Financial Accounting Study Guide

Journal entries are formatted as "Debit / Credit"

Generally Accepted Accounting Principles

The conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

Journal (Includes 4 parts)

The first place where a transaction is recorded in the accounting system. Includes the transaction date, the names of the accounts to be adjusted, the amount to be adjusted, and a brief explanation.

Source Document

An invoice, receipt, bill, or other evidence of a transaction which is necessary to record a journal entry.

Ledger

The “Book of accounts”; the collection of accounts used by the company. Transactions recorded in the journal provide info from which the accounts in the ledger are updated.

Trial Balance

A list of all of a company’s accounts and their balances. The balances are recorded in the appropriate column, either “debit” or “credit”.

Chart of Accounts

A list of all the account names, and associated account numbers, that are used by the company.

DEA/LER

Debit, Expenses, Assets / Liabilities, Equity (contributed capital), Revenue.

Left is increased by edits and decreased by credits. Right is increased by credits and decreased by debits.

What is the Retained Earnings account used for and which side does it increase/decrease?

Used for closing entries; it has a normal credit balance and increases with credit and decreases with debits.

Revenue Recognition Principle

Revenues are recorded in the accounting period in which they are EARNED.

Matching Principle

Expenses are recorded in the accounting period in which the company recieves the benefit (revenue) from them; i.e. expenses are “matched” to the related revenue.

Generally Accepted Accounting Principles

The conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

Define the 8 Adjusting entries as accrual or deferral. (debit / credit)

1. Tax Expense / Taxes Payable

2. Depreciation Expense / Accum. Dep.

3. Supplies Expense / Supplies

4. Wages Expense / Wages Payable

5. Interest Expense / Interest payable

6. Rent Expense / Prepaid Rent

7. Unearned Revenue / Revenue

8. Accounts Receivable / Revenue

Accrual:

1. Tax Expense / Taxes Payable

2. Interest Expense / Interest Payable

3. Wages Expense / Wages Payable

4. Accounts Receivable / Revenue
   
   Deferral:

5. Depreciation Expense / Accum. Dep.

6. Supplies Expense / Supplies Payable

7. Rent Expense / Prepaid Rent

8. Unearned Revenue

Which accounts are closed at the end of each accounting period? How?

Revenue, Expense, Dividend accounts. Transfer their balances to the Retained Earnings account.

ABC Company’s Supplies account showed a balance of $100 on the first day of the month. $500 in supplies were purchased during the month. At the end of the month, there were $200 of supplies on hand; the rest has been used. What entry should be made to adjust the account?

Answer: Supplies Expense $400 / Supplies $400

Explanation: Supplies account would have a $600 balance before we make our adjustment, because supplies purchased would have been added to the account during the period. Since $200 was left at the end, that means $400 must have been used up and therefore accounted for.

4 Categories of assets included on the balance sheet:

Current assets, Investments, Property/Plant/Equipment, and Intangible assets

Current assets

Short term assets (like cash) that’ll be gone within a year

Investments

Long term notes receivables & investments. Includes physical assets that are not currently in use by the company; expected to be used for a year or more.

Property/Plant/Equipment

Physical company assets (like chairs, cars, etc) that are currently use in the company, and which are expected to benefit the company for a year or more. All are depreciated except for land.

Intangible assets

Non-physical rights used for operating the company that are expected to benefit the company for a year or more (e.g., patents, copyrights, franchises, and trademarks).

What are Selling Expenses?

Expenses that include salaries, wages, commissions, freight out, maintenance, and sales vehicle costs.

What are General & Administrative Expenses?

Expenses that include office salaries & wages, office maintenance, and office-use vehicle costs.

1. Sales Returns and Allowances definition:

2. Example problem: “A customer purchases goods for $100 and then returns them” the entry to record the return would be:

1. A contra account subtracted from Sales, used to keep track of customer returns & allowances made for the sale of damaged goods.

