Accounting Exam 1

Financial Accounting

Process to identify and record financial data from transactions that arise from entities business activites

Summarizes financial data into dfinancial reports so users can analyze and make decisions

Entities

Corporations that conduct busness

Categories of business are NOT mutually exclusive

Manufactured

Make products and goods

sell goods to merchandisers

Merchandisers

Buy g/s from wholesalers and sell to consymersS

Service Providers

Provide service to customers

3 steps to start a LEGAL company

1. Select one state (follow states requirements)

2. Select form of organization (sole proprietorship, partnership, corporation, hybrid forms

3. Complete documents+file

Sole Proprietorship

Simple to establish

One person controls

Better for taxes

Personally Liable

Tax advantages and disadvantages of Sole Proprietorship

Business is NOT considered a separate entity from owner

Any profit from company gets reported under owners own tax return

Profit taxed ONCE (business no tax returns only owner

Disadvantages- [ersonal liability (owner personally liable for debts, govt will come after YOU), financing difficult, transfer of ownership difficult

Partnership

Simple to establish, shared control, increases skills and resources

Good for taxes but personally liable

If one person does not have enough economic resources or skills

Tax advantages and disadvantages of Partnership

Same as SP, only taxed once, business NOT operate entity, business profits under owners tax return

Disadvatages- personal liablilty, financing difficult, transfer of ownership difficult

Hybrid

The best

Govt can only go after business assets not personal

Typers of hybrid orginizations

LLC- Limited Liability Company

LLP- Limited Liability Partnership

Bulk of legal business orginizations

SP, Partnetships, LLC, LLP

But not most profit

Corperations

Most Complex organization

Solve all disadvantages (easy to fund and transfer ownership), limited legal liability

TRADE STOCK

Disadvatages of corperations

Tax- separate legal entity

Corporations must file own tax returns AND owners must file own tax returns

Creating a Corperation

Charter

1. Name

2. Description of business

3. Amount of shares in corporations stock (Common stock = percent ownership of a corporation)

IPO

Initial Public Offering - first primary stock

Common stock

Sell to raise funds- Equity financing

Investors buy = own % in company

Traded on organized stock exchanges - NYSE

CS= total Amt paid by all stockholders

S corperation

LLC

Shareholders have to pay tax on their common stock. This is good bc now their shares are only taxed once and are not taxed by the corporation

All advantages or a corp, but NO TAX DISADVANTAGES!!

But- can’t have more then 100 owners

But- cant be publicly traded

C corperation

Non hybrid corperation

PUBLIC

Internal users of accounting data

Internal - ppl who organize, plan, run business

ex. mangers

External users of accounting data (6)

Taxing authorities - does company follow tax laws?

Customers - Do they honor product warranties?
Labor unions - Increased wage?

Regulatory agencies - Following rules?

Investors - Buy, hold, or sell stock?

Creditors - Lend money?

Data Analyitcs

Software systems collect data abt companies economic events

3 types of business activites

1. finacing

2. investing

3. operating activites

Financing

Raising money from outside sources for business

Debt finiacing

Borrowing money

BONDS = company borrowing money from someone

Loans = Banks

Creditors loan

Equity financing

Selling stock

Creditor

People who a company promises to pay back = Liability

Note payable - company owes bank

Bond payable - company owns investors

LEGAL RIGHT to be paid back

Claims get paid before stockholders claims do

Stockholders legal righhts

NO legal right to be paid

Dividents - optional but payments co makes to stockholders

Creditor claims paid before stockholder if bankrupt

Investing

Purchase of resources company needs to operate

Assets

Assets

Resources company owns

Types

PPE

Cash

Investments in other corporations

Operating Activites

Actions taken by company to produce/ sell rpduct

Revenue : Increasing assets or deaceraing liabilities from sale of good

Types of expenses

Cost of materals

Seeling expenses (sales person salaries

Admisitrative expenses
Interest Expense

Income tax Expense

Accounts payable

People to pay when you purchase goods ON CREDIT from suppliers

Interest payable

To bank

interest u need to pay

Wages, sales tax, property tax, income tax PAYABLE

Yup u need to pay

Public Corp

Goal for most corperations

Means anyone can buy stock on Public stock exchange

NYSE, NASDAQ (national asso. of securities, dealers, auto quotations

Private corperation

Still equity financing

Stock is privately sold

How do stockholders profit?

