Chapter 05 – The Operating Cycle and Merchandising Operations
TRUE/FALSE
1. Businesses can be classified as service companies, wholesalers, or retailers.
2. Profitability means having enough cash on hand to pay bills when they become due.
3. The operating cycle involves the purchase and sale of merchandise inventory as well as the subsequent
collection of cash from credit sales.
4. When a U.S. company does business with a British company and payment is in U.S. dollars, an
exchange gain or loss occurs if the exchange rate between dollars and pounds changes between the
date of sale and the date of payment.
5. An advantage of using the periodic inventory system is that it requires less recordkeeping than the
perpetual inventory system.
6. The perpetual inventory system relies on a physical count of merchandise for its balance sheet amount.
7. The periodic inventory system provides an up–to-date amount of inventory on hand.
8. A retail operation would still have to take a physical inventory even if it uses a perpetual inventory
system.
9. Under the periodic inventory system, Cost of goods sold must be computed on the income statement
because it is not updated for purchases, sales, and other transactions during the accounting period.
10. Computerization has led to a large increase in the use of the periodic inventory system.
11. Taking a physical inventory refers to making a count of all merchandise on hand at a particular time.
12. When the periodic inventory system is used, a physical inventory does not need to be taken at the end
of the fiscal year.
13. Computerization has helped to make taking physical inventory a much easier process in both the
periodic and perpetual inventory systems.
14. A company with a current ratio of 1.0 is considered more liquid than one with a current ratio of 2.0.
15. A company would be more likely to know the amount of inventory on hand if it used the perpetual
inventory system rather than the periodic inventory system.
16. Under the periodic inventory system, cost of goods sold is treated as an account.
17. A large discount chain, like Wal-Mart or Target, most likely would use the perpetual inventory system
to maintain control of its inventory.
18. Liquidity management involves planning a business’s cash receipts and cash payments.
19. Cash flow cannot be managed, but it is a natural component of business operations.
20. When the terms of sale include a sales discount, it usually is advisable for the buyer to pay within the
discount period.
21. The terms “2/10, n/30” mean that a 2 percent discount is allowed on payments made before 10 days
after the invoice date.
22. Terms of “2/10, n/30” are an example of a trade discount.
23. Sale and purchase of goods should be recorded at their list price, before any trade discount is recorded.
24. FOB shipping point means that the seller incurs the shipping costs.
25. Freight-in is not considered a cost of merchandise purchased.
26. The use of major credit cards requires sellers to establish the customer’s credit.
27. The fee paid by a retailer to a credit card company is considered an expense account by the retailer.
28. When the buyer bears the transportation charge, it is called freight-out.
29. Upon making a credit card sale, a business should record the sale as an accounts receivable until the
customer pays his or her credit card bill.
30. When a business is able to deposit its credit card sales invoices directly into a special bank account, it
debits Accounts Receivable.
31. If insured goods are shipped FOB destination, the seller should file a claim for goods damaged in
transit.
32. Cost of goods sold is not considered an expense of a merchandising business.
33. A sale takes place when title to the goods transfers to the buyer.
34. Sales Discounts and Sales Returns and Allowances are revenue accounts.
35. The difference between gross sales and net sales is equal to the sum of sales discounts and sales
returns and allowances.
36. When a customer returns goods, the company increases the Sales Returns and Allowances account.
37. Inventory losses are easier to identify under the perpetual inventory system than under the periodic
inventory system.
38. The net cost of purchases is found by adding freight-in to net purchases.
39. With the periodic inventory system, goods available for sale must be calculated before cost of goods
sold.
40. Adding together the beginning merchandise inventory and cost of goods sold gives the amount of
goods available for sale.
41. Ending merchandise inventory is included in the calculation of goods available for sale.
42. Freight-In is treated as an addition in the cost of goods sold section of the income statement.
43. Under the periodic inventory system, the Purchases account is used to accumulate all purchases of
merchandise for resale.