2. Solution:

   Sales Returns and Allowances 100

   …………………Accounts Receivable 100

1. Sales Discounts definition:

2. Example problem: Jones sells $1,000 of merchandise to the James company with terms “2/10, net/30”. James pays for the merch 8 days later. Journal entry:

1. A contra account subtracted from Sales that is used to keep track of cash discounts offered to customers for early payment.

2. Solution: 2/10 means 2% if paid in 10 days. Paid in 8, so subtract 2% from 1000 and record the discount.
   

   Cash 980

   Sales Discounts 20

   ……….Accounts Recievable 1000

“Consistency” Accounting Principle

A company must use the same accounting method each month. They can switch if the company can justify it as providing users with a more fair representation of the company’s performance.
Example: A company must use FIFO if that is their method, unless LIFO will provide a more accurate representation.

“Materiality” Accounting Principle

Assets that cost very little can be expensed as a cost rather than recording it as an asset. Example: Toilet paper

“Conservatism” Accounting Principle

If the company spends money on research, design, new venture, etc, and there is huge doubt about whether it will succeed, then they should expense the costs and not record the cost as an asset.

“Full Disclosure” Accounting Principle

Anything about the company that would significantly affect an outside investor’s opinion of the company must be disclosed in the notes to the financial statements.

Cost of Goods Sold sample problem (using LIFO, FIFO, and Weighted Ave.)
Sample Problem:

July 1 Inventory 50 @ $4.00
5 Purchased 40 @ $4.10
10 Purchased 30 @ $4.20
17 Purchased 80 @ $4.30
28 Purchased 20 @ $4.40
Total Units: 220 $922
Total Units Sold In July: 150 Units

1. Use the Weighted Average method to calculate Cost of Goods Sold and Ending Inventory. Round to the nearest dollar.

2. Use the FIFO method to calculate Cost of Goods Sold and Ending Inventory.

3. Use the LIFO method to calculate Cost of Goods Sold and Ending Inventory

1. 50 x $4 = 200
   40 x $4.1 = $164
   30 x $4.2 = $126
   80 x $4.3 = $344
   20 x $4.4 = $88
   220 Units, $922
   
   $922 inventory cost/220 Units = $4.1909 cost per unit
   $4.1909 average cost per unit x 150 sold = $629 COGS
   $922 - $629 = $293 Ending Inventory
   

2. 50 x $4 = 200
   40 x $4.1 = $164
   30 x $4.2 = $126
   30 x $4.3 = $129
   150 Units, $619 COGS
   $922 - $619 = $303 Ending Inventory
   

3. 20 x $4.4 = $88
   80 x $4.3 = $344
   30 x $4.2 = $126
   20 x $4.1 = $82
   120 Units, $640 COGS
   922 - 640 = $282 Ending Inventory

Of the 3 inventory cost flow methods (Average, LIFO, FIFO), which ones:
1. Produce the highest Net Income, most ending inventory, and least COGS
2. Produce the lowest Net Income, least ending inventory, and most COGS.
3. Produces somewhere in the middle between the other two.

1. Fifo

2. Lifo

3. Average

What will be the effect on Net Income for the next two years if inventory is overstated by $5,000?

Net income will be overstated by $5,000 this year, and understated by $5,000 next year.

Estimating the cost of ending inventory using the Retail Estimation Method.

Sample Problem:

• $240,000 cost of goods avaiable for sale

• $400,000 retail price of goods available for sale

• $350,000 sales for the period

What is the estimated cost of the unsold (ending) inventory?

1. $240k cost/ $400k retail = 60% cost percent of selling price

2. 60% x 350k sales = $210k cost of goods sold

3. $240k cost - $210k cogs = $30,000 Ending Inventory

Estimating the cost of ending inventory using the Gross Profit Method.

Sample Problem:

• $280k cost of goods available for sale

• 30% gross profit (markup) percentage

• $320k sales for the period

What is the estimated cost of the unsold (ending) inventory?

