Accounting 303 Exam 3, Chapters 7-9 Fall 2011 Section Row

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1 Accounting 303 Name Exam 3, Chapters 7-9 Fall 2011 Section Row I. Multiple Choice Questions. (2 points each, 34 points in total) Read each question carefully and indicate your answer by circling the letter preceding the one best answer. 1. What is a compensating balance? a. Savings account balances. b. Margin accounts held with brokers. c. Temporary investments serving as collateral for outstanding loans. d. Minimum deposits required to be maintained in connection with a borrowing arrangement. 2. Which of the following is an appropriate reconciling item to the balance per bank in a bank reconciliation? a. Bank service charge. b. Deposit in transit. c. Bank interest earned. d. Error made on the company s books. 3. Why is the allowance method preferred over the direct write-off method of accounting for bad debts? a. Allowance method is used for tax purposes. b. Estimates are used. c. Determining worthless accounts under direct write-off method is difficult to do. d. Improved matching of bad debt expense with revenue. 4. Which of the following statements is incorrect regarding the classification of accounts and notes receivable? a. Segregation of the different types of receivables is required if they are material. b. Disclose any loss contingencies that exist on the receivables. c. Any discount or premium resulting from the determination of present value in notes receivable transactions is an asset or liability respectively. d. Valuation accounts should be appropriately offset against the proper receivable accounts. 5. Equestrian Roads sold $80,000 of goods and accepted the customer's $80,000 10% 1-year note receivable in exchange. Assuming 10% approximates the market rate of return, what would be the debit in this journal entry to record the sale? a. No journal entry until cash is collected. b. Debit Notes Receivable for $80,000. c. Debit Accounts Receivable for $80,000. d. Debit Notes Receivable for $72,000. 1

2 6. On December 31, 2012, Flint Corporation sold for $100,000 an old machine having an original cost of $180,000 and a book value of $80,000. The terms of the sale were as follows: $20,000 down payment $40,000 payable on December 31 each of the next two years The agreement of sale made no mention of interest; however, 9% would be a fair rate for this type of transaction. What should be the amount of the notes receivable net of the unamortized discount on December 31, 2012 rounded to the nearest dollar? (The present value of an ordinary annuity of 1 at 9% for 2 years is ) a. $70,364 b. $90,364. c. $80,000. d. $140, If ending inventory is overstated, a. net income is understated. b. gross profit is overstated. c. cost of goods sold is overstated. d. the effect cannot be determined without more information. 8. The failure to record a purchase of merchandise on account even though the goods are properly included in the physical inventory results in a. an overstatement of assets and net income. b. an understatement of assets and net income. c. an understatement of cost of goods sold and liabilities and an overstatement of assets. d. an understatement of liabilities and an overstatement of owners' equity. 9. In a period of rising prices, the inventory method which tends to give the highest reported cost of goods sold is a. FIFO. b. average cost. c. LIFO. d. none of these. 10. When valuing raw materials inventory at lower-of-cost-or-market, what is the meaning of the term "market"? a. Net realizable value b. Net realizable value less a normal profit margin c. Current replacement cost d. Discounted present value 11. If a material amount of inventory has been ordered through a formal purchase contract at the balance sheet date for future delivery at firm prices, a. this fact must be disclosed. b. disclosure is required only if prices have declined since the date of the order. c. disclosure is required only if prices have since risen substantially. d. an appropriation of retained earnings is necessary. 2

3 Use the following information for questions 12 and 13. Transactions for the month of June were: Date Purchases Date Sales June 1 (balance) $3.20 = 3,840 June 2 $ = 10, = 5, = 9, = 2, Assuming that periodic inventory records are kept, the ending inventory on a LIFO basis is a. $6,165. b. $6,240. c. $6,435. d. $6, Assuming that perpetual inventory records are kept, the ending inventory on a FIFO basis is a. $6,165. b. $6,240. c. $6,705. d. $6, Muckenthaler Company sells product 2005WSC for $30 per unit. The cost of one unit of 2005WSC is $27, and the replacement cost is $26. The estimated cost to dispose of a unit is $6, and the normal profit is 40%. At what amount per unit should product 2005WSC be reported, applying lower-of-cost-or-market? a. $12. b. $24. c. $26. d. $ On October 31, a fire destroyed PH Inc.'s entire retail inventory. The inventory on hand as of January 1 totaled $1,360,000. From January 1 through the time of the fire, the company made purchases of $330,000 and had sales of $720,000. Assuming the rate of gross profit to selling price is 40%, what is the approximate value of the inventory that was destroyed? a. $1,360,000. b. $1,346,000. c. $970,000. d. $1,258,000. 3

4 16. Linguini, Inc. had an ending inventory valued at year-end costs of 127,200. Linguini had adopted dollar-value LIFO at the beginning of the current year when its inventory value was 100,000 (base year with index 1.00). If for the current year Linguini added a new layer to its ending inventory (measured in base year amounts) of 20,000, what was the cost index for the current year? a b c d Under the lower-of-cost-or-market method, the replacement cost of an inventory item would be used as the designated market value a. when it is below the net realizable value less the normal profit margin. b. when it is above the net realizable value. c. when it is below the net realizable value and above the net realizable value less the normal profit margin. d. regardless of net realizable value. 4

