Indiana University BUS-A200 Exam 1 latest updated exam with complete solutions

Why is accounting called the language of business?

Accounting tells the financial story of a company

Financial Accounting

External decision makers

Managerial Accounting

Internal decision makers

Role and Expectations of Creditors

decisions related to lending money to the company

What is meant by "claims to resources"?

creditors have claims equal to the amount loaned to the company

Operating Activities

include transactions that relate to the primary operations of the company, such as providing products and services to customers and the associated costs of doing so, like rent, salaries, utilities, taxes, and advertising

Investing Activities

transactions involving the purchase and sale of resources that provide benefit for several years

Financing Activities

transactions with investors and creditors, such as issuing stock

Corporation

a company that is legally separate from its owners, stockholders have limited liability

Sole Proprietorship

A business owned by one person

Partnership

a business owned by two or more persons

Accounting Equation

Assets = Liabilities + Owner's Equity

Assets

total resources of a company

Examples of Assets

cash, accounts receivable, supplies, inventory, equipment, land, prepaid rent

Liabilities

Amounts owed to creditors

Examples of Liabilities

accounts payable, notes payable, salaries payable

Stockholders' Equity

The owners' claim to assets.

example of stockholders equity

common stock and retained earnings

Revenues/Gains

the amounts recognized when the company sells products or provides services to customers

Expenses/Losses

the costs of providing products and services and other business activities during the current period

Net

the difference between two amounts, often describing a company's profitability

Dividends

earnings distributed to stockholders, typically in the form of cash. dividends are not an expense

Financial Statements

1. Income Statement

2. Statement of Stockholders Equity

3. Balance Sheet

4. Statement of Cash Flows

5. Statement of Comprehensive Income (only when necessary)

Income Statement

A financial statement that reports the company's revenues and expenses over an interval of time

Net Income Formula

Revenues- Expenses = Net Income

If expenses exceed revenues, then the company reports a net loss.

Gross Profit

Revenues- Cost of Goods Sold

Statement of Stockholders' Equity

summarizes the changes in stockholders' equity over an interval of time

Stockholders Equity

Common stock + Retained Earnings

Common Stock

External source of equity, invested by stockholders when they purchase shares of stock

Change in Common Stock

beginning common stock + new issuances = ending common stock

Balance Sheet

a financial statement that presents the financial position of the company on a particular date

Statement of Cash Flows

a financial statement that measures activities involving cash receipts and cash payments over an interval of time

Net Change in Cash

change in cash= Operating cash flows + investing cash flows + financing cash flows

Statement of Comprehensive Income

measures changes in equity that arise from non-owner sources (primarily for large or complicated companies)

Capital Markets

a composite of all investors and creditors who provide funds to businesses who need them

Best explanation of Stock Performance

financial accounting net income, the bottom line in the income statement

GAAP

Generally accepted accounting principles, the rules of financial accounting

SEC

Securities and Exchange Commission

FASB

Financial Accounting Standards Board. Independent group of full-time members responsible for setting accounting rules.

IASB

International Accounting Standards Board

IFRS

International Financial Reporting Standards

SOX

Sarbanes-Oxley Act, provides regulation of auditors and the types of services they provide

4 Basic Auditor Reports

1. Unqualified

2. Unqualified with an explanatory or emphasis paragraph

3. Qualified

4. Adverse

Unqualified Report

A "clean" audit report, indicating the auditor's opinion that a client's financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP).

Unqualified with an Explanatory or Emphasis Paragraph

auditor believes the financial statements are in conformity with GAAP, but feels that other important information needs to be emphasized

Qualified Report

limited audit process or if there has been a departure from GAAP

Adverse Report

the auditor has specific knowledge that financial statements or disclosures are seriously misstated or misleading

Annual Reports

at the end of each fiscal year, companies with public securities are required to provide stockholders with an annual report in a Form 10-K

Disclosure Notes

additional insights about company operations, accounting principles, contractual agreements, and pending litigation

Management's Discussion and Analysis

a section of the annual report that provides a discussion and explanation of various items reported in the financial statements. Management uses this section to highlight favorable and unfavorable trends and significant risks facing the company.

Quarterly Reports on Form 10-Q

The SEC form 10-Q is a comprehensive report of a company's performance that must be submitted quarterly by all public companies to the Securities and Exchange Commission.

Current Reports on Form 8-K

An 8-K is a report of unscheduled material events or corporate changes at a company that could be of importance to the shareholders or the Securities and Exchange Commission (SEC).

