Financial Accounting FINAL EXAM

Broad Finance (definition)

Finance is the study and management of money and resources, focusing on how they are acquired, allocated and used to optimize outcome and manage risks

Importance of Finance

Drives Economic Growth
Informed Decision-Making
Efficient use of resources

Financial Accounting (definition)

Measures the financial performance of an organization

Managerial Accounting (definition)

Uses both financial and nonfinancial information to make decisions

Types of Financial Statements

Income Statement
Owner’s Equity
Balance Sheet
Cash Flow Statement

What does GAAP stand for

Generally Accepted Accounting Principles (US)

Who sets the GAAP

Financial Accounting Standards Board (FASB) (US)

Who cares about financial accounting

Internal users
External users

What does SEC stand for

Securities Exchange Commission

What is the purpose of the SEC

To regulate publically traded companies in the US

Types of organizations

For Profit
Not-for-Profit
Government Entities

Accounting Journals Flow (Steps)

1. Accurate Business Data

2. Recordable Transactions

3. Accounting Journals

4. Financial Statements

Income Statement Components

Revenue
Expenses
Gains
Losses
Net Income (Net Loss)

Complete Income Statement (All Steps)

Sales Revenue

- Cost of goods sold

= Gross Margin

- Operating Expenses

= EBITDA

- Depreciation and Amortization

= EBIT

- Interest payment

= Taxable Income

- Taxes

= Net Income

Balance Sheet Components

Assets

Liabilities

Equity

Current vs Noncurrent Assets & Liabilities

Current: Consumed in a year or less

Noncurrent: Consumed in more than a year

What is the Cash Flow Statement

Cash flowing in and out of the business

What are Financial Ratios used for

Analyze the health of an organization

Types of Financial Ratios

Liquidity

Working Capital

Current Ratio

Financial Ratios

What is Liquidity

Business’s ability to turn assets into cash

Financial Ratios

What is Working Capital (Formula)

Current Assets - Current Liabilties

Financial Ratios

What is Current Ratio (Formula)

Current Assets / Current Liabilities

What is Cash Basis Accounting

Recording revenue and expenses when cash is received, not when the transaction occurs

What is Accrual Accounting

Recording revenue and expenses when the transaction occurs, not when cash is received

Assets (Formula)

Assets = Liabilities + Owner[s Equity

What does IFRS stand for

International Financial Reporting Standards

What is the IFRS

Globally equivalent to GAAP

List all Conceptual Accounting Frameworks

Revenue Recognition Principle
Expense Recognition Principle (Matching)
Cost Principle
Full Disclosure Principle
Separate Entity Concept
Conservatism
Monetary measurement Concept
Going Concern
Time Period Assumption

Conceptual Accounting Frameworks

Revenue Recognition Principle

Revenues must be recorded when earned regardless of when revenue is collected

Conceptual Accounting Frameworks

Expense Recognition Principle

Businesses record expenses in the same period as the related revenue.

Conceptual Accounting Frameworks

Cost Principle

States that virtually everything the company owns or controls (assets) must be recorded at its value at the date of acquisition

Conceptual Accounting Frameworks

Full Disclosure Principle

Businesses must report any business activities that could affect what is reported on the financial statements

Conceptual Accounting Frameworks

Separate Entity Concept

The business keeps its finances separate from the personal assets of anyone with a stake in the company.

Conceptual Accounting Frameworks

Conservatism

If there is uncertainty in a potential financial estimate, a company should use caution and report the most conservative amount

Conceptual Accounting Frameworks

Monetary Measurement Concept

Must be a monetary unit by which to value the transaction

Conceptual Accounting Frameworks

Going Concern Assumption

Assumes a business will continue to operate in the foreseeable future

Conceptual Accounting Frameworks

Time Period Assumption

A company should report their financial position at regular intervals

Key Asset Accounts (9)

Cash
Accounts receivable
Inventory
Supplies
Prepaid expenses
Equipment
Buildings, Machinery, and Land

Key Liability Accounts (3)

Accounts payable
Other payable
Unearned (Deferred) revenue

Key Equity Accounts (2)

Contributed capital
Retained earnings

Types of Adjusting Entries

Deferrals
Accruals

Adjusting Entries

What are Deferrals

You're deferring (postponing) the recognition of income or expense to a future period.

Adjusting Entries

What are Accruals

You're recognizing revenue or expense now, and the cash comes later.

Types of Deferrals

Prepaid Expenses

Unearned Revenue

Types of Accruals

Accrued Revenue

Accruad Expenses

Closing Entries (definition)

Prepare a company for the next accounting period by clearing any outstanding balances

(Zero the Income Statement)

Closing Entries

Four Standard Closing Journals

1. Revenue with Income Summary

2. Income Summary with Expenses

3. Income Summary with Retained Earnings

4. Retained Earnings with Dividends

Classified Balance sheet (definition)

Breaks assets and liabilities into smaller categories to make analysis and decision-making easier

Merchandising vs Service Active and Transactions (Operating Cycles)

How does the Service Organization Cycle look?

1. Collect Payment

2. Cash Available

3. Provide Service

4. Accounts Receivable

Merchandising vs Service Active and Transactions (Operating Cycles)

How does the Merchandising Organization Cycle look?

1. Collect Payment

2. Cash Available

3. Purchase Inventory

4. Sell Merchandise

5. Accounts Receivable

Merchandising vs Service Active and Transactions (Operating Cycles)

Income Statement for Service Organization

Sales

Expenses

Net Income (Loss)

Merchandising vs Service Active and Transactions (Operating Cycles)

Income Statement for Merchandising Organization

Net Sales

Cost of Goods Sold

Gross Margin

Expenses

Net Income (Loss)

How to record an (adjustment) supplies expense

Debit: Supplies Expense

Credit: Supplies

How to record an (adjustment) Equipment Depreciation

Debit: Equipment Depreciation Expense

Credit: Accumulated Equipment Depreciation

How to record an (adjustment) unearned revenue now earned

Debit: Unearned RevnueRevenue

Credit: Service Revenue

How to record an (adjustment) interest revenue increase

Debit: Interest Receivable

Credit: Interest Revenue

How to record an (adjustment) Income Tax expense

Debit: Income Tax Expense

Credit: Income Tax Payable

How to record journal for Merchandise Organization Sale

Debit: Cash
Credit: Sales

Debit: Cost of Goods Sold
Credit: Merchandise Inventory

What is Sales Return

Customer returns the merchandise and receives full refund

What is Sales Allowance

Customer keeps defective merchandise and is given partial refund

What is Earnings Management

Works within GAAP to improve stakeholder’s view of the company’s financial position

What is Earnings Manipulation

Ignoring GAAP rules to alter earnings significantly

Revenue Recognition Principle

Four-Step Process

1. Evidence that an arrangement exists

2. Goods have been delivered or services have been performed

3. The price is fixed

4. Reasonable assurance that the amount will be collected

What are the Special Revenue Recognition Cases

Percentage of Completion
Subscriptions
Combined Equipment Sale with Service Contract

Special Revenue Recognition Cases

When is revenue recognized with Percentage of Completion

Revenue recognized based on percentage of work done

Special Revenue Recognition Cases

When is revenue recognized with Subscriptions

Revenue recognized as service is performed

Special Revenue Recognition Cases

When is revenue recognized with Combined Equipment Sale with Service Contract

Revenue from the sale is recognized immediately

Revenue from the Service is recognized over the service period

What are Bad debts

Uncollectable amounts from customer accounts

What does Bad Debt negatively affect

Accounts Receivable

What are the methods used to recognize Bad Debt

Direct Write-off Method

Allowance Method

Aging of Accounts recivable Methods

Bad Debt

What is the Direct Write-off Method

Bad debt is written-off when a company is fairly certain that collection is not possible

(Violates GAAP)

How to record the Direct Write-off Method

Debit: Bad Debt
Credit: Accounts Receivable

What is the Allowance Method

Estimates bad debt during a period based on experience or industry standards

(Matches Bad Debt with Sales during period - Does NOT violate GAAP)

Allowance Method
What are the Two Approaches to calculate Bad Debt

Income Statement Approach: Average % of yearly revenue
Balance Sheet Approach: Average % closing accounts recivable balance

Bad Debt
How to record the Allowance Method

Debit: Bad Debt Expense
Credit: Allowance for Doubtful Accounts

What is the Balance Sheet Aging of Receivables method

Estimates bad debt expenses based on the balance in accounts receivable, considering the uncollectible time period

What is the difference between Accounts Receivable and Notes Receivable

Notes Receivable are more formal with written agreements, for more extended payment periods, and with interest charges.

How to record Notes Receivable

Initial:

Debit: Notes Receivable
Credit: Sales Revenue

After Interest:

Debit: Interest Receivable
Credit: Interest Revenue

How to calculate interest

Interest = Annual Interest Rate x Loan Principle x Part of year

eg. 10% x 2,000 x (12/12)

What are Sales Discounts

Incentives given to customers to entice them to pay off their accounts early

What is Fraud

The act of intentionally deceiving a person or organization for financial or nonfinancial gain

What is Financial Statements Fraud

Financial statements are used to misrepresent actual financial condition of a company

Components of the Fraud Triangle

Incentive or Pressure

Perceived Opportunity

Rationalization

Ways to reduce risk of fraud

Proper Internal Controls

Adequate Internal and External Audit

Rigid Laws: SOX for US

Penalties

What are internal controls

Controls used to manage risk of fraud occurrence

What does COSO stand for

Committee of Sponsoring Organizations

What is an effective control system

Committee of Sponsoring Organizations (COSO)

What are the 5 components of COSO

1. Control Environment

2. Risk Assessment

3. Control Activities

4. Information and communication

5. Monitoring Activities

Types of Auditors

Internal and External Auditor

What does SOX stand for

Sarbanes-Oxley Act

What is the Sarbanes-Oxley Act

Certification and documentation of internal controls

What must auditors do to comply with the Sarbanes-Oxley Act

1. Issue an internal control report following the evaluation of internal controls.

2. Limit non-audit services, such as consulting, that are provided to a client.

3. Rotate who can lead the audit.

Why is Inventory / COGS valuation important

They determine your profits

What is the Perpetual Inventory System

Automatically updates and records the inventory account every time a sale, or purchase of inventory occurs

What is the Periodic Inventory System

Updates and records inventory account at the end of an operating cycle

How to record Perpetual Inventory Method

Ordering Inventory

Debit: Inventory
Credit: Accounts Payable

Selling Inventory

Debit: Accounts Receivable
Credit: Sales

Debit: COGS
Credit: Merchandise Inventory

What is an important component of the recording of inventory purchases and sales

Shipping Terms

What and who are shipping terms determined by

Contract Terms between the seller and buyer

What does the transfer point of ownership indicate

• Who pays the shipping charges

• Who is responsible for the merchandise (i.e., if damaged, lost, or stolen)

• On whose balance sheet the assets would be recorded

• How and when to record the transaction for the buyer and seller

What is Goods in transit

Goods in transit refers to the time in which the merchandise is transported from the seller to the buyer