Financial Accounting

Accounting

System that collects and processes (analyzes, measures, and records) financial information about an organization and reports that information to decision makers.

Accounting entity

Is the organization for with financial data are to be collected.

The four basic statements:

1. Balance Sheet

2. Income Statement

3. Statement of Retained Earnings

4. Statement of Cash flows

Balance Sheet

Reports the amount of assets, liabilities and stockholders' equity of an accounting entry at a point in time.

Income Statement

Reports the revenues less the expenses of the accounting period.

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.

Statement of Cash Flows

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

Basic Accounting Equation

Assets = Liabilities + Stockholders' Equity

Assets

Are the economic resources owned by the company. Each of these economic resources is expected to provide future benefits to the firm.

Liabilities

Are the company's debts or obligations. Which will be paid with assets or services.

Stockholders' Equity (Owners' Equity)

Indicates the amount of financing provided by owners of the business and earnings. Is the sum of the contribute capital + the retained earnings.

Accounting Period

Is the time period cover by the financial statements.

Elements of the Income Statement

Revenues, Expenses and Net Income.

Revenues

Earnings from the sale of goods or services to costumers. Revenues are reported whether or not have yet been paid for.

Expenses

Represent the dollar amount of resources the entity used to earn revenue during the period.

Net Income ("the bottom line")

Is the excess of total revenues over total expenses.

Net Loss

If total expenses exceed total revenues.

Retained Earning Equation

Ending Retained Earnings = (Beginning of Retained Earnings + Net Income) - Dividends

The Cash Flow Statement Equation

+/- Cash flow from Operating Activities (CFO)

+/- Cash flow from Investing Activities (CFI)

+/- Cash flow from Financing Activities (CFF)

----------------------------------------

Change in Cash

Cash Flow from Operating Activities, and examples

CFO- Are cash flow that are directly related to earning income. Example, collecting cash from costumers, pay salaries, pay bills, pay to suppliers.

Cash Flow from Investing Activities, and examples

CFI- Are cash flow related to the acquisition or sale of the company's productive assets. Example, the purchase of additional equipment.

Cash Flow from Financing Activities, and examples

CFF- Are cash flow directly related to the financing of the enterprise itself. Example, the payment of money to investors and creditors.

Notes

"Footnotes" provide supplemental information about the financial condition of a company.

GAAP

Generally Accepted Accounting Principles, are the measurement rules used to develop the information in financial statements.

SEC

Security and Exchange Commission, is the U.S government agency that determines the financial statements that public companies must provide to stockholders, and the rules that they must use in producing those statements.

FASB

Financial Accounting Standards Board, is the private sector body given the primary responsibility to work out the detailed rules that become GAAP.

Audit

Is an examination of the financial reports to ensure that they represent claim and comfort with GAAP.

Primary objective of external financial reporting

Is to provide useful economic information to help external parties make financial decisions.

Qualitative Characteristics of Financial Information

Information should be Relevant and Reliable.

Separate-Entity Assumption

States that a business transactions are accounted for separately from the transactions of owners.

Unit-Measure Assumption

States that accounting information should be measure and reported in the national monetary unit.

Continuity Assumption

States that businesses are assumed to continue to operate into the foreseeable future.

Cost Principle

Requires assets to be recorded at historical cost-cash paid plus the current dollar value of all none cash considerations given on the date of the exchange.

Current Assets

Are assets that will be used or turned into cash within one year.

Current Liabilities

Are obligations that will be settle by providing cash, goods, or services within the coming year.

Materiality

Exception suggest that small amounts that not likely to influence a user's decision can be accounted for in the most beneficial manner.

Conservatism

Exception suggest that care should be taken not to over state assets and revenues or understate liabilities and expenses.

Transaction

Is an exchange of assets or services to pay between a business and one or more external parties to a business or a measurable internal event such as the use of assets in operations.

Accounts

Is a standardized format that organizations use to accumulate the dollar effect of transactions on each financial statement item. "Chart of account"

Transaction Analysis

Every transaction affects at least two accounts (dual effect), and the accounting equation MUST remain in balance after each transaction.

The three steps in the transaction analysis process

1. Identify the accounts affected and classify them by type of account.

2. Determine the direction of the effect on each account.

3. Verify that the accounting equation remains in balance.

Direction of Transactions

Debit (dr) is on the LEFT side of an account.

Credit (cr) is on the RIGHT side of an account.

General Journal

Is a bookkeeping system, that records transactions in chronological order.

Journal Entry

Is an accounting method for expressing the effects of a transaction on accounts in debits-equal-credits format.

T-Account

Is a tool for summarizing transaction effects for each account, determining balances, and drawing inferences about a company's activities.

Current Ratio and formula

Helps measure the ability of the company to pay its short-term obligations with short-term assets.

Current Ratio = Current Assets / Current Liabilities

Operating cycle

"Cash-to-cash" is the time it takes for a company to pay cash to suppliers, sell goods and services to costumers, and collect cash from costumers.

Time Period Assumption

Indicates that the long life of a company can be reported in shorter time periods.

Gains

Are increases in assets or decreases in liabilities from peripheral transactions.

Losses

Are decreases is assets or increases in liabilities from peripheral transactions.

Cash Basis Accounting

Records revenues when cash is received and expenses hen cash is paid.

Accrual Basis Accounting

Records revenue when earned and expenses when incurred, regardless of the timing of cash receipts or payments.

Revenue Principle

States that revenues are recognize when:

1. Good or services are delivered.

2. There is persuasive evidence of an arrangement for costumer payment.

3. The price is fixed or determinable.

4. Collection is reasonably assured.

Matching Principle

Requires that expenses be recorded when incurred in earning revenue.

