CMA® > CMA® Part 1 > A.2. Receivables and Inventory > Flashcards

A.2. Receivables and Inventory Flashcards

Learn to account for accounts receivable, credit losses, sales returns, and inventory cost tracking under various systems. (83 cards)

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1
Q

When does a company recognize an account receivable according to ASC 606?

A

When it satisfies its performance obligation by transferring control of the good or service sold to the customer.

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2
Q

What are the main issues with respect to receivables?

A
  • Valuing the accounts receivable on the balance sheet
  • Calculating the allowance for credit losses
  • Understanding the factoring of receivables with and without recourse
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3
Q

How are accounts receivable valued for financial statement presentation?

A

At the net amount expected to be collected.

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4
Q

What factors are considered when determining the net amount expected to be collected on accounts receivable?

A
  • Expected credit losses on receivables
  • Any returns or allowances to be granted
  • Other variable consideration expected
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5
Q

What are trade discounts?

A

Discounts given:

  • for large purchases
  • to repeat customers
  • for a special offer
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6
Q

How are trade discounts accounted for?

A

Sales revenue and the receivable are recorded at the discounted price.

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7
Q

What is a cash discount?

A

A discount given when a customer pays a receivable in full before a set date.

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8
Q

What does “Terms: 2/10, n/30” mean on an invoice?

A

If the customer pays within 10 days, they can pay 2% less than the invoiced amount. If the customer does not pay within 10 days, the full undiscounted amount is due within 30 days.

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9
Q

What are the two methods for accounting for cash discounts?

A
  • Gross method
  • Net method
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10
Q

Under the gross method, how is a receivable that offers a cash discount accounted for?

A

It is recorded at the full (gross) amount of the sale. If it is paid within the discount period and thus less than the full amount is paid, an adjusting entry is made to account for the fact that less than the full amount was received.

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11
Q

What is the purpose of the Allowance for Discounts account under the gross method?

A

To reasonably estimate the expected discounts to be taken and set up a valuation account.

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12
Q

Under the net method, how is a receivable that offers a cash discount accounted for?

A

It is recorded at its net amount after the discount, assuming the customer will take the discount. If the invoice is not paid within the discount period, the forfeited discount is recognized as revenue in a revenue account such as cash discounts forfeited.

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13
Q

What is the CECL model used for?

A

It is used for accounting for credit losses on financial instruments, including trade receivables.

“CECL” stands for “Current Expected Credit Loss.”

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14
Q

What is the term for the estimated collectible amount of receivables presented on the balance sheet?

A

Net receivables

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15
Q

What is the purpose of the Allowance for Credit Losses-Trade Receivables account, a valuation account, in relation to accounts receivable?

A

To decrease the value of net accounts receivable reported on the balance sheet to the amount management expects to be collectible and account for expected credit losses.

The valuation account, a contra-asset account, carries a negative balance and is used to decrease the value of accounts receivable to the balance management expects will be collectible.

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16
Q

What are the three types of journal entries that affect the Allowance for Credit Losses-Trade Receivables account?

A
  • To record the credit loss expense for the period
  • To write off a specific receivable when it becomes uncollectible
  • To record the collection of a previously written-off receivable
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17
Q

What is the purpose of valuing accounts receivable?

A

To recognize anticipated credit loss expense before write-offs occur and to report the accounts receivable balance that the company realistically expects to collect.

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18
Q

How are current credit losses on receivables to be determined?

A

The current expected credit loss (CECL) model is to be used. Measurement of expected credit losses is to be based on information about past events and historical experience but also on current conditions and forecasted changes, such as changes in economic conditions.

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19
Q

With respect to the CECL model for determining expected losses on receivables, what is the practical expedient provided by Accounting Standards Update No. 2025-05?

A

Companies may elect to assume that current conditions as of the balance sheet date will not change for the remaining life of the asset.

This expedient is available to all entities and allows for more straightforward forecasting of expected credit losses.

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20
Q

What is the usual journal entry to record estimated credit loss expense?

A

Dr Credit Loss Expense-Trade Receivables
Cr Allowance for Credit Losses-Trade Receivables

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21
Q

How is a previously written-off receivable that is subsequently collected accounted for?

