accounting_exam_1_study_guide

Chapter 1 – Financial Accounting & Decision Makers

• Financial Accounting: Focused on providing information to external parties including:

  • Investors/stockholders/shareholders/owners

  • Creditors and lenders

• Incorporation:

  • Legal process allowing owners to form a separate entity, limiting personal liability.

  • Risks of loss confined to the invested amount.

• Motivations for Becoming a Stockholder:

  • Potential appreciation in stock value and dividends.

  • Neither appreciation nor dividends are guaranteed outcomes.

• Role of Creditors:

  • Lend money in exchange for interest; depend on financial data to gauge solvency.

• Dividends: Discretionary payments decided by the board of directors.

• Stock Markets (e.g., NYSE): Facilitate trading of stocks without affecting the company's capital stock on financial statements.

• Rate of Return Calculation:

  • Formula: [\text{Rate of Return} = \frac{\text{Ending Stock Value} - \text{Beginning Stock Value} + \text{Dividends Received}}{\text{Beginning Stock Value}}]

Chapter 2 – Types of Accounts & Accounting Standards

• Transaction Definition: Event affecting financial statements; not all events qualify (e.g., unexecuted contracts).

• Recording Transactions: Minimum of 2 accounts involved.

• Key Accounting Terms:

  • Assets: Future economic benefits controlled by an entity.

  • Liabilities: Future sacrifices arising from present obligations.

  • Revenues: Earned amounts from goods/services.

  • Expenses: Costs incurred to generate revenues.

• Asset vs. Expense Determination:

  • Assets represent future benefits, whereas expenses reflect past benefits.

• Accounting Standards:

  • Provide guidance for uncertain transactions, ensuring consistency and transparency for investors.

  • GAAP: U.S. standards by FASB.

  • IFRS: International standards by IASB.

• Material Misstatements:

  • Errors or intentional fraud; financial statements must be free from them.

  • Materiality: The significance of an omission or misstatement depends on company size and transaction nature.

Chapter 3 – The Financial Statements

• Revenue & Expense Recognition:

  • Occur due to primary operations; gains/losses arise from secondary activities.

• Inventory Sale Process (2-step transaction):

  • Step 1: Debit COGS, Credit Inventory.

  • Step 2: Debit Cash/Accounts Receivable, Credit Sales Revenue.

• Balance Sheet:

  • Follows the accounting equation: Assets = Liabilities + Stockholder’s Equity.

  • Assets categorized by liquidity:

    • Current: Usable or payable within 1 year.

    • Noncurrent: Held or due longer than 1 year.

• Key Calculations:

  • Working Capital: Current Assets - Current Liabilities.

  • Current Ratio: Current Assets / Current Liabilities.

• Dividends: A contra-equity account; not an expense.

• Cash Flow Statement Categories:

  • Operating: Core business activities.

  • Investing: Transactions involving assets other than inventory.

  • Financing: Involvement with liabilities or equity accounts.

Chapter 4 – Debits and Credits

• Accounts Increased By:

  • Debits: Assets, Expenses, Losses, Dividends.

  • Credits: Revenues, Gains, Liabilities, Capital Stock, Retained Earnings.

• Journal Entries: Total debits equal total credits.

• Key Accounting Reports:

  • Journal: Chronological list of entries.

  • T-Chart: Shows debit/credit activity per account.

  • General Ledger: Compilation of all accounts.

  • Trial Balance: Lists ending account balances; total debits equal total credits to prepare financial statements.

• Accrual-Basis Accounting Principles:

  • Revenue recognized upon fulfilling performance obligations.

  • Expense recognized when incurred, aligning with associated revenues.

  • Cash exchange timing does not dictate revenue/expense recognition.

Chapter 5 – Adjusting Entries & The Closing Process

• Importance of Adjusting Entries:

  • Address timing differences in revenue and expense recognition.

• Types of Adjusting Entries:

  • Accruals: Recognized now, cash exchanged later.

  • Deferrals: Cash exchanged now, recognition later.

• Common Adjustments:

  • Unearned Revenue (D): Received but not yet earned.

  • Accrued Revenue (A): Earned but not yet received.

  • Prepaid Expenses (D): Paid but not yet incurred.

  • Accrued Expenses (A): Incurred but not yet paid.

• Closing Process:

  • Temporary accounts revert to zero; use balances from the adjusted trial balance.

  • Closing entries involve:

    1. Debit to Revenues/Gains.

    2. Credit to Expenses/Losses/Dividends.

    3. Credit to Retained Earnings for net income remaining after dividends.

• Permanent Accounts: They carry forward their balances into the next period (Assets, Liabilities, Capital Stock, Retained Earnings).