44. The change in merchandise inventory level from the beginning to the end of the year does not affect
cost of goods sold.
45. The calculation of goods available for sale during the year is affected by the previous year’s ending
merchandise inventory.
46. Good internal control dictates that key employees be rotated among different jobs.
47. At the end of each day, the cashier should not be the one responsible for comparing the amount on the
cash register tape with the day’s cash additions to the cash register.
48. Management’s authorization of transactions relates to a control activity in the accounting system.
49. Merchandising businesses and servicing companies both need a good system of internal control.
50. An effective system of internal control centralizes functions in a single, capable individual.
51. An effective system of internal control requires that individuals never take vacations.
52. Bonding means insuring a company against employee theft.
53. Management’s regular assessment of its internal controls is called monitoring.
54. Management is responsible for establishing a satisfactory system of internal control.
55. The separation-of-duties feature of internal control can be negated when the owner of a small company
has an active involvement in the company.
56. One example of a periodic independent verification is the bank reconciliation.
57. A system of internal control cannot be considered good until the possibility of human error has been
completely eliminated.
58. Proper control procedures do not guarantee the prevention of theft.
59. All systems of internal control are identical and, once established, do not need to be changed.
60. Under an effective system of internal control, errors occur only as a result of fraud or dishonesty.
61. It is likely that a company would want to bond its employees who handle cash or inventory.
62. A formal request for a purchase from the requesting department of a business is known as a purchase
order.
63. The purchasing department prepares a purchase requisition addressed to the vendor (seller) containing
instructions related to the items ordered.
64. Another term for an invoice is a check.
65. In addition to keeping the records of a purchase transaction, the accounting department should prepare
and mail checks for payment of invoices.
66. Effective internal control requires a department to purchase supplies through a formal purchasing
process.
67. The treasurer should prepare and sign a check only after a proper check authorization has been
provided.
MULTIPLE CHOICE
1. Which of the following is a measure of liquidity?
a.
Return on equity
b.
Return on assets
c.
Working capital
d.
Profit margin
2. Current assets divided by current liabilities is known as the
a.
profit margin.
b.
current ratio.
c.
working capital.
d.
capital structure.
3. Working capital measures
a.
the excess of current assets over current liabilities—what is on hand to continue business
operations.
b.
the ability to earn a satisfactory income.
c.
the amount of debt in the company.
d.
the profitability of the business.
4. The perpetual inventory system has traditionally been used most commonly by companies that sell
a.
low-priced, high-volume merchandise.
b.
low-priced, low-volume merchandise.
c.
high-priced, low-volume merchandise.
d.
high-priced, high-volume merchandise.
5. A physical inventory is usually taken
a.
at the beginning of the fiscal year.
b.
at the end of the busy season.
c.
at the end of the fiscal year.
d.
when the perpetual inventory system, but not the periodic inventory system, is being used.
6. Under the perpetual inventory system,
a.
continuous records of the quantity and cost of inventory items are kept as they are bought
and sold.
b.
up–to-date information about product availability is more accessible to managers.
c.
the cost of inventory items purchased for resale is recorded in the Merchandise Inventory
account.
d.
all of these are correct.
7. Which of the following activities is not a component of the operating cycle?
a.
Payment of rent
b.
Payment for purchases made on credit
c.
Purchase of merchandise
d.
Collection of cash from credit sales
8. Each of the following companies is a merchandising business except a
a.
candy store.
b.
car wash.
c.
wholesale parts company.
d.
furniture store.
9. Which of the following companies would be most likely to use a computerized perpetual inventory
system?
a.
Antique dealer
b.
Car dealership
c.
Auto parts store
d.
Large appliance retailer
10. A merchandising business will earn an income before income taxes of exactly $0 when
a.
net sales equals cost of goods sold.
b.
operating expenses equal net sales.
c.
gross margin equals operating expenses.
d.
cost of goods sold equals gross margin.