A

Two journal entries are made:

Dr Accounts Receivable
Cr Allowance for Credit Losses-Trade Receivables
Dr Cash
Cr Accounts Receivable

The first general ledger entry above debits the Accounts Receivable account and the second one credits the same account for the same amount. If the accounting system permits, the two entries can be combined into one journal entry that debits Cash and credits the Allowance account.

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22
Q

What is the ending balance in the Allowance for Credit Losses-Trade Receivables account used for?

A

To reduce the ending net accounts receivable balance shown on the balance sheet to the amount expected to be received.

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23
Q

What method is commonly used to calculate the required ending balance in the Allowance for Credit Losses-Trade Receivables account?

A

An aging report combined with other relevant information such as economic conditions.

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24
Q

What method of valuing receivables is not acceptable under U.S. GAAP for external financial reporting?

A

The direct write-off method, where receivables are written off to expense only when they specifically go bad.

However, the direct write-off method may be required for income tax reporting.

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25
What are the two forms of **factoring**?
* Without recourse * With recourse
26
Why is the direct write-off method of accounting for credit losses not acceptable under U.S. GAAP for external financial reporting?
It does not match revenues and expenses, which is inconsistent with **accrual accounting**.
27
What does the **percentage of sales method** of determining estimated credit losses on trade receivables help achieve?
Recognizing current **expected credit loss expense** in the same period as current **revenue** from **credit sales**.
28
What are the **two valuation accounts** used for sales returns and allowances?
* Sales Returns and Allowances, a contra-revenue account * Allowance for Sales Returns and Allowances, a contra-asset account
29
What is the **purpose** of the Sales Returns and Allowances account?
To **reduce Sales Revenue** on the income statement to recognize estimated sales returns and other allowances that are estimated to decrease the current period sales revenue reported.
30
How does selling receivables to a factor **differ** from pledging them as collateral?
* The receivables are removed from the seller’s balance sheet. * No loan is reported on the balance sheet for the funds received.
31
What is the impact of factoring receivables without recourse?
The factor assumes the **risk** of any credit losses on the receivables.
32
What must be considered when using the **percentage of sales method** for estimating credit losses on accounts receivable?
Management must **evaluate the ending balance** in the Allowance for Credit Losses account to ensure it is reasonable.
33
What is the **purpose** of the Allowance for Sales Returns and Allowances account?
To **reduce Accounts Receivable** on the balance sheet to recognize estimated sales returns and other allowances that are estimated to decrease the current period credit sales reported.
34
What are the three classifications of **inventory** for a manufacturing company?
* Raw materials * Work-in-process * Finished goods
35
What **costs** should be included when valuing inventory at purchase?
* Cost of the inventory * Shipping-in costs * Insurance in transit * Taxes and tariffs * Duties * Other necessary costs
36
What is the main focus of **inventory accounting** for a retailer or wholesaler?
Accounting for purchased merchandise inventory.
37
What are **landing costs**?
The **costs of receiving the inventory**, including shipping-in charges, taxes, tariffs, duties, and any other costs necessary for the company to receive the inventory to sell to the customer.
38
How should discounts related to **inventory purchases** be recorded?
The discounted price paid should be recorded as the **value of the inventory**.
39
Who owns in-transit goods shipped **FOB Shipping Point**?
The **buyer** owns the goods from the moment the seller gives them to the shipping company.
40
Who owns in-transit goods shipped **FOB Destination**?
The **seller** owns the goods until the buyer receives them.
41
How should **consigned goods** be reported in the financial statements by the consignor?
As **inventory** on the records of the consignor.
42
How should **goods out on approval** be reported in the financial statements of the seller?
They should be included in the seller’s inventory at their **original cost** until either the customer accepts the goods or the return period expires.
43
How should **obsolete inventory** be treated?
It should be written off as a **loss** in the period it is determined to be obsolete.
44
What are **product costs**?