1. 100% - 30% markup = 70% cost percentage of selling price

2. 70% x $320k sales = $224k cost of goods sold

3. $280k inventory cost - $224k cogs = $56,000 Ending Inventory

Calculating & recording the adjustment to the “Allowance for Uncollectible Accounts”.

Sample problem:

• Sales $1,000,000

• Estimated uncollectible (based on past experience): 2%

• Current balance of the AUA account: $4,000 debit

1. Calculate the adjustment to the Allowance for Uncollectible Accounts, using the percentage of credit sales method.

$1,000,000 × 2% = $20,000 (current balance is irrelevant with this method)

Calculating & recording the adjustment to the “Allowance for Uncollectible Accounts”.

Sample problem:

• An aging analysis indicates that $25,000 of accounts receivable will become uncollectible.

• The current balance of the AUA account is $2,000 credit

Calculate the adjustment to the Allowance for Uncollectible Accounts, using the aging method.

$25,000 - $2,000 = $23,000

Explanation: A credit balance is positive in the AUA account, so you only have to adjust by 23k to reach your goal. If the account were a DEBIT, you would add instead of subtract; making the adjustment $27,000.

A debit balance in the allowance for uncollectible is a __ (negative or positive) balance, and indicates that:

negative; the account has been overdrawn with bad debts.

Maturity Value of a Note

Sample Problem:

• $10,000 Note

• 90 days to maturity

• 9% interest rate

Calculate the maturity value (pay-off) for this note.

1. $10,000 × 0.09 = $900 interest for 1 year

2. $900/365 = $2.466 daily interest

3. $2.466×90 = $221.92 interest for 90 days

4. 10,000 + $221.92 = $10,221.92 maturity value

OR

1. $10,000 × 0.09 / 365 × 90 = $221.92

2. $10,000 + $221.92 = $10,221.92

Maturity Date of a Note

Sample Problem:

• A note is made on July 27

• 90 days to maturity

What is the due date?

July 31-27 = 4 days
August +31
September +30
October +25 = 90
Due October 25th

Calculating Depreciation using the production depreciation method

Sample problem:

• $60,000 cost of vehicle

• 90,000 mile useful life

• $15,000 residual value

Using the production method, calculate depreciation for the current year if the vehicle was driven 10,000 miles this year.

1. $60k cost - $15k residual = $45k total depreciation

2. $45k / 90k miles = $0.50 decpreciation per mile

3. $0.50 × 10,000 miles = $5,000 dollar depreciation this year

Calculating Depreciation using the double-declining-balance depreciation method.

Sample problem:

• $28,000 cost of the truck

• 8-year useful life

• $4,000 residual value

Using double-declining method, calculate depreciation for year two.

Bonus: When is the residual value relevant for depreciation?

1. %200 / 8 = 25% per year

2. Year 1: $28,000 × 0.25 = $7,000 year one dep.
   $28,000 - $7000 = $21,000 year 1 carrying value

3. Year 2: $21,000 × 0.25 = $5,250 year 2 depreciation

Bonus: Only when calculating depreciation for the last year of the asset’s life.

Calculating Depreciation using the straight-line method.

Sample problem:

• $28,000 cost of the truck

• 8-year useful life

• $4,000 residual value

Using straight-line method, calculate depreciation expense for each year.

1. $28,000 cost - $4,000 residual = $24,000 total depreciation

2. $24,000 / 8 = $3,000 yearly depreciation

Calculating depreciation after a revision has been made.

Sample problem:

• $28,000 cost of truck

• 8-year useful life

• $4,000 residual value

• After 3 years of use, the useful life of the truck is increased by 2 years; no change in residual.

Use the Straight-line method to calculate the depreciation expense for year 4.