ESG

Environmental, Social, Governance

Conceptual Framework

"theory of accounting"

Financial Accounting should provide information that is:

1. Useful to investors and creditors in making decisions

2. Helps predict cash flows

3. Tells about economic resources, claims to resources, and changes in resources and claims

Current Assets

those that are expected to provide a benefit within the next year

Long Term Assets

those that are expected to provide a benefit for more than one year

Depreciation

allocating the cost of a long-term asset to an expense over its service life

4 Common Asset Measurements

1. Historical Cost

2. Amortized Cost

3. Net realizable value

4. Fair value

-market value

-present value

Historical Cost

original transaction value

Amoritized Cost

Historical cost of an asset adjusted for the depreciation or amortization accumulated over its lifetime

Net Realizable Value

Estimated selling price of the inventory in the ordinary course of business less any cost of completion, disposal, and transportation

Fair Value

The amount for which the investment could be bought or sold in a current transaction between willing parties

Market Value

the amount for which something can be sold on a given market.

Present Value

the value today of receiving some amount in the future

Current Liabilities

1. Accounts Payable

2. Deferred Revenues

3. Accrued Liabilities

4. Current portion of long-term debt

Contributed Capital

The amount of money paid into a company by its owners. (Often partitioned into common stock and additional paid-in capital)

Retained Earnings

All net income minus all dividends over the life of the company; internal source of equity

Accumulated other comprehensive income (AOCI)

A component of stockholders' equity that reports the accumulated amount of other comprehensive income items in the current and prior periods

Limitations of the Balance Sheet

1. The difference between a company's book value and its market value

2. The potential misuse of estimates and judgements

Book Value

an asset's original cost less accumulated depreciation

Examples of Expenses

1. Cost of Goods Sold (COGS)

2. Cost of services

3. Selling, general, administrative expenses

4. Interest Expense

5. Tax Expense

Operating Income

gross profit less additional expenses related to the operating activities

Non-operating Income

Includes revenues, expenses, gains, and losses related to investing and financing activities

Pretax Income

The sum of operating income and non-operating income

Net Income

Difference between revenues and expenses

Earnings per Share (EPS)

Net income available to common shareholders divided by average shares of common stock outstanding

Limitations of the Income Statement

1. The inclusion of recurring and non-recurring items

2. The inclusion of operating and non-operating items

3. The potential misuse of estimates and judgements

Transactions affecting cash flows fall into 3 categories

1. Operating Activities

2. Investing Activities

3. Financing Activities

Cash flows from financing activities

Cash Inflows- when cash is borrowed from creditors or invested by owners

Cash Outflows- when cash is paid back to creditors or distributed to owners

Comprehensive Income

A broader definition of income that includes all revenues, expenses, gains, and losses; it's all changes in stockholders' equity other than investments by stockholders and distributions to stockholders

Other Comprehensive Income (OCI)

Gains and losses from non-owner transactions that are not reported in the income statement

External Transactions

Transaction the firm conducts with a separated economic entity

Revenue Recognition Principle

Record revenue in the period in which we provide goods and services to customers for the amount the company is entitled to receive

The Accounting Cycle

1. Account for transactions

2. Make adjustments to accounts

3. Prepare financial statements

4. Close temporary accounts

Accrual Basis Accounting

Record revenues when goods and services are provided to customers, and record expenses for the costs used to provide those goods and services to customers

Cash Basis Accounting

Record transactions only at the time cash is received or paid. If cash is not received or paid, no transaction is recorded

Timing Differences

Under both accrural-basis and cash-basis accounting, all revenues are eventually recorded for the same amount

Is Cash- Basis accounting in accordance with the GAAP?

Generally cash-basis accounting is not part of GAAP

Adjustments

Made at the end of the period, used to update balances of revenues and expenses (and changes in their related assets and liabilities) that have occurred during the period but that we have not yet recorded

Deferred Revenues

Arise when a company receives cash in advance from customers, but goods and services won't be provided until a later period

Accrued Expense

Occur when a company has used costs in the current period, but the company hasn't yet paid cash for those costs

Accrued Revenues

Occur when a company provides products or services but hasn't yet received cash

Cases where Adjustments are Unnecessary:

1. transactions that do not involve the recognition of revenues or expenses

2. transactions that result in revenues or expenses being recorded at the same time as the cash flow

The income statement reports revenues and expenses...

over an interval of time

Classified Balance Sheet

Groups a company's liability accounts into current and long-term categories

vertical analysis

Expresses each item in a financial statement as a percentage of the same base amount. (For an income statement its a percentage of sales)

Capital Structure

the mixture of liabilities and stockholders' equity in a business

Horizontal Analysis (Trend Analysis)

Analyzes trends in financial statement data for a single company over time

% Increase (Decrease)=

(Current Year Amount-Prior Year Amount)/Prior Year Amount