Financial Accounting Exam 1

What is accounting?

the language of business- it measures and reports finical data

What are the two types of accounting users

external and internal

External Accounting Users

-finical accounting
-conveying info to external parties (ex. investors)

Internal Accounting Users

-managerial accounting
-conveying info within a single company

What is the order of a financial statement?

1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows

What is on the income statement?

Net income (revenues - expenses)

What is on the statement of retained earnings?

Computes equity for balance sheet
(Beginning balance of retained earnings + Net Income - Dividends)

What is the balance sheet

Overall financial position
(Assets= Liabilities + Equity)

What is GAAP?

Generally Accepted Accounting Principles
-requires info to have relevance and faithful representation (free from bias and no fudging)

FASB

Financial Accounting Standards Board

Who created GAAP?

FASB

Who provides accounting authority?

SEC (Securities and Exchange Commission) which is a US gov agency

Who does GAAP apply to?

US only

Who sets the international standards?

IASB

What is IASB?

International Accounting Standards Board

What is the name for the international standards?

International Financial Reporting Standards (IFRS)

Are GAAP and IFRS the same?

No- they are similar but have slight differences

What are the different types of business entities?

Flow through and separate

Flow through business

all finances, taxes, legal etc. flows from company to owner
-able to come after owners personal bank account

Business types that are flow through

sole proprietor and partnership

Separate Business

Not personally responsible for legal entities

Business types that are separate

corporations and limited liability companies

What is the simple accounting equation?

Assets = Liability + Equity

Assets

what company owns/controls - expected to produce benefits in the future

Liabilities

outside claims on company assets (ex. money from lenders and/or creditors)

Equity

owner claims on company assets

Expanded Accounting Equation

Assets= Liabilities + Contributes Capital + Retained Earnings
Assets= Liabilities + Common Stock - Dividends + Revenues - Expenses
Dividends + Expenses + Assets = Liabilities + Common Stock + Revenues (DEA=LCSR)

How do the 4 parts of the financial statement connect?

Income statement gives you net income which is used in the statement of retained earnings
statement of retained earnings calculates your equity which is used in the balance sheet

Complete transaction analysis:
Chas Taylor invests $30,000 cash into a new company and received common stock

cash debited
common stock credited

Complete transaction analysis:
A company buys $2,500 worth of supplies and pays in cash

supplies debited
cash credited

Complete transaction analysis:
Company pays $1000 in rent and $700 in salaries

Salaries expense debited
Rent expense debited
Cash credited

Complete transaction analysis:
Company purchased $7100 of supplies on credit

supplies debited
accounts payable credited

Complete transaction analysis:
Company provided services and received $4200 cash immediately

cash debited
service revenue credited

Return on Assets

= net income/ average total assets (beginning of year assets + end of year/ 2)
- tells you how well your assets are doing
- want a high %

Accounting Cycle

1. ID Transaction
2. Analyze Transaction using accounting equation
3. Journal entry
4. Post Journal Entry to ledger
5. Prepare and analyze trial balance and financial statements

What is a general ledger?

record of all accounts used by a company

Asset Accounts

-cash
-accounts receivable
-notes receivable
- prepaid accounts
-supplies
-equipment
-buildings
-land

Liability Accounts

-accounts payable
-notes payable
-accrued liabilities
-unearned revenue (ex. customer pays for services before reciving them)

Equity Accounts

-Common stock
-Revenues
-Dividends
-Expenses

T account

used to show the effects of a transactions on specific accounts

How are debits and credits shown within a T-account

Debit on let credit on right

Double Entry accounting

requires every entry to affect at least two accounts and one has to be debited and the other has to be credited

Do individual t accounts have to balance?

No but overall ledger does

Trial Balance

list all ledger accounts (t accounts) and their balance at a point in time

Debt Ratio

= total liabilities/ total assets
- evaluates level of debt risk
-higher number indicates a greater probability that a company will not be able to pay off debts in future

Time Period assumption

a company's financial information can be divided into specific time periods (months, quarters, years)

10Qs

Quarterly reports (required by SEC)

10Ks

Annual reports (required SEC)

Calendar Year

Jan 1 to Dec 31

Fiscal Year

any consecutive 12 month period (ex. July 1 to Jun 30)

Accrual Method

Revenues are recorded when performance obligation is completed and expenses are recorded when incurred (ex. prepaid expense would be recorded at $100/month for 24 months)

Cash Method

Revenues are recorded when cash is received and expenses are recorded when cash is paid
(ex. prepaid expense would be recorded as $2,400 all at once)

Which method are publicly traded companies required to use?

accrual

Revenue Recognition Principle

requires that revenue be recorded when the goods or services are provided to customer and at an amount expected to be received from customers
- simply receiving cash doesn't mean you can recognize it as revenue yet

Expense Recognition Principle

Requires expenses to be recorded in the same accounting period as the revenues that are recognized as a result of those expenses

In its first year of operations, Grace Company reports the following:
Revenue of $60,000 ($52,000 cash received from customers);
Expenses of $35,000 ($31,000 cash paid toward expenses).
Find the net income under both methods.

Accrual: 60,000 minus 35,000 = 25,000
Cash: 52,000 minus 31,000 = $21,000

When do accounts have to be adjusted?

when transactions overlap time periods (ex. began in December but not completed till January)

What are the four types of adjustments?

Deferred Expense, Deferred Revenue, Accrued Expense, Accrued Revenue

Deferred Expense

aka prepaid expense
-assets paid for in advance of receiving their benefits
-ex. prepaid insurance, prepaid rent, and supplies
- once benefit is received, and adjusting entry must be made

Deferred Revenue

aka unearned revenue
-cash received in advance of providing products or services
-once revenue is earned adjusting entry must be made

Accrued Expense

- costs that we have received the benefit of before paying for them
- ex. accrued salaries

Accrued Revenue

- revenues that we earned but have not been paid for yet or providing services but getting paid later

Deferred Revenue Entries

Journal: Cash/ unearned rev
Adjusting: Unearned revenue and revenue

Deferred Expense Entries

Journal: Prepaid expense/ cash
Adjusting: Expense and prepaid expense

Accrued Revenue Entries

Adjusting: Accounts receivable / rev
Journal: Cash/ accounts receivable

Accrued Expense Entries

Adjusting: Expense/ Account payable
Journal: account payable/ cash

What accounts are always involved in an adjusting entry?

expense / revenue

Where does adjusted trial balance fall in the order of financial statement documents?

General Ledger
Trial Balance
ADJUSTED TRIAL BALANCE
Financial Statement

What does the closing process do?

- reset some account balances to zero to ensure they don't blend together throughout different periods
-helps summarize a period's revenues and expenses in the income summary

What is the income summary?

temporary account which equals net income or loss for a period

What types of accounts are temporary?

revenues, expenses, income summary, dividends

What types of accounts are permanent?

assets, common stock, retained earnings, liabilities

The closing process only applies to what type of accounts?

temporary

Steps to closing process

1) Revenue to income summary
2) Expenses to income summary
3) Income summary (rev - exp) to retained earnings
4) Dividends to retained earnings

what is the post-closing trial balance?

list of permanent accounts and their balances after closing entries (total debits must equal total credits)

What is a classified balance sheet?

have specific titles and classifications for accounts for oganization

What are examples of classified balance sheet organization titles?

current assets, non current assets, etc.

what is the difference between current and non current accounts?

when they need to be paid

profit margins

= net income/ net sales
- shows how much of your income is from sales

current ratio

= current assets/ current liabilities
-helps assess the company's ability to pay debts in near future
-want a higher number (< 1 may not be able to cover debt)