5 II. Problems (66 points in total) Show all work where appropriate! 1. (10 points) Sofia Company uses the allowance method to account for its bad debts. The December 31, 2011, trial balance for Sofia before adjustment included the following: Debit Credit Accounts receivable $120,000 Allowance for doubtful accounts 730 Sales $510,000 Sales returns and allowances 8,000 (a) Give the year end journal entry for bad debts expense assuming Sofia s estimate is calculated as 5% of gross accounts receivable. (b) Give the year end journal entry for bad debts expense assuming Sofia s estimate is calculated as 1% of net sales. (c) Give the entry for Sofia to write off an accounts receivable with a balance of $200. 5

6 2. (14 points) On May 1, 2011, Blagoevgrad, Inc. factored $1,200,000 of accounts receivable with Quick Finance on a without recourse basis. Under the arrangement, Blagoevgrad was to handle disputes concerning service, and Quick Finance was to make the collections, handle the sales discounts, and absorb the credit losses. Quick Finance assessed a finance charge of 6% of the total accounts receivable factored and retained an amount equal to 2% of the total receivables to cover sales discounts. (a) Prepare the journal entry required on Blagoevgrad's books on May 1. (b) Instead of factoring without recourse, assume Blagoevgrad factored their $1,200,000 of accounts receivable with Quick Finance on a with recourse basis. Assume the recourse provision has a fair value of $21,000. Prepare the journal entry required on Blagoevgrad's books on May 1. 6

7 3. (12 points) Skopje Co. records purchases at net amounts and uses periodic inventories. Prepare entries for the following transactions that took place in 2011: June 11 Purchased merchandise on account, $8,000, terms 2/10, n/ Returned $500 of June 11 purchase and received credit on account. 20 Paid one-half of the invoice. July 7 Paid the remaining amount due on the invoice. Date Entry June 11, 2011 June 15, 2011 June 20, 2011 July 7,

8 4. (14 points) On December 31, 2011, Rila Ltd. adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO inventory method was $270,000. Other inventory data are as follows: Inventory at Price index Year year-end prices (base year 2009) 2012 $281, , Compute the inventory at December 31, 2012 and 2013, using the dollar-value LIFO method for each year

9 5. (16 points) When you undertook the preparation of the financial statements for Varna Company at December 31, 2011, you determined that Varna uses the LIFO Retail method for their inventory valuation, and the following data were available: At Cost At Retail Inventory, January 1, 2011 $70,800 $ 98,500 Purchases 219, ,000 Purchases returns and allowances 4,300 5,500 In addition to the above information, you discovered that Net Markdowns were $15,000, Net Markups were $53,000, Sales were $275,000, and Sales Returns were $10,000. (a.) In the space provided below, recap the above information in a retail method format. At Cost At Retail (b.) What is Varna s December 31, 2011, inventory at cost using the LIFO Retail method? (c.) If instead, Varna had used the LCM (conventional) Retail method, what would be the Cost Ratio based on that method? (Do not give ending inventory value, just cost ratio carried out to 4 significant digits.) (d.) If instead, Varna had used the Average Retail method, what would be the Cost Ratio based on that method? (Do not give ending inventory value, just cost ratio carried out to 4 significant digits.) 9

10 Solutions Multiple Choice Question Answer Question Answer 1 d 11 a 2 b 12 a 3 d 13 c 4 c 14 b 5 b 15 d 6 a 16 a 7 b 17 c 8 d 9 c 10 c Problems Solution for Problem 1 (a) Bad Debt Expense... 5,270 Allowance for Doubtful Accounts... 5,270 Gross receivables $120,000 Rate 5% Total allowance needed 6,000 Present allowance (730) Adjustment needed $ 5,270 (b) Bad Debt Expense... 5,020 Allowance for Doubtful Accounts... 5,020 Sales $510,000 Sales returns and allowances 8,000 Net sales 502,000 Rate 1% Bad debt expense $ 5,020 (c) Allowance for Doubtful Accounts Accounts Receivable

11 Solution for Problem 2 (a) Cash... 1,104,000 Due from Factor (2% $1,200,000)... 24,000 Loss on Sale of Receivables (6% $1,200,000)... 72,000 Accounts Receivable... 1,200,000 (b) Cash... 1,104,000 Due from Factor... 24,000 Loss on Sale of Receivables... 93,000 Accounts Receivable... 1,200,000 Recourse Liability... 21,000 Solution for Problem 3 Solution June 11 Purchases (.98 $8,000)... 7,840 Accounts Payable... 7, Accounts Payable (.98 $500) Purchase Returns and Allowances Accounts Payable Cash July 7 Accounts Payable Purchase Discounts Lost Cash Solution for Problem 4 Ending Layers at Inventory at Base-Year Ending Inventory Base-Year Price Prices Price Index Dollar-Value LIFO At 12/31, $281, $268, = $268, : = $268,000 At 12/31, $402, $268, = $268, : = $350,000 $82, = 94,300 $362,300 11

12 Solution for Problem 5 (a) At Cost At Retail Beginning inventory, 5/1 $ 70,800 $ 98,500 Purchases 219, ,000 Purchase Returns <4,300> <5,500> Markups (net) 53,000 Markdowns (net) <15,000> Available for sale $286,000 $ 425,800 Sales <275,000> Sales discounts 10,000 Ending inventory at retail $ 160,000 (b) At Retail Cost Ratio At Cost 2011 Layer 98,500 x = 70, Layer 61,500 x.6591 = 40, ,335 (c) LCM Ratio: $286,000 $440,000 =.6500 (c) Average Ratio: $286,000 $425,000 =