Accounting Chapters 1-4

Accounting is the language of business. True or False?

True

Accounting is the system of maintaining records of a company’s operations and communicating that information to decision-makers.

decision makers

Investors decide whether to

invest in stock

credits decide whether to

lend money

customers decide whether to

purchase products

suppliers decide

customers ability to pay for supplies

managers decide

production and expansion

employees decide

employment opportunities

competitors decide

market share and profitability

regulators decide on

social welfare

tax authorities decide on

taxation policies

local communities decide on

environmental issues

investors and creditors make decisions about

companies

company activities are measured by

accountants

accountants communicate information to

investors and creditors

accounting information that is provided for internal users (managers) is referred to as

managerial accounting

accounting information that is provided for external users is referred to as

financial accounting

What is stock?

Stock refers to a type of security that represents ownership in a company. When you own stock in a company, you become a shareholder and have a claim on the company's assets and earnings.

The two primary functions of financial accounting are to

measure business activities of a company and communicate information about those activities to investors and creditors and other outside users for decision-making purposes

financing activities include

transactions the companies have with investors and credits, such as issuing stock and borrowing money

investing activities include

transactions involving the purchase and sale of resources that are expected to benefit the company for several years such as equipment

operating activities will include

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

a corporation is a company that is

legally separated from its owners

sole proprietorship is a business owned

by one person

a partnership is a business owned by

two or more persons

double taxation

refers to a situation where the same income or assets are taxed twice by two different taxing authorities

assets are

the total resources of a company

liabilities are

amounts owed to creditors

stockholder’s equity represents

owner’s claims to resources

accounting equation

assets (resources) = liabilities (creditor’s claims) + stockholder’s equity (owner’s claims)

revenue

amount recognized when a company sells products or services

expenses

costs of providing products and services

net income

the difference between revenues and profits

when the difference in revenue and expenses leads to a negative amount

net loss

cash payments to stockholders are referred to as

dividends

dividends are not an expense. True or False?

True

income statement

the financial statement that reports the company’s revenues and expenses over an interval of time.

statement of stockholder’s equity

is a financial statement that summarizes the changes in stockholder’s equity over an interval of time.

stockholder’s equity arises from two primary sources

common stock and retained earnings

stockholder’s equity =

common stock + retained earnings

common stock (external source of equity) represents

amounts invested by stockholders when they purchase shares of stock

retained earnings represent

all net income minus dividends over the life of the company

balance sheet

the financial statement that represents the financial position of the company on a particular date. Assets = Liabilities + Stockholder’s Equity.

statement of cash flows

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

operating cash flows include

cash receipts and cash payments for transactions involving revenue and expense activities during the period

investing cash flows include

cash transaction for the purchase and sale of investments and long term assets

financing cash flows

include cash transactions with lenders, such as borrowing money and repaying debt, and with stockholders, such as issuing stock and paying dividends.

an account provides a

record of the business activities to a particular item

chart of accounts

list of all account names used to record transactions of a company

Which of the following is **not** an advantage of the corporate form of business organization?

\
\n a. No personal liability

b. Favorable tax treatment

c.Easy to raise funds

d. Easy to transfer ownership

Favorable Tax Treatment

\
Corporations do not receive favorable tax treatment. They pay tax on corporate income and then any dividends distributed to owners are taxed again on the owners' individual tax returns.

Name 3 characteristics of a corporation

Easier to transfer ownership and raise funds, with no personal liability

If a company pays dividends of $10,000, what happens

Both retained earnings and stockholders' equity will be reduced by $10,000.

Howard Company had a transaction that caused a $5,000 increase in both total assets and total liabilities. This transaction could have been a(n)

Purchase of office equipment for $12,000, paying $7,000 cash and issuing a note payable for the balance.

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Here’s the entry:

 Office Equipment              12,000

            Cash                                  7,000

            Note Payable                     5,000

Total assets increase by $5,000 ($12,000 - $7,000) and total liabilities also increase by $5,000 (the credit to the note payable account).

JayHawk Company began the year with $126,000 in its Common Stock account and a **debit** balance in Retained Earnings of $54,000. During the year, the company earned net income of $69,000 and declared and paid $9,000 of dividends. In addition, the company sold additional common stock amounting to $33,000. Based on this information, what should be the ending total of all stockholders' equity accounts?

$165,000

\
$126,000 - $54,000 + $69,000 - $9,000 + $33,000 = $165,000

Subtract the $54,000 RE balance because it is a debit (i.e., negative) balance

You can also see this by looking at the two accounts separately:

Common Stock : $126,000 beginning balance + $33,000 issued = $159,000

Retained Earnings: $(54,000) beginning balance + $69,000 net income - $9,000 dividends = $6,000

$159,000 CS + $6,000 RE = $165,000 SE

The normal balance of any account is the

The side which increases the account balance

Which pair of accounts follows the rules of debit and credit in relation to increases and decreases in the same manner?

Dividends and Rent Expense

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Dividends and Expenses behave the same way. Debits increase balances and credits decrease balances.

