ACC 211 Test #1

hat is accounting?

An information and measurement system that identifies, records, and communicates an organization’s business activities.

What are the three stages of accounting?

Identifying relevant events, recording them in a chronological dollar-based record, and communicating results through reports.

How does bookkeeping differ from accounting?

Bookkeeping is mainly the recording stage. Accounting also includes identifying, analyzing, interpreting, and communicating information.

Why is accounting called the language of business?

It communicates financial information that helps people make decisions.

Who are external users of accounting information?

People outside daily management, such as shareholders, lenders, auditors, regulators, customers, and suppliers.

Who are internal users of accounting information?

Managers and employees who operate the company, including people in purchasing, HR, production, marketing, and executive leadership.

Financial accounting vs. managerial accounting

Financial accounting primarily serves external users. Managerial accounting prepares information for internal decision-makers.

What are financing activities?

Activities used to obtain money, such as borrowing funds or issuing common stock.

What are investing activities?

Buying or selling long-term resources used to operate, such as equipment, land, buildings, and investments.

What are operating activities?

The main activities a business performs to earn revenue, such as selling products or providing services.

Define assets

Resources a company owns or controls that are expected to provide future benefits.

Define liabilities

Debts and obligations owed to creditors, representing creditors’ claims on assets.

Define equity

The owners’ residual claim on assets after liabilities are deducted. Equity equals assets minus liabilities.

What is common stock?

The primary ownership interest in a corporation. Issuing common stock increases assets and equity.

Define revenues

Inflows or increases in assets from selling products or providing services. Revenues increase equity.

Define expenses

Costs of assets consumed or services used to earn revenue. Expenses decrease equity.

Define dividends

Distributions of cash or other assets to shareholders. Dividends decrease equity and are not expenses.

Net income formula

Net income equals revenues minus expenses.

What is a net loss?

The result when total expenses exceed total revenues.

Basic accounting equation

Assets = Liabilities + Equity.

Expanded accounting equation

Assets = Liabilities + Common Stock − Dividends + Revenues − Expenses.

How do revenues, expenses, and dividends affect equity?

Revenues increase equity. Expenses and dividends decrease equity.

What is a receivable?

A promise of a future inflow of resources, usually an amount a customer owes the company.

What is a payable?

A promise or obligation requiring a future outflow of resources.

What does the income statement report?

Revenues, expenses, and net income or loss over a period of time.

What does the statement of retained earnings report?

Changes in retained earnings over a period: beginning retained earnings plus net income minus dividends.

Ending retained earnings formula

Beginning retained earnings + Net income − Dividends = Ending retained earnings.

What does the balance sheet report?

Assets, liabilities, and equity at a specific date.

What does the statement of cash flows report?

Cash receipts and cash payments from operating, investing, and financing activities over a period.

Order of financial statements

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

Why is the income statement prepared before the retained earnings statement?

Net income from the income statement is needed to calculate ending retained earnings.

Why is the retained earnings statement prepared before the balance sheet?

Ending retained earnings is needed in the equity section of the balance sheet.

What is GAAP?

Generally accepted accounting principles, the rules governing U.S. financial accounting.

What organization sets U.S. GAAP?

The Financial Accounting Standards Board, or FASB.

What is the SEC’s role in accounting?

It oversees financial reporting by public companies and gives the FASB authority to set U.S. accounting standards.

What organization issues IFRS?

The International Accounting Standards Board, or IASB.

Relevance

Accounting information is relevant when it can affect a user’s decision.

Faithful representation

Information faithfully represents events when it accurately reflects the economic substance of business activities.

Measurement or cost principle

Record information using actual cost measured on a cash or equal-to-cash basis and supported by objective evidence.

Revenue recognition principle

Recognize revenue when goods or services are provided, at the amount expected to be received.

Expense recognition or matching principle

Record expenses in the same period as the revenues they help generate.

Full disclosure principle

Report information that could affect users’ decisions, often in notes to the financial statements.

Going-concern assumption

Assume the business will continue operating rather than be closed or sold.

Monetary-unit assumption

Express transactions and events in money units.

Time-period assumption

Divide a company’s life into reporting periods such as months, quarters, and years.

Business-entity assumption

Account for the business separately from its owners and other entities.

Cost-benefit constraint

Provide information only when its expected benefit exceeds the cost of providing it.

Materiality constraint

Disclose information when it could influence a user’s decision.

Fraud triangle

Opportunity, pressure or incentive, and rationalization or attitude.