1. $28k cost - $4k residual = $24k total depreciation

2. $24k depreciation / 8 = $3,000 yearly depreciation

3. $3,000 x 3 years of use = $9,000 3-year depreciation

4. $28,000 cost - $9,000 = $19,000 carrying value year 3

5. $19,000 CV - $4,000 residual = $15,000 revised total depreciation

6. $15,000 / 7 years (5 remaining years + 2 additional) = $2,142 Yearly depreciation after year 3. Thus, the depreciation expense for year 4 is $2,142

Additions & betterments definition + what account they’re charged to

Upgrades to an asset; charged to the asset account

Extraordinary Repairs + what account they’re charged to

Major repairs that extend the life/value of an asset; charged to the asset’s accumulated depreciation account. (reduces accumulated depreciation and increases carrying value)

Ordinary repairs + what account they’re charged to

Routine maintenance; costs are expensed

1. What is the “initial cost” of an asset?

2. If the asset is land, would it include the cost of assets built on it?

1. All the costs necessary to prepare the asset for its intended use.

2. No. It only includes costs to prepare the land itself for building on it.

How to allocate the cost of a group purchase between the assets acquired.

Sample problem:

• $200,000 cost of restaurant

• $70,000 appraised value of the lot

• $150,000 appraised value of the building

• $30,000 appraised value of the equipment

How much of the amount paid for the restaurant should be charged to the building account?

1. $70k + $150k + $30k = $250,000 total appraised value

2. $200k / $250k = 80% cost to value ratio

3. $150k x 80% = $120,000

How to record the sale of an asset for an amount that is less than its carrying value:

Sample problem:

$100,000 cost of furniture

• $70,000 accumulated depreciation on furniture

• $15,000 amount recieved from sale of furniture

Prepare the journal entry for the sale of the furniture.

1. $100k cost - $70k accum dep. = $30,000 carrying value at sale

2. $15k sale - $30k carrying value = -$15k (loss)

3. Journal entry:
   Loss on sale of furniture $15,000
   Cash $15,000
   Accum. Depreciation $70,000
   …………………Furniture $100,000

How to record the sale of an asset for an amount that is more than its carrying value:

Sample problem:

• $100,000 cost of furniture

• $70,000 accumulated depreciation on furniture

• $35,000 amount recieved from sale of furniture

Prepare the journal entry for the sale of the furniture.

1. $100k cost - $70k accum dep. = $30k carrying value at sale

2. $35k sale - $30k carrying value = $5k gain on sale

3. Journal entry:
   Cash $35,000
   Accum. Dep. $70,000
   …………….Furniture $100,000
   …………… Gain on sale $5,000

How to calculate & account for warranty expense and warranty liability.

Sample problem:

• 1,000 widgets sold this month

• 4% will fail & be replaced under full warranty

• $30 cost to make a widget

• 50 widgets replaced this month (most probably sold in prior months)

1. Calculate and record warranty expense for this period

2. Prepare a journal entry for the 50 units replaced under warranty in the current month

1. 1000 widgets sold x 4% failure rate = 40 widgets this month will fail
   40 failed x $30 cost to make = $1,200 cost to replace the failed widgets
   

   Warranty Expense $1,200
   ……….Estimated Warranty Liability $1,200
   
   (In this instance, we are predicting that $1,200 worth of product will need to be replaced, so we are adding to the contra account “budget” and recording it as an expense)

2. 50 units x $30 cost to make = $1,500
   
   Estimated Warranty Liability $1,500
   …………………..Inventory $1,500
   
   ($1,500 of inventory would be used to pay the warranty liability account down)

Which interest table do you use when you’re trying to find what must be invested today to have certain cash flows in the future?

Example: “What would I have to invest today to get $1,000 in 5 years?”

Present Value

Which interest table do you use when you’re trying to to find the amount that an investment will grow to in the future.

Example: “What will monthly deposits of $100 accumulate to in 5 years?”

Future Value

When working with bonds, what must you do before finding your present value factors if the interest is compounded semiannually?

Divide the interest rate by 2 and the term of the bond (years) by 2. DR. MY

How to calculate interest expense on bond indebtedness.