Wait until stock increases in value then sell at higher price

Receive dividends

Founders structuring common stock

Sell common stock that doesn’t impact founders legal ownership

Structure into different class types, founders stock has more authority

Cooperation tax disadvatages

Double tax

1st tax- Companies earnings (separate legal entity)

2nd - stockholders dividends get taxed

The four financial statements

How assets, liabilities, expenses, and revenues are arranged

1. Income statements - shows how successful ur business is in a period of time (revenues-expenses)

2. Retained earning statement- How much previous income was given to dividends and how much was retained

3. Balance sheet- Picture of what our busiess owns (assets) and what it owes (liabilites

4. Statement of cash flows - Where business obtained cash and how it was used

Income statemet

Reports companies revenues and expenses, and net income and net loss for a period of time

revenues- expenses

Who cares?
Investors- predict future, buy/sell stock

Creditiors- Predict future earnings, will they pay me back?

Not on income statement

• Money from stock = NOT REVNUE

• money for dividends = NOT EXPENSES

Shows if co is profitable

REVENUE = SERVICE REVENUE

Expenses = salaries, rent, supplies, interest, etc

Retained Earnings statement

Net income retained in corperation

Shows amount and causes of change in Retained earnings for time period

DEDUCT dividends, ADD net income

Past retained earnings + net income - dividends = RE

Balance sheet

Reports assets

And claims to assets (creditors and stockholders)

AT A SPECIFIC POINT IN TIME - last day of reporting period

2 catergories

1. Claims of creditors: Liabilities

2. Claims of Owners: Stockholders equity

RE that was calculated before is used in stockholders equity

Accounting Equation

Assets = Liabilities +Stockholders equity

Statement of Cash Flows

Provide financial info about cash receipts and cash payments of a business

Specific point in time

Operating, investing, and financing activites

Interrelationship of the 4 statments

1. RE uses income statement results (net income)

2. Balance sheet and RE related (BS needs RE)

3. Cash flows relates to info on balance sheet

Annual Report

Public corporation must give shareholders an annual report

Financial stamenets, management discussion, analysis section

Management discussion and analysis - Annual Report

Management view on company’s ability to…

Pay near obligations

Fund operations and expansions

Results of operations

Notes to the financial statements - Annual Report

Clarify and add detail

Auditors report - Annual Report`

Done by outside auditors to verify

Accounts recivable

Extends credit to customers

Co agrees to collect money later on = selling on account

ASSET

Receiving credit extensions

Operating

Company buys a g/s from seller

Seller agrees to get payment later on

Purchasing on account, legal obligation

LIABILITY

GAAP

Generally Accepted Accounting Principles

US set of rules for accounting

Set by FASB

Private companies don’t necessarily have to follow… but then suspicious

FASB

Financial Accounting Securities Board

Sets GAAP

SEC

Securities and Exchange Commission

Oversee US Financial markets and exchanges

Requires all public (stock exchanger) Corperations to USE GAAP

Gaap means all records are open to public

10-K SEC Form

Annual report

Annual report of companies financial info

1. Financial Statements (4)

2. Notes to the financial statement (clarify, qualitative)

3. Auditors report (outside examination from cpa)

4. Management discussion and analysis

Unqualified Opinion

Best opinion a company could get from a CPA

Means financial statement is fair and following GAAP

If no unqualified opinion, means users can necessarily trust the financial reports

The classified balance sheet

Puts categories in groups - assets, liabilities, stockholders E

Asset Category

Current assets

Long term Investments

PPE

Intangible assets

Current assets

ASSET

Will be converted to cash within 1 yr/ Operating cycle

List in order of liquidity

Types

• Cash

• Investments (short term) - debt or equity investments

• Receivables - right to collect money

• Inventory - goods to be sold

• Prepaid Insurance - coverage begins in future

• Supplies

List flor class - cash first, then highest to lowest amount of money

Operating cycle

Time it takes company to go from cash to revenue

May take longer then yr (ex. shipbuilding company)

Long term investments

ASSET

Investments in other companies

Long term notes recievable

Or other fixed assets that aren’t used currently (investment purposes)

Property, plant, and Equipment

ASSET

long lives, used in operationg

land, buildings, equipment

Physical substance and used currently

Hold for longer then one year

Depreciation - EXPENSING cost of asset over multiple yrs

Intangible Assets

ASSET

copyrights, trademanrks

No physical value, value is in words

EXCLUSIVE RIGHTS

goodwill- when co buys other co but pays more

Depreciation

Money subtracted from equipment in PPE

PPEs useful life- estimate amount of years a PPE will be useful for

Depreciation expenses part of PPE that is an expense for that year

Shown in IS and BS

Accumulated Deprecation

Running total of assets expense

Contra asset- subtracts money from asset

Book value

PPE value - depreciation = book value

How much of PPEs cost was NOT used to generate revenue

Current Liabilities

Obligations that company has to pay in ONE YEAR

Accounts payable, salaries and wages payable, notes payable, interest tax

Long term liabilities

Company agrees to pay after one year

Bonds payable, mortgages, long term notes

Stockholders Equity

1. Common stock - amount given to company from stockholders

2. Retainted earnings - net income/loss - dividends

Qualitative characteristics of useful financial reporting

Qualitative (useful) Charactersitics

1. Fundamental Qualities

   1. Relevant - predictive and confirmatory, impacts decision making

   2. Faithfully represented - complete and nutural

2. Enhancing qualities

   1. Comparibility

   2. Verifiability

   3. Timelines

   4. Understandability

2 Qualities of useful info

Relevance- would it make a difference in a decision, does it have predictive and confirmatory value (confirms data)

Faithful representation- accurate and truthful

Enhancing Qualities

In addition to useful info, they enhance it

1. Comparibility- easy to compare

2. Consitancy- same principles year to year

3. Verifiable- CPA

4. Timely

5. Understandability

Monetary Unit Assumption

Only things that can be expressed in terms of Money are included in accounting rrecords

Economic Entity Assumption

Every economic entity can be separately identified and accounted for

Growing concern assumption

Business will remain in operation in the future

Periodicity assumption

Life of business can be divided into time periods and useful reports are produced for those time periods

Measurement Principles

1. Historical cost principle

   1. Company will record assets at their cost

   2. Even if asset increases in price, still report at the price it was bought at

2. Fair value principle

   1. Assets and liabilities reported at fair value- how much money would be received if it sold

How to determine which measurement principle to use

FASB weighs factual cost vs relevance of fair value

Most use HISTORICAL

only use fair with assets that are active being traded

Full disclosure principle

disclose all detailes

Cost contraint

To decide if company should be required to provide a type of info, weigh cost and benefits of providing info then decide

The 8 Conceptual Framework Chapters

1. Objective of financial reports - reports that are useful in decision making

2. Reporting Entity - The company

3. Qualitative characteristics - fundamental + enhancing

4. Elements - helps define certain financial terms

5-8. Recognition, measurement, presentation, notes - guidance on how to recognize, measure and present elements in financial statements

4 assumptions about reporting entities

1. Economic entity - business activity separate from owner

2. Growing concern - co is in it for the long haul and will follow GAAP

3. Monetary unit- Use us money

4. Periodicity - divide business activites into time periods

EGMP

Entities grow mega penises

Conceptual framework operational concepts PRINCIPLES

1. Measurement - measure transactions 2 different ways

   1. Historical cost

   2. Fair value cost

2. Full disclosure principle - co myst disclose everything that can be useful

Accounting information system

Collecting, processing, and communicating financial data

EDP

electronic data processing system

for accounting information system

Accounting cycle

Analyze → Journalize → Post→ Trial balance→ ……

Analyzing transactions

Only record economic events that change A = L + SE

Expanded Accounting Equation

Assets = Liabilities + Stockholders Equity

Common Stock + Retained Earnings

Net Income - Dividends

Revenues - Expenses

Assets= Liabilities + CS + Revenues - Expenses - Dividends

Categories of expanded accounting equation listed

A C S I E L N A U S C R R E D

Asset

• Cash

• Supplies

• Insurance prepaid

• Equipment

Liabilities

• Notes payable

• Accounts payable

• Unearned service revenue

Stockholders Equity

• Common Stock

Retained Earnings

• Revenues

• Expenses

• Dividends

Revenue recognition

contract between company and consumer

company - performance obligation or contract right (to receive money)

• satisfied during, prior, or after companys action depending on contract

Revenue recognition principle

Only recognize revenue when PREFORMANCE obligation is satisfied (don’t think abt contract right… company will receive money eventually)

Expense recognition principle

1. “let the expenses follow the revenues”

   1. If cost is directly associated with revenues, cost should be an expense in the same period.

   2. If revenue can’t be recorded, neither can expenses!!!

2. Cost can’t be specifically ties to revenue

   1. If benefit from cost has already been consumed in reporting period… EXPENSE

3. If cost gives benefit overall several reporting periods..

   1. Record as an ASSET and gradually expense

   2. depreciation

Accural Basis of accounting

Any accounting system that’s using GAAP

revenue and expenses recognized when economic substances changes