Financial Accounting Fundamentals: Statements, GAAP, and Adjusting Entries

Who oversees (writes and is authoritative body) GAAP?

FASB (Financial Accounting Standards Board) And the SEC oversees the FASB

Accounting Equation

Assets = Liabilities + Equity

Assets

Resources owned or controlled by the company Can the company say "I HAVE"?

Liabilities

Claims on assets that require repayment (not ownership) Can the company say "I OWE"?

Equity

Contributed Capital + Retained Earnings Formula: Common Stock + Retained Earnings (BOY) + Net Income (Current Year) - Dividends = Equity (EOY)

Balance Sheet

Point in Time (specific date) Shows the Accounting Equation: Assets = Liabilities + Equity

Income Statement

Period of Time (i.e. a year) Revenues - Expenses = Net Income

Multi-Step Income Statement

Includes subtotals for: Gross Profit, Operating Income, Other Income/Expense, Income before Income Taxes, Net Income

Categories of Cash Flows

Operating, Investing and Financing

Operating Cash Flows

Cash in and outflows related to the direct activities of the company (selling to customers, paying expenses)

Investing Cash Flows

Cash transactions for the purchase and sale of investments and long-term assets

Financing Cash Flows

Cash transactions with lenders and stockholders

Annual Report Name File with SEC

10-K

Describe what is meant by the company buying things "ON CREDIT"

Supplier (vendor) has given our company time to pay them (typically 30 days) Use the Accounts Payable (liability) account to track amounts owed to vendors

Describe what is meant by the company selling things "ON CREDIT"

Company has given a customer time to pay (typically 30 days) Use the Accounts Receivable (asset) account to track amounts owed to us

An accounts 'normal' balance (either Debit or Credit) is what causes it to [fill in blank]

Go Up (Increase)

Debits increase which accounts?

Expenses, Assets and Dividends (DEAD)

Credits increase which accounts?

Equity, Revenue and Liabilities (CERL)

What is meant by a 'Current Asset'?

Assets that are or can be converted to cash within 1 year. (Cash, Accounts Receivable, Inventory, Supplies, Prepaids)

What is meant by a 'Current Liability'?

Liabilities that are due within 1 year. (Accounts Payable, Wages Payable, Interest Payable, Unearned (deferred) Revenue)

If an asset or liability is not 'current' then it is called what?

Long-Term

What is meant by a 'classified balance sheet'?

Assets are presented in order of liquidity and there is a sub-total for Current Assets. Liabilities are presented in order of maturity and there is a sub-total for Current Liabilities.

What is the typical adjusting journal entry for prepaid insurance?

DEBIT Insurance Expense CREDIT Prepaid Insurance Amount 'used' ('expired') each month due to passage of time

What is the typical adjusting journal entry for prepaid rent?

DEBIT Rent Expense CREDIT Prepaid Rent Amount 'used' of rent due to passage of each

What is the typical adjusting journal entry for supplies?

DEBIT Supply Expense CREDIT Supplies Amount 'used' each month (typically determined by counting the supplies)

What is the typical adjusting journal entry for depreciation?

DEBIT Depreciation Expense CREDIT Accumulated Depreciation

How is depreciation calculated?

(Cost of Asset - Salvage Value) / Useful Life

What type of account is Accumulated Depreciation? And what is its Normal balance?

Contra-Asset Normal Balance is: CREDIT

What is the typical adjusting journal entry for unearned (deferred) revenue?

DEBIT Unearned (deferred) revenue CREDIT Revenue Amount 'earned' due to company providing goods or services

What is the typical adjusting journal entry for sales made on credit?

DEBIT Accounts Receivable CREDIT Revenue Amount to be received from customer in future for goods or services provided by the company

What is the typical adjusting journal entry for wages?

DEBIT Wage Expense CREDIT Wages Payable Amount is supplies 'received' and owing (not yet paid for) at month end.

What is the typical adjusting journal entry for interest (like on a loan)?

DEBIT Interest Expense CREDIT Interest Payable Amount is interest owing based on number of days the company had the borrowed funds.

Which accounts are Permanent?

Assets, Liabilities, Common Stock and Retained Earnings

Which accounts are Temporary?

Revenues, Expenses and Dividends

Which accounts get 'closed' to Retained Earnings at the end of a year?

Temporary Accounts

What are the three types of business activities?

Operating, investing, and financing.

What is operating activity?

The company's primary business operations.

What is investing activity?

Purchasing and selling long-term assets and investments.

What is financing activity?

Transactions with investors and creditors.

What is a corporation?

A business legally separate from its owners; stockholders have limited liability.

What is a sole proprietorship?

A business owned by one person.

What is a partnership?

A business owned by two or more people.

What are the four major financial statements?

Balance sheet, income statement, statement of stockholders' equity, statement of cash flows.

What does the statement of stockholders' equity show?

Changes in the company's equity accounts during a period.

What does the statement of cash flows show?

Cash inflows and outflows during a period, grouped as operating, investing, and financing.

What is GAAP?

Generally Accepted Accounting Principles; US financial reporting rules.

What does FASB stand for?

Financial Accounting Standards Board.

What does SEC stand for?

Securities and Exchange Commission.

What does the SEC do regarding GAAP?

Enforces GAAP for publicly traded US companies.

What is liquidity?

How quickly an asset can be converted to cash.

What is a long-term asset?

An asset expected to provide benefit beyond one year or the operating cycle.

What is historical cost?

An asset's original transaction value.

What is amortized cost?

Historical cost adjusted for accumulated depreciation or amortization.

What is net realizable value?

The net cash expected from converting an asset in normal business.

What is fair value?

Price received to sell an asset in an orderly market transaction on the measurement date.

What is accounts payable?

Amounts owed to suppliers for purchases on account; a liability.

What is accounts receivable?

Amounts customers owe the company; an asset.

What is unearned revenue?

Cash received before goods or services are provided; a liability until earned.

What is an accrued liability?

An expense incurred but not yet paid, such as wages payable or interest payable.

What is a note payable?

A loan obligation of the company.

What is a bond payable?

A formal debt security issued by the company.

What are the two main sources of stockholders' equity?

Contributed capital and retained earnings.

What is contributed capital?

Equity received from stockholders, including common stock and additional paid-in capital.

What are retained earnings?

Cumulative earnings kept in the business after dividends.

What is the formula for ending retained earnings?

Beginning retained earnings + net income - dividends.

What is the formula for ending equity?

Beginning equity + stock issued + net income - dividends.

What is gross profit?

Sales revenue - cost of goods sold.

What is operating income?

Gross profit - operating expenses.

What is pretax income?

Operating income + nonoperating income (or minus nonoperating loss).

What is net income?

Total revenues and gains - total expenses and losses.

Are dividends an expense on the income statement?

No. Dividends reduce retained earnings, not net income.

What is the formula for change in cash?

Cash receipts - cash payments.

What is the formula for ending cash?

Beginning cash + cash receipts - cash disbursements.

Give examples of operating cash inflows.

Cash from customers, dividends received, and interest received.

Give examples of operating cash outflows.

Payments to suppliers, employees, and interest to lenders.

Give examples of investing cash flows.

Cash from selling long-term assets; cash paid to buy equipment or investments.

Give examples of financing cash inflows.

Issuing common stock and borrowing money through notes or bonds.

Give examples of financing cash outflows.

Paying dividends, repaying loan principal, and repurchasing stock.

What is a source document?

Evidence of a transaction, such as an invoice, contract, or promissory note.

What is the expanded accounting equation?

Assets = Liabilities + Common Stock + Retained Earnings; retained earnings changes with revenues - expenses - dividends.

What is a debit?

An entry on the left side of an account.

What is a credit?

An entry on the right side of an account.

What must be true of every journal entry?

Total debits equal total credits.

What is a journal?

A chronological record of business transactions and their debits and credits.

What is a ledger?

The collection of a company's accounts and their balances.

What is a trial balance?

A listing of accounts and balances used to check that total debits equal total credits.

Does a balanced trial balance prove there are no accounting errors?

No. Some errors leave debits and credits equal.

What happens when a company buys equipment on account?

Equipment (asset) increases; accounts payable (liability) increases.

What happens when a company collects accounts receivable?

Cash increases and accounts receivable decreases; total assets do not change.

What happens when a company pays an accounts payable?

Cash decreases and accounts payable decreases.

What happens when a company issues common stock for cash?

Cash and common stock both increase.

What happens when a company pays a cash dividend?

Cash decreases and dividends increase, reducing equity.

What happens when a company makes a sale on account?

Debit accounts receivable; credit revenue.

What is accrual-basis accounting?

Recognize revenues when earned and expenses when incurred, regardless of cash timing.

What is cash-basis accounting?

Record revenues when cash is received and expenses when cash is paid.

When should revenue be recognized?

When the company provides the goods or services and earns the revenue.

When should expenses be recognized?

When resources are used or expenses are incurred, not necessarily when paid.

What is a prepaid expense?

An asset for a payment made before the benefit is used, such as prepaid insurance.

What is an adjusting entry?

An end-of-period entry to update accounts for earned revenues or incurred expenses.

Do typical adjusting entries involve the Cash account?

No. Adjustments generally do not debit or credit cash.