ACCT 2121 Quiz 1 (Ch. 1 & 4)

What are the two primary functions of financial accounting?

1. To measure business activities of a company

2. To communicate information about those activities to investors, creditors, and others for decision-making purposes

What business activities does financial accounting measure?

Changes in assets, liabilities, stockholders’ equity, dividends, revenues, and expenses

How does financial accounting play a role in the decision-making process?

By providing information useful in investment and lending decisions

Ex. Net income used to explain stock price performance; Liabilities used to measure debt level and indicate the possibility of bankruptcy.

What do accountants count as “cash”?

1. coins and currency

2. checks received

3. balances in savings and checking accounts

4. credit and debit card sales

5. cash equivalents

What do accountants count as “cash equivalents”?

1. money-market funds

2. treasury bills

3. certificates of deposit

How are cash and cash equivalents treated on a balance sheet?

They are usually combined and reported as a single asset, either “cash” or “cash and cash equivalents”

What is the accounting equation?

Assets = Liabilities + Stockholders’ Equity

( A = L + SE )

All receivables are…

Assets

All payables are…

Liabilities

“Unearned revenue” is classified as what type of account?

Liability, since it represents payment for a good or service that has not been rendered

“Prepaid expenses” are all classified as what type of account?

Assets, since it represents a cost that does not have to be paid in the next period

Contra accounts do what to the value of their parent accounts?

Reduce the value.

Ex. Depreciation is a contra account that is subtracted from the value of the LTA

Stakeholders are classified into what 2 groups?

Internal and external stakeholders

Internal stakeholders

Managers, employees, and executives of a company; primarily use managerial accounting information.

External stakeholders

Investors, creditors, customers, suppliers, competitors, regulators, tax authorities, local communities (anyone OUTSIDE of a company); primarily use financial accounting information.

Qualitative characteristics of useful financial information

1. Decision usefulness

   1. Relevance

      1. Confirmatory value

      2. Predictive value

      3. Materiality

   2. Faithful representation

      1. Completeness

      2. Neutrality

      3. Free from error

Enhancing characteristics of useful financial information

1. Comparability

2. Consistency

3. Verifiability

4. Timeliness

5. Understandability

Cost constraint of useful financial information

The concept that financial information is only provided when the benefits outweigh the costs of reporting that information

4 underlying assumptions in financial reporting

1. Economic entity assumption

2. Monetary unit assumption

3. Periodicity assumption

4. Going concern assumption

Economic entity assumption

States that only business transactions involving a company should be part of their financial accounting information; Assets of the owners’ are separate from assets of the company

Monetary unit assumption

States that companies should use only one currency in financial information; If doing business abroad, currencies need to be converted

Periodicity assumption

Divides into artificial time periods for reporting (fiscal years/periods)

Going concern assumption

In absence of information to the contrary, you must assume business will continue to operate indefinitely; Provides justification for the historical cost principle (measuring assets based on their original costs)

Components of internal controls

1. Control environment (the “tone” set by management’s formal policies)

2. Risk assessment (identification of internal and external risk factors)

3. Control activities (preventative and detective control activities)

4. Continual monitoring (& procedure for reporting deficiencies)

Preventative controls

Keeps errors or fraud from occurring.

Ex. Separation of duties, physical controls, proper authorization, employee management, E-commerce controls

Detective controls

Detect errors and fraud that have already occurred.

Ex. Reconciliations, performance reviews, audits

Which financial statement represents a single moment in time, rather than an interval?

Balance sheet

Which financial statement uses the cash-basis of accounting?

Statement of cash flows

What is the order in which the 4 financial statements are prepared?

1. Income Statement (I/S)

2. Statement of Retained Earnings (SRE)

3. Balance Sheet (B/S)

4. Statement of Cash Flows (SCF)

What is the 1-step income statement?

I/S

Revenues

(Expenses)

=Net Income

What is the 4-Line statement of retained earnings?

SRE

Beginning RE

+NI

(DIV)

=End RE

What is the 5-Line statement of retained earnings?

SRE

Beginning RE

+Rev

(Exp)

(DIV)

=End RE

How to construct a balance sheet?

Sum all assets, and compare to the sum of all liabilities and SE

In what order are the 3 activities measured on the statement of cash flows?

1. Operating activities

2. Investing activities

3. Financing activities

Examples of operating activities on a SCF

Inflow: Cash collected for goods or services sold

Outflow: Cash paid for salaries, rent, or supplies

Examples of investing activities on a SCF

Inflow: Selling investments or long-term assets, collecting loan payments

Outflow: Purchase of long-term assets like equipment, buildings, or land

Examples of financing activities on a SCF

Inflow: Issuance of stock, loans taken out, contributions from owners

Outflow: Payments of dividends, repaying debts

Who sets the accounting “rules” in the US, and what are they called?

Financial Accounting Standards Board (FASB); Generally Accepted Accounting Principles (GAAP)

Who sets the accounting “rules” internationally, and what are they called?

International Accounting Standards Board (IASB); International Financial Reporting Standards (IFRS)

What is the PCAOB, and what do they do?

Public Company Accounting Oversight Board; Established by SOX; Oversees quality of audits of publicly traded companies

What is the SEC, and what do they do?

Securities and Exchange Commission; Requires filing annual Form 10-K and quarterly Form 10-Q for all publicly-traded companies

What does the annual Form 10-K contain?

• Financial statements

• “notes” on financial statements

• Management’s discussion & analysis (MD&A)

• Management and independent auditor’s statements as to the quality of internal controls and document’s accuracy

Effects of the Enron Scandal

• Caused the Arthur Andersen firm to go out of business

• Caused passage of the Sarbanes-Oxley Act (SOX) of 2002

Provisions of the Sarbanes-Oxley Act (SOX) of 2002

• Applies to all companies required to file with the SEC (publicly-traded only)

• Established the Public Company Accounting Oversight Board (PCAOB)

• Corporate executives must sign forms personally (increased accountability)

• Independent auditors may not perform certain non-audit services to audit clients

• Auditors must retain all work papers for 7 years

• Lead auditors of a company must rotate every 5 years

• Audit firms can’t audit companies that have executives who worked for the firm too recently

3 major lines of service in public accounting firms

1. Audit

2. Tax

3. Advisory/consulting

Big 4 accounting firms

1. Deloitte

2. PwC

3. EY (Ernst-Young)

4. KPMG