Midterm Review Study Guide: Chapters 1-6

Midterm Exam Logistics

  • Date and Time: Monday, from 05:30 to 07:30.

  • Coverage: The exam covers material from Chapters 1 through 6 inclusive.

  • Platform: The exam will be taken on Moodle while joined to a Zoom meeting.

  • Requirement: Cameras must remain open for the full duration of the exam.

  • Preparation Strategy: Use class time to study; the instructor will not introduce new material before the midterm.

Chapter 1: Overview of Financial Statements

  • The Four Financial Statements:

    • Balance Sheet.

    • Income Statement.

    • Statement of Stockholders' Equity.

    • Statement of Cash Flows (Note: Statement of Cash Flows will be covered heavily in a dedicated chapter later and is not required for the first midterm).

  • Balance Sheet Fundamentals:

    • Structure: Assets = Liabilities + Stockholders' Equity.

    • Organization: Assets and Liabilities must be listed by current versus non-current order.

    • Stockholders' Equity includes Common Stock and Retained Earnings.

    • Formatting Tip: Do not waste time making the balance sheet "perfect" regarding boxes, dollar signs, or underlines. The instructor gives significant partial credit if specific accounts like Accounts Receivable or Accounts Payable are mostly correct.

  • Income Statement Fundamentals:

    • Structure: Revenue−Expenses=Income before Income Taxes\text{Revenue} - \text{Expenses} = \text{Income before Income Taxes}.

    • Income before Income Taxes−Tax Expense=Net Income\text{Income before Income Taxes} - \text{Tax Expense} = \text{Net Income}.

    • Components: Includes the company name, statement type, year, and units of measurement.

  • Statement of Stockholders' Equity:

    • Common Stock Equation: Beginning Common Stock+Stock Issued=Ending Common Stock\text{Beginning Common Stock} + \text{Stock Issued} = \text{Ending Common Stock}.

    • Retained Earnings Equation: Beginning Retained Earnings+Net Income−Dividends=Ending Retained Earnings\text{Beginning Retained Earnings} + \text{Net Income} - \text{Dividends} = \text{Ending Retained Earnings}.

    • Note: For the first year of operations, beginning balances for Common Stock and Retained Earnings are zero.

  • Statement Interconnectivity: Net Income from the Income Statement flows into the Retained Earnings calculation. The Ending Common Stock and Ending Retained Earnings from the Statement of Stockholders' Equity then appear on the Balance Sheet.

Chapter 2: The Balance Sheet and Journal Entries

  • Asset and Liability Definitions: Assets (what you own); Liabilities (what you owe).

  • Current vs. Non-current Assets:

    • Current: Cash, short-term investments, accounts receivable, and supplies.

    • Non-current: Typically Property, Plant, and Equipment (PP&E), and Land.

  • Current vs. Non-current Liabilities:

    • Current: Accounts payable, unearned revenue, utilities payable, and taxes payable (due within a year).

    • Non-current: Long-term notes payable.

  • Specific Account Classifications:

    • Prepaid Expenses: Always an Asset, despite the word "expense" in the name, because it represents payment for future use.

    • Unearned Revenue: Always a Liability, despite the word "revenue," because the service has not yet been earned.

    • Treasury Stock: A Contra-equity account. It represents shares repurchased from the public and is shown as a negative value under Stockholders' Equity.

  • Journal Entry Rules:

    • Assets: Increase with a Debit; decrease with a Credit.

    • Liabilities/Equity: Increase with a Credit; decrease with a Debit.

    • Issuing Stock Example:

      • Scenario: Issue stock at $0.01\$0.01 par value and $0.17\$0.17 market value.

      • Debit Cash (Shares ×\times Market Value).

      • Credit Common Stock (Shares ×\times Par Value).

      • Credit Additional Paid-in Capital (The difference).

    • Borrowing Money Example:

      • Debit Cash (Asset increase).

      • Credit Notes Payable (Liability increase).

    • Repurchasing Shares:

      • Debit Treasury Stock.

      • Credit Cash.

    • Declaring Dividends:

      • Debit Retained Earnings.

      • Credit Dividends Payable.

Chapter 3: Revenue and Expenses (Accrual Basis)

  • Accrual Basis of Accounting: Revenue is recognized when earned (service provided or goods delivered), and expenses are recognized when incurred, regardless of when cash is exchanged.

  • Operating vs. Non-operating Items:

    • Sales Revenue−Operating Expenses=Income from Operations\text{Sales Revenue} - \text{Operating Expenses} = \text{Income from Operations}.

    • Income from Operations ±\pm Other items = Income before Income Taxes.

  • Journal Entry Continuation:

    • Revenue: Always increased with a Credit.

    • Expenses: Always increased with a Debit.

