MGMT 350 Purdue Exam 1 Review

Purpose of Financial Accounting

To identify, measure, and communicate financial info to various external users (creditors, Gov. Agencies, unions, stock investors)

Purpose of Mangerial Accounting

Identifying, measuring, analyzing, and communicating financial info needed by management to plan, evaluate, and control an organization's operations.

4 big financial statements

1) balance sheet

2) income statement

3) statement of cash flows

4)statement of stockholder's equity

GAAP (generally accepted accounting principles)

The standard and rules that accountants follow while recording and reporting financial activities

SEC ( securities and exchange commission)

An independent federal agency that overses the exchange of securities to protect investors. Requires all public companies to follow GAAP and has oversight and enforcement authority.

FASB (Financial accounting standards board)

Private board that establishes the general accepted accounting principles used in the practice of financial accounting.

Type of SEC filings:

10-k= annual report

10-q= Quarterly report

8-k= Interim report which announces any changes (business deals, CEO/CFO leaves, SEC launches an investigation, shutting down a factory, layoffs, bankruptcy, changes between the 10-Qs)

What are corps whose securities are listen on the US stock exchange required to do?

File audited financial statements w/ the SEC

Financial accounting standard-setting in US is a _____ process, which reflects _______ actions of various interested ___________ as well as a product of _______ & _______

Social

Political

User Groups

Research

Logic

Cash Basis Accounting

Records revenues when cash is received and expenses when cash is paid

Accrual Basis accounting

method of accounting that recognizes revenue when it is earning and matches expenses to the revenues they help produced

Overview of Conceptual Framework:

First level: Basic objectives

Second level: Qualitative characteristics and elements

Third level: recognition, measurement, and disclosure concepts

First level

Basic objectives

the "why" purpose of accounting

Contains: Objective of financial reporting

- Useful in investment and credit decisions

-Useful in investment and credit decisions-

-Useful in assessing enterprise resources

Second level

Qualitative characteristics and elements

Third level

Recognition, measurement, and disclosure

the "how" implementation

Contains: assumptions, principles, and constraints

What are the 2 fundamental qualities that define usefulness of financial statements for decision makers?

Relevance: Predictive value, confirmatory value, and materiality

Faithful Representation: Completeness, neutrality, free from error

Predictive Value

Info has value as an input to predictive processes used by investors or creditors to form their own expectations

Confirmatory Value

Helps users confirm/ correct prior expectations

Materiality

Info is matieral if omitting it or mistating it could influence a user's decision (materiality is determined on a company-by-company basis based on the nature and/or magnitude of items)

Completeness

All info that is necessary for faithful representation is provided

Neutrality

A company cant select info to favor on set of interested parties over another; ignores the economic consequences of a standard rule

Free from Error

There are no errors and inaccuracies in the description of the phenomenon and no errors made in the process by which the financial information was produced (no inaccuracies or omissions)

4 Important assumptions in accounting

Economic entity, Going concern, Monetary unit, and Periodicity

Economic Entity

Company keeps its activity seperate from its owners and other businesses

Going concern

Company to last long enough to fulfill objectives and commitments

Monetary unit

Money is the common denominator

Periodicity

Company can divide its economic activities into time periods

4 enhancing qualities that bind relevance and faithfulness together

Comparability, verifiability, timeliness, understandability

Comparability

info measured and reported in a similar manner for different companies over different years.

Verifiability

occurs when independent measurers, using the same methods, and obtain similar results

Timeliness

having info sent to decision makers before it loses its capacity to influence decisions

Understandability

Quality of information that lets reasonably informed users see its significance

What elements measure a point-in-time?

Assets, Liabilities, and Equity

What elements measure a period-of-time?

Investment by owners, distribution to owners, comprehensive income, revenue, expenses, gains, losses

Most commonly used measurements are based on ____ & _____

Historical costs; fair value

Fair Value

The price that would be recieved to sell an asset or paid to transfer liability in an orderly transaction between market participants at the measurement date.

