Financial Accounting - Exam 1

sole proprietorship

business owned by one person

positives of sole proprietorships

* more control over business
* simple
* tax advantages (only taxed to one person)

negatives of sole proprietorships

* limited capital/money
* limited expertise
* limited life for business
* hard to sell
* liability (risk of losing personal items)

partnership

business owned by two or more persons

positives of partnerships

* more capital
* more expertise
* tax advantages (can be split)

negatives of partnerships

* more complicated
* limited life (if one person leaves, then business dies)


* liability (everyone is liable)

general partner

responsible for everything within a partnership

limited partner

only invests some money into a partnership, but does not take responsibility for anything

corporation

business organized as a separate legal entity owned by stockholders/shareholders

positives of corporations

* more capital
* more expertise
* unlimited life
* easy to transfer ownership
* liability (no ones personal items are at risk)


* easier to raise funds

negatives of corporations

* complex
* double taxed
* company is taxed on profits and the dividends paid to stockholders are taxed

dividend

payments of cash from a corporation to a stockholder

hybrid forms of organizations

combines the tax advantages of partnerships with limited liability of corporations

accounting

information system that identifies, records, and communicates economic events of an organization to interested users

internal users

people directly in the business who use information to make decisions; includes officers of the company and managers

external users

people who are not in the business that use information to evaluate the business; includes investors, creditors, and unions

accounting information system

keeps track of the results of each of the various business activities including financing, investing, and operating

operating

day-to-day activities taken by a company to produce and sell a product, or provide a service; concerned with earning revenue and tracking expenses

annual revenue equation

ending retained earnings + dividends + expenses - beginning retained earnings

supplies

assets used in day-to-day operations

inventory

goods available for future sales to customers

investing

the purchase of the resources a company needs in order to operate; can be the purchase of a long-term asset (ex: vehicles, building, land, etc.) or the sale of a long-term asset (ex: buying land then selling it after a few years)

financing

raising money from outside sources; includes borrowing a loan/bond, repayment of a loan, issuing stock, purchasing stock, and payments of dividends

bond

taking out a loan at a bank or borrowing directly from investors by issuing debt securities

income statement

measures the profit or loss of a company and resulting net income; shows how successful your business performed during a period of time (typically says Month/Year Ended)

revenue

amounts earned from the sale of goods and services; increases assets or decreases liabilities; example includes cash received from customers

expenses

cost of assets consumed or services used in the process of generating revenues; amounts paid in order to fund operations; example includes cash paid to suppliers for equipment

net income equation

revenues - expenses

balance sheet

explains what is in assets, liabilities, and stockholder’s equity; presents a picture at a point in time of what your business owns (assets) and what it owes (liabilities); only lists the date (ex: January 31, 2023)

assets

resources owned by a business; examples include cash, investments, property, plant, and equipment, accounts receivable, etc.

accounts receivable

the right to receive money in the future; considered an asset

liabilities

amounts owed to creditors in the form of debts and other obligations; examples include accounts payable, unearned revenue, interest payable, etc.

accounts payable

obligations to pay for goods (ex: purchasing goods on credit from suppliers)

stockholder’s equity

the owners’ claim to assets; how much actually belongs to an owner after liabilities; consists of common stock and retained earnings

common stock

the total amount paid in by stockholders for the shares they purchase; money stockholders directly invested

retained earnings

net income kept in the corporation and not paid out in dividends

balance sheet equation/accounting equation

assets = liabilities + stockholder’s equity

stockholder’s equity equations

* (total assets - liabilities) + (net income) - dividend
* common stock + retained earnings
* assets - liabilities

statement of retained earnings

shows the amounts and causes of changes in retained earnings for a specific time period (For Month/Year Ended); shows how much previous income was paid in the form of dividends and how much was kept in the business

retained earning equations

* net income - dividends
* assets - liabilities - common stock

10 Q

quarterly reports; unaudited financial statements

10 K

annual audited financial statement

elements of an annual report

* financial statements (4)
* management’s discussion and analysis (MD&A)
* notes (footnotes)
* auditor’s report

management’s discussion and analysis (MD&A)

presents management’s views on the company’s ability to pay near-term obligations, ability to fund operations and expansion, and address the results of operations

footnotes

clarifies financial statements and provide additional detail

auditor’s report

an auditor conducts an examination of a company’s financial statements and gives it an unqualified or qualified opinion

unqualified opinion

the auditor believes the financial statements fairly represent the company

qualified opinion

the auditor believes the financial statement does not fairly represent the company

accrual accounting

set of rules that states cash that goes in may not be revenue and cash that goes out is not necessarily expenses

monetary unit assumption

requires that only things that can be expresses in money are included in accounting records (dollars)

economic entity assumption

every economic entity can be separately identified and accounted for; solely looking at the business and company transactions and not personal transactions

periodicity assumption

life of a business can be divided into artificial time periods and useful reports covering those periods can be prepared for the business; financial statements will always be measured in months, quarters, or years

going concern assumption

states the business will remain in operation for the foreseeable future; assumes a company will stay in business to accomplish their goals

historical cost/cost principle

companies record assets at their costs; using the original cost

fair value principle

assets and liabilities should be reported at the price that would be received if an asset was sold or the amount that would be required to be paid to settle a liability; keeping books at market value; only applied in situations where assets are actively traded

full disclosure principle

requires that companies disclose sufficient details regarding circumstances and events that would make a different to financial statement users

generally accepted accounting principles (GAAP)

sets of accounting standards (rules and practices) that have authoritative support; body of knowledge; written by FASB and enforced by SEC

financial accounting standards board (FASB)

primary accounting-standard body in the US; decides what the rules are

security and exchange commission (SEC)

agency of US government that oversees US publicly traded companies, financial markets, and accounting standard-setting bodies; regular and makes sure that publicly traded businesses follow the rules

public company accounting oversight board (PCAOB)

created as a result of the Sarbanes-Oxley Act to help determine auditing standards and review the performance of auditing firms; “police” for CPA firms to ensure they are correctly recording financial statements

sarbanes-oxley act (SOX)

reduces unethical corporate behavior and decreases the likelihood of future corporate scandals

relevance

accounting information that would make a difference in a business decision; consists of predictive and confirmative values and materiality

predictive value

helps provide accurate expectations about the future; good indicator if a business will be successful

confirmative value

confirms or corrects prior expectations; can be proven

materiality

when omitting or misstating an item could influence the decision of a financial statement user such as investors or creditors

faithful representation

information accurately depicts what really existed or happened

complete

everything is in the statement and nothing important has been omitted

neutral

not biased toward one position or another

free from error

as accurate as possible

comparable

when different companies use the same accounting principles; comparing financial statements of different organizations

consistent

a company uses the same accounting principles and methods from year to year

verifiable

independent observers, using the same methods, obtain similar results

timely

accounting information must be available to decision-makers before it loses its capacity to influence decisions

understandability

information is presented in a clear and concise fashion so that reasonably informed users can interpret it and comprehend its meaning

cost constraint

the cost to provide information should be weighed against the benefit that users will gain from having the information available

conservatism

if you have to make an estimate between two numbers, choose the number which results with the lowest income

classified balance sheet

groups together similar assets and similar liabilities, using a number of standard classifications and sections

assets typically contain

* current assets
* long-term assets/investments
* property, plant, and equipment
* intangible assets

current assets

assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer; listed in order of liquidity

operating cycle

average time required to go from cash to cash in producing revenue - to purchase revenue, sell it on account, and then collect cash from customers

liquidity order of current assets

1. cash
2. investments
3. receivables (account receivables, notes receivables, interest receivables, etc.)
4. inventories
5. prepaid expenses (insurance and supplies)

long-term assets/investments

investments in stocks and bonds of other corporations that are held for more than one year or one operating cycle

property, plant, and equipment

assets with relatively long, useful lives that are currently used in operating the business; consists of depreciation and accumulated depreciation; examples include land, buildings, equipment, furniture, etc.

depreciation

systematic allocation of the cost of an asset to expense over a number of years

accumulated depreciation

shows the total amount of depreciation the company has expensed thus far in the asset’s life

intangible assets

assets that do not have physical substance and often are very valuable; includes goodwill, patents, trademarks, trade names, and copyright

current liabilities

obligations/debts the company is to pay within the next year or operating cycle; include maturities of long-term obligations, accounts payable, notes payable, unearned revenue, etc.

maturities of long-term obligations

payments to be made within a year of the balance sheet date on long-term obligations

long-term liabilities

obligations that a company expects to pay after one year or operating cycle; includes bonds payable, mortgages payable, lease liabilities, etc.

ratio analysis

expresses the relationship among selected items of financial statement data

profitability ratios

measures the income or operating success of a company for a given period of time

earnings per share (EPS)

measures the net income earned on each share of common stock

earnings per share equations

earnings available to common stockholders (net income - preferred dividends ) / weighted-average common shares outstanding during the year

earnings per share is what type of ratio analysis?

type of profitability ratio

liquidity

company’s ability to pay obligations expected to become due within the next year or operating cycle; something can be put into cash quickly

working capital equation

current assets - current liabilities

working capital is a measurement of what?

measures liquidity

company is more likely to pay its liabilities with a …

positive working capital (current assets > current liabilities)

company might be forced into bankruptcy with a …

negative working capital (current liabilities > current assets)

liquidity ratios

measures the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash