Financial Accounting - Exam #1

Assets = Liabilities + Shareholder’s Equity

What is the accounting equation?

Resources owned by a company that provide a future benefit

What are assets?

Amounts a company owes to other parties

What are liabilities?

The owners’ claim on the company’s assets

What is shareholder’s equity?

Money or other resourced invested in the company by its owners/shareholders

What is contributed capital?

A system in which every transaction affects at least two accounts and keeps the accounting equation balanced

What is double-entry accounting?

It shows that a company’s assets must always equal its liabilities plus shareholder’s equity

What is the purpose of the accounting equation?

An asset expected to be used, sold, or converted to cash within one year

What is a current asset?

An asset expected to provide benefits for more than one year

What is a noncurrent asset?

A liability expected to be paid within one year

What is a current liability?

A liability expected to be paid after more than one year

What is a noncurrent liability?

As a current/short-term liability

How should Notes Payable be classified on the test unless told otherwise?

Generally Accepted Accounting Principles, the accounting principles used in the United States

What is GAAP?

The Financial Accounting Standards Board? (FASB)

Who establishes GAAP?

A financial statement showing assets, liabilities, and shareholder’s equity as of a specific date

What is the balance sheet?

A financial statement showing revenues, expenses, gains, losses, and net income for a period of time

What is the income statement?

A Balance Sheet is reported as of a specific date; an Income Statement covers a period of time

What is the difference between “as of” and “for the period ended”?

Revenue - Expenses = Net Income

What is the formula for net income?

The amount earned from providing goods or services

What is revenue?

A cost incurred to generate revenue

What is an expense?

The amount earned when an asset is sold for more than its cost

What is a gain?

The amount lost when an asset is sold for less than its cost

What is a loss?

Record expenses in the same period as the revenue they helped generate

What is the matching principle?

An error or reporting problem that could influence the decision of an average prudent investor

What is materiality?

The financial statements are presented fairly (the best opinion you can get)

What is an unqualified audit opinion?

The financial statements are presented fairly except for a specific issue

What is a qualified audit opinion?

The financial statements are not presented fairly (the worst opinion you can get)

What is an adverse audit opinion?

The auditor does not express an opinion on the financial statements

What is a disclaimer of opinion?

Recording a transaction before cash is exchanged

What is an accrual?

Cash is exchanged before the related revenue or expense is recognized

What is a deferral?

Accrual = cash later; Deferral = cash first

What is the easiest way to remember accrual vs. deferral?

Revenue that has been earned before cash has been received

What is accrued revenue?

Revenue increases and Accounts Receivable increases

What accounts are affected by accrued revenue?

An expense that has been incurred before cash has been paid

What is an accrued expense?

Expense increases and Accounts Payable increases

What accounts are affected by an accrued expense?

Cash received before the company has earned the revenue

What is deferred revenue?

A liability

What type of account is deferred revenue?

Deferred revenue decreases and revenue increases

What happens to deferred revenue when the company performs the service?

Cash paid before the related service or benefit has been used

What is a prepaid expense?

An asset

What type of account is a prepaid expense initially?

The prepaid asset decreases and the related expense increases

What happens to a prepaid expense when it is used?

Prepaid insurance, prepaid rent, and supplies

What are examples of prepaid expenses?

Recording transactions when they occur rather than when cash is exchanged

What is accrual-basis accounting?

When it is earned

When is revenue recognized under accrual accounting?

When it is incurred

When is an expense recognized under accrual accounting?

Recognition means formally recording an event; realization generally means receiving the cash

What is the difference between recognition and realization?

When there is uncertainty, choose the accounting treatment that results in the lowest net income

What is the conservatism principle?

Revenue should be recognized later when there is uncertainty

How does conservatism affect revenue?

Expenses should be recognized sooner when there is uncertainty

How does conservatism affect expenses?

Accrual accounting causes net income to differ from actual cash inflows and outflows, so the statement shows what actually happened to cash

Why is the Statement of Cash Flows needed?