Revenue Recognition Principle

Record revenue in the period in which its earned

Expense recognition principle

Match expenses with revenues in the period when the company makes the efforts to generate those revenues.

Full disclosure principle

Accounting principle that dictates that companies disclose circumstances and events that make a difference to financial statement users

Cost Constraint

Cost of providing info must be weighed against the benefits that can be derived from using it

Asset Normal Balance

Debit

Liability Normal Balance

Credit

Equity normal balance

Credit

Revenue normal balance

Credit

Expenses normal balance

Debit

Dividends normal balance

Debit

Accounting Equation

Assets= Liabilities+Equity

2 Parts of Equity

paid-in capital and retained earnings

Retained earnings

Revenues +, Gains +

Expenses -, losses -, and Dividends -

External Transactions

Transactions the firm conducts with a separate economic entity

Internal transactions

Activities within an organization that can affect the accounting equation

Order of the Accounting Cycle

Journalize transactions into the journal,

journalize and post the adjusting entries,

prepare the adjusted trial balance,

prepare the financial statements,

journalize and post closing entries,

prepare post-closing trial balance.

General Journal

The chronological accounting record of the transactions of a business

Posting

The procedure of transferring journal entry amounts to the ledger accounts

Trial Balance

A list of accounts and their balances at a given time; used to prove equality of debit and credit balances

Adjusting Entries

Journal entries that bring accounts up to date at the end of the accounting period

Revenues: Recorded in the period they are earned

Expenses: Recognized in the period in which they are incurred.

Adjusting Entries: needed to ensure that the revenue recognition and matching principles are followed

Class of adjusting entries

Prepayments/ deferrals vs accurals

Prepayment/ Deferrals

Prepaid expenses (debit) = expenses paid in cash and recorded as assets before they are used or consumed

Unearned revenues (debit)= revenues recieved in cash and recorded as liabilities before they are earned

Accruals

Accrued revenues (credit) = revenues earned but not yet recieved in cash or recorded

Accrued expenses (credit)= expenses incurred but not yet paid in cash or recorded .

Adjusting entry for prepaid expenses

debit to an expense account and a credit to an asset account

Adjusting entry- Debit prepaid insurance, credit cash

Debit insurance expense and credit prepaid insurance

Adjusting Entry: Debit supplies, Credit Cash

Debit supplies expense, Credit supplies

Adjusting entry: debit equipment, credit cash

Debit depciation expense and credit accumulated depreciation

Adjustment for unearned/deferred revenue

Debit unearned rev and credit rent revenue

Adjusting entry: debit cash, credit unearned rent revenue

debit unearned rent revenue and credit rent revenue

Debit cash and credit unearned subscriber revenue

debit unearned subscriber revenue and credit subscriber rev

Debit cash, credit unearned service revenue

debit unearned service revenue and credit service revenue

Adjustment for accrued expenses

debit liability account, credit cash

Debit wage, creit wages payable

Debit wages payable and credit cash

Debit interest expense and credit interest payable

debit interest payable and credit cash

Debit interest expense and credit income tax payable

debit income taxes payable and credit cash

Adjustment for accrued revenues

Increase assets and increase revenues

Adjusting entry: debit accounts recievable and create service rev

Debit cash and credit A/R

Debit interest recievable and credit interest revenue

debit cash and credit interest recievable

Chage in assets=

Change in liabilities + change in equity

Change in retained earning:

net income- dividends

Closing Entries

A journal entry made at the end of the accounting cycle

Involves shifting data from temp accounts on the income statement to perm accounts on the balance sheet.