Total Assets Turnover Ratio and formula

Measures the sales generated per dollar of assets.

TATR = Sales Revenue / Average Total Assets

average (beginning balance + ending balance)/2

Order of the financial statements.

Income statement, statement of retained earnings, balance sheet, and statement of cash flows.

Accounting Cycle

Is the process followed by entities to analyze and record transactions, adjust the records at the end of the period, prepare financial statements, and prepare the records for the next cycle.

Trial Balance

Is a list of all accounts with their balances to provide a check on the equality of the debits and credits.

Adjusting Entries

Are entries necessary at the end of the accounting period to measure all revenues and expenses of that period.

Deferred Revenues

"Unearned revenues" are previously recorded liabilities that need to be adjusted at the end of the accounting period to reflect the amount of revenue earned. Example, when cash was received and previously recorded:

Unearned revenue xxx

Revenue xxx

Accrued Revenues

Are previously unrecorded revenues that need to be adjusted at the end of the accounting period to reflect the amount earned and the related receivable account. Example, cash will be received:

Receivable xxx

Revenue xxx

Deferred Expenses

Are previously acquired assets that need to be adjusted at the end of the accounting period to reflect the amount of expenses incurred in using the asset to generate revenue. Example, if cash was paid and previously recorded:

Expense xxx

Prepaid Expense xxx

Accrued Expenses

Are previously unrecorded expenses that need to be adjusted at the end of the accounting period to reflect the amount incurred and the related payable account. Example, if cash will be paid:

Expense xxx

Payable xxx

Contra-Account

Is an account that is an offset to, or reduction of, the primary accout.

Net Book Value

Of an asset is the difference between its acquisition cost and accumulated depreciation, its related contra-account.

Earnings Per Share and formula

Is the ratio that evaluates the operating performance and profitability of a company.

EPS = Net Income / Average number of shares of common stock outstanding during the period

Permanent Accounts

"Real" are the Balance Sheet accounts that carry their anding balances into the next accounting period.

Temporary Accounts

"Nominal" are Income Statement accounts that are closed to Retained earnings at the end of the accounting period.

Closing Entry

Transfers balances in temporary accounts to Retained Earnings and establishes zero balances in temporary accounts.

Post-Closing Trial Balance

Should be prepared as the last step of the accounting cycle to check that debits equal credits and all temporary accounts have been closed.

Order of the steps in the

accounting cycle at the end of the accounting period

Prepare a trial balance, journalize and post

adjustments, prepare financial statements, and

journalize and post the closing entries.

Gross Profit

Net sales revenue minus cost of sales.

FOB Shipping Point (free on board)

When goods are shipped, title changes hands at shipment, and the buyer normally pays for shipping.

FOB Destination

When title changes hand on delivery, and the seller normally pays for shipping.

FOB Shipping Point vs FOB Destination

Revenues from good shipped FOB Shipping Point are normally recognized at shipment. Revenues from goods shipped FOB destination are normally recognized at delivery.

Credit Card Discount

Is the fee charged by the credit card company for its services.

Sales Discount

(Cash discount) is a cash discount offered to encourage prompt payment of an account receivable.

Sales Returns and Allowances

Is a reduction of sales revenues for return of or allowances for unsatisfactory good.

Gross Profit Percentage and formula

Measures a company's ability to charge premium prices and produce goods and services at low cost.

Gross Profit Percentage = Gross Profit / Net sales

Accounts Receivables

Are open accounts owned to the business by trade costumers.

Notes Receivables

Are written promises that require another party to pay the business under specified conditions (amount, time, interest).

Allowance Method

Bases bad debt expenses on an estimate of uncollectible accounts.

Bad Debt Expense

Is the expense associated with estimated uncollectible account receivable.

Bad debt expense xxx

Allowance for doubtful accounts xxx

Allowance for Doubtful Accounts

Is a contra-asset account containing the estimated uncollectible account receivable.

Writing Off Uncollectible Accounts

Writing off of an individual bad debt is recorded through a journal entry.

Allowance for doubtful accounts xxx

Accounts Receivables xxx

Percentage of Credit Sales Method

Bases bad debt expenses on the historical percentage of credit sales that result in bad debts.

Aging of Accounts Receivable Method

Estimates uncollectible accounts based on the age of each account receivable.

Receivables Turnover Ratio and formula

Reflects how many times average trade receivables are recorded and collected during the period.

Receivables Turnover = Net sales / Average net trade account receivables

Cash

Is money or any instrument that banks will accept for deposit and immediate credit to a company's account, such as check, money, or bank draft.

Cash Equivalents

Are short-term investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change.

Internal Controls

Are the process by which a company safeguards its assets.

Bank Statement

Is a monthly report from a bank that shows deposits recorded, checks cleared, other debits and credits and a running bank balance.

Bank Reconciliation

Is the process of verifying the accuracy of both the bank statement and the cash accounts of a business.

Inventory

Is tangible property held for sale in the normal course of business or used in producing goods or services for sale.

Merchandise Inventory

Includes goods held for sale in the ordinary course of business.

Raw Materials Inventory

Includes items acquire for the purpose of processing into finish goods.

Work In Proces Inventory

Includes goods in the process of being manufactured.

Finished Goods Inventory

Includes manufactured good that are complete and ready for sale.

Direct Labor

Refers to the earnings of employees who work directly on the products being manufactured.

Factory Overhead

Are manufacturing costs that are not raw material or direct cost labor. Example, cost of light, supervisor's salary.