11. On average, it takes Straford Corporation 30 days to sell its inventory and 45 days to collect payment
from customers. Straford normally pays for inventory purchases within 15 days. Its financing period is
a.
15.
b.
30.
c.
60.
d.
90.
12. Use this balance sheet and income statement for the first year of operations for Layton Novelties, Inc.
to answer the following question.
Layton Novelties, Inc.
Balance Sheet
December 31, 2013
Assets
Liabilities
Current assets
Current liabilities
$ 16,000
Investments
Long-term liabilities
4,000
Property, plant, and equipment
Total liabilities
$ 20,000
Intangible assets
Stockholders’ Equity
Common stock
$ 80,000
Retained earnings
20,000
Total stockholders’ equity
$100,000
Total liabilities and
Total assets
stockholders’ equity
$120,000
Layton Novelties, Inc.
Income Statement
For the Year Ended December 31, 2013
Net sales
$ 80,000
Costs of goods sold
32,000
Gross margin
$ 48,000
Operating expenses
12,000
Income before income taxes
$ 36,000
Income taxes
14,400
Net income
$ 21,600
The total amount of working capital of Layton Novelties is
a.
$8,000
b.
$28,000
c.
$12,000
d.
$4,000
13. Use this balance sheet and income statement for the first year of operations for Layton Novelties, Inc.
to answer the following question.
Layton Novelties, Inc.
Balance Sheet
December 31, 2013
Assets
Liabilities
Current assets
Current liabilities
$ 16,000
Investments
Long-term liabilities
4,000
Property, plant, and equipment
Total liabilities
$ 20,000
Intangible assets
Stockholders’ Equity
Common stock
$ 80,000
Retained earnings
20,000
Total stockholders’ equity
$100,000
Total liabilities and
Total assets
stockholders’ equity
$120,000
Layton Novelties, Inc.
Income Statement
For the Year Ended December 31, 2013
Net sales
$ 80,000
Costs of goods sold
32,000
Gross margin
$ 48,000
Operating expenses
12,000
Income before income taxes
$ 36,000
Income taxes
14,400
Net income
$ 21,600
The current ratio for Layton Novelties is
a.
1.75.
b.
.57.
c.
1.4.
d.
2.0.
14. Use this balance sheet and income statement to answer the following question.
Abner Systems, Inc.
Balance Sheet
December 31, 2013
Assets
Liabilities
Current assets
$ 6,000
Current liabilities
$ 4,000
Investments
1,000
Long-term liabilities
1,000
Property, plant, and equipment
8,000
Total liabilities
$ 5,000
Intangible assets
5,000
Stockholders’ Equity
Common stock
$10,000
Retained earnings
5,000
Total stockholders’ equity
$15,000
Total liabilities and
Total assets
$20,000
stockholders’ equity
$20,000
Abner Systems, Inc.
Income Statement
For the Year Ended December 31, 2013
Net sales
$ 24,000
Costs of goods sold
8,000
Gross margin
$ 16,000
Operating expenses
8,000
Income before income taxes
$ 8,000
Income taxes
3,200
Net income
$ 4,800
The total amount of working capital of Abner Systems is
a.
$0.
b.
$6,000.
c.
$2,000.
d.
$10,000.
15. Use this balance sheet and income statement to answer the following question.
Abner Systems, Inc.
Balance Sheet
December 31, 2013
Assets
Liabilities
Current assets
$ 6,000
Current liabilities
$ 4,000
Investments
1,000
Long-term liabilities
1,000
Property, plant, and equipment
8,000
Total liabilities
$ 5,000
Intangible assets
5,000
Stockholders’ Equity
Common stock
$10,000
Retained earnings
5,000
Total stockholders’ equity
$15,000
Total liabilities and
Total assets
$20,000
stockholders’ equity
$20,000
Abner Systems, Inc.
