FINANCIAL ACCOUNTING: Exam 1

Chapter 1: Accounting in Action; Chapter 2: Recording Process

Marketing Manager

Internal User

Production Supervisor

Internal Users

Store Manager

Vice-President of Finance

Customers

External Users

Internal Revenue Service

External User

Labor Unions

External Users

Securities and Exchange Commission

External User

Suppliers

External User

Accounting Equation

Assets = Liabilities + Stockholders Equity

Retained Earnings

Revenue - Expenses - Dividends

Stockholders Equity

• Common Stock (+)

• Revenue (+)

• Dividends (-)

• Expenses (-)

Liabilities

• Notes Payable

• Accounts Payable

Assets

• Cash

• Equipment

• Supplies

• Accounts Receivable

Asset Increase

Debit

Asset Decrease

Credit

Liabilities Increase

Credit

Liabilities Decrease

Debit

(Stockholder Equity) Common Stock Increase

Credit

(Stockholder Equity) Common Stock Decrease

Debit

(Stockholder Equity) Dividend Increase

Debit

(Stockholder Equity) Dividend Decrease

Credit

(Stockholder Equity) Expenses Increase

Debit

(Stockholder Equity) Expenses Decrease

Credit

Retained Earnings Increase

Credit

Retained Earnings Decrease

Debit

Qualitative Characteristics of Useful Information

• Relevance

• Faithful Representation

Relevance

Provides information that has predictive value (FUTURE) and confirmatory value (PAST). Accounting info must be timely.

Faithful Representation

Accurately depicts what really happened within the company.

• Complete

• Neutral/Unibiased

• Free from error

Assumptions of Financial Accounting

• Monetary Unit

• Economic Entity

• Time Period

• Going Concern

Monetary Unit Assumption

Requires only things expressed in money are included in accounting records.

Economic Entity Assumption

Every business, accounting, or commercial entity can be separately identified and accounted for.

Time Period Assumption

The life of a business can be divided into artificial intervals.

Going Concern Assumption

Business will remain in operation for the foreseeable future

Principles of Financial Reporting

• Historical Cost Principle

• Fair Value Principle

• Revenue Recognition Principle

• Expense Recognition (Matching) Principle

• Full Disclosure Principle

Historical Cost Principle

The price established by an exchange transaction is its cost when purchased. Most assets follow this principle.

Fair Value Principle

Indicates assets and liabilities should be reported at a reasonable cost. This principle is applied where assets are actively traded.

Revenue Recognition Principle

A company's revenue is the amount earned during the accounting period.

• When the exchange takes place

• when the earning process is complete

Expense Recognition (Matching) Principle

Efforts (expenses) should be matched w/ accomplishment (revenues) whenever it is reasonable and practicable to do so. (If an expense helped you make money today, it should be recorded today—not next month when you get around to paying the bill.)

Full Disclosure Principle

Companies must disclose in financial statements + notes, all circumstances + events that would make a difference to financial statement users. (ie. lawsuits, destroyed equipment, etc)

Accounting Constraints (Modifying Principles)

• Cost-Benefit

• Materiality

• Conservatism

Cost-Benefit

Standard setters weigh the cost that companies will incur to provide info against the benefit that financial statement users will gain from having the info available.

Materiality

It’s inclusion or omission would influence or change the judgement of a resonable.

Conservatism

There are several equally acceptable accounting alternatives; choose the one that is LEAST likely to overstate assets and income. (ie. recognize/disclose losses in the period they occur but not gains until they’re realized.)