Accounting Chapters 1-4

1.  What is the definition of a sole proprietorship? A business owned by one person.

2. What are three advantages of a sole proprietorship?

   1. Simple to establish

   2. Owner Controlled

   3. Tax advantages

3. What are a few examples of typical sole proprietorships? Barber shop, auto repair shop, small businesses

4. What is the definition of a Partnership? A business owned by two or more people called partners.

5. What are the four advantages of a partnership?

   1. Simple to establish

   2. Shared control

   3. Broader skills and resources

   4. Tax advantages

6. What type of businesses typically form partnerships?  Retail and service businesses, including lawyers, doctors, accountants.

7. What is the definition of a Corporation? A business organized as a separate legal entity and owned by stockholders.

8. What are three advantages of a corporation?

   1. Easier to transfer ownership

   2. Easier to raise funds

   3. No personal liability

9. What is a disadvantage of sole proprietorship and partnerships? Proprietors and partners are personally liable for all debts and legal obligations.

10.  What form of business has the highest revenue produced  and is used by most large businesses in the United States? Corporation

11. What is the definition of accounting? The information system that identifies, records, and communicates the economic events of an organization to interested users.

12. Who are the internal users of accounting information? Managers who plan, organize, and run a business.

13. Who are some of the external users of accounting information?

    1. Investors

    2. Creditors

    3. Taxing authorities

    4. Customers

    5. Labor Unions

    6. Regulatory agencies

14.  Why did congress pass the Sarbanes-Oxley Act (SOX)? To reduce unethical corporate behavior and decrease the likelihood of future corporate scandals.

Review Questions Learning Objective 2 Explain the three principal types of business activity.

1.  What are the three principal business activities? 

   1. Financing

   2. Investing

   3. Operating

2. What is the purpose of the accounting information system? To keep track of each of the business activities.

3. What are the two primary sources of outside financing for corporations?

   1. Borrowing money (debt financing)

   2. Issuing (selling) shares of stock in exchange for cash (Equity Financing)

4. What is a creditor? The persons or entities a business owes money to.

5. What are amounts owed to creditors called? Liabilities.

6. What are two examples of liabilities? 

   1. Notes payable 

   2. Bonds payable

7. What is common stock? The total amount paid in by stockholders for the shares they purchase.

8. What is a dividend? The cash payments to stockholders.

9. What are investing activities? The purchase of resources a company needs in order to operate.

10. What are assets? Resources owned by a business

11. What is revenue? The increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the course of business.

12. What are three types of revenue used by Columbia Sportswear?

    1. Sales revenue

    2. Service revenue

    3. Interest revenue

13. What are supplies? Assets used in day to day operations.

14. What is inventory? An asset, goods available for future sale to customers

15. What is account receivable? The right to receive money in the future

16. What are expenses? The cost of assets consumed or services used in the process of generating revenue.

17. What are some examples of the expenses Columbia Sportswear uses?

    1. Cost of goods sold

    2. Selling expense

    3. Marketing expense

    4. Administrative expense

    5. Interest expense

    6. Income tax expense

18. What are accounts payable? The obligation to pay for goods and services bought on credit from suppliers.

19. What is net income? When revenue exceeds expenses

20. What is net loss? When expenses exceed revenue

Review Questions Learning Objective 3 Describe the four financial statements and how they are prepared. 

1. What are the four different financial statements? 

   1. Income statement

   2. Retained earnings statement

   3. Balance sheet

   4. Statement of cash flows

2. What is an income statement? A financial statement that reports a company's revenue and expenses and resulting net income or net loss for a specific period of time. (for period ended)

3. What is retained earnings? The portion of net income retained in a corporation.

4. What is a retained earnings statement? The amounts and causes of changes in retained earnings for a specific time period. (for period ended)

5. What is a balance sheet? A financial statement that reports the assets and claims to those assets at a specific point in time.(Date)

6. What is the basic accounting equation? Assets = Liabilities + Stockholders Equity

7. What are the two parts of Stockholders Equity?

   1. Common Stock

   2. Retained Earnings

8. What is the primary purpose of the statement of cash flows? To provide financial information about the cash receipts and cash payments of a business for a specific period of time.(for period ended)

9. What is an annual report? A report prepared by corporate management that presents financial information including financial statements, a management discussion and analysis section, notes and an independent auditor’s report.

10. What is a Management discussion and analysis (MD&A)? A section of the annual report that presents management's views on the company's ability to pay near term obligations, its ability to fund operations and expansion, and its results of operations.

11. What are the Notes to the financial statements? Notes clarify information presented in the financial statements and provide additional detail.

12. What is an Auditors Report? A report prepared by an independent auditor stating the auditor's opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles.

13. What does an auditor do? An accounting professional who conducts an independent examination of a company's financial statements.

14. What is a Certified public accountant (CPA)? A person who has met certain criteria and is allowed to perform audits of corporations.

1.  What is the definition of a classified balance sheet? A balance sheet that groups together simital assets and similar liabilities, using a number of standard classifications and sections. 

2. What are current assets? Assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer.

3. What is an operating cycle?The average time required to purchase inventory, sell it on account, and then collect cash from customers.

4. What is the definition of liquidity? How easily an asset can be converted to cash.

5. What is the order of liquidity used in the Wiley textbook?Cash, investments, receivables,inventory,prepaid items

6. What are examples of long term investments? Investments in stocks and bonds of other companies, long term assets, such as land and building, not currently being used in the companies operations, and long term notes receivable 

7. What are property, plant and equipment? (also called fixed or plant assets) assets with relatively long useful lives that are currently used in operating the business. (e.g., land, buildings, equipment, vehicles and furniture.)

8. What are intangible Assets?Assets that do not have physical substance. Ie patents, copyright, goodwill, trademarks, and trade names, reputation, R&D

9. What is a current liability? Obligations that the company is to pay within the next year or operating cycle, whichever is longer. (e.g, Accounts payable,salaries payable, notes payable,ect.)

10.  What are long term liabilities? (debt) obligations that a company expects to pay after one year. (e.g., bonds payable, mortgages payable, long term notes payable,ect)

11. What are the two parts of stockholders equity? Common stock and retained earnings.

12. What is common stock? Ownership is in a corporation.

13. What is retained earnings? The amount retained from a company's net income after paying dividends.

Review Questions Learning Objective 2 Use ratios to evaluate a company's profitability, liquidity and solvency

1.  What is ratio analysis? A technique that expresses the relationship among selected items of financial statement data.

2. What are the three classification of ratios?

   1. Profitability ratios: measuring the income or operating success of a company for a given period of time.

   2. Liquidity ratios: measures short term ability of a company to pay its short term obligations

   3. Solvency ratios: measure the ability of the company to survive over a long period of time.

3. How do you calculate the profitability ratio, Earnings per share(EPS)?(Net income - preferred dividends)/Weighted-average common shares outstanding. 

4. What is working capital? A measure of liquidity which is calculated as follows: Current assets-Current liabilities = working capital

5. What is the current ratio? A measure of liquidity that measures the short term ability of the company to pay its current obligations, calculated as: (current assets)/Current liabilities

6. How do you calculate the solvency ratio, debt to assets ratio and what does it measure? Debt to assets ratio= (Total Liabilities)/(Total assets), it measures the percentage of the company financed by creditors

7. How is free cash flow calculated? Free cash flow= net cash provided by operating activities-capital expenditures- cash dividends.

Review Questions Learning Objective 3 Discuss financial reporting concepts 

1. What are the Generally accepted accounting principles (GAAP)? A set of accounting standards that have substantial authoritative support and which guide accounting professionals.

2. What is the Securities and Exchange Commision (SEC)? The agency of the US government that oversees US financial markets and accounting standard-setting bodies.

3. What is the Financial Accounting Standards Board (FASB)? The primary accounting standard setting body in the US.

4. What is the International Accounting Standards Board (IASB)? An accounting standards setting body that issues standards adopted by many countries outside the US

5. What are the International Financial Reporting Standards (IFRS)? Accounting standards, issued by the IASB, that have been adopted by many countries outside of the US.

