Accounting 284 Exam 1 Iowa State

ACCT 284, ACCT 2840, iowa state university, exam 1

Accounting

A system that collects and processes financial information about an organization and reports that information to decision makers.

External Decision makers

Deal with financial accounting system (focus of Accounting 284)

Balance Sheet (BS), Statement of Retained Earnings (SRE), Statement of Cash Flows (SCF), and the Income Statement (IS)

4 Things provided by a financial accounting system

Balance Sheet

Reports the financial position of an accounting entity AT A POINT IN TIME. Also called the "statement of financial position". Reports assets, liabilities, and stockholders' equity.

Assets=Liabilities+Stockholders' Equity

Balance Sheet Equation

Statement of Retained Earnings

Reports how net income and the distribution of dividends affected the financial position of the company FOR THIS ACCOUNTING PERIOD.

Beginning RE + Net Income - Dividends = Ending RE

Retained Earnings Equation

Income Statement

Reports revenues less expenses for the accounting period. Shows net income (aka net profit, net earnings, the bottom line). Also called "statement of income", "statement of earnings", and "statement of operations".

Revenue - Expenses = Net Income

Income Statement Equation

Statement of Cash Flows

Reports inflows and outflows of cash DURING THE ACCOUNTING PERIOD. Provides information about cash flows not provided by ACCRUAL-BASED net income. Reports cash flows from operating, investing and financing activities.

Cash flows from operating activities + Cash flows from investing activities + Cash flows from financing activities = Change in cash

Statement of Cash Flows Equation

Income statement equation and retained earnings equation.

Net income is in what two equations?

Retained earnings equation and balance sheet equation (goes into stockholders equity along with contributed capital.

Ending RE goes into what two equations?

Contributed Capital and Retained Earnings.

Two factors that go into stockholders equity.

1. Describe accounting rules used

2. Provides detail of specific items on the financial statements.

3. Disclose information not shown on the financial Statements.

Three types of financial statements

GAAP (Generally Accepted Accounting Principles)

The measurement rules used to develop the information in the financial statements. Consists of SEC, FASB, PCAOB.

SEC

The federal agency with the power to determine the rules.

FASB

The private body that actually writes the rules. (Body that currently writes U.S. accounting rules)

PCAOB

The body that approves the rules

Relevant, faithful representation, comparable, verifiable, timely, understandable.

Qualitative Characteristics of Accounting Information

Management

Who is primarily responsible for the information contained in the financial statements.

Sole proprietorship, partnership, corporation

3 types of business entities

Ability to raise capital, ease of ownership transfer, and limited liability of stockholder.

Advantages of incorporation

Double taxation of earnings

Disadvantage of incorporation

Assets

Resources presently owned by a business that generate future economic benefits.

Liabilities

Amounts presently owed by a business.

Stokeholders' Equity

Financing provided by owners (contributed capital) and operations (retained earnings)

Financing Activities

Borrowing money (loans) and issuing stock.

Investing Activities

Purchasing PP&E, Purchasing the securities of another company.

Cost Principle

Assets are recorded at the cash-equivalent cost on the transaction date.

Conservatism in the Cost Principle Practice

We use the LEAST optimistic measures when uncertainty exists about the value of an asset or liability (i.e., never overstate an asset or understate a liability). Some assets are not recorded.

Cost does not represent market or current value.

Very important part of Cost Principle practice

Current Assets, investments, property, plant and equipment, intangible assets, deferred charges.

Things that go into assets (5).

Current liabilities and long term liabilities

Things that go into liabilities (2)

Common stock, capital paid in excess of par, retained earnings, and accumulated other comprehensive income.

Things that go into stockholders' equity

Chart of Accounts

A list of all account names and corresponding account numbers used in an accounting system.

Transaction

An event that is recorded as part of the accounting process

An exchange with an external party, a measurable internal event (e.g., adjustments)

Two main types of events in accounting (Related to to transactions)

BLANK 1: events

BLANK 2: transactions

Not all BLANK 1 are BLANK 2, but all BLANK 2 are results of past BLANK 1

Transaction analysis

Determining the economic effect of a transaction on the accounting equation.

1. Every transaction affects AT LEAST 2 accounts.

2. The accounting equation MUST remain in balance after transaction.

Two rules of transaction analysis

1. Identify accounts affected.

2. Determine the effect on each account.

3. Determine that the accounting equation remains in balance.

3 Steps in transactions analysis

Left

Debit goes on what side of a T-account?

Right

Credit goes on what side of a T-account?

Summarize transaction effects for each account, determine account balances, draw inferences about a company's activities.

What are T-Accounts used for?

+,-

Types of Account Charts: Assets

-,+

Types of Account Charts: Liabilities

-,+

Types of Account Charts: Equity

-,+

Types of Account Charts: Revenues

-,+

Types of Account Charts: Expenses

+,-

Types of Account Charts: Dividends

Journal Entry

An accounting method for expressing the effects of a transaction on accounts in a debit-equal-credits format.

