Intro Accounting: Exam 1 Definitions

1) Financial Accounting

Keeping the financial score for the entity

follows GAAP

Users: External- stockholders, bankers, lenders, creditors, vendors

Managerial Accounting

Using Accounting and non-accounting info to make decisions

Follows: Conventions (No GAAP)

Users: Internal - people making decisions about costs

FASB

Financial Accounting Standards Board

GAAP

Generally Accepted Accounting Principles

Financial Accounting

Keeping the financial score for the entity

Cost

all costs are historical

Revenue Recognition

• Earned

• Recognized

Earned

Rendered goods and services

Recognized

Expectation of payment

Matching

match expenses with revenue in the period they occur

Materiality

If you knew the fact it could change your mind; 5% of something

Accounting Equation

Assets = Liabilities + Stockholders Equity

Assets

Something of future economic value

Are all assets shown on the balance sheet? If not, why not?

No. Assets must be objectively quantifiable to be recorded on the balance sheet

Liability

something owed

Are all liabilities shown on the balance sheet? If not, why?

No. Liabilities must be objectively quantifiable to be recorded on the balance sheet.

Contingent Liability:

Liability that cannot be objectively quantifiable

Stockholder’s Equity

Capital plus retained earnings

Capital

Investment by the stockholders

Retained earnings

Earnings retained in the business

Ending Retained Earnings

= Beginning RE plus NIAT minus Dividends

Dividend

Distribution of retained earnings to stockholders

Expense

Expired asset

Revenue

rendered goods and/or services with the expectation of payment

“B to B“

(Business to business) companies selling primarily to other companies

“B to C“

(Business to consumer) Companies selling primarily to consumers

“C level“

the executive level of a company e.g. chief executive officer, chief financial officer, chief

technology officer, chief marketing officer, chief (whatever)

What is the purpose of a for-profit and a not-for-profit entity?

What is the purpose of a non-governmental entity?

To satisfy a customer demand

How can a company “make” money and not have any cash?

The company keeps its books on the accrual basis which follows transactions, but the Real World

operates on the cash basis of cash in/cash out

Why does a for-profit company need to make a profit?

To reward the stockholders for taking the investment risk

Why does a not-for-profit entity need to make a profit?

To build reserves and to fund future activities.

Who pays the corporation or business entity income taxes?

the customer pays the taxes. Revenue must cover all expenses which includes taxes

1) What is the difference between a for-profit entity and a not-for-profit entity?

Not-for-profit entity: pays no income taxes

For profit entity pays taxes and thereby subsidizes non-for-profit entities

2)What is the difference between a for-profit entity and a not-for-profit entity?

For profit entity has stockholders

Not for profit entity has no owners

Do taxes matter? Why?

Yes. Taxes represent unavoidable cash out which makes the cash unavailable for reinvestment in the

business

Debt Service (aka servicing debt)

timely payment for principal and interest

Annuity cash flow pattern

same amount (in or out) in each period

loan

a. monthly payment

b. total interest paid

c. calculate savings if pay above the minimum amount

Income Statement

matches revenue with expense over a period of time (financial video) aka: the operating or “the P & L” - profit and loss statement

Cost of Goods Sold

I/S

Definition: Cost of what is not there

Formula: beginning inventory plus net purchases minus ending inventory

Gross Profit

I/S

Net revenue minus costs of goods sold

SG & A

I/S

Selling, general, and administrative expense (aka operating expenses)

Operating Income

I/S

Gross profit minus S, G, & A; income from the core business

Non-Operating Income (aka other)

I/S

Income from the core business

Balance Sheet

Shows assets equal liabilities plus stockholders’ equity at a point in time (financial snapshot)

Current

B/S

within 12 months or one operating cycle

Current Assets

B/S

Assets that will be used up or converted to cash within one year

Current Liabilities

B/S

Liabilities which are due within one year

Statement of Changes in Cash Position

difference between two balance sheets expressed in cash

“Capitalize it“

put the amount on the balance sheet; generally, as an asset to be depreciated or amortized

increases net income

“Expense It “= “Write It Off “

Deduct the amount on the income statement

Decreases net income

“Capitalize It” versus” Expense It” versus “Write It Off”

Why Important?

Want net income to be

Book Value of an Asset

B/S in assets

Original cost minus accumulated depreciation

Market Value of an Asset

Value paid by a willing buyer and willing seller

not found on the financial statements

Book Value of a company

B/S under stockholders’ equity

common stockholders’ equity

Market Value of a Company

Value paid by a willing buyer and willing seller

not found on the financial statements

Sales vs. Revenue

There is no difference

Accrued

Estimated

Net Income

revenue minus expense

expense

expired asset

prepaid expense

paid cash but have not yet received the goods and services

Unearned revenue

(aka customer deposit) Received cash but have not yet rendered the goods and services

Depreciation, Amortization, and Depletion

method of cost allocation of long-term assets over the estimated useful life under the Matching Principle

• Dose NOT represent wear and tear or loss of value

Formulas: Depreciation

Allocation of original costs over the estimated useful life of a tangible asset

Formulas: Amortization

Allocation of original costs over the estimated useful life of an intangible asset

Formulas: Depletion

Allocation of original costs over the estimated useful life of a natural resource asset

Depreciation, amortization or depletion versus accumulated depreciation, accumulated amortization,

or accumulated depletion:

Expense for the period (expense on I/S) versus sum of the expense across all

periods since the asset was placed in service (contra asset account on the B/S)

Six Elements of Internal Control

1. Establishment of responsibility – “who” is responsible

2. Segregation of duties – for “what” is “who” responsible

3. Documentation procedures – required paperwork to trace the transaction

4. Physical Controls – physical barriers

5. Independent internal verification – check by someone independent of the process

6. Human resource control – hiring people with the appropriate skills

Check and balance

organizing work so people naturally check on each other

(Both for internal control as well as to catch mistakes)

“It is easier/cheaper to keep a customer than to find a new one”

Calendar Year

accounting year ends December 31

Fiscal Year

accounting years ends on any other month

Other Income and Expense (Non-operating portion of the income statement)

Interest income and interest expense

Gain or loss on the sale of assets

Freight In versus Freight Out

Normal assumption

buyer pays freight

Freight In versus Freight Out

FOB

Normal assumption: buyer pays freight

Free on Board

point at which title transfers: FOB Plant, FOB destination

not to be confused with who ultimately pays the shipping cost

Freight In

part of inventory which is a current asset on B/S

cost of getting materials to the plant or warehouse

Freight Out

part of SG&A – sales/marketing expense of getting product to the customer;

deduction from gross profit on I/S

Value Chain

All the processes and procedures which add value to product or service in the customers eyes

Value Chain: Value Added

added value in the customer’s eyes

Value chain; non-value added

don’t add value in the customer’s eyes

Supply Chain

All the activities to get the product made and in the hands of the customer

Tax Expense

– expense to company

-appears on income statement

- examples: income tax, employer payroll taxes, sales tax paid by company on its purchases

Tax Pass Through

- taxes collected on behalf of a governmental entity and passed through to the entity

- neither a revenue nor an expense

- may appear on balance sheet as liability if not yet paid

-examples: sales taxes, excise taxes, employee payroll taxes