Temp accounts: revenues, expenses, and dividends

(these accounts must be closed at the end of the accounting year)

Examples) closing revenues to income summary, closing expenses to income summary, closing income summary to retained earnings, and closing dividends to retained earnings

Examples of closing entires for temp accounts continued:

Revenue accounts: since rev accounts have a normal credit balance, they must be debited to close them out

Expense accounts: expense accounts are closed out by crediting the expense

Income Summary Account: if a company's revenues are greater than its expenses, the income summary account is debited and retained earning is credited. If the company has a loss, the income summary account is credited and retained earnings are debited.

Current Ratio

FInancial ratio that measures a company's ability to pay short-term debt

Formula: current assets/ current liabilities

a current ratio more than 1 Indicates that a company is financially healthy and has room to spare to pay off its debts. A ratio of 1 mean that a company can pay off its debts, while a ratio below 1 means a company is falling short.

Acid-test Ratio

Compares a company's most recent short-term assets to its most recent short-term liabilties, such as short-term debt.

Disregards current assets that are more difficult to liquidate quickly, such as INVENTORY.

Formula: (cash & equivalents + Accounts Recievables)/ Current liabiltiies

or

(cash + short term investments + current recievables - inventory - prepaid expenses)/ current liabilties

Accumlated Other Comprehensive Income (AOCI)

Component of a company's equity that includes all other comprehensive income from the current or previous period.

These are special gains and losses that are listed as special items in the shareholder equity of a company's balance sheet.

=balance of preceding period's of AOCI + Current period's other comprehnsive income

Earnings per share

= Net income of the company/ Average outstanding shares of the company

or

(net income- pref dividend)/ shares outstanding

Which assumption indicates that the company will last long enough to fulfll its objectives and commitments?

a) going concern

b) economic entity

c) periodicity

d) monetary unity

e) historical cost

answer: A) going concern

Which of the following is an ingredient of faithful representation?

a) confirmatory value

b) verifiability

c) neutrality

d) materiality

e) comparability

answer: C) Neutrality

Which of the following could not be an example of adjusting entry?

a) recording depreciating expense

b) recording the collection of cash from a customer

c)recording salary expense

d)recording the use of pre-paid rent

e)all of these could be adjusting entries

answer: B) recording the collection of cash from a customer

(paying cash is a transaction, not an adjusting entry.)

Which of the following could be part of closing entries?

a) Debit income summary, credit prepaid rent

b) debit rent expense, credit income summary

c) debit income summary, credit rent expense

d) debit rent expense, credit prepaid rent

e) debit prepaid rent, credit rent expense

answer: C

Which of the following is not a nominal (temp) account?

a) rent expense

b) salaries expense

c) sales revenue

d) deferred revenue

e) all of the above

answer: D) Deferred Revenue

(deferred revenue is a liability)

Which of the following statements is CORRECT?

a) profits from discontinued operations are reported after-tax on the income statement

b)unusual gains and losses are reported after-tax on the income statement

c)If managers revise their estimate about an asset's useful life, then they will retrospectively adjust prior financials

d) Intangible assets are classified as current assets on the balance sheet.

e) none of the above are correct

answer) A

Which of these statement about the immediate effect of a transaction on ratios is accurate?

a) using cash to purchase a short-term investment would decrease a firm's acid-test ratio

b) using cash to purchase a short-term investment would decrease a firm's current ratio

c) using cash to prepay for rent that would be used over the next 6 months would decrease a firm's acid-test ratio

d) using cash to prepay for rent that would be used over the next 6 months would decrease a firm's current ratio

e) none of these statement are accurate

answer: C

(because the firms liquid assets decrease (due to the reduction in cash) the numerator of the acid-test ratio decrease, as a result, the ratio decreases .

Gravity Falls reports the following information for 2018:

Sales Revenue: $20,000

COGS: $10,000

Operating Expense: $7,000

Loss on the sale of Equipment: $1000

Unrealized holding loss on avail-for-sale debit securities for 2018: $21,000

Declared and paid a cash dividend of $5,000 in 2018.

Gravity Falls has Jan 1. 2018 balances in common stock of $100,000, accumulated other comprehnesive income of $40,000, retained earnings of $30,000. It issued no stock during 2018.

