ACC212 GVSU Exam 1

What are the two functions of financial accounting?

1. To measure business activities of a company

2. To communicate those activities to investors and creditors and other outside users for decision-making purposes

Sole proprietorship and partnership

A business owned by one person, a business owned by two or more persons

Pros: All the profits, flexibility, easy to track

Cons: Sole responsibility (lawsuits), come after personal assets

Corporation

A company that is legally separted from its owners (stockholders/shareholders)

Pros: Limited Liability

Cons: Any income is double taxed

A business engages in three fundamental activities:

Financing activities, investing activities, and operating activities

Financing activities

Include transactions the company has with investors and creditors

Inflows: Borrowing from creditors (notes, loans, mortgage, bonds), issuing common stock

Outflows: Stock repurchase, repay principle amount of debt, dividend distributions

Investing activities

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

Inflows: Selling long term assets, collecting loans, selling investment securities

Outflows: Purchasing long term assets, purchasing investment securities stocks, bonds

Operating activities

Include transactions that relate to the primary operations of the company

Inflows: Sale of goods/services to customers, interest & dividends from other investments

Outflows: Salaries, utilities, purchase inventory, income taxes, advertisement, interest on debt

Assets

Total resources of a company

Ex: Current: Cash, supplies, inventory, accounts receivable, prepaid __

Ex: Non-current: PPE (Property, plant, and equipment), operating lease, intangible (patent, copyright), other (long term investment (real estate))

Liabilities

Amounts owed to creditors

Ex: Current: Accounts payable, deferred revenue, accrued salary payable, accrued interest payable

Ex: Non-current (>1 year): note payable, bond payable, lease payable, pension obligation

Stockholder’s equity

Owner’s claim to resources

Ex: Common Stock

Ex: Retained earnings - Beg. R/E + Net Income(Rev-Exp) - Dividends = End R/E

A Balance Sheet demonstrates…

A position in time

A = L + SHE

What are the rules of financial accounting called in the US and who sets the rules?

Financial accounting standards board = FASB → US GAAP

What does an auditor do?

Hired by a company as an independent party to express an opinion on financial statements (F/S)

Which audit opinion means that the financial statements are “presented in conformity with US Accounting Standards”?

Unqualified opinion

Who makes the rules for auditors?

PCAOB - Public Commission Accounting Oversight Board

What is the name of the annual and quarterly report that a company must file at the end fo their fiscal year?

Quarterly: 10-Q

Annually: 10-K

Qualitative Characteristics of Useful Financial Information: Fundamental Characteristics

Relevance (dealing with numbers)

Confirmatory value: It acts as feedback on previous evaluations, such as comparing current year revenue against prior predictions, helping to refine future decision-making. Ex: Employees of Starbucks can use the company’s financial statements to analyze the efficiency with which management has conducted operations over the past year.

Predictive value: Help users forecast future company outcomes, including future earnings, cash flows, or financial position, using past and present data. Ex: Companies report sales revenue each year. Financial statement users may use the prior year's revenues to predict future revenues.

Materiality: It acts as a guide for relevance, ensuring that only significant items are reported in detail while allowing immaterial, low-value items to be ignored or aggregated for efficiency. Ex: Target prpays $600 to rent a post office box for the next six months and decides to record the entire payment to Rent Expense (instead of Prepaid Rent) in the current month.

Faithful Representation (dealing with reliability)

Completeness: All transactions, events, assets, liabilities, and disclosures that should have been recorded are fully captured in the financial statements. Ex: When Harley-Davidson reports revenue for the year, the amount includes sales not only in the United States but also outside the United States.

Neutrality: Requiring financial information to be free from bias, manipulation, and outside influence, ensuring reported data is objective rather than designed to achieve a predetermined result. Ex: When first requiring firms to prepare a statement of cash flows, the FASB’s intent was not to discourage or promote investment in the automobile industry.

Free from error: Using the correct process to make the proper estimate. Ex: To provide the most reliable information about future sales, Walmart’s management uses an appropriate process to estimate the decline in inventory value each year.

Qualitative Characteristics of Useful Financial Information: Enhancing Characteristics

Comparability: Users can identify similarities and differences between financial statements of different companies or across different periods for the same company. Ex: In deciding whether to invest in Southwest Airlines or American Airlines, investors evaluate the companies’ income statements

Verifiability: Ensuring that different, independent observers can reach a consensus—though not necessarily complete agreement—that a particular depiction is a faithful representation. Ex: The amount of total assets reported by General Mills can be substantiated by its auditors

Timeliness: Providing financial information to decision-makers, such as investors or management, quickly enough to influence their decisions, generally by closing books and issuing reports shortly after a period ends. Ex: IBM is required to issue public financial statements within 60 days of its year-end

Understandability: Requiring financial information to be clear, concise, and comprehensible to users with a reasonable knowledge of business and economic activities. Ex: The Cheesecake Factory prepares its balance sheet in a clear format using basic accounting terminology to allow its users to easily comprehend the company’s assets, liabilities, and stockholders’ equity

GAAP: Underlying assumptions

Economic entity: Economic events can be identified with a particular economic body. Ex: Only business transactions involving Nike should be reported as part of Nike’s financial accounting information

Monetary unit: A common denominator is needed to measure all business activities. Ex: Information would be difficult to use if, for example, we listed assets as “three machines, two trucks, and a building”.

Periodicity: The life of a company can be divided into artificial time periods for periodic reporting. Ex: Corporations like Nike, whose securities are publicly traded, are required to provide financial information to the SEC on a quarterly and annual basis. Quarterly reports are more timely, while annual reports allow the full application of GAAP

Going concern: In the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely. Ex: If we knew an enterprise was going to cease operations in the near future, we would measure assets and liabilities not at their original costs but at their current liquidation values

Asset measurement method: Historical cost

Assets to be recorded and reported at their original purchase price or acquisition value, unadjusted for subsequent market value changes

Ex: Land used to be 100k now 3 million, record 100k

Asset measurement method: Amortized cost

Spreads the cost of an asset or financial instrument over its useful life

Ex: Purchasing a 5-year, $10,000 software license, resulting in a $2,000 annual expense

Asset measurement method: Net realizable value

The estimated selling price of an asset (usually inventory or accounts receivable) in the ordinary course of business, minus any costs required to complete, transport, and sell it

• OG Cost - ADA (depreciation) = NRV

Asset measurement method: Fair value

The estimated current market price at which an asset can be sold or a liability transferred. It acts as a dynamic market-based measurement rather than a historical cost.

Ex: Land used to be 100k now 3 million, record 3 million

Gains/Losses are ___ While Revenues and Expenses are ___

Incidental, Non incidental

Multi-Step Income Statement

Sales Revenues:

-Cost of Goods Sold:

Gross Profit

-S,G,A Expenses (Selling, General, Administrative):

Operating Income:

+/-Other Income (expenses) (Sum of expenses or gains/losses related to investing + financing):

Pre-tax Income:

-Income Tax Expense:

Net Income:

Basic Earnings per Share

________________NI_____________________

Weighted avg. of # of common stock outstanding

How is Diluted EPs different?

Any stock options converts to C/S

______NI_________ + any stock options

Weighted avg. of C/S

Any Increases/decreases in income from peripheral or incidental transactions of an entity are referred to as….

Gains / Losses

The income measurement that includes revenues, expenses, gains, and losses related to investing and financing activities, not operating activities is…

Nonoperating income (pre-tax income)

Statement of Cash Flow

S of CF = Cash Receipts (+) - Cash Payments (-) = Change in Cash for the Period

Accrual Accounting

Recognizes revenue when earned

Recognizes expenses when incurred

Cash-Basis Accounting

Recognizes revenue when cash is received

Recognizes expenses when paid

Statement of Stockholder’s Equity

The change in common stock over the period is shown as:

• Beginning C/S + new issuances = End C/S

The change in retained earnings over the period is shown as:

• Beginning R/E + NI - Div = End R/E

Statement of Comprehensive Income

NI + Other Comprehensive income (Non Owner Transactions) = Comprehensive Income

The income measurement that includes all revenues, expenses, gains, and losses arising from “non owner transactions” is: Comprehensive Income

If you increase a revenue account, how does it impact net income, retained earnings, and equity?

Net Income: +

Retained Earnings: +

Equity: +

If you increase an expense account, how does it impact net income, retained earnings, and equity?

Net Income: -

Retained Earnings: -

Equity: -

If you increase a dividend account, how does it impact net income, retained earnings, and equity?

Net Income: no affect

Retained Earnings: -

Equity: -

In accounting, recording a transaction is called a…

journal entry

Every journal entry includes at least one ___ and one ___

debit / credit