Financial Accounting: Key Problems and Concepts Study Guide

Problem 1: Notes Payable and Loan Accounting

Understanding Notes Payable

Notes payable are written promises to pay a certain amount of money at a future date, often with interest. They are commonly used for short-term financing in business.

• Principal: The original amount borrowed ($100,000 in this case).

• Interest Rate: The annual percentage charged on the principal (7% per annum).

• Maturity Value: The total amount to be repaid at the end of the loan period, including interest.

• Maturity Date: The date on which the note is due (90 days from July 1, 2024).

Formula for Interest:

$\text{Interest} = \text{Principal} \times \text{Rate} \times \frac{\text{Time}}{360}$

Example Calculation:

• Principal = $100,000

• Rate = 7% per annum

• Time = 90 days

• Interest = $100,000 \times 0.07 \times \frac{90}{360} = $1,750

• Maturity Value = $100,000 + $1,750 = $101,750

Journal Entry on July 1, 2024 (Issuance):

• Debit: Cash $100,000

• Credit: Notes Payable $100,000

Journal Entry on Maturity Date (Repayment):

• Debit: Notes Payable $100,000

• Debit: Interest Expense $1,750

• Credit: Cash $101,750

Additional info: The 360-day year is commonly used in accounting for simplicity in interest calculations.

Problem 2: Journalizing Merchandising Transactions

Recording Purchases, Returns, and Sales

Merchandising companies buy and sell goods. Transactions must be recorded in the journal to reflect purchases, returns, payments, and sales.

• Purchase on Account: Buying inventory on credit.

• Purchase Returns: Returning defective or unwanted goods to the supplier.

• Payment with Discount: Taking advantage of early payment discounts (e.g., 2/10, n/30 means 2% discount if paid within 10 days, net due in 30 days).

• Sales on Account: Selling goods to customers on credit.

• Sales Returns: Accepting returns from customers.

• Receipt of Payment with Discount: Customer pays within discount period.

Example Journal Entries:

• Jan 1: Purchase Inventory on Account Debit: Inventory $5,000 Credit: Accounts Payable $5,000

• Jan 5: Return Merchandise Debit: Accounts Payable $500 Credit: Inventory $500

• Jan 9: Payment with Discount (2% of $4,500 = $90) Debit: Accounts Payable $4,500 Credit: Cash $4,410 Credit: Inventory $90

• Jan 15: Sale on Account Debit: Accounts Receivable $7,000 Credit: Sales Revenue $7,000 Debit: Cost of Goods Sold $4,000 Credit: Inventory $4,000

• Jan 25: Receipt of Payment with Discount (2% of $7,000 = $140) Debit: Cash $6,860 Debit: Sales Discounts $140 Credit: Accounts Receivable $7,000

Additional info: Discounts reduce the cost of inventory (for purchases) or are recorded as sales discounts (for sales).

Problem 3: Inventory Costing Methods

FIFO, LIFO, and Average Cost

Inventory costing methods determine the cost of goods sold (COGS) and ending inventory. The three main methods are:

• FIFO (First-In, First-Out): Assumes earliest goods purchased are sold first.

• LIFO (Last-In, First-Out): Assumes latest goods purchased are sold first.

• Average Cost: Uses weighted average cost for all units available for sale.

Example Table:

Units	Unit Cost	Total Cost
Beginning Inventory	30	$2.00	$60.00
Purchases	40	$2.05	$82.00
Purchases	35	$2.10	$73.50
Purchases	20	$2.20	$44.00

Formulas:

• FIFO: COGS = Cost of earliest units; Ending Inventory = Cost of latest units.

• LIFO: COGS = Cost of latest units; Ending Inventory = Cost of earliest units.

• Average Cost: $\text{Average Cost per Unit} = \frac{\text{Total Cost of Goods Available}}{\text{Total Units Available}}$

Additional info: The choice of method affects reported profits and taxes.

Problem 4: Multiple-Step Income Statement

Preparing a Multiple-Step Income Statement

A multiple-step income statement separates operating revenues and expenses from non-operating items and provides subtotals such as gross profit and operating income.

Smith Company Adjusted Trial Balance December 31, 2024
Sales Revenue	300,000
Sales Discount	2,000
Sales Returns and Allowances	1,000
Cost of Goods Sold	130,000
Selling Expenses	25,500
General and Administrative Expenses	15,400
Gain on Sale of Asset	3,000

Income Tax Rate: 21%

Steps:

1. Calculate Net Sales: $\text{Net Sales} = \text{Sales Revenue} - \text{Sales Discounts} - \text{Sales Returns and Allowances}$ $300,000 - 2,000 - 1,000 = 297,000$

2. Calculate Gross Profit: $\text{Gross Profit} = \text{Net Sales} - \text{Cost of Goods Sold}$ $297,000 - 130,000 = 167,000$

3. Calculate Operating Income: $\text{Operating Income} = \text{Gross Profit} - \text{Total Operating Expenses}$ $167,000 - (25,500 + 15,400) = 126,100$

4. Add Non-Operating Items: $\text{Income Before Tax} = \text{Operating Income} + \text{Gain on Sale of Asset}$ $126,100 + 3,000 = 129,100$

5. Calculate Income Tax: $\text{Income Tax} = 129,100 \times 0.21 = 27,111$

6. Calculate Net Income: $\text{Net Income} = 129,100 - 27,111 = 101,989$

Additional info: Multiple-step statements provide more detail than single-step statements, aiding analysis.

Problem 5: Accounts Receivable and Allowance for Uncollectible Accounts

Estimating and Reporting Uncollectible Accounts

Companies estimate uncollectible accounts to match bad debt expense to the period in which related sales occur. The Allowance for Uncollectible Accounts is a contra-asset account that reduces Accounts Receivable to its net realizable value.

• Accounts Receivable: Amounts owed by customers.

• Allowance for Uncollectible Accounts: Estimated amount of receivables that will not be collected.

• Aging of Receivables: Classifies receivables by how long they have been outstanding to estimate uncollectibles.

Example Table: Aging of Receivables

Age of Receivable	Amount	% Uncollectible
1-30 Days	$235,000	0.5%
31-60 Days	$132,000	2%
61-90 Days	$52,000	15%
Over 90 Days	$15,000	35%

Formula for Allowance:

$\text{Estimated Uncollectible} = \sum (\text{Amount in Each Age Category} \times \text{Estimated % Uncollectible})$

Reporting on the Balance Sheet:

• Accounts Receivable (gross)

• Less: Allowance for Uncollectible Accounts

• Equals: Accounts Receivable, Net

Additional info: The allowance method is preferred under GAAP because it matches expenses to revenues and provides a more accurate picture of net receivables.