What is the ending balance of Accumulated Other Comprehensive Income on 12/31/2018?

a) 27,000

b) 25,000

c) 23,000

d) 21,000

e) 19,000

answer: e) 19,000

(40,000-21,000)

Table/ Data for Jan 31, 2022

Debit Credit

Supplies 50000

Prepaid Insurance 24000

Salaries/wages Payable 60000

Unearned Service Rev 20000

Supplies Expense 15000

Salaries/WagesExpense 35000

Insurance expense 80000

Service Rev 80000

Assume 57000 was recieved in Jan for serviced performed in Jan. What was the balance in Uneared Service Revenue at Dec 31, 2021?

a) 41000

b) 43000

C) 45000

D) 47000

E) 49000

Answer: B) 43000

=(80,000-57000)+20000

=43000

Table/ Data for Jan 31, 2022

Debit Credit

Supplies 50000

Prepaid Insurance 24000

Salaries/wages Payable 60000

Unearned Service Rev 20000

Supplies Expense 15000

Salaries/WagesExpense 35000

Insurance expense 80000

Service Rev 80000

If 23000 of salaries was paid in Jan, what was the balance in Salaries and wages payable at Dec 31, 2021?

a) 48000

b) 46000

c) 44000

d) 42000

e) 40000

answer: a) 48000

(35000-23000) = 12000

(60000-12000)=48000

Table/ Data for Jan 31, 2022

Debit Credit

Supplies 50000

Prepaid Insurance 24000

Salaries/wages Payable 60000

Unearned Service Rev 20000

Supplies Expense 15000

Salaries/WagesExpense 35000

Insurance expense 80000

Service Rev 80000

If the amount in Insurance Expense is the Jan 31 adjusting entry, when does the policy expire?

a) July 31, 2022

b) june 30, 2022

c) may 31, 2022

d) April 30, 2022

e) march 31, 2022

answer: d) april 30, 2022

(Prepid insurance: 24,000; adjusted entry insurance exp for jan 31: 8000; 24000/8000= 3 months)

The stockholders' equity section of ABC corp appears below as of Dec 31, 2017.

-5% preferred stock, $40 per value, authorized 100,000 shares, outstanding 70,000 shares: 2,800,000

-Common stock, $1 par, authorized 4 mil shares: 4,000,000

-Additional paid-in-capital: $8,200,000

- Retained earnings (includes 2017 net income of 8,500,000: 40,000,000

Net income for 2017 reflects a total effective tax rate of 20%. Including in the net income figure is a loss of $500,000 (before tax) as a result of non-recurring major casualty. Preferred stock dividends of 140,000 were declared and paid in 2017. Dividends of 420,000 were declared and paid to common stockholders 2017.

Calculate earnings per share for 2017 (round to nearest cent)

a) EPS: $2

b)EPS: $2.02

c)EPS: $2.05

d)EPS: $2.09

e)EPS: $2.13

answer: D. $2.09

(net income- pref dividend)/shares outstanding

(8500000 - 140000)/4000000 = $2.09

Chapter 1 Review

What is the quality of information that enables users to confirm or correct prior expectations?

Confirmatory Value

Chapter 1 Review

Identify the pervasive constraint developed in the conceptual framework:

Cost

Chapter 1 Review

The chairman of the SEC at one time noted, "If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement, we assume a grave risk that confidence in the credibility of our financial information system will be undermined." Which qualitative characteristic of accounting information should ensure that such a situation will not occur? (Do not use faithful representation.)

Neutrality

Muruyama Corp switches from FIFO to average-cost to FIFO over a 2-year period. Which qualitative characteristic of accounting is now followed?

Comparability (consistency)

Assume that the profession permits the savings and loan industry to defer losses on investments it sells because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed?

Neutrality

What are the 2 fundamental qualities that make accounting information useful for decision-making purposes?

Relevance and Faithful Representation