickly receivables are collected
c) How much profit a company earns
d) How quickly inventory is sold
Answer: b) How quickly receivables are collected
4. The formula for return on assets is: a) Net Income / Total Assets
b) Net Income / Total Liabilities
c) Net Income / Shareholders' Equity
d) Total Assets / Total Liabilities
Answer: a) Net Income / Total Assets
5. The price-earnings ratio is calculated as: a) Market Price per Share / Earnings per Share
b) Net Income / Earnings per Share
c) Market Price per Share / Net Income
d) Earnings per Share / Market Price per Share
Answer: a) Market Price per Share / Earnings per Share
Bonus Notes
1. The Basic Accounting Equation (Extended)
● Basic Equation: A = L + E
● Extended Equation: A = L + SC + R - E - D
● Rules of Debit and Credit:
○ Debits (Dr): Increase assets and expenses; decrease liabilities, revenues, and
equity.
○ Credits (Cr): Increase liabilities, revenues, and equity; decrease assets and
expenses.
● Summary of Rules:
○ Assets = Debit for increase, Credit for decrease.
○ Liabilities = Credit for increase, Debit for decrease.
○ Revenues = Credit for increase, Debit for decrease.
○ Expenses = Debit for increase, Credit for decrease.
2. Accounting Principles
● Historical Cost Principle: Assets are recorded at their original purchase cost.
● Monetary Unit Assumption: Accounting records use a stable currency for
measurement.
● Fair Value Principle: Certain assets and liabilities are measured at their current market
value.
● Economic Entity Assumption: Business transactions are kept separate from personal
transactions of the owner or other entities.
3. Difference Between Accrual and Cash Basis Accounting
● Accrual Basis:
1. Revenue is recognized when earned, not when cash is received.
2. Expenses are recognized when incurred, not when paid.
● Cash Basis:
1. Revenue is recognized when cash is received.
2. Expenses are recognized when cash is paid.
● Revenue and Expense Recognition:
1. Accrual accounting follows the matching principle: Revenue is matched with the
expenses incurred to generate it.
● Types of Adjusting Entries:
1. Prepaid Expenses: Allocate expenses over time (e.g., insurance, rent).
2. Unearned Revenue: Recognize revenue as it is earned.
3. Accrued Revenues: Record revenues earned but not yet received.
4. Accrued Expenses: Record expenses incurred but not yet paid.
4. The Accounting Cycle
1. Analyze Transactions: Examine source documents to identify transactions.
2. Journalize: Record transactions in the journal chronologically.
3. Post to Ledger: Transfer journal entries to ledger accounts.
4. Prepare Trial Balance: List all accounts with their balances to check if debits equal
credits.
5. Adjust Entries: Record adjusting entries for accruals and deferrals.
6. Prepare Adjusted Trial Balance: Verify balances after adjustments.
7. Prepare Financial Statements: Create the income statement, balance sheet, and cash
flow statement.
8. Close Accounts: Close temporary accounts (revenues, expenses, dividends) to
retained earnings.
9. Post-Closing Trial Balance: Verify only permanent accounts remain open with correct
balances.
Explanation of Ratios:
1. Current Ratio: Measures the company's ability to pay short-term liabilities with
short-term assets. Higher values indicate better liquidity.
2. Acid-Test Ratio: Indicates whether a company can meet its short-term obligations
without relying on inventory sales.
3. Accounts Receivable Turnover: Measures how efficiently a company collects revenue
from its credit sales..
4. Inventory Turnover: Indicates how many times inventory is sold and replaced during a
period..
5. Profit Margin: Shows the percentage of profit generated from sales.
6. Asset Turnover: Measures how efficiently a company uses its assets to generate sales.
7. Return on Assets (ROA): Indicates how effectively a company is using its assets to
generate profits.
8. Return on Ordinary Shareholders’ Equity (ROE): Measures profitability from the
shareholders' perspective..
9. Earnings Per Share (EPS): Shows the portion of net income available to each
outstanding share.
10.Price-Earnings Ratio (P/E): Reflects investor expectations and measures stock
valuation.
11.Payout Ratio: Shows the proportion of earnings paid as dividends to shareholders..
12.Debt to Asset Ratio: Measures the proportion of assets financed through debt.
13.Times Interest Earned Ratio: Indicates the company's ability to cover its interest
expenses with its earnings.
1. Which ratio measures a company’s ability to meet its short-term liabilities with
short-term assets?
a) Asset Turnover
b) Current Ratio
c) Debt to Asset Ratio
d) Profit Margin
Answer: b) Current Ratio
2. The Acid-Test Ratio excludes which of the following from current assets?
a) Accounts Receivable
b) Cash
c) Inventory
d) Marketable Securities
Answer: c) Inventory
3. Which ratio shows how efficiently a company is using its assets to generate
sales?
a) Return on Assets
b) Asset Turnover
c) Inventory Turnover
d) Payout Ratio
Answer: b) Asset Turnover
4. What does the Times Interest Earned Ratio evaluate?
a) Profitability
b) Stock Valuation
c) Debt-Servicing Ability
d) Dividend Policy
Answer: c) Debt-Servicing Ability
5. Earnings Per Share (EPS) is calculated using which of the following?
a) Net Sales and Average Assets
b) Net Income and Weighted Average Ordinary Shares Outstanding
c) Net Income and Cash Dividends
d) Net Credit Sales and Accounts Receivable
Answer: b) Net Income and Weighted Average Ordinary Shares Outstanding