Balance sheet accounts that remain open from year to year

What are permanent accounts?

Assets, liabilities, and equity

What are examples of permanent accounts?

Accounts that track financial results for a specific period and are closed at the end of the period

What are temporary accounts?

Revenue, expenses, gains, losses, and dividends

What are examples of temporary accounts?

The process of closing temporary accounts and resetting their balances to zero

What is the closing process?

Record transactions → Adjust accounts → Prepare financial statements → Close temporary accounts

What is the basic accounting cycle?

Goods purchased or manufactured for resale to customers

What is inventory?

It provides a future benefit because it can be sold to generate revenue

Why is inventory an asset?

A system in which the Inventory account is updated continuously as purchases and sales occur

What is a perpetual inventory system?

A system in which inventory is physically counted at the end of the period to determine ending inventory and cost of goods sold

What is a periodic inventory system?

The cost of inventory that has been sold

What is Cost of Goods Sold (COGS)?

A cost included in inventory because it is associated with obtaining or preparing goods for sale

What is a product cost?

A cost that is not included in inventory and is recorded as an expense

What is a period cost?

On the Balance Sheet as Inventory

Where are the product costs reported before the inventory is sold?

On the Income Statement as expenses

Where are period costs reported?

Inventory purchases, Freight In, factory worker salaries, factory utilities, factory rent, factory insurance

What are examples of product costs?

Office salaries, office utilities, office rent, advertising, marketing salaries, sales salaries, and Freight Out

What are examples of period costs?

The cost of shipping purchased goods to the buyer’s location; it is included in Inventory

What is Freight In?

The cost of shipping goods to customers; it is recorded as an expense

What is Freight Out?

The buyer pays shipping, and ownership and risk of loss transfer when the goods are shipped

What is FOB Shipping Point?

The seller pays shipping, and ownership and risk of loss transfer when the goods arrive at the destination

What is FOB Destination?

A reduction in the invoice price offered for paying quickly

What is a cash discount?

A 2% discount is available if paid within 10 days; otherwise, the full amount is due within 30 days

What does 2/10, n/30 mean?

Inventory returned to the seller, which reduces Inventory and the amount owed or paid

What is a purchase return?

A reduction in the amount owed because purchased inventory is damaged or has another issue but is kept by the buyer

What is a purchase allowance?

Inventory that is missing because of theft, damage, breakage, spoilage, or other causes

What is inventory shrinkage?

Book Inventory - Physical Inventory = Inventory Shrinkage

How is inventory shrinkage calculated?

The total cost of inventory available to be sold during the period

What is Goods Available for Sale?

Beginning Inventory + Purchases - Purchase Returns - Purchase Discounts + Freight In

What is the Goods Available for Sale formula?

Goods Available for Sale - Ending Inventory = Cost of Goods Sold

What is the periodic Cost of Goods Sold formula?

Inventory decreases and Cash decreases

What happens when inventory is purchased for cash under the perpetual system?

Inventory increases and Accounts Payable increases

What happens when inventory is purchased on account?

Cash increases and Sales Revenue increases; COGS increases and Inventory decreases

What happens when inventory is sold for cash?

One entry records the revenue from the sale and the other records the cost of the inventory that was sold

Why does an inventory sale require two entries under the perpetual system?

Cash +$50,000, Sales Revenue $50,000; COGS +$10,000, Inventory -$10,000

A company buys $10,000 of inventory and sells it for $50,000 cash. What happens?

$9,000

A company buys $10,000 of inventory and returns $1,000. How much inventory remains from the purchase?

Inventory decreases by the amount of the discount

What happens to inventory when a purchase discount is taken?

Accounts Payable decreases by the amount paid

What happens to Accounts Payable when a purchase discount is taken?

Inventory increases and Cash decreases

What happens with Freight In under the perpetual system?

An expense increases and Cash decreases

What happens with Freight Out?