Accounting Exam 1

Generally Accepted Accounting Principles (GAAP)

The concepts and rules that govern financial accounting practice, requiring faithful representation and relevance.

Revenue cannot be counted until

1) There is evidence of an agreement

2) The price can be determined

3) The product has been delivered or the services have been completed

4) Collection is reasonably assured

Accounting Equation

Assets = Liabilities + Owners Equity (or Total Equity)

• Assets = Liabilities + Common Stock - Dividends + Revenue - Expenses

Change in Accounting Equation

If one part of the accounting equation changes, the other side must change to keep the equation balanced.

Owner’s Equity

Composed of Contributed Capital (Common Stock) and Retained Earnings (prior year profits).

Calculation of Retained Earnings

Beginning Retained Earnings + Profits - Dividends = Ending Retained Earnings.

Four Financial Statements

Income statement, Balance sheet, Retained earning statement, Cash flow statement.

Sole Proprietorship vs. Corporation

Sole proprietorship = One owner, LLC = One or more owners, C Corporation = No restrictions on ownership type.

Return on Assets Ratio

Calculated as Net Income / Average Total Assets

• Indicates a company's health and how stakeholders interact with it.

• A higher return on assets ratio means the better a company is

Debits and Credits

Debits record incoming money, while credits record outgoing money.

• Debits ↑ Assets, Credits ↓ Assets

• Debits ↓ Liabilities, Credits ↑ Liabilities

• Debits ↓ Equity, Credits ↑ Equity

• Expenses = Debits, Revenues = Credits

T-accounts

Used to visualize debits and credits for different accounts.

Debt to Assets Ratio

Total Liabilities / Total Assets

• Indicates how much of the assets belong to lenders vs owners.

• If the number is large then the company is more likely to fall into debt.

Cash Method of Accounting

Records revenues when collected and expenses when paid; not GAAP approved.

• Ex. Sales $4,500 on credit - NO (money owed but not paid)

• Ex. Collected $2,500 for services to be performed in 2018 - YES

Accrual Method of Accounting

Records revenues when earned and expenses when incurred; GAAP approved.

• Ex. Sales $4,500 on credit - YES

• Ex. Collected $2,500 for services to be performed in 2018 - NO (hasn’t been earned yet)

Current Ratio

Current Assets / Current Liabilities

• Indicates a company's ability to cover short-term obligations.

• “Current Assets” are things that is anticipated to be used in the current year

• “Current Liabilities” are things that will be paid back in the next year

• A large ration means that the company isn’t properly using their money because they could be using it to grow instead of letting it sit

Net Profit Ratio

Net Profit / Sales

• Measures how much profit is made for every dollar of sales.

• A higher ration profit means that the company is managing its costs well and also generating good levels of revenue

Assets Examples

Cash, Equipment, Land, Buildings, Accounts Receivable, Inventory, Prepaid Expenses, Investments, Vehicles, Goodwill.

Liabilities Examples

Notes Payable, Accounts Payable, Loans Payable.

Equity Examples

Common Stock, Retained Earnings

• Temporary Equity: Revenues, Expenses, and Dividends.