Fin Acc and Reporting Exam 1

Financial accounting

Accounting focused on producing general-purpose financial statements for external users (investors, creditors, regulators) to make resource-allocation decisions; backward-looking and standardized under GAAP.

Managerial accounting

Internal accounting for management decision-making; forward-looking and not governed by GAAP.

Cash basis accounting

Revenue and expenses are recorded only when cash is received or paid; not GAAP-compliant.

Accrual basis accounting

Revenue is recorded when earned and expenses when incurred, regardless of when cash changes hands; required under GAAP.

GAAP

Generally Accepted Accounting Principles; the rules and conventions that define accepted accounting practice in the U.S., primarily set by the FASB.

FASB

Financial Accounting Standards Board; the primary body responsible for setting U.S. GAAP through the Accounting Standards Codification.

SEC's role in standard-setting

Has legal authority over public company reporting but has largely delegated standard-setting to the FASB.

Why standard-setting is political

Accounting standards affect real economic outcomes (stock prices, compensation, loan covenants), so companies, auditors, and regulators lobby the FASB during its due process to influence outcomes.

Factors encouraging high-quality financial reporting

SEC oversight, independent audits, internal controls (e.g., SOX), codes of professional conduct, and legal/civil liability exposure.

Conceptual framework (purpose)

Provides a coherent, consistent foundation for developing accounting standards; not GAAP itself, but the theoretical structure standards are built from.

Objective of financial reporting

To provide financial information about the entity that is useful to existing and potential investors, lenders, and creditors in making resource decisions.

Relevance

A fundamental qualitative characteristic: information has predictive value, confirmatory value, or both, and is material.

Faithful representation

A fundamental qualitative characteristic: information is complete, neutral, and free from error.

Comparability, Verifiability, Timeliness, Understandability

The four enhancing qualitative characteristics of useful financial information.

Elements of financial statements

Assets, Liabilities, Equity, Investments by owners, Distributions to owners, Comprehensive income, Revenues, Expenses, Gains, Losses.

Economic entity assumption

The business is accounted for separately from its owners and from other entities.

Going concern assumption

The business is assumed to continue operating indefinitely; justifies historical cost and depreciating assets over time.

Periodicity assumption

The life of a company can be divided into artificial time periods (months, quarters, years) for reporting purposes.

Monetary unit assumption

Transactions are measured and reported in a stable, nominal currency unit.

Recognition (concept)

The process of formally recording an item into the financial statements.

Measurement (concept)

The process of associating a monetary amount with an item; historical cost is the primary GAAP basis, though fair value is used in specific cases.

Disclosure (concept)

Information in the notes to the financial statements that isn't captured by the numbers alone but is necessary for a complete picture.

Transaction

Any economic event that changes a company's financial position and can be reliably measured; affects at least two accounts under double-entry accounting.

Accounting equation

Assets = Liabilities + Stockholders' Equity; must stay in balance after every transaction.

Debit/credit rule: Assets

Increase with a debit, decrease with a credit; normal balance is a debit.

Debit/credit rule: Liabilities

Increase with a credit, decrease with a debit; normal balance is a credit.

Debit/credit rule: Equity

Increase with a credit, decrease with a debit; normal balance is a credit.

Debit/credit rule: Revenue

Increase with a credit, decrease with a debit; normal balance is a credit.

Debit/credit rule: Expenses

Increase with a debit, decrease with a credit; normal balance is a debit.

Debit/credit rule: Dividends

Increase with a debit, decrease with a credit; normal balance is a debit.

Accounting processing cycle (steps in order)

Analyze transactions, record in the general journal, post to the general ledger, prepare unadjusted trial balance, record adjusting entries, prepare adjusted trial balance, prepare financial statements, record closing entries, prepare post-closing trial balance.

General journal

The chronological record where transactions are first recorded as journal entries.

General ledger

The collection of accounts (T-accounts) that journal entries are posted to, organized by account.

Posting

The process of transferring debit and credit amounts from journal entries into the corresponding ledger accounts.

Unadjusted trial balance

A list of all accounts and their balances before adjustments; confirms total debits equal total credits but does not guarantee accuracy.

Adjusting entries (why needed)

Because cash hasn't yet moved but revenue/expense has already been earned/incurred, or vice versa; required to accurately match revenues and expenses to the period.

Prepaid expense (adjusting entry type)

Cash paid before the expense is incurred (e.g., prepaid insurance); adjustment debits the expense and credits the prepaid asset.

Unearned revenue (adjusting entry type)

Cash received before revenue is earned (e.g., deferred subscription revenue); adjustment debits unearned revenue and credits revenue.

Accrued expense (adjusting entry type)

Expense incurred before cash is paid (e.g., accrued salaries); adjustment debits the expense and credits a payable.

Accrued revenue (adjusting entry type)

Revenue earned before cash is received (e.g., accrued interest receivable); adjustment debits a receivable and credits revenue.

Depreciation adjusting entry

Debit Depreciation Expense, credit Accumulated Depreciation (a contra-asset account); never credited directly to the asset account.

Adjusted trial balance

A trial balance prepared after adjusting entries are posted; the financial statements are built from this trial balance.

Income Statement

Reports Revenues minus Expenses equals Net Income for a period of time; the first financial statement prepared.

Statement of Stockholders' Equity

Rolls net income (from the income statement) into ending equity/retained earnings; prepared second.

Balance Sheet

Reports Assets = Liabilities + Equity as of a point in time, using ending equity from the statement of stockholders' equity; prepared third.

Statement of Cash Flows

Reports cash inflows and outflows classified as operating, investing, and financing activities; prepared fourth.

Temporary (nominal) accounts

Revenue, expense, and dividend accounts; zeroed out at period end via closing entries.

Permanent (real) accounts

Asset, liability, and equity accounts; balances carry forward to the next period and are not closed.

Closing process (purpose)

Transfers all temporary account balances into Retained Earnings so temporary accounts start each new period at zero.

Closing entry 1

Close revenue accounts to Income Summary: debit Revenue, credit Income Summary.

Closing entry 2

Close expense accounts to Income Summary: debit Income Summary, credit each Expense account.

Closing entry 3

Close Income Summary to Retained Earnings: debit Income Summary and credit Retained Earnings if net income; reverse if net loss.

Closing entry 4

Close Dividends to Retained Earnings: debit Retained Earnings, credit Dividends.

Post-closing trial balance

Prepared after closing entries; should show nonzero balances only in permanent (balance sheet) accounts.