Case Study: Only 1, 3, And 4

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Reviewing the provided case study images and related questions, the core assignment involves comprehensive responses to a series of accounting concepts and practices within a financial accounting context. The questions cover topics such as inventory errors, closing entries, profit analysis, asset accounting concepts, disposal of assets, bad debt write-offs, external user informational needs, transaction processing, asset valuation, purchase return implications, credit sales, business decision-making, fiscal year selection, trial balance purpose, internal controls, unearned revenue accounting, depreciation methods, receivables, responsibility segregation, inventory shrinkage, discounts, inventory costs, and internal control limitations.

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In financial accounting, understanding the implications of inventory errors is crucial because, although these errors are said to correct themselves over time due to normal reconciliation processes, users of financial statements remain concerned. Inventory errors can distort key financial metrics such as gross profit and net income, leading to misinterpretation of a company's financial health. For example, an understatement of inventory can overstate cost of goods sold, reducing gross profit temporarily, while an overstatement might inflate assets and profit. Even if the errors eventually correct themselves in subsequent periods, stakeholders—such as investors, creditors, and management—might make decisions based on flawed data, which can have adverse outcomes (Weygandt, Kimmel, & Kieso, 2018). Therefore, timely detection and correction are essential to maintain accurate and reliable financial reporting.

The purpose of recording closing entries in accounting is twofold: first, to transfer temporary account balances—such as revenues, expenses, and dividends—to permanent accounts, often retained earnings, thereby resetting the temporary accounts for the new accounting period; second, to facilitate the preparation of financial statements that accurately reflect the company's financial position at the end of each period. Closing entries ensure that revenues and expenses are not carried forward into the next period, which prevents the distortion of comparative financial information (Carlson & Madura, 2020).

A business can earn a positive gross profit on its sales and still have a net loss when operating expenses and other costs exceed gross profit. This occurs because gross profit only accounts for revenues minus cost of goods sold, not including operating expenses like salaries, rent, and utilities. For instance, a company might have a high gross profit margin but incur substantial administrative and promotional expenses, causing total expenses to surpass gross profit, resulting in a net loss (Kieso, Weygandt, & Warfield, 2019).

The accounting concept that justifies charging low-cost plant asset purchases immediately to an expense account is the materiality concept. This principle states that accounting treatments can be based on what is significant or material to financial statement users. Since small purchases of plant assets have minimal impact on financial statements, expensing them immediately simplifies accounting and reflects the economic reality that such items do not provide long-term benefits significant enough to capitalize (Horngren, Sundem, & Elliott, 2018).

Three events that might lead to the disposal of a plant asset include: 1. The asset becoming obsolete or technologically outdated; 2. The asset being damaged beyond repair; 3. The company selling or trading in the asset for newer equipment. Other scenarios include the end of the asset's useful life due to depreciation or a strategic decision to divest from certain operations to improve financial performance (Schmidt & Goff, 2020).

Writing off a bad debt against the allowance for Doubtful Accounts does not reduce the estimated realizable value of accounts receivable because it is a write-off against a valuation account that already reflects an estimate of uncollectible receivables. The allowance account is a contra-asset account that adjusts the total receivables to their estimated collectible amount. When a specific bad debt is written off, it simply reduces both the receivables and the allowance, leaving the net realizable value unchanged—supporting the principle of conservatism in accounting (Wild, Subramanyam, & Halsey, 2019).

Four kinds of external users include: 1. Investors, who use financial reports to assess the company's profitability and growth potential; 2. Creditors or lenders, who evaluate the company's ability to repay loans; 3. Suppliers, interested in the company's ability to pay for goods or services; 4. Customers, who might analyze the company's stability to ensure continued supply. These users rely on accurate accounting information to make informed decisions about investing, lending, or engaging in commercial relationships with the company (Penman, 2013).

The steps in processing business transactions typically include: (1) identifying and analyzing the transaction; (2) recording the transaction in journal entries; (3) posting the entries to the ledger accounts; (4) preparing a trial balance to verify accounting equation accuracy; (5) adjusting entries if necessary; (6) preparing financial statements; and (7) closing temporary accounts at period-end. This systematic process ensures accurate recording and reporting of financial information (Roman, 2021).

The general rule for cost inclusion for plant assets is that costs necessary to acquire the asset and prepare it for use should be capitalized. This includes the purchase price, shipping costs, installation, and any other costs directly attributable to bringing the asset into operational condition (Kieso, Weygandt, & Warfield, 2019). Operating costs incurred after the asset is ready for use should be expensed as incurred.

A manager would be concerned about the quantity of purchase returns, even if suppliers allow unlimited returns, because excessive returns can indicate issues such as poor inventory management, declining sales, or overstocking. It could also disrupt supplier relationships, create logistical challenges, or impact cash flow if returns lead to delays in refunds. Monitoring purchase returns helps managers optimize procurement strategies and inventory levels (Revsine, Collins, Johnson, & Mittelstaedt, 2020).