Recorded in a journal in chronological order, debits are written first, credits are indented below debits, total debits equal total credits (Dr=Cr)

Characteristics of a journal entry

1. Analyze events

2. Make journal entries

3. post to the ledger

4. Prepare a trial balance

5. Make adjustments

6. Prepare financial statements

7. Make closing entries

The accounting cycle (7)

Current Assets / Current Liabilities

Current Ratio Equation for assets and liabilities

Ratio Analysis Assets and Liabilities

Assesses whether current assets are sufficient to pay current liabilities and the high ratio means better able to pay.

Buy goods and services > Pay cash to suppliers > sell goods and services > collect cash from customers > back to beginning of the cycle, etc.

The Operating Cycle (4) (Continuous) (No specific order?)

Cash Basis Accounting

Revenues are recognized when cash is collected and expenses are recognized when cash is paid.

Accrual Basis Accounting

Revenues are recognized WHEN EARNED and expenses are recognized WHEN INCURRED.

Accrual Basis

Required by GAAP for external reporting.

Revenues

Amounts earned by selling goods or services to customers

Expenses

Costs of business necessary to earn revenues

Operating

Revenues and expenses result primarily from BLANK activities

Time Period Assumption

The long life of a company can be reporter in shorter time periods.

1. Sales Revenue

2. Service Revenue

3. Rental Revenue

4. Interest Revenue

5. Dividend Revenue

6. Fees earned

Revenue account names (6)

1. Cost of goods sold

2. Repairs and maintenance expense

3. Advertising expense

4. Depreciation and amortization expense

5. Insurance expense

6. Salaries and wages expense

7. Rent Expense

8. Supplies Expense

9. Transportation Expense

10. Utilities Expense

11. Interest Expense

12. Income Tax Expense

Expense Account Names (12)

Revenue, Matching

Income statement principles

Revenues are recognized when they are earned, usually at the point of sale.

Revenue part of income statement principle

Requires that expenses be matched into the period in which the related revenue is recognized.

Matching part of income statement principle

Unadjusted Trial Balance

Looks at where all the accounts stand at the end of the period as a result of recording the external transactions.

The balance on each account and whether or not the accounts are in balance (do total debits equal total credits?)

Unadjusted trial balance tells us...

1. Does NOT indicate the amount of cash the company is generating.

2. Does not directly measure the change in the value of a company.

3. Uses estimates to measure income.

Income statement limitations

During the accounting period

Accounting Cycle Steps: Analyzing transactions, making journal entries, and posting to accounts occur when?

At the end of the accounting period

Accounting Cycle Steps: Preparing a trial balance, making adjustments, preparing financial statements, and making closing entries occur when?

Ratio Analysis Income and Revenue

Assesses how much profit comes from each dollar of sales and a higher ratio indicates higher profitability.

Net Income / Net Revenues

Net Profit Margin (Ratio equation for income and revenues)

Adjusting entries make the accounting records reflect the actual situation and they are necessary if cash changes hands at a different time than revenues are earned or expenses incurred.

Why do we need adjusting entries?

Deferral

Cash comes BEFORE the recognition of revenue or expenses.

Accrual

Cash comes AFTER the recognition of revenue or expense.

Deferred Expense (Asset & Expense)

When an asset is purchased and paid for that will last multiple periods.

Deferred Expense example

Paying $2,400 for an insurance policy on October 1, 2012 that will last 12 months is an example of what?

Deferred Revenue example

On October 31, a tenant paying us 6 months rent for November 1, through April 30, at the rate of $500 per month is an example of what?

Deferred Revenue (Liability & Revenue)

When we receive cash in advance of earning revenue.

Accrued Expense (Expense & Liability)

When an expense is incurred before it is paid.

Accrued Revenue (Asset & Revenue)

When revenue is earned before cash is received.

Accrued Expense example

Weekly payroll for a 5 day week is $10,000. A situation where the year ends on Wednesday and employees are paid on friday is an example of what?

Accrued Revenue example

Us depositing $100,00 in a C.D. on December 1, 2012 that earns 6% interest is paid quarterly is an example of what?

1. Adjustments NEVER involve cash.

2. Adjustments ALWAYS affect both the balance sheet and the income statement.

2 general rules for adjustment

Prepaid Expense (asset) -

Expense +

Adjusting entries - deferred expense

Unearned revenue (liability) -

Revenue +

Adjusting entries - deferred revenue

Expense +

Payable (liability) +

Adjusting entries - accrued expense

Receivable (asset) +

Revenue +

Adjusting entries - accrued revenue

Contra-Account

An account that is an offset to, or deduction from, the primary account.

Book Value (Net Book Value, Carrying Value)

The difference between an asset's acquisition cost and its contra-account.

Depreciation

Example of Book Value (Net Book Value, Carrying Value)

Depreciation - an adjusting entry

A deferred expense. Capitalize the fixed asset purchased (buildings, equipment, vehicles, computers, officer furniture, etc.). Apply the matching principle, record a portion of the asset's cost as depreciation expense each accounting period.

Accumulated Depreciation

Depreciation - New account

adjusted trial balance

After adjustments have been prepared and recorded, we prepare the BLANK

1. Income Statement

2.Statement of Retained Earnings

3. Balance Sheet

4. Statement of Cash Flows (uses B/S and I/S)

After the adjusted trial balance, we prepare the next items in the financial statements. Which are...

Permanent, so we don't close them

Balance Sheet accounts are what accounts?