6. What is the Public Company Accounting Oversight Board (PCAOB)? The group charged with determining the auditing standards and reviewing the performance of auditing firms.

7. According to the FASB, useful information should possess what two fundamental qualities? Relevance and faithful representation

8. What does relevance mean? The quality of information that indicates the information makes a difference in a decision.

9. What does faithful representation mean? Information this is complete, neutral, and free from error.

10. What are the key assumptions the FASB relies on?

    1. Monetary unit assumption: requires that only things that can be expressed in money are included in the accounting records

    2. Economic Entity Assumption: every economic entity can be separately identified and accounted for. i.e. keep personal records and business records separate.

    3. Periodicity assumption: the life of the business can be divided into artificial time periods and that reports covering those periods can be prepared. Ie monthly,quarterly, annually

    4. Going Concern Assumption: the business will remain in operation for the foreseeable future

11. What are the two measurement principles that GAAP generally uses?

    1. Historical cost principle: Companies should record assets at their cost.

    2. Fair value principle: Assets and liabilities should be reported at fair value (current market value)

12. What is the full disclosure principle?  Companies disclose circumstances that make a difference to financial statement users, (a GAAP Principle)

13. What is the cost constraint? When the cost of obtaining the financial information outweighs the benefit

14. 
    The accounting cycle: Journalize, post, trial balance, adjusting entries, adjusted trial balance, financial statements, closing entries, post closing trial balance 

15. What is an accounting transaction? Economic events that require recording in the the financial statements because they affect the assets, liabilities or stockholders equity 

16. Assets = Liabilities + Stockholders Equity, must always be in balance.

17. Event 1: Investment of cash by stockholders: (a) increase asset, cash, (b) increase stockholders equity, common stock.

18. Event 2: Note issued in exchange for cash: (a)increase asset, cash,  (b)increase liability, notes payable

19. Event 3: Purchase of equipment for cash: (a)decrease asset, cash, (b)increase asset, equipment. 

20. Event 4: Receipt of cash in advance from customer: (a)increase asset, cash, (a)increase liability, Unearned service revenue

21. Event 5: Services performed for cash: (a)Increase asset, cash, (b) increase stockholders equity, (Revenue)

22. Event 6: Payment of rent: (a) decrease asset, cash, (b) decrease stockholders equity, rent expense

23. Event 7: Purchase of insurance policy for cash:  (a)decrease asset, cash, (b)increase asset, prepaid insurance

24. Event 8: purchase supplies on account: (a) increase asset, supplies, (b) increase liability, Accounts payable

25. Event 9: hiring on new employees: no effect on the accounting equation until they work.

26. Event 10: Payment of dividend: (a) decrease asset, cash, (b) decrease stockholders equity, dividends

27. Event 11: Payment of cash for employee salaries: (a) decrease asset, cash, (b) decrease stockholders equity, expense

Learning Objective 2 Explain how accounts, debits and credits are used to record business transactions

1.  Debit (Dr): left side of an account

2. Credit(Cr): right side of an account

3. Assets: normal balance debit, increase on debit side, decrease on credit

4. Liabilities: normal balance credit: increase on credit side, decrease on debit side

5. Stockholders Equity:

   1. Common Stock: normal balance credit, increase on credit side, decrease on debit side

   2. Retained earnings: normal balance credit, increase on credit side, decrease on debit side

   3. Revenue: normal balance credit, increase on credit side, decrease on debit side

   4. Dividends: (contra account) normal balance debit, increase on debit side, decrease on credit side

   5. Expenses: (contra account) normal balance on debit, increase on debit side, decrease on credit side

6. Stockholders equity relationship on financial statements

   1. Income Statement: Revenue-expenses=net income or net loss

   2. Retained earnings statement: Beginning retained earnings + net income - dividends

   3. Balance sheet: Asset, Liabilities & Stockholders equity (common stock + retained earnings)

Learning Objective 3 Indicate how a journal is used in the recording process 

1. Threes steps to the recording process

   1. Analyze each transaction

   2. Enter the transaction in a journal

   3. Transfer the journal information to the appropriate account ledger(post)

2. Three purposes of the journal

   1. Discloses in one place the effect of a transaction

   2. Provides a chronological record of transactions

   3. Helps to prevent or locate errors in transactions.

Learning Objective 4 Explain how a ledger and posting help in the recording process

