Comprehensive Financial Accounting CLEP Study Guide
Foundational Accounting Concepts and Terms
Assets: Economic resources that a business plans to use in the future to generate money.
Capital: Specific assets that assist a business or an individual in making money.
Liabilities: Debts owed to individuals or entities outside of the company.
Creditors: The outsiders to whom a company owes money.
Owner's Equity: The portion of the business that the owner is entitled to keep after all creditors have been paid off.
Balanced Books: A state in which the question "Where did it go?" equals "Where did it come from?" Specifically, this occurs when a company's assets are equal to the sum of its liabilities and owner's equity. This can be expressed by the fundamental accounting equation: .
Sole Proprietor: An individual who owns an unincorporated business alone, without partners.
Corporation: An artificial "person" created under state laws that possesses the legal right to conduct business.
Fiscal Year: A period used by a business to report the results of its operational activities.
Operating Cycle: The natural duration of time before specific business activities tend to repeat, which is normally year.
Liquid: A descriptor for assets; the easier it is to convert an asset into cash, the more liquid that asset is said to be.
Material: Information that is significant enough to influence decision-making processes.
On Account: Refers to a sale for which the payment is scheduled to be made at a later date.
The Financial Statements
Balance Sheet: A financial report that displays the business assets, liabilities, and owner's equity as of a specific, particular day.
Income Statement: A financial report illustrating the results of business operations over a defined period of time. It details income and expenses.
Statement of Owner's Equity: A financial statement that calculates the balance of the owner's equity account at the end of a period.
Cash Flow Statement: A statement showing the origins and uses of cash during a period. It is divided into four major sections:
Cash flow from operations.
Cash flow from investing activities.
Cash flow from financing activities.
A calculation of (1) net cash flow and (2) cash at the end of the period.
Interim Financial Statements: Financial reports prepared for any period of time that is less than one full year.
Income and Expense Concepts
Income: Accounts used to explain why assets increased as a result of operations.
Sales: A specific income account that explains the increase in business assets resulting from the sale of goods.
Expenses: Accounts used to explain why assets decreased due to operations.
Net Income: Calculated as .
Cost of Goods Sold (COGS): The cost to the business for the merchandise or goods that it actually sells.
Depreciation Expense: The portion of long-lived assets that is used up during the course of business operations.
Transportation Expense: The cost of business-related airplane fares, trains, and long-distance buses.
Travel Expense: The cost of living and associated costs while away from home on business business.
Miscellaneous Expense: An account used for small expenses that are not considered significant enough to warrant their own dedicated account.
Expensed: Money is considered "expensed" if it is gone forever, meaning no useful asset remains as a result of the spending. This is the opposite of being capitalized.
Capitalized: This occurs when money is changed into another asset intended to help the business make money. To "capitalize" is to record a cost as an asset rather than an expense.
Accounting Recording and Process
Account: A specific place on the financial books used to track financial information that the owner wishes to monitor.
Chart of Accounts: The official comprehensive list of all business accounts.
T-Account: A tool for tracking the increases ("ups") and decreases ("downs") in accounts. Increases are placed on one side of the "T" and decreases on the other.
Debit: The left side of a T-account. Debits increase assets, withdrawal, and expense accounts, but decrease liabilities and equity accounts.
Credit: The right side of a T-account. Credits increase liabilities, equity, and income accounts, but decrease asset accounts.
Normal Balance: The expectation that all accounts normally maintain balances that are either debits or credits.
General Journal: A book or computer subroutine used to record any type of accounting entry.
General Ledger: A book or computer subroutine containing all individual accounts.
Specialized Journal: A book or computer subroutine designed for the rapid input of frequent types of business transactions.
Vertical Journal Entries: A method where accounts are journalized and posted simultaneously by recording transactions vertically in columns.
Posting: The process of taking amounts from recorded business transactions and entering them as debits or credits into the various accounts.
Control Account: An account that shows the total of all individual records kept in a subsidiary record.
Subsidiary Record: A separate record containing the details of a control account (e.g., an accounts receivable subsidiary record lists everyone who owes money, the total of which matches the Accounts Receivable control account).