Income Statement
For the Year Ended December 31, 2013
Net sales
$ 24,000
Costs of goods sold
8,000
Gross margin
$ 16,000
Operating expenses
8,000
Income before income taxes
$ 8,000
Income taxes
3,200
Net income
$ 4,800
The current ratio for Abner Systems is (after rounding to two decimal places
a.
.67.
b.
1.25.
c.
1.13.
d.
1.50.
16. Use this information to answer the following question.
J. & B. Auto Parts, Inc.
Balance Sheet
December 31, 2013
Assets
Cash
$ 60,000
Short-term investments
40,000
Notes receivable (due in ten months)
30,000
Accounts receivable
20,000
Merchandise inventory
70,000
Land held for future use
80,000
Land
90,000
Building
$100,000
Less accumulated depreciation
20,000
80,000
Trademark
70,000
Total assets
$540,000
Liabilities
Notes payable (due in six months)
$ 50,000
Accounts payable
20,000
Salaries payable
10,000
Mortgage payable (due in seven years)
90,000
Total liabilities
$170,000
Stockholders’ Equity
Common stock
$310,000
Retained earnings
60,000
Total stockholders’ equity
370,000
Total liabilities and stockholders’ equity
$540,000
The total amount of working capital is
a.
$370,000.
b.
$40,000.
c.
$140,000.
d.
$60,000.
17. Use this information to answer the following question.
J. & B. Auto Parts, Inc.
Balance Sheet
December 31, 2013
Assets
Cash
$ 60,000
Short-term investments
40,000
Notes receivable (due in ten months)
30,000
Accounts receivable
20,000
Merchandise inventory
70,000
Land held for future use
80,000
Land
90,000
Building
$100,000
Less accumulated depreciation
20,000
80,000
Trademark
70,000
Total assets
$540,000
Liabilities
Notes payable (due in six months)
$ 50,000
Accounts payable
20,000
Salaries payable
10,000
Mortgage payable (due in seven years)
90,000
Total liabilities
$170,000
Stockholders’ Equity
Common stock
$310,000
Retained earnings
60,000
Total stockholders’ equity
370,000
Total liabilities and stockholders’ equity
$540,000
The current ratio is
a.
3.18.
b.
2.75.
c.
1.45.
d.
.36
18. Use this information to answer the following question.
Coyne Corporation
Balance Sheet
December 31, 2010
Assets
Cash
$ 70,000
Short-term investments
56,000
Accounts receivable
28,000
Notes receivable (due in one year)
42,000
Merchandise inventory
98,000
Land held for future use
112,000
Land
140,000
Building
$150,000
Less accumulated depreciation
28,000
122,000
Trademark
92,000
Total assets
$760,000
Liabilities
Notes payable (due in one year)
$ 70,000
Accounts payable
30,000
Salaries payable
14,000
Mortgage payable (due in seven years)
146,000
Total liabilities
$260,000
Stockholders’ Equity
Common stock
$300,000
Retained earnings
200,000
500,000
Total liabilities and stockholders’ equity
$760,000
The total amount of working capital is
a.
$70,000.
b.
$180,000.
c.
$124,000.
d.
$500,000.
19. A discount that buyers take for early payment of merchandise is called a
a.
customer discount.
b.
purchases discount.
c.
sales discount.
d.
trade discount.
20. Which of the following does not represent a sale?
a.
Merchandise placed aside for a customer who plans to come in next week and pay with
cash
b.
Purchase of merchandise by a customer who pays cash
c.
Sale of merchandise to a customer who uses a credit card
d.
Purchase of merchandise by a customer who uses a debit card
21. Which of the following goods would not be included in merchandise inventory for a purchasing
company?
a.
Goods in transit shipped FOB shipping point
b.
Goods on hand in the showroom
c.
Goods in transit shipped FOB destination
d.
Goods ordered and received from the supplier
22. A sale on June 21 with terms of n/10 eom is due to be collected by
a.
June 30.
b.
July 31.
c.
July 10.
d.
July 21.