Sample problem:

• $400,000 bond issue (final payment of principal)

• $425,678 present value of bonds (amount for which the bonds were issued—the amount borrowed by the corporation)

• 4% market interest rate, compounded semi-annually

What is the interest expense for the first 6 months?

$425,678 x (4% / 2) = $8513.56

(Note: Interest is calculated on the amount borrowed and not the final principal payment made at the end. The rate must be divided in half because it’s semiannual.)

How to calculate the updated carrying value of bond indebtedness.

Sample problem:

• $40,000 bond issue semi-annual payments

• $37,800 accrued bond interest expense for the first 6 months

By how much will the carrying value of the bonds change once the payment is made? Will the carrying value decrease or increase?

1. $40,000 payments - $37,800 accured expense = $2,200.
   
   Carrying Value of the bonds will DECREASE by $2,200 because payment exceeds interest expense for the period.

Stock Issue facts:

1. How is legal capital recorded in a journal entry?

2. What is the legal capital of stock if there is no par value / stated value?

3. What is the legal capital stock if there is a stated value / par value?

4. If the shares have a par or stated value, what is the excess received from the sale of the shares above the Par / Stated value recorded as?

Sample problem:

5. If 100 shares of $10 par value stock were issued for $50 each, what would be the journal entry to record it?

1. In the “Common Stock” account.

2. The amount for which the stock is issued (the amount stockholders pay for the shares)

3. The legal capital is the par or stated value.

4. Additional Paid-in Capital

5. Cash $5,000
   ……Common Stock $1,000
   ……Additional Paid-in Capital $5,000

If a new corporation—that has never before issued any stock—issues some shares in exchange for an asset other than cash (like land or equipment), what dollar amount should be used to record the transaction?

The fair market value of the asset recieved by the company.

1. What happens to the par value if it is split?

2. T/F The split changes the company’s legal capital

1. Reduces proportionately.
   (Example: 100,000 shares of stock with a $4 par value split 2-to-1 would become 200,000 shares with a par value of $2 each.)

2. False (refer to the example above, they’re both equal)

How to record the reissuance of treasury shares previously acquired by a company:

Sample Problem:

• The company has 1,000 shares of stock in treasury that they paid $75 each for.

• The company wants to sell (reissue) the shares for $80 each.

Prepare the journal entry if the shares are reissued.

$80 selling price - $75 cost = $5 extra capital gained from the sale of each share
$5 × 1000 shares = $5,000 total extra capital gained from the sale, recorded as “Paid-in Capital, Treasury Stock”

Cash ($80 selling price x 1,000 Shares) $80,000
……….Treasury Stock ($75 cost x 1,000 shares) $75,000
……….Paid in Capital, Treasury Stock ($5 × 1000) $5,000

How to calculate the weighted average number of shares outstanding for the year for earnings per share calculations.

Sample problem:

• The company has 90,000 shares of stock outstanding 1/1/10

• 4,000 new shares were issued on 6/1/10

• 15,000 Treasury shares were bought back from the shareholders on 10/1

Compute the average number of shares outstanding for the year for earnings per share calculations (round to the nearest whole share).

90,000 shares outstanding x 5 months = 450,000
94,000 shares outstanding x 4 months = 376,000
(90,000 outstanding + 4,000 new shares)
79,000 shares outstanding x 3 months = 237,000
(94,000 outstanding - 15,000 bought back)
Total: 1,063,000 shares for all 12 months

1,063,000 / 12 = 88,583 average number of outstanding shares

Determine all of the following as either an Operating Activity, Investing Activity, or a Financing Activity.