* Costs directly incurred to bring goods in and convert them to a salable product * Include cost of the product, freight-in charges, direct costs, and production costs for manufacturers
45
What are **period costs**?
* Costs not directly related to acquiring or producing goods * Include general and administrative expenses and selling costs
46
What is the **FIFO** inventory cost flow assumption?
Under FIFO (first-in-first-out), it is assumed that an item sold is the **earliest** unit purchased by the seller that has not yet been sold.
47
What is the **LIFO** inventory cost flow assumption?
Under LIFO (last-in-first-out), it is assumed that an item sold is the **latest** unit purchased by the seller.
48
What is the **average cost** inventory cost flow assumption?
The **average cost method** uses an average cost for the calculation of **ending inventory and COGS**. ## Footnote For each sale, the average cost per unit of each inventory item is calculated by dividing the total cost paid for all the units of that inventory item on hand (before the sale took place) by the number of units on hand.
49
What is the **specific identification** inventory cost flow assumption?
It **tracks each unit** of inventory individually. Used for low quantity, high value items that can be specifically identified such as by serial number.
50
What are the **advantages** of the **FIFO** inventory cost flow assumption?
* Lower cost of goods sold in periods of rising prices * Higher reported net income * Inventory reflects more-current market prices
51
What are the **disadvantages** of the **FIFO** inventory cost flow assumption?
* Higher taxable income and taxes in rising prices * Overstated operating income in periods of rising prices
52
What are the **advantages** of the **LIFO** inventory cost flow assumption?
* Better matches current costs against current revenues * Lower taxable income and taxes in periods of rising prices
53
What are the **disadvantages** of the **LIFO** inventory cost flow assumption?
* Lower reported earnings * Inventory undervalued on the balance sheet * Complexity in accounting
54
What is the impact on **net income** of using LIFO when selling prices and revenues are increasing faster than costs?
LIFO is preferable because it helps to **reduce net income distortion**.
55
Is LIFO permitted under IFRS for inventory valuation?
No
56
What is the main **difference** between the periodic and perpetual inventory systems?
* The **periodic system** calculates ending inventory and COGS only at the end of a period * The **perpetual system** updates inventory and COGS continuously after each sale
57
Under which conditions is **LIFO** less preferable?
* When selling prices tend to lag behind costs * When specific identification is needed * When unit costs decrease as production increases * When prices tend to decrease
58
How is the **cost per unit sold** calculated under the average cost inventory cost flow assumption?
By dividing the total cost paid for all the units of that inventory item on hand (before the sale took place) by the number of units on hand.
59
What is a **LIFO liquidation**?
It occurs when a company **sells more units** during a period than it purchased during the period, eliminating one or more LIFO layers.
60
What is the effect of **rising prices** on ending inventory and COGS under FIFO, as compared to LIFO?
* Ending Inventory: Higher * COGS: Lower * Gross Profit: Higher
61
What is the **rolling-average** inventory **cost flow assumption** according to the U.S. IRS?
It is the **average cost method** that may be used in the U.S. to value inventory for **tax purposes** when the average cost method is used for financial accounting. It is allowed if the difference between the ending inventory under the rolling-average method and the ending inventory under FIFO or the specific identification method would be **no more than 1%**. ## Footnote Because of the limitations, the rolling-average cost method is seldom used for tax purposes
62
What is the **moving average method** in a perpetual inventory system?
A method where a new average cost is calculated after each purchase, applied to ending inventory and COGS.
63
What is the primary **advantage** of a perpetual inventory system?
It provides a more accurate reflection of inventory transactions.
64
How is the **weighted average cost** of each unit of inventory calculated in a periodic inventory system?
This is calculated only at the **end of the period**. The company determines the total number of units it had available for sale during the period and the total inventory cost for all the units available for sale and divides the total cost by the total units available for sale.
65
What is the **purpose** of a physical inventory count?
To determine the number of units on hand of each item. ## Footnote A physical inventory count can be done annually or through cycle counting.
66
What is **cycle counting**?
