Accounting Exam 1

Study Guide: Exam 1

Chapter 1: Introduction to Accounting

Forms of Business Ownership:

1. Sole Proprietorship (Prop.):
   
   

   • Owned by one individual.

   • Unlimited liability.

   • Simplest form of business ownership.

2. Partnership (P/S):
   
   

   • Owned by two or more individuals.

   • Shared liability and management.

   • Can be general or limited.

3. Corporation (Corp.):
   
   

   • Separate legal entity from its owners.

   • Owners (shareholders) have limited liability.

   • Can raise capital by issuing shares.

4. Limited Liability Partnership (LLP):
   
   

   • Similar to a partnership but with limited liability for each partner.

   • Protects individual partners from personal liability for business debts.

5. Limited Liability Company (LLC):
   
   

   • Combines the flexibility of a partnership with the limited liability of a corporation.

   • Owners are members, not shareholders.

6. S Corporation (S Corp):
   
   

   • A corporation that elects to pass income, losses, and other tax items to shareholders for federal tax purposes.

   • Owners (shareholders) have limited liability, and the business is taxed similarly to a partnership.

5/6 Kinds of Accounts:

1. Assets:
   
   

   • Resources owned by the company (e.g., cash, inventory, buildings).

2. Liabilities:
   
   

   • Obligations owed to creditors (e.g., accounts payable, loans).

3. Owner’s Equity (or Stockholders’ Equity):
   
   

   • The residual interest in the assets of the entity after deducting liabilities.

4. Revenue (or Income):
   
   

   • Earnings from the sale of goods or services.

5. Expenses:
   
   

   • Costs incurred to generate revenue (e.g., wages, rent, utilities).

6. Gains/Losses (sometimes a separate account):
   
   

   • Increases/decreases in equity from peripheral activities.

4 Basic Financial Statements:

1. Balance Sheet:
   
   

   • A snapshot of the company’s financial position at a specific point in time (Assets = Liabilities + Equity).

2. Income Statement:
   
   

   • Shows the company’s performance over a period (Revenue - Expenses = Net Income).

3. Statement of Retained Earnings:
   
   

   • Shows changes in retained earnings over a period (Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earnings).

4. Statement of Cash Flows:
   
   

   • Reports cash inflows and outflows from operating, investing, and financing activities.

Accounting Equation:

• Assets = Liabilities + Owner’s Equity

Flow of Information Between Financial Statements:

1. Income Statement → Statement of Retained Earnings:
   
   

   • Net income from the income statement affects the retained earnings.

2. Statement of Retained Earnings → Balance Sheet:
   
   

   • Retained earnings from the statement impact the equity section of the balance sheet.

3. Balance Sheet → Statement of Cash Flows:
   
   

   • Cash from the balance sheet is reflected in the cash flow statement.

Users of Accounting Information:

1. Internal Users:
   
   

   • Management, employees, etc., use information for decision-making and operations.

2. External Users:
   
   

   • Investors, creditors, regulators, and others who use accounting information to assess the financial health of a company.

CPAs (Certified Public Accountants):

• Accountants licensed to provide auditing, tax, and advisory services. They must pass a rigorous exam and meet continuing education requirements.

SEC, FASB, AICPA, IASB:

• SEC (Securities and Exchange Commission):
  
  

  • U.S. government agency that oversees the securities industry and enforces accounting standards for public companies.

• FASB (Financial Accounting Standards Board):
  
  

  • Sets accounting standards in the U.S.

• AICPA (American Institute of Certified Public Accountants):
  
  

  • A professional organization for CPAs in the U.S., responsible for setting professional ethics and standards.

• IASB (International Accounting Standards Board):
  
  

  • Develops and promotes global financial reporting standards (IFRS).

Audits:

• Independent examination of financial statements to ensure accuracy and compliance with accounting standards (e.g., GAAP or IFRS).

GAAP (Generally Accepted Accounting Principles):

• A set of accounting standards and procedures used in the U.S. for preparing financial statements.

Conceptual Framework:

• The foundation of accounting theory that defines the principles and concepts that guide the development of accounting standards.

Chapter 2: Accounting Basics

Double Entry Accounting:

• Every transaction affects at least two accounts (one debit, one credit).

• The system ensures that the accounting equation (Assets = Liabilities + Owner’s Equity) stays balanced.

T Accounts:

• A visual representation of individual accounts in a ledger.

• Left side (debit side): Increases in assets and expenses, decreases in liabilities and equity.

• Right side (credit side): Increases in liabilities and equity, decreases in assets and expenses.

Debits and Credits:

• Debits (Dr):
  
  

  • Increases in assets.

  • Decreases in liabilities and equity.

  • Expenses and losses are debited.

• Credits (Cr):
  
  

  • Increases in liabilities and equity.

  • Decreases in assets.

  • Revenue and gains are credited.

Normal Balances:

• Assets: Normal balance is a debit.

• Liabilities: Normal balance is a credit.

• Owner’s Equity: Normal balance is a credit.

• Revenue: Normal balance is a credit.

• Expenses: Normal balance is a debit.

Journal Entries:

• The record of each transaction that includes the accounts affected, the amounts debited and credited, and a brief description.

• Format:

  • Debit account(s) | Amount

    • Credit account(s) | Amount

Trial Balance:

• A listing of all account balances to ensure that debits equal credits.

• The trial balance is used to check for errors in the accounting records.