What are internal controls?

Procedures that protect assets, promote reliable accounting, improve efficiency, and support company policies.

Return on assets formula

Return on assets = Net income ÷ Average total assets.

Average total assets formula

Beginning total assets plus ending total assets, divided by two.

How should ROA be evaluated?

Compare it with the company’s prior years and with competitors or industry benchmarks.

What is a source document?

Objective, verifiable evidence describing a transaction, such as an invoice, receipt, check, purchase order, payroll record, or bank statement.

What is an account?

A record of increases and decreases in a specific asset, liability, equity, revenue, or expense.

What is the general ledger?

The complete collection of all accounts and their current balances in an accounting system.

What is a chart of accounts?

A numbered list or index of all accounts in the general ledger.

Common chart-of-accounts numbering

100s assets, 200s liabilities, 300s equity, 400s revenues, and 600s or 700s expenses.

What is a T-account?

A visual account format with debits on the left and credits on the right.

Debit and credit locations

Debit is always the left side. Credit is always the right side.

What is double-entry accounting?

A system in which each transaction affects at least two accounts and total debits equal total credits.

DEAD memory aid

Debits increase Expenses, Assets, and Dividends.

CLER memory aid

Credits increase Liabilities, Equity, and Revenues.

Normal balance of assets

Debit.

Normal balance of liabilities

Credit.

Normal balance of common stock and retained earnings

Credit.

Normal balance of revenues

Credit.

Normal balance of expenses and dividends

Debit.

How is an account balance determined?

Subtract the smaller side from the larger side. More debits produces a debit balance and more credits produces a credit balance.

Define accounts receivable

Amounts customers owe based on oral or implied promises to pay for goods or services delivered on credit.

Define notes receivable

Formal written promises to receive a definite amount on a specified date.

Define accounts payable

Amounts owed to suppliers based on oral or implied promises to pay for purchases made on credit.

Define notes payable

Formal written promises to pay a specific amount, usually plus interest, at a future date.

Why is unearned revenue a liability?

The company received cash before earning it and still owes goods or services to the customer.

Why is a prepaid expense initially an asset?

It represents a future benefit that has been paid for but not yet used.

When do supplies become an expense?

When the supplies are consumed, not when they are purchased.

What is a journal?

A chronological record in which transactions are first recorded as debits and credits.

Standard journal-entry format

List the debited account first at the left, list the credited account second and indented, then add a brief explanation.

What is posting?

Transferring debit and credit information from the journal to individual accounts in the general ledger.

Purpose of the posting-reference column

It cross-references journal entries and ledger accounts so transactions can be traced in both directions.

What is a compound journal entry?

A journal entry affecting three or more accounts.

Entry for owner investment for common stock

Debit Cash and credit Common Stock.

Entry for a cash purchase of equipment

Debit Equipment and credit Cash.

Entry for a purchase of supplies on credit

Debit Supplies and credit Accounts Payable.

Entry for cash service revenue

Debit Cash and credit Service Revenue.

Entry for services provided on credit

Debit Accounts Receivable and credit Service Revenue.

Entry when a customer pays an account receivable

Debit Cash and credit Accounts Receivable.

Entry when the company pays an account payable

Debit Accounts Payable and credit Cash.

Entry when cash is received before services are provided

Debit Cash and credit Unearned Revenue.

Entry when insurance is paid in advance

Debit Prepaid Insurance and credit Cash.

Entry for a cash dividend

Debit Dividends and credit Cash.

What is a trial balance?

A list of all ledger accounts and their balances at a specific point in time used to verify that total debits equal total credits.

Three steps for preparing a trial balance

List every account and balance, total the debit and credit columns, and verify that the totals are equal.

What does a balanced trial balance prove?

Only that total debits equal total credits mathematically.

Errors a balanced trial balance may not detect

Omitted transactions, duplicate entries, wrong accounts with the same normal balance, and equal offsetting errors.

First checks when a trial balance does not balance

Re-add the columns, compare amounts with ledger balances, and check whether balances were placed in the correct debit or credit column.

Debt ratio formula

Debt ratio = Total liabilities ÷ Total assets.

What does the debt ratio measure?

The portion of assets financed by creditors and the company’s financial leverage or debt risk.

How is a higher debt ratio generally interpreted?

As higher financial risk because more assets are financed by debt.

What is the time-period assumption?

The assumption that a company’s activities can be divided into reporting periods such as months, quarters, and years.