In cycle counting of inventory, different portions of the inventory are counted on a **rotating schedule throughout the year**, rather than conducting one comprehensive physical count of everything at once. The counting is done according to a schedule that assures that every item is counted at least once each year.
67
What journal entry is made if the physical count of inventory is less than the accounting records indicate?
* Dr Inventory loss * Cr Inventory ## Footnote This entry adjusts the balance sheet to reflect the physical inventory balance.
68
Is a physical count of all inventory required by U.S. GAAP for interim financial statements?
No ## Footnote A physical count is not required for interim financial statements, though it is required for **annual** reporting purposes.
69
What is the basic **inventory formula** for a **reseller**?
Beginning Inventory + Purchases – Cost of Sales = Ending Inventory
70
What happens to operating income when COGS is overstated?
It is understated. ## Footnote Conversely, when COGS is understated, operating income is overstated.
71
What is a **self-correcting error** in inventory?
An error that corrects itself in time, even if it is not discovered. ## Footnote Miscounting of inventory is an example of a self-correcting error.
72
How should **inventories** be measured under U.S. GAAP for methods other than LIFO or the Retail Method?
At the Lower of Cost or Net Realizable Value | (LCNRV) ## Footnote Net realizable value is the estimated selling price minus costs of completion, disposal, and transportation.
73
What is the designated **market value** for inventory in LIFO and LCM (lower of cost or market) calculations?
The middle value of the ceiling (NRV), the current replacement cost, and the floor (NRV minus normal profit margin). ## Footnote This value is used to determine the lower of cost or market.
74
What is the effect of using the **LIFO** inventory cost flow assumption during a period of rising prices?
Of all the inventory cost flow assumptions, LIFO yields the **highest cost of goods sold** and the **lowest net income**. ## Footnote In contrast, FIFO results in the lowest cost of goods sold and the highest net income.
75
What is the **LCM method** used for in inventory valuation?
The LCM (Lower of Cost or Market) method is used for inventories measured using LIFO or the Retail Method. ## Footnote Under LIFO, "market" is the middle value of replacement cost, NRV, and NRV minus normal profit. The Retail Method is a method of estimating inventory cost often used by retailers that label their inventory with price tags when it is received. When the physical count is made, the retailer compiles the ending inventory at retail prices instead of at cost. To determine the cost of the ending inventory to be reported on the balance sheet, the retail value of the ending inventory is multiplied by a cost/retail (C/R) ratio. LCM calculations are included in the C/R ratio.
76
Under U.S. GAAP, when must **inventory write-downs** be recognized?
If the market value or net realizable value is **lower than the cost** of the inventory. ## Footnote The loss is recorded on the income statement as a reduction of income in that period.
77
What are the **three components** used to determine the designated market value under LIFO for purposes of determining the lower of cost or market valuation for inventory?
* Ceiling (NRV): Selling price minus completion/disposal costs * Current replacement cost * Floor: NRV minus a normal profit margin
78
How does IFRS **differ** from U.S. GAAP regarding inventory write-down reversals?
* Under **IFRS**, previous write-downs of inventory may be recovered up to the original cost * **U.S. GAAP** does not allow reversals in later annual periods ## Footnote Under U.S. GAAP, inventory write-downs in interim financial statements may be reversed up to the original cost of the inventory only within the same fiscal year.
79
What is the purpose of a **valuation allowance account** in inventory accounting?
It is used to adjust the inventory value to market or **net realizable value** while preserving the historical cost records. ## Footnote This account helps maintain correspondence between subsidiary inventory ledgers and the control account.
80
# True or False: Under U.S. GAAP, inventory write-downs can be reversed in later annual periods.
False ## Footnote Inventory write-downs reported on annual financial statements cannot be reversed in later annual periods under U.S. GAAP.
81
What is the journal entry for recording an inventory write-down?
Dr Inventory loss or cost of goods sold Cr Inventory ## Footnote U.S. GAAP does not specify which account should be debited. It can be either a loss account or cost of goods sold.
82
What is the effect of **inventory miscounts** on financial statements?
They affect two periods but resolve automatically if the next period’s count is accurate. ## Footnote They are self-correcting errors.
83
What is the **net realizable value** (NRV) formula?
Net Realizable Value = Estimated selling price − costs of completion, disposal, and transportation
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