23. Goods totaling $56,000 purchased August 2 on terms of 2/10, n/30 and on which returns of $2,000
were made on August 10 would be subject to which of the following discounts if paid for on August
12?
a.
$1,080
b.
$1,120
c.
$1,160
d.
$40
24. Use this information to answer the following question.
Alfalfa Company experienced the following events during the period:
1.
A tabulation of invoices at the end of the day showed $1,600 in VISA invoices, which
were deposited in a bank account at full value less a 5 percent discount.
2.
Made a sale on an American Express card for $800 and mailed invoice to American
Express for payment. The discount charged by American Express is 4 percent.
The entry to record transaction 1 would include an increase in
a.
Credit Card Expense for $80.
b.
Sales for $1,520.
c.
Cash for $1,600.
d.
Accounts Receivable for $1,520.
25. Use this information to answer the following question.
Alfalfa Company experienced the following events during the period:
1.
A tabulation of invoices at the end of the day showed $1,600 in VISA invoices, which
were deposited in a bank account at full value less a 5 percent discount.
2.
Made a sale on an American Express card for $800 and mailed invoice to American
Express for payment. The discount charged by American Express is 4 percent.
The entry to record transaction 2 would include a(n)
a.
increase in Accounts Receivable for $800.
b.
increase in Sales for $800.
c.
decrease in Credit Card Expense for $32.
d.
decrease in Cash for $768.
26. A retailer accepted Visa charge sales totaling $1,500 and deposited the charge slips in the bank.
Assuming a credit card discount expense of 4 percent, what would be the increase to Cash and the
increase to Sales, respectively?
a.
$1,500 and $1,440
b.
$1,440 and $1,500
c.
$1,440 and $1,440
d.
$1,500 and $1,500
27. The entry to record payment of a $1,500 purchase within the 2 percent discount period would include
a(n)
a.
decrease to Accounts Payable for $1,470.
b.
increase to Purchases Discounts for $30.
c.
increase to Accounts Payable for $1,500.
d.
increase to Cash for $1,500.
28. A purchase on account with an invoice price of $1,500 has been made. The entry to record the
payment after the 2 percent discount period would include a(n)
a.
decrease to Accounts Payable for $1,500.
b.
decrease to Purchases Discounts for $30.
c.
increase to Accounts Payable for $1,470.
d.
decrease to Cash for $1,470.
29. The entry to record a $750 sale with terms of 2/10, n/30 would include a(n)
a.
decrease to Accounts Receivable for $750.
b.
increase to Sales for $750.
c.
increase to Sales Discounts for $15.
d.
decrease to Sales for $735.
30. The collection of a $400 account within the 2 percent discount period would result in a(n)
a.
increase to Accounts Receivable for $392.
b.
decrease to Cash for $392.
c.
increase to Sales Discounts for $8.
d.
decrease to Accounts Receivable for $392.
31. The collection of a $2,000 account beyond the 2 percent discount period would result in a(n)
a.
increase to Cash for $1,960.
b.
decrease to Accounts Receivable for $2,000.
c.
decrease to Cash for $2,000.
d.
increase to Sales Discounts for $40.
32. Under the perpetual inventory system, which of the following accounts would not be used?
a.
Cost of Gods Sold
b.
Sales Returns and Allowances
c.
Accounts Receivable
d.
Purchases
33. Under the perpetual inventory system, in addition to making the entry to record a sale, a company
would
a.
record an increase in inventory corresponding to the amount of the sale.
b.
record a decrease in inventory and an increase in cost of goods sold for the cost of the
merchandise sold.
c.
record an increase in inventory corresponding to the cost of the inventory.
d.
make no additional entry until the end of the period.
34. Merchandise inventory becomes part of cost of goods sold when a company
a.
receives payment from the customer.
b.
pays for the inventory.
c.
purchases the inventory.
d.
sells the inventory.
35. The entry to record a sales return from a customer in the perpetual inventory system would require a(n)