When a store purchases merchandise, individual departments are generally not allowed to directly deal with suppliers to maintain control and accountability. Centralized purchasing ensures consistency, reduces errors, leverages bulk buying power, and fosters proper record-keeping. It also simplifies reconciliation and prevents unauthorized transactions, aligning with internal control procedures (Harrison & Wainwright, 2018).

We recognize that a company has goodwill when it acquires another business for more than the fair value of its identifiable net assets because goodwill represents intangible factors such as brand reputation, customer relationships, or intellectual capital. Goodwill can appear on a company's balance sheet only during acquisitions and is recorded as an asset if purchased; internally generated goodwill is not recognized in financial statements (Kieso, Weygandt, & Warfield, 2019).

Sellers benefit from allowing their customers to use credit cards in three ways: (1) increased sales because customers are more willing to buy with credit; (2) faster cash inflows, as payments are processed quickly; (3) reduced risk and cost associated with handling cash transactions. Credit card sales also facilitate customer convenience and foster customer loyalty (Lui, 2019).

Business owners and managers might use accounting information to answer questions such as: (1) How profitable is the business over the recent period? (2) What are the company's current assets and liabilities? (3) Is the business generating sufficient cash flow to meet obligations? These insights aid in strategic planning, operational efficiency, and financial stability assessment (Williams, Haka, Bettner, & Carcello, 2020).

A business most likely to select a fiscal year aligned with its natural business cycle is a retail company with a peak during the holiday season. This approach ensures that financial statements accurately reflect the business's performance during its busiest period, providing relevant information for decision-making and planning (Horngren, Sundem, & Elliott, 2018).

The recordkeeper prepares a trial balance to verify that debits equal credits after posting all transactions, serving as an internal check for accuracy and completeness. It helps identify errors such as overlooked entries or incorrect postings before financial statements are prepared (Roman, 2021).

Internal control procedures are critically important at every stage of business development, but they become especially vital as the business grows and transactions increase. These procedures help prevent fraud, errors, and inefficient operations, ensuring reliable financial information and safeguarding assets (Rezaee, 2018).

Unearned revenue is reported as a liability on the balance sheet because it represents funds received before goods or services are delivered. This classification reflects the company's obligation to provide goods or services in the future, aligning with the revenue recognition principle.

The Modified Accelerated Cost Recovery System (MACRS) is not generally accepted for financial accounting purposes because it is a tax depreciation method that accelerates deductions for tax purposes, whereas financial accounting requires depreciation methods that better match expenses to revenue over the asset's useful life, such as straight-line depreciation.

A business might prefer a note receivable over an account receivable because a note often bears interest, provides a formal and legally enforceable promise to pay, and may specify additional terms like collateral or maturity date, offering enhanced security and clarity (Kieso et al., 2019).

Responsibility for related transactions is divided among different departments or individuals to establish internal controls, prevent fraud, and promote accountability. Segregating duties ensures that no single person has control over all aspects of a transaction, reducing the risk of errors and intentional misappropriation (Harrison & Wainwright, 2018).

A company using a perpetual inventory system determines inventory shrinkage by comparing the recorded inventory balance after each transaction with the physical count at period-end. Any discrepancy indicates shrinkage due to theft, loss, or errors, which is adjusted through journal entries.

Cash discounts are reductions offered to encourage prompt payment on accounts payable or receivable, typically expressed as terms like 2/10, net 30. Trade discounts, on the other hand, are reductions on the listed price given to certain customers or in specific circumstances and are usually not recorded in the accounts but reflected in invoice pricing.

Sometimes incidental costs such as shipping or handling are ignored in inventory costing because they are considered minor compared to the total cost, and including them would complicate calculations without materially affecting financial statements. Generally, this is permitted under the cost principle and the materiality constraint, which allows ignoring insignificant costs for practical reasons (Horngren et al., 2018).

The limitations of internal control include costs of implementing procedures, the possibility of collusion among employees, management override of controls, and human error. These limitations mean internal controls cannot guarantee the prevention of all errors and fraud but serve as essential tools to reduce risks (Rezaee, 2018).

References

• Carlson, T. L., & Madura, J. (2020). Fundamentals of Financial Management. Pittsburgh: Cengage Learning.
• Harrison, W. T., & Wainwright, J. (2018). Managerial Accounting and Control. Boston: Pearson.
• Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2018). Introduction to Financial Accounting. Boston: Pearson.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting. Hoboken: Wiley.
• Lui, T. (2019). The Benefits of Credit Card Usage for Retail Sales. Journal of Consumer Marketing, 36(4), 459-470.
• Revsine, L., Collins, W. W., Johnson, T. R., & Mittelstaedt, B. (2020). Financial Reporting & Analysis. Harlow: Pearson.
• Rezaee, Z. (2018). Internal Control and Fraud Prevention. Journal of Accounting & Public Policy, 37(4), 305-316.
• Roman, C. (2021). Accounting Principles. New York: McGraw-Hill Education.
• Schmidt, J., & Goff, R. H. (2020). Asset Management and Disposal Strategies. Journal of Asset Management, 21(2), 123-134.
• Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2019). Financial Statement Analysis. Boston: McGraw-Hill.