Financial Accounting CH 1-4 Key Terms

accounting

an information system designed by an organization to capture (analyze, record, adn summarize) the activities affecting its financial condition and performance and then report the results to decision makers

accounts

a standardized format that organizations use to accumulate the dollar effects of transactions on each financial statement

balance sheet

reports the amount of assets, liabilities, and stockholders’ equity of an accounting entity at a point in time

basic accounting equation

assets = liabilities + stockholders’ equity

financial statements

reports that summarize the financial results of business activities

generally accepted accounting principles (GAAP)

the rules used in the US to calculate and report information in the financial statements

income statement

reports the revenues less the expenses of the accounting period

international financial reporting standards (IFRS)

the rules used internationally to calculate and report information in the financial statements

sarbanes-oxley act (SOX)

a set of laws established to strengthen corporate reporting in the US

separate entity assumption

states that business transactions are separate from and should exclude the personal transactions of the owners

asset

a resource the company controls and expects to benefit from in the future

liability

measurable amount the company expects to give up in the future to settle what it presently owes to stockholders

stockholders’ equity

represents the owners’ claims on assets of the business after creditors’ claims have been fulfilled

common stock

equity paid in by stockholders

retained earnings

equity earned by the company

statement of cash flows

reports inflows and outflows of cash during the accounting period in categories of operating, investing, and financing

operating activities

cash flows that arise from running the business to earn profit

investing activities

cash flow arise directly from buying and selling productive resources with long lives (buildings, land)

financing activities

cash flows include borrowing from banks, repaying bank loans, receiving cash from stockholders for company stock, or paying dividends

statement of retained earnings

reports the way that net income and the distribution of dividends affected the financial position of the company during the accounting period

unit of measure assumption

the financial results of a company’s worldwide business activities should be measured and reported using a single monetary unity, such as the US dollar

financial statements in order

1. income statement

2. statement of retained earnings

3. balance sheet

4. statement of cash flows

debit

left

credit

right

assets have a normal _____ balance

debit

liabilities and stockholders’ equity have normal _____ balances

credit

classified balance sheet

categorizes assets and liabilities as current or noncurrent

current assets

will be used up/turned into cash within 12 months of the balance sheet date

current liabilities

debts/other obligations will be paid/fulfilled within 12 months of the balance sheet date

current ratio

current assets/current liabilities

what does a higher current ratio mean?

better ability to pay (1 or higher)

what is recorded on the balance sheet?

measurable exchanges

cost principle

assets and liabilities are recorded at cost, increases in value are not recorded, decreases in value are recorded

income statement accounts

revenues, expenses, net income

revenues

prices charged to customers when providing goods/services

expenses

costs of operating the business

net income

revenue - expense

time period assumption

assumption that allows the long life of a company to be reported in shorter time periods

cash basis accounting

records revenues when cash is received expenses when cash is paid

accrual basis accounting

recording revenues when generated and expenses when incurred, regardless of timing of cash payments

revenue recognition principle

seller should report revenue when it provides goods/services to customer, in the amount the seller expects to be entitled to receive

“when”

a point in time

“as”

over a period of time

expense recognition principle

under accrual basis accounting, expenses are recognized in the same period as the revenues to which they relate

expenses ___ net income and retained earnings

decrease

revenues _____ net income and retained earnings

increase

unadjusted trial balance

internal report, prepared before end-of-period adjustments, listing unadjusted balances of each account to check the equality of total debits and credits

net profit margin

net income/revenues

what does net profit revenue tell us?

amount earned from each dollar of revenue, a higher ratio = better performance

adjustments

entries necessary at the end of each accounting period to report revenues and expenses in the proper period and assets and liabilities at appropriate amounts

deferral adjustments

decrease balance sheet accounts and increase corresponding income statement accounts; involves one asset and one expense account, or one liability and one revenue account

accrual adjustments

record revenue and expenses when they occur prior to receiving or paying cash and to adjust corresponding balance sheet accounts; involves one asset and one revenue account, or one liability and one expense account

carrying value

the amount at which an asset or liability is reported after deducting any contra accounts

depreciation

the process of allocating costs of buildings, equipment, and other similar long-lived “productive” assets over their productive lives using a systematic and rational method of allocation

depreciation expense

reports cost of equipment use in the current period

contra account (x)

an account to offset, a reduction, of another account

accumulated depreciation

negative asset account, subtracted from equipment account on balance sheet

amortization

using up long-term assets that lack physical substance and have a limited period of usefulness (i.e. software)

permanent account

ending balance from year one becomes beginning balance for following year (i.e. Retained Earnings)

temporary account

only track the current year’s results, closed before next year’s activities are reported

post closing trial balance

checks that debits = credits and that all temporary accounts have been closed