Under __accrual accounting__, the revenue recognition principle dictates that revenue should be recognized in the accounting records:

When the performance obligation is satisfied.

Adjusting entries are:

Typically required before financial statements are prepared.

WP Company had the following transactions during 2020:

Sales of $15,000 on account

Collected $5,000 for services to be performed in 2021

Paid $2,500 cash in salaries for 2020

Purchased airline tickets for $1,000 in December for a trip to take place in 2021

What is WP’s 2020 net income using __**accrual accounting**__?

$15,000 revenue - $2,500 expense = $12,500 net income

WP Company had the following transactions during 2020:

Sales of $15,000 on account

Collected $5,000 for services to be performed in 2021

Paid $2,500 cash in salaries for 2020

Purchased airline tickets for $1,000 in December for a trip to take place in 2021

What is WP’s 2020 net income using __**cash basis accounting**__?

$5,000 cash received - $2,500 - $1,000 cash spent = $1,500 net income

An architecture firm earned $2,000 for architecture services provided with the fee to be paid in the future. No entry was made at the time the service was provided. If the fee has not been paid by the end of the accounting period and no adjusting entry is made, this would cause:

Assets to be understated.

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We’ve earned this $2,000 so it should appear on the current year’s income statement. Since we have not been paid we should recognize accounts receivable for this balance. If we do not then assets will be $2,000 too small (understated).

The adjusting entry would be:

 Accounts Receivable         2,000

Service Revenue                2,000

Which of the following accounts will reflect the account’s beginning balance on the adjusted trial balance?

Retained Earnings

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The adjusted trial balance includes balances for revenues, expenses, and dividends (if any). Until these accounts are **closed**, the retained earnings balance has not been updated for the current accounting period.

Closing entries:

Cause the revenue and expense accounts to have zero balances.

Equipment costing $20,000 is purchased by paying $5,000 cash and signing a note for the balance owed. The journal entry should include a

Credit to Notes Payable for $15,000

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Equipment                                              20,000

Cash                                                                      5,000

Notes Payable                                                      15,000

Using __accrual accounting__, expenses are recorded and reported only:

When they are incurred whether or not cash is paid

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The cash payment does not need to coincide with the expense being incurred. If incurred it should be recognized.

A chart of accounts for a business firm

Lists the accounts in the general ledger

Consider the following transactions:

\
Issued common stock for cash.

Purchased equipment by signing a note payable.

Paid rent for the current month.

Collected cash from customers on account.

Paid the balance due on an accounts payable.

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How many of these five transactions increased the given company’s total assets?

Two

The first two above involve increases to assets and increases to stockholders’ equity and liabilities, respectively—so total assets increase. The third and fifth transactions involve a decrease in cash (asset). The fourth transaction involves an increase and a decrease in assets (cash increases but A/R decreases) so total assets are unchanged.

Consider the following eight accounts:

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Accounts Payable               Insurance Expense

Prepaid Rent                      Common Stock

Salaries Payable                 Dividends

Supplies                             Deferred Revenue

\
How many of these accounts have a normal credit balance?

Four

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Liabilities, Stockholders’ Equity, and Revenue accounts have normal credit balances. Here, A/P,  Salaries Payable, and Deferred Revenue are liabilities and Common Stock is an SE account. Assets, Expenses, and Dividends have normal debit balances. Recall DEALOR

James & Younger Corporation purchased a one-year insurance policy on March 1, 2020, for $42,000 and recorded it as a Prepaid Insurance. The insurance policy is in effect from March 2020 through February 2021. If the company neglects to make the proper year-end adjusting entry on December 31, 2020:

The required adjusting entry is:

 Insurance Expense                                    35,000

 Prepaid Insurance                                         35,000

\
This represents 10 months (March – December) of insurance. Failure to make this entry would cause assets (Prepaid Insurance) and net income to be overstated by $35,000. Net income is overstated because we have not recognized the $35,000 of expense.

\
Net income and assets will be overstated by $35,000

Issuing shares of stock in exchange for cash is an example of a(n)

Financing activity

Lankston Company began the year by issuing $120,000 of common stock for cash. The company recorded revenues of $1,160,000, expenses of $960,000, and paid dividends of $60,000. What was Lankston’s **net income** for the year?

$1,160,000 revenues = $960,000 expenses = $200,000 net income

Recall that dividends are not expenses

On July 1 the Fisher Shoe Store paid $24,000 to Acme Realty for 6 months rent beginning July 1. Prepaid Rent was debited for the full amount. If financial statements are prepared on July 31, the adjusting entry to be made by the Fisher Shoe Store is:

Debit Rent Expense, $4,000; credit Prepaid Rent, $4,000

The Harris Company purchased equipment for $15,000 on December 1. It is estimated that the equipment will last five years and have a salvage value of $-0- at the end of the five years. If financial statements are to be prepared on December 31, the company should make the following adjusting entry:

Annual depreciation expense = ($15,000 - $-0-)/5 years = $3,000/year

If annual depreciation expense = $3,000 then one month = $3,000/12 = $250.