    • Revenue Example: If $1,359\$1,359 in food is sold with $1,030.15\$1,030.15 in cash received and $44\$44 on account:

      • Debit Cash for $1,030.15\$1,030.15.

      • Debit Accounts Receivable for $44\$44.

      • Credit Restaurant Sales Revenue for $1,359\$1,359.

Chapter 4: Adjusting Journal Entries (AJE)

  • Purpose: To update account balances before finalizing financial statements.

  • Gift Card/Unearned Revenue Adjustment: When a customer redeems a gift card, you must decrease the liability and increase revenue.

    • Debit Unearned Revenue.

    • Credit Revenue.

  • Interest Accrual: If interest is earned but not yet received:

    • Debit Interest Receivable.

    • Credit Interest Revenue.

    • Formula for Interest Expense: Principal×Interest Rate×Number of Months12\text{Principal} \times \text{Interest Rate} \times \frac{\text{Number of Months}}{12}.

  • Supplies Adjustment:

    • Formula: Beginning Supplies+Purchases−Ending Supplies=Supplies Expense\text{Beginning Supplies} + \text{Purchases} - \text{Ending Supplies} = \text{Supplies Expense}.

    • Entry: Debit Supplies Expense; Credit Supplies (Asset).

  • Depreciation:

    • Entry: Debit Depreciation Expense; Credit Accumulated Depreciation (Contra-asset).

  • Wages Accrual:

    • Entry: Debit Wages Expense; Credit Wages Payable.

  • Closing Process: Revenue (debit to close) and Expenses (credit to close) are moved to Retained Earnings so they start the new year with a zero balance.

Chapter 5: Multi-Step Income Statement

  • Structure Hierarchy:

    1. Net Revenue

    2. Less: Cost of Goods Sold (COGS)

    3. Equals: Gross Profit (or Gross Margin)

    4. Less: Operating Expenses

    5. Equals: Operating Income (Income from Operations)

    6. Plus/Minus: Other items

    7. Equals: Income before Income Taxes

    8. Less: Tax Expense

    9. Equals: Net Income

Chapter 6: Receivables, Net Sales, and Cash

  • Discount Terms: e.g., 2/10,n/302/10, n/30 means a 2\text{%} discount if paid within 1010 days; otherwise, the full amount is due in 3030 days.

  • Net Sales Revenue Formula:

    • Sales Revenue−Credit Card Discounts−Sales Discounts−Sales Returns and Allowances=Net Sales Revenue\text{Sales Revenue} - \text{Credit Card Discounts} - \text{Sales Discounts} - \text{Sales Returns and Allowances} = \text{Net Sales Revenue}.

  • Bad Debt Expense - The Allowance Method:

    • Estimation Entry: Debit Bad Debt Expense; Credit Allowance for Doubtful Accounts (ADA).

    • Write-off Entry (Specific customer found): Debit ADA; Credit Accounts Receivable.

    • Recovery of Write-off:

      1. Reverse write-off: Debit Accounts Receivable; Credit ADA.

      2. Record payment: Debit Cash; Credit Accounts Receivable.

  • Estimating Bad Debt:

    • Percentage of Sales: Sales×Percentage=Bad Debt Expense\text{Sales} \times \text{Percentage} = \text{Bad Debt Expense}.

    • Aging of Accounts Receivable: Balances in age categories multiplied by uncollectible percentages equals the required Ending ADA Balance. You must then adjust the current ADA balance to reach this target.

  • Bank Reconciliation:

    • Book Side Adjustments: Add interest earned; subtract bank service charges; adjust for errors; subtract Non-Sufficient Funds (NSF) checks.

    • Bank Side Adjustments: Add deposits in transit; subtract outstanding checks.

Questions & Discussion

  • Question (Unidentified Student): Regarding the midterm and writing the balance sheet, will it be like the homework with a blank screen to fill in?

    • Response: You are required to create the financial statement from scratch. Focus on the structure: Name, Statement Type, Year, Units, and the order of Assets, Liabilities, and Equity. Just list them out; no boxes or tables are necessary.

  • Question (Alex): If we are given a list for a balance sheet but Retained Earnings\text{Retained Earnings} or Common Stock\text{Common Stock} for that year are missing, should we prepare to calculate them?

    • Response: You might be asked to calculate Net Income or Ending Retained Earnings separately. However, when creating a full Balance Sheet or Income Statement on the exam, all necessary account information will be provided. You won't have to derive missing accounts from a trial balance for the specific "create a statement" questions.

  • Audience Interaction Note: During the recording, an audience member was heard saying "Kira, what the fuck?" and "Look right there. You have to get close."

  • Resource Note: The instructor mentioned having summaries in Excel that will be posted to help students prioritize their study time, focusing on journal entries and statement structures.