Accounting

What is accounting?

The process of identifying measuring recording aggregating and communicating economic activity

What is financial accounting?

Accounting for external users such as investors lenders creditors suppliers employees and other stakeholders

What is managerial accounting?

Accounting for internal users to support planning control pricing budgeting and decision making

What is tax accounting?

Accounting prepared under tax law for tax authorities

Why do firms issue public financial reports?

To help outsiders make trust based resource allocation decisions

Who are key users of financial accounting?

Investors lenders creditors suppliers employees customers government and society

What makes financial information useful?

It should be relevant faithfully represented comparable verifiable timely and understandable

Why should financial statements not be trusted blindly?

Because many figures use estimates management has incentives to bias results reporting can be used as marketing and audits are not perfect

What is the accounting equation?

Assets equals Liabilities plus Owners Equity

What does Owners Equity represent?

The residual claim left for owners after liabilities are subtracted from assets

What is the balance sheet?

A snapshot of what is owned what is owed and what is left for owners at a date

What is the income statement?

A flow statement showing revenue expenses and net income over a period

What is the cash flow statement?

A flow statement showing why and how cash changed over a period

Which statement is a stock statement?

The balance sheet

Which statements are flow statements?

The income statement and the cash flow statement

What are current assets?

Short term assets expected to be used or turned into cash within one operating cycle usually one year

Give examples of current assets

Cash inventory accounts receivable prepaid expenses

What are non current assets?

Long lived assets used over multiple periods

Give examples of non current assets

Property plant and equipment goodwill and some intangibles

What are current liabilities?

Short term obligations due within one operating cycle

Give examples of current liabilities

Accounts payable salaries payable interest payable

What are non current liabilities?

Long term obligations due after the current operating cycle

Give examples of non current liabilities

Bank loans bonds payable long term notes payable

What is liquidity?

The ability of a firm to meet liabilities as they become due

What is working capital?

Current Assets minus Current Liabilities

What is the current ratio?

Current Assets divided by Current Liabilities

What is revenue?

The inflow earned from selling goods or providing services

What is net income?

Revenue minus expenses for the period

Why is revenue not the same as income?

Because revenue is top line sales while income is what remains after expenses are subtracted

What is gross margin?

Sales Revenue minus Cost of Goods Sold

What is operating income?

Gross Margin minus operating expenses

What is EBIT?

Earnings before interest and taxes

What is net income formula?

Revenue minus Expenses equals Net Income

Why does profit quality matter?

Because equal net income can come from recurring operations or one off gains and those imply different business health

How are the income statement and balance sheet linked?

Net income flows into retained earnings within owners equity

What is retained earnings?

Accumulated profits kept in the business after subtracting dividends

What is the retained earnings equation?

Ending Retained Earnings equals Beginning Retained Earnings plus Net Income minus Dividends

Are dividends expenses?

No dividends are distributions to owners after profit is measured

How do dividends affect the statements?

They reduce cash and equity but do not reduce net income

What is double entry bookkeeping?

A system where every transaction has at least two balancing effects and the accounting equation still holds after each transaction

What is a T account?

A simple ledger format with debits on the left and credits on the right

For all T accounts where are debits and credits?

Debits are always on the left and credits are always on the right

How do assets behave under debits and credits?

Assets increase with debits and decrease with credits

How do expenses behave under debits and credits?

Expenses increase with debits and decrease with credits

How do liabilities behave under debits and credits?

Liabilities increase with credits and decrease with debits

How does equity behave under debits and credits?

Equity increases with credits and decreases with debits

How does revenue behave under debits and credits?

Revenue increases with credits and decreases with debits

How do dividends behave under debits and credits?

Dividends increase with debits and decrease with credits

Journal entry for owner investing cash?

Debit Cash and credit Capital

Journal entry for buying inventory with cash?

Debit Inventory and credit Cash

Journal entry for buying a long lived asset with cash?

Debit PPandE and credit Cash

Journal entry for paying wages in cash?

Debit Salary Expense and credit Cash

What are the two entries for a cash sale of inventory?

Debit Cash and credit Sales Revenue then debit COGS and credit Inventory

What are the two entries for a credit sale of inventory?

Debit Accounts Receivable and credit Sales Revenue then debit COGS and credit Inventory

Why is buying inventory not an expense immediately?

Because the cash is converted into an asset and the expense is recognised later when the inventory is sold

Why is buying equipment not an immediate expense?

Because cash is converted into a long lived asset and the cost is allocated over time

What is cash accounting?

Recording revenue when cash is received and expenses when cash is paid

What is accrual accounting?

Recording revenue when earned and expenses when incurred regardless of cash timing

Which better represents firm performance cash or accrual accounting?

Accrual accounting

Why is accrual accounting better for performance measurement?

Because it matches revenues with the expenses incurred to generate them and avoids cash timing distortions

What is the matching principle?

When revenue is recognised the costs necessary to generate that revenue should be recognised in the same period

What is an adjusting entry?

A period end entry used to ensure revenues and expenses are reported in the correct accounting period

What is a prepaid asset?

Cash paid in advance for future benefit that is initially recorded as an asset

Give examples of prepaid assets

Insurance rent advertising maintenance contracts

Adjustment for a prepaid asset as it is used?

Debit Expense and credit the Prepaid Asset

What is unearned or deferred revenue?

Cash received before goods or services are delivered so it is initially a liability

Adjustment for unearned revenue when earned?

Debit Deferred Revenue and credit Revenue

What is depreciation?

Allocation of the cost of a long lived asset over its expected useful life

What is the basic depreciation entry?

Debit Depreciation Expense and credit Accumulated Depreciation

Is depreciation a cash expense in the period recorded?

No it reduces income without using current period cash

What is accumulated depreciation?

A contra asset that reduces the net carrying amount of PPandE

What is an accrued revenue?

Revenue earned but not yet received in cash

Entry for accrued revenue?

Debit Receivable and credit Revenue

What is an accrued expense?

Expense incurred but not yet paid in cash

Entry for accrued expense?

Debit Expense and credit Payable

What is revenue recognition?

The rule that revenue is recognised when a performance obligation is satisfied

What is a performance obligation?

A promised good or service that the company owes the customer under a contract

Can cash received before delivery be recognised as revenue immediately?

No it is usually recorded as deferred revenue until performance occurs

Concert ticket sold before the show what is recorded?

Debit Cash and credit Deferred Revenue

After the concert happens what is recorded?

Debit Deferred Revenue and credit Revenue

Why is deferred revenue a liability?

Because the company still owes the customer a good service or refund

What is a bundled product in revenue recognition?

A sale containing more than one promised good or service such as a phone plus updates or support

How do you account for a bundle?

Identify each performance obligation determine the transaction price allocate it using standalone selling prices and recognise each part when satisfied

What part of a phone plus future updates bundle is recognised immediately?

The phone portion if the phone is delivered now

What part of a phone plus updates bundle stays deferred?

The updates or support portion until delivered over time

What is a standalone selling price?

The price at which a good or service would be sold separately

Why is revenue recognition a major fraud risk?

Because managers can accelerate or delay revenue or bias bundle allocations returns and estimates to hit targets

How are expected sales returns handled?

Recognise revenue net of expected returns and create a returns liability

What is the returns liability?

A liability for expected refunds on sales likely to be returned

What is the return inventory asset?

An asset for the expected cost of goods likely to come back from customers

What is Accounts Receivable?

An asset representing amounts owed by customers for credit sales already delivered

Why is Accounts Receivable an asset?

Because it is a claim to future cash

Basic credit sale entry for service or goods delivered?

Debit Accounts Receivable and credit Revenue

When cash is later collected from a receivable what is the entry?

Debit Cash and credit Accounts Receivable

A R T account formula?

Beginning A R plus credit sales minus cash collections minus write offs equals ending gross A R

What is a contra account?

A deduction account linked to another account that moves in the opposite direction

What is AFDA?

Allowance for Doubtful Accounts which is the contra asset linked to Accounts Receivable

Why do firms use AFDA?

To show that not all gross receivables are expected to be collected

What is the net receivables formula?

Net A R equals Gross A R minus AFDA

What is bad debt expense?

The estimated credit loss recognised on the income statement for receivables likely to default