Debit Depreciation Expense, $250; credit Accumulated Depreciation, $250.

If total liabilities decreased by $4,000, then

assets must have decreased by $4,000, or stockholders’ equity must have increased by $4,000.

\
To preserve the balance in the fundamental equation either assets must decrease by $4,000 or stockholders' equity must increase by $4,000

Clemson Company purchased equipment for $2,400 cash. As a result of this event,

Total assets remained unchanged.

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One asset account, equipment, increased by $2,400 and a second asset account, cash, decreased by $2,400 so no net change in assets

The double-entry system requires that each transaction must be recorded

In at least two different accounts.

On March 1, 2022, Freeze Company hires a new employee who will start to work on March 6. The employee will be paid on the last day of each month. Should a journal entry be made on March 1? Why or why not?

No, hiring an employee is an important event; however, it is not an economic event that should be recorded.

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No entry is required on March 1. No changes in any account balances have occurred on the date of the hire.

Brokaw Industries borrows $40,000 and signs a 6%, 6-month note payable on **September 1, 2021**. How much interest expense will Brokaw report in its **2022** financial statements?

Brokaw will recognize two months of interest expense in 2022 (for January and February). \n $40,000 x .06 x 2/12 = $400 \n We use 2/12 since it is for two months and 6% is an annual interest rate

Breeze Company purchased office supplies costing $7,000 and debited Supplies for the full amount. At the end of the accounting period, a physical count of office supplies revealed $2,500 still on hand. The appropriate adjusting journal entry to be made at the end of the period would be:

Debit Supplies Expense, $4,500; credit Supplies, $4,500.

Separation of duties refers to:

\
Individuals who have physical responsibility for assets should not also have access to accounting records.

The Sarbanes-Oxley Act (SOX) mandates which of the following?

a. Increased regulations related to auditor-client relations

b. Increased regulations related to internal control

c. Increased regulations related to corporate executive accountability

d. All of the other answers represent mandates of the Sarbanes-Oxley Act

All of the other answers represent mandates of the Sarbanes-Oxley Act

Which of the following items would cause the balance of cash in the bank statement to *not* equal the balance of cash in the accounting records?

a.Interest earned on the bank balance that the company has not recorded

b. Checks are written by the company that has not cleared the bank

c. Cash receipts by the company that have not been deposited in the bank.

d. A customer's check is returned to our bank stamped "NSF"

e. All of the other answers would cause the two cash balances to differ

All of the other answers would cause the two cash balances to differ

The balance in NoleCo’s Cash GL account on August 31 was $19,700, before the bank reconciliation was prepared. After examining the August bank statement and items included with it, the company's accountant found:                         

Checks outstanding                                                      $4,300           

NSF check                                                                          140           

Note collected by bank for NoleCo                                1,200           

Deposits in transit                                                            1,800           

Bank service fees                                                                 60           

What is the amount of cash that should be reported in the balance sheet as of August 31?

$19,700 +$1,200 note collected - $140 NSF check - $60 service fees = $20,700

The balance shown in the August bank statement of WP, Inc. was $22,300. After examining the August bank statement and items included with it, the company's accountant found:                         

Checks outstanding                                                      $4,300           

NSF check                                                                           140           

Note collected by the bank for the Colt Company       1,200           

Deposits in transit                                                            1,800           

Bank service fees                                                                 60           

What is the amount of cash that should be reported in the balance sheet as of August 31?

$22,300 + $1,800 deposit in transit - $4,300 checks outstanding = $19,800

Cash equivalents refer to:

Short-term investments that have a maturity date no longer than three months from the current date

Which financial statement should be prepared first?

Income Statement

Which one of the following financial statements is prepared **as of** a particular date as opposed to providing information covering a specific time period (e.g., one month)?

Balance Sheet

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The balance sheet provides information about the financial position of a company as of a particular date (for example, December 31). The other financial statements provide information about a particular time period (for example, the month of December).

What are the 3 components of relevance?

Confirmatory value, predictive value and materiality

What does the acronym GAAP stand for?

GAAP stands for generally accepted accounting principles

The overriding objective of financial reporting is to provide information that is:

Useful in decision-making.

Transactions related to revenues and expenses is which business activity?

Operating

Transactions with lenders and owners is which business activity?

Financing

Transactions involving the purchase and sale of productive assets is which business activity?

Investing

Which financial statement can you find revenue from sales to customers during the year.

Income statement

Which financial statement can you find the total amounts owed to workers at the end of the year.

Balance sheet

Which financial statement can you find the change in retained earnings due to net income and dividends?

Statement of stockholders' equity

Which financial statement can you find Amount of cash received from borrowing money from a local bank.

Statement of cash flows

This financial statement summarizes the changes in stockholder’s equity over a period of time.

Statement of stockholders' equity

This financial statement presents the financial position of the company on a particular date (point in time)

Balance Sheet

This financial statement summarizes cash receipts (inflows) and disbursements (outflows) over a period of time

Statement of cash flows