1. Cash paid for any investment asset or received from its sale

2. Cash purchases of inventory

3. Treasury stock transactions

4. Cash from customers

5. Notes receivable transactions

6. Dividend payments

7. Cash payments for taxes

8. Cash paid for Long Term assets or received from their sale

9. Cash payments of operating expenses

10. Long term debt transactions (borrowing and repayment)

11. Sale of new shares of stock

1. Investing

2. Operating

3. Financing

4. Operating

5. Investing

6. Financing

7. Operating

8. Investing

9. Operating

10. Financing

11. Financing

Basic Journal Entries Practice: Record the journal entries for the transactions below.

• Sept 1: Janie began the business by depositing $5,000 in a bank account in the name of the business in exchange for 5,000 shares of $1 par value stock.

• Sept 2: Janie rented office space for $700 per month. She put one month’s rent down as a deposit and paid rent for 4 months.

• Sept 3: Janie purchased a one-year liability insurance policy for $480 cash to protect her business against property damage when cleaning.

• Sept 3: Janie purchased $1,000 of cleaning supplies on credit from Wallis Company.

• Sept 1: debit Cash $5000 / credit Common Stock $5000

• Sept 2: debit Deposits $700, Prepaid Rent $2,800 / credit Cash $3,500

• Sept 3: Prepaid Insurance $480 / Cash $480

• Spet 3: Cleaning supplies $1,000 / Accounts Payable (wallis) $1,000

Basic Journal Entries Practice: Record the journal entries for the transactions below.

• Sept 6: Janie completed her first cleaning job and was paid $800 for cleaning an office building.

• Sept 10: Janie agreed to hire two employees to help her at $12 per hour each

• Sept 12: Janie completed her second cleaning job and charged $950 to the account of her client, Johnson Company.

• Sept 14: Janie borrowed $3,000 from the state bank on a note so that she could purchase new equipment

• Sept 6: Cash $800 / Cleaning Revenue $800

• Sept 10: No entry

• Sept 12: Accounts Receivable (Johnson) $900 / Cleaning Revenue $900

• Sept 14: Cash $3,000 / Notes Payable (state bank) $3,000

Basic Journal Entries Practice: Record the journal entries for the transactions below.

• Sept 15: Janie purchased 2 professional HEPA vacuum cleaners with cash for $1500 each.

• Sept 16: Janie was paid $3,500 in advance to clean Aspect Co’s offices through the end of the year; the advance will be considered to be earned evenly over the 3 ½ period.

• Sept 18: Janie’s assistants completed a large cleaning job for Baines Company and Janie charged $1,200 to Baines account

• Sept 19: Janie received a payment of $950 from Johnson Company on Account

• Equipment $3,000 / Cash $3,000

• Cash $3,500 / Unearned Revenue $3,500

• Accounts Receivable (Baines) $1,200 / Cleaning Revenue $1,200

• Cash $950 / Accounts Receivable $950 (Johnson)

Basic Journal Entries Practice: Record the journal entries for the transactions below.

• Sept 20: Janie made a payment of $750 on the supplies she purchased from Wallis Company on credit on Sept 3

• Sept 22: Janie paid her assistants each $300 for their work on the Baines Company job.

• Sept 24: Janie’s assistants completed another large cleaning job, this time for Fossil Company, and Janie charged $1,500 to Fossil’s account.

• Sept 26: Janie received a $1,000 payment from Baines Company on account.

• Sept 20: Accounts payable (Wallis) $750 / Cash $750

• Sept 22: Wages Expense $300 / Cash $300

• Sept 24: Accounts Receivable (Fossil) $1,500 / Cleaning Revenue $1,500

• Sept 26: Cash $1,000 / Accounts Receivable $1,000

Basic Journal Entries Practice: Record the journal entries for the transactions below.

• Sept 29: Janie reimbursed her assistants $25 each for gas they used in driving to cleaning jobs.

• Sept 30: Janie paid her assistants each $350 for their work on the Fossil Company job.

• Sept 30: Janie declared and paid herself a dividend of $2,000

• Sept 29: Gas Expense $25 / Cash $25

• Sept 30: Wages Expense $350 / Cash $350

• Sept 30: Dividend $2,000 / Cash $2,000