1. Ledger: a record of all the accounts maintained by a company

2. General ledger: contains all the asset, liability, stockholders’ equity, revenue, and expense accounts

3. Chart of accounts: A list of the names of a companies accounts

4. Trial balance: 

   1. lists accounts and their balances at a given time.

   2. Total the debits and credits columns

   3. Verify the equality of the debits and credits

Revenue recognition principle: revenue is recognized in the accounting period in which the service is performed.

1. Five step revenue recognition process:

   1. Identify the contract with customers

   2. Identify the separate performance obligation in the contract

   3. Determine the transaction price

   4. Allocate the transaction price to the performance obligation

   5. Recognize revenue when each performance obligation is satisfied

2. Expense recognition principle: (matching principle) expenses be recognized with revenues in the period when the company generates the revenue.

3. Accrual basis accounting: transactions that change a company’s financial statements are recorded in the period in which the event occurs, even if cash was not exchanged.

4. Cash basis accounting: companies record revenue when they receive cash. Cash basis does not follow GAAP.

5. Adjusting entries: Entries made at the end of the end of a fiscal period to assure the revenue and expense recognition principles are followed.

6. Types of Adjusting entries:

   1. Deferrals:

      1. Prepaid expenses: expenses paid before they are used. e.g.: insurance.

      2. Unearned revenues: cash received before services are performed

   2. Accruals:

      1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded

      2. Accrued expenses: expenses incurred but not yet paid in cash or recorded

Learning Objective 2 Prepare adjusting entries for deferrals:

1.  Prepaid expenses: expenses paid in cash before they are used or consumed. E.g. Insurance, supplies, depreciation.

2. Depreciation: the process of allocating the cost of an asset to expense over its useful life.

3. Accumulated depreciation is a contra-asset account. (it is tied to a specific asset,e.g. A car

4. Book value: (Carrying value) the difference between the cost of any depreciable asset and its related accumulated depreciation.

5. Unearned revenues: cash received and a liability created before a service is performed 

Learning Objective 3 Prepare adjusting entries for accruals 

1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded.

2. Accrued Expenses: Expenses incurred but not yet paid or recorded. E. g. Accrued interest and accrued salaries.

3. Each adjusting entry affects one balance sheet account and one income statement account.

Learning Objective 4 Prepare an adjusted trial balance and closing entries.

1. Adjusted trial balance: A list of all accounts and their balances after adjusting entries have been made.

2. Financial statements are prepared directly from an adjusted trial balance.

3. Earnings management: the planned timing of revenues, expenses gains and losses to smooth out bumps in net income.

4. Quality of earnings: full and transparent information that a company provides to users of its financial statements.

5. Temporary accounts: revenue, expenses, and dividends whose balances are transferred to retained earnings at the end of an accounting period.

6. Permanent accounts: Balance sheet accounts that are carried forward to the next accounting period.

7. Closing entries: entries at the end of an accounting period that transfer temporary account balances (revenue, expenses, dividends) to a permanent stockholders equity account. (Retained earnings)

8. Income summary: a temporary account used to close revenue and expense accounts

9. Post closing trial balance: a list of permanent accounts and their balances after a company has journalized and posted closing entries.

10. The Accounting cycle: 

    1. Analyze business transactions

    2. journal the transactions

    3. Post to the ledger accounts

    4. Prepare a trial balance

    5. Journalize and post adjusting entries: Deferrals/accruals

    6. Prepare an adjusted trial balance

    7. Prepare financial statements

    8. Journalize and post closing entries

    9. Prepare a post closing trial balance