Introduction to Financial Accounting and Business Transactions

What do investors decide regarding companies?

Whether to invest in stock.

What is the role of creditors in business decisions?

They decide whether to lend money.

What do customers decide about products?

Whether to purchase products.

What is the primary function of financial accounting?

To provide information to external users.

What are the two main functions of financial accounting?

Measure and communicate.

What are financing activities in business?

Transactions the company has with investors and creditors, such as issuing stock or borrowing money.

Define investing activities.

Transactions involving the purchase and sale of long-term assets.

What are operating activities?

Transactions that relate to the primary operations of the company, like rent and salaries.

What is a corporation?

A company that is legally separate from its owners.

What is a sole proprietorship?

A business owned by one person.

What is a partnership?

A business owned by two or more people.

What is the accounting equation?

Assets = Liabilities + Stockholders' Equity.

What are revenues?

Amounts recognized when the company sells products or services.

Define expenses in financial accounting.

Costs of providing products and services during the current period.

What is net income?

The difference between revenues and expenses.

What are dividends?

Cash payments to stockholders that are not considered expenses.

What are the four main financial statements?

Income Statement, Statement of Stockholders' Equity, Balance Sheet, Statement of Cash Flows.

What does the income statement report?

Revenues and expenses over a period of time.

What does the Statement of Shareholders' Equity summarize?

The change in stockholders' equity over an interval of time.

What does the balance sheet present?

The financial position of the company at a particular date.

What does the Statement of Cash Flows measure?

Activities involving cash receipts and cash payments over an interval of time.

What is GAAP?

Generally Accepted Accounting Principles.

Who establishes GAAP in the United States?

The Financial Accounting Standards Board (FASB).

What is the role of auditors in financial accounting?

To ensure that management has applied GAAP in preparing financial statements.

What is the first step in measuring external transactions?

Use source documents to identify accounts affected by the transaction.

What is a trial balance?

A list of all accounts and their balances at a particular date.

What is the difference between external and internal transactions?

External transactions involve exchanges with other entities, while internal transactions affect the company's financial position without such exchanges.

What is the purpose of posting to the general ledger?

To transfer debit and credit information from the journal to individual general ledger accounts.

What is the first step in the accounting cycle during the year?

A company records and posts external transactions.

What is the purpose of adjusting entries?

To update balances of assets and liabilities at the end of the period.

What is the primary difference between cash basis and accrual basis accounting?

The timing of when revenues and expenses are recorded.

Is cash basis accounting part of GAAP?

No, cash basis accounting is NOT part of GAAP.

What are prepaid expenses?

Expenses that arise when a company pays cash to acquire an asset not used until a later period.

What journal entry is needed when recognizing deferred revenues?

A journal entry is needed to record the liability and recognize the revenue once services are performed.

What are accrued expenses?

Costs that have been incurred in the current period but have not yet been paid.

What is an adjusted trial balance?

A list of all accounts and their balances at a particular date after updating for adjusting entries.

What is the purpose of closing entries?

To transfer temporary accounts (revenues, expenses, dividends) to Retained Earnings and reset them to $0.

What is depreciation?

The process of spreading the cost of a long-term asset across its period of use.

What is the formula for straight-line depreciation?

(Cost − Residual Value) ÷ Useful Life.

What is the fraud triangle?

A model that explains the three elements that lead to fraud: opportunity, pressure, and rationalization.

What does the Sarbanes-Oxley Act (SOX) aim to improve?

The accuracy and reliability of accounting information and internal control procedures.

What are internal controls?

Procedures implemented to safeguard company assets and ensure the accuracy of financial reporting.

What scandal led to the creation of the Sarbanes-Oxley Act?

The Enron scandal, where auditors did not report significant debt and losses.

What is the role of top executives in internal controls according to SOX?

Top executives must take final responsibility for the operations and internal control procedures.

What is a control environment?

Management's attitudes and actions that affect the overall control environment.

What is the purpose of risk assessment in internal controls?

To identify and consider internal and external risks to the organization.

What is the significance of monitoring in internal controls?

Internal controls should be checked continuously to ensure effectiveness.

What is an example of a preventative control?

Separation of duties to prevent fraud by ensuring no single employee has control over all aspects of a transaction.

What is the purpose of proper authorization in internal controls?

To prevent improper use of company resources.

What are e-commerce controls designed to do?

Ensure that only authorized personnel can conduct e-commerce transactions.

What happens to temporary accounts at the end of the accounting period?

They are reset to $0 after being transferred to Retained Earnings.

What is accumulated depreciation?

A contra-asset account that reduces an asset's book value.

What is the book value of an asset?

The cost of the asset minus accumulated depreciation.

What is the role of adjusting entries in accrual accounting?

To account for cash flows or obligations that occur before or after the related revenue or expense activity.

What are detective controls in management?

Controls that help identify errors or irregularities after they occur, such as reconciliations and audits.

What is a bank reconciliation?

A process to ensure that the amounts of physical assets agree with accounting records.

What is the purpose of performance reviews in internal controls?

To check actual performance against expected performance.

What is a limitation of internal control?

Financial misstatements can still occur due to collusion or override by top-level employees.

What does cash include?

Coins, currency, checks received, balances in savings & checking accounts, and credit/debit card sales.

What are cash equivalents?

Investments that mature within 3 months from the date of purchase, such as money market funds and certificates of deposit.

What are the controls over cash receipts?

Open mail daily, prepare a list of cash & checks received, and designate separate employees for receiving and recording cash.

What is the purpose of using checks for cash disbursements?

To ensure all disbursements are authorized and properly documented.

What is a petty cash fund?

A small amount of cash kept on hand for minor purchases.

What is a sales return?

When a customer returns goods previously purchased, resulting in a reduction of accounts receivable.

What is a sales allowance?

A reduction in the amount owed by a customer without returning the goods.

What does a sales discount represent?

A reduction in the amount to be received from a credit customer if payment is made within a specified period.

How is net revenue calculated?

Net Revenues = Total Revenue - (Returns + Allowances + Discounts).

What is the allowance for uncollectible accounts?

A contra-asset account that reduces accounts receivable to reflect estimated uncollectible amounts.

What is the journal entry for writing off an account receivable?

Debit Allowance for Uncollectible Accounts and credit Accounts Receivable.

What happens if a customer pays after their account has been written off?

Reverse the write-off and record the cash received.

What is the percentage of receivables method?

A method that estimates bad debts as a percentage of accounts receivable.

What is the aging method for estimating uncollectible accounts?

A method that estimates bad debts based on the age of each accounts receivable account.

What is recorded when a note receivable is signed?

The note receivable is recorded at its face value, with no interest recorded initially.

What is the journal entry when a note receivable is collected with interest?

Debit Cash, credit Note Receivable, and credit Interest Revenue.

What is the effect of sales discounts on financial statements?

Sales discounts decrease net revenue and net income.

What is the role of auditors in internal control?

To assess the effectiveness of internal control procedures.

What should be done with checks to ensure proper control?

Ensure checks are numbered, signed off by an executive, and that expenditures are authorized before purchase.

What is the significance of having a separate employee review receipts?

To maintain checks and balances in the accounting process.

What is the impact of trade discounts on revenue recognition?

Trade discounts reduce the list price but are not recorded in net revenue calculations.

What is the accounting treatment for sales returns?

Sales returns are recorded by debiting Sales Returns and crediting Accounts Receivable.

What is the purpose of setting maximum purchase limits on debit and credit cards?

To control spending and prevent unauthorized purchases.

What is the impact of collusion on internal controls?

Collusion can undermine internal controls, allowing fraud to occur.