Financial Accounting Midterm

Accounting Equation

Assets = Liabilities + Stockholders’ Equity (A = L + SE) which defines the relationship between a company's assets, liabilities, and equity.

Assets

What the company owns, including cash, inventory, and equipment.

Liabilities

What the company owes, such as loans and accounts payable.

Stockholders’ Equity

Owner’s claim on the company, consisting of common stock and retained earnings.

Net Income

Calculated by subtracting expenses from revenue on the Income Statement.

Classified Balance Sheet

A financial statement that separates assets and liabilities into current and non-current categories.

Multistep Income Statement

An income statement that breaks down revenue and expenses into multiple sections including Gross Profit and Operating Income.

Statement of Retained Earnings

A financial report that summarizes retained earnings changes over time.

Statement of Retained Earnings Formula

Beginning RE + Net Income - Dividends = Ending RE

Revenue Recognition Principle

Revenue is recorded when earned, not when cash is received.

Expense Recognition Principle (Matching)

Expenses are recorded when incurred, not when paid.

Historical Cost Principle

Assets are recorded at the price paid, not at current market value.

Monetary Unit Assumption

Only transactions in a stable currency are recorded

Time Period Assumption

Financial reports are prepared at regular intervals (monthly, quarterly, yearly).

Debits (Left side of T- account)

Increase: Assets, Expenses, and Dividends

Decrease Liabilities, Revenue, and Stockholders’ Equity.

Credits (Right side of T Account)

Increase: Liabilities, Revenue, and Stockholders’ Equity

Decrease: Assets, Expenses, and Dividends.

Trial Balance aka General Ledger (After Journal Entries)

A list of all accounts to check if debits = credits before preparing financial statements.

Accrual Accounting

Revenue and expenses are recognized when they occur, rather than when cash is exchanged.

Adjusting Entries

Entries made at the end of a period to ensure revenue and expenses are recorded properly.

Closing Process

The procedure of closing temporary accounts (revenues, expenses, dividends) to retained earnings at the end of a period.

1. Close Revenues: (debit revenues, Credit Income summary)

2. Close Expense: (credit Expenses, debit Income summary)

3. Close Income summary: (debit Net income, credit retained earnings)

4. Close Dividends: (credit dividends, debit retained earnings)

Journal Entries for Perpetual Inventory

• Purchases:

  • Inventory (D)

  • Accounts Payable (C)

• Sales:

  • Accounts Receivable (D)

  • Sales Revenue (C)

  • Cost of Goods Sold (D)

  • Inventory (C)

• Returns:

  • Sales Returns & Allowances (D)

  • Accounts Receivable (C)

  • Inventory (D)

  • Cost of Goods Sold (C)

Cost of Goods Sold (COGS) formula

Beginning Inventory + Purchases - Ending Inventory.

Gross Profit formula

Revenue - Cost of Goods Sold.

Credit Terms (example: 2/10, n/30)

A 2% discount if paid within 10 days, with the full amount due in 30 days.

Journal Entry for Purchase with Discount (A 2% discount if paid within 10 days, with the fill amount due in 30 days)

• Accounts Payable (D) Full Amount

• Cash (C) Discounted Amount

• Inventory (C) Discount Amount

Perpetual Inventory System

An inventory accounting method that continuously updates inventory accounts with each purchase and sale transaction.

Operating Activities

(Statement of cash flows) Day-to-day transactions (sales, expenses)

Investing Activities

(Statement of cash flows) Buying/selling assets.

Financing Activities

(Statement of cash flows) Borrowing/repaying debt, issuing stock.