Trial Balance: A list of all accounts and their respective balances. Debit balances are in the debit column and credit balances in the credit column. For the books to be balanced, the debit column must equal the credit column.
Net/Netted: "Net" indicates a subtraction has occurred. Numbers are "netted" when they combine so that negative numbers are subtracted from positive numbers.
Year-End and Closing Procedures
Closing: The process of end-of-year posting to bring temporary accounts to a zero balance and transfer those balances into the owner's equity account.
Temporary Accounts: Accounts that are closed (brought to zero) at the end of each year. These include income, expenses, withdrawal, and dividends.
Income Summary: An account utilized once a year strictly for closing entries to record the net income for the year.
Post-Closing Trial Balance: A trial balance prepared specifically after the books have been closed at the end of the fiscal year.
Adjusting Entry: A non-cash journal entry made at the end of a period to adjust a balance sheet account.
Reversing Entries: Entries made on the first day of a new period that switch the debits and credits of the adjusting entries made on the final day of the previous period.
Accounting Bases and Rules
Accrual Basis Accounting: A system where income is recognized when it is earned and expenses are recognized when they are incurred, regardless of when cash is exchanged. This system meets GAAP requirements.
Cash Basis Accounting: A system where income and expenses are recognized only when cash changes hands. This does not meet GAAP requirements.
Accrue: To recognize revenues or expenses on the books even though no cash has changed hands yet.
Generally Accepted Accounting Principles (GAAP): The standard rules of accounting that everyone must follow.
Financial Accounting Standards Board (FASB): The organization of accountants responsible for creating accounting rules.
Professional Stewardship and Ethics
Financial Accounting: The skill of producing financial statements based on business transactions.
Managerial Accounting: The skill of providing financial information specifically to run a large business.
Audit: A check of business accounting records to provide an opinion on whether the financial statements present the business fairly.
Auditors: Certified Public Accountants (CPAs) who perform the audit of accounting records.
Certified Public Accountants (CPAs): Accountants licensed by the state to serve as professional, independent verifiers of financial statements.
AICPA: The American Institute of Certified Public Accountants; the professional organization issued the code of ethics for accountants.
Ethics: Standards defining how one should act in business situations.
Internal Controls: Business procedures designed to make it difficult for individuals to engage in and get away with wrongful behavior.
Bonded: Refers to an employee for whom an insurance company has issued a policy to pay the employer if the employee steals.
Asset Categories and Inventory
Current Assets: Assets that can be used to pay current liabilities or are available to spend within one year.
Quick Assets: Assets that are quickly convertible into cash, including cash, short-term investments, and net accounts receivable.
Fixed Assets (also Capital or Plant Assets): Assets expected to last longer than year.
Inventory: A supply of items a business has on hand for use or sale.
Intangible Assets: Assets with no physical form that offer value for more than one year (e.g., patents, copyrights, trademarks, goodwill).
Investments: The use of money to purchase assets that generate more money.
Short-term: Planned to be resold within one year (e.g., certificates of deposit, stocks). Also called marketable securities.
Long-term: Assets such as buildings and equipment.
Trading Investments: Short-term investments bought with the express purpose of reselling them for profit.
Inventory Costing Methods
FIFO (First-In, First-Out): Assumes the oldest items in inventory are the first ones sold.
LIFO (Last-In, First-Out): Assumes the latest items purchased are the first ones sold.
Specific Unit: Tracks the actual historic cost of every individual inventory item. When sold, that specific cost flows to COGS.
Weighted Average: Averages the cost of all items in inventory and assigns that averaged cost to items as they are sold.
Inventory Systems
Periodic Inventory Method: Tracks merchandise costs in various purchase and contra-purchase accounts. COGS is computed on the income statement, and inventory on the books is only adjusted at year-end.
Perpetual Inventory Method: Increases the inventory account with every purchase and decreases it with every sale in real-time.
Contra Accounts
Contra Account: An account subtracted from its related (brother) account, always reported as a negative number. They have a normal balance opposite to their related account.
Contra-Asset Account: An account subtracted specifically from an asset account.
Accumulated Depreciation: The contra-asset account that accumulates all depreciation of long-lived assets over time.
Contra-Purchases Account: Subtracted from Purchases to calculate Net Purchases. Examples include Purchases Discounts and Purchases Returns and Allowances.
Contra-Liability Account: A negative liability, such as a bond discount.
Accounts Receivable and Notes
Write-off: When a company gives up on collecting an account receivable and removes it from the records.
Direct Write-off Method: Recognizes bad-debt expense only in the period the account is written off. This is not GAAP compliant.
Principal: The loan amount that remains unpaid; the non-interest portion of a loan.
Face Amount: The dollar amount written on the face of a note or bond.
Face Interest: The interest rate written on the face of a note.
Present Value of a Note: The amount borrowed (the principal).
Future Value (Maturity Value) of a Note: The amount borrowed plus all interest accrued up to the maturity date.
Interest-bearing Note: A note with an interest rate on its face; the face amount represents the present value.
Non-interest-bearing Note: A note without an interest rate on its face; the face amount represents the future value.
Discount a Note: To sell a note to a bank that subtracts a discount and provides the seller with the proceeds.
Proceeds of a Note: The amount the bank gives in exchange for a note.
Maker: The person who borrows money, writes a note, or writes a check.
Cash Management and Banking
Clear the Bank: Occurs when a payee presents a check to the bank, and the bank pays it by deducting funds from the maker's account.
Outstanding Check: A check that has been written but has not yet cleared the bank.
Deposit Not Shown: A bank deposit made too late to appear on the current bank statement.
Payee: The person to whom a check is written.
Petty Cash System: A system for making small payments using cash.
Realized Gain/Loss: A gain or loss occurring when an asset is actually sold.
Unrealized Gain/Loss: A change in the value of a business asset that has not yet been sold.
Depreciation and Amortization
Depreciable Cost: The historical cost of an asset that is allocated over its useful life.
Residual Value (Salvage or Scrap Value): The estimated amount received for an asset at the end of its useful life.
Fully Depreciated (Depreciated Out): When an asset's book value equals its salvage value.
Depreciation Schedule: A list of all fixed assets, purchase dates, methods, and yearly depreciation.
Depreciation Convention: Assumptions about purchase dates to simplify the depreciation process.
Accelerated Depreciation Method: Results in higher depreciation expense in the early years of an asset's life.
MACRS: Modified Accelerated Cost Recovery System; IRS tables that provide the rates to multiply against an asset's historical cost.
Amortization Expense: The amount of an intangible asset used during a period.
Fully Amortized: When an intangible asset's book value reaches zero and all costs have been allocated.
Depletion Expense: The amount of a natural resource used during a period.
Intangible Asset Types
Patents: Exclusive rights to produce/sell an invention.
Copyrights: Exclusive rights to publish or perform music, art, film, books, or software.
Trademarks/Trade Names: Identifications protected against infringement.
Goodwill: Extra cost paid when buying a business for being unusually profitable.
Franchises and Licenses: Contracts/grants giving special rights.
Research and Development (R&D): Costs to create/develop products; these are expensed annually and are NOT intangible assets.
Liabilities and Bonds
Current Liabilities: Debts must be paid within one year or one operating cycle, whichever is longer.
Wages Payable: Reflects wages earned by the end of the period but not yet paid.
Interest Payable: Reflects interest accrued on business debts.
Warranty: A promise to pay for future expenses of a sold product.
Warranties Payable: Estimated amount owed on warranties.
Bonds: Certificates issued by corporations or governments to borrow large sums from many people. Includes periodic payments and a lump sum at maturity.
Bondholder: The investor owning the bond certificates.
Bond Book Value: The true value of the bond liability.
Face (of a Bond): The frontside of the certificate.
Face Rate: The percentage on the bond used to calculate periodic cash payments.
Market Interest Rate: The rate lenders can currently get for their money elsewhere.
Discount (Bond): When lenders pay less than the face amount for a bond.
Premium (Bond): When lenders pay more than the face amount for a bond.
Underwriter: A company that buys an entire bond offering to resell it for profit.
Deferred Credit/Deferred Revenue: Liabilities resulting from receiving cash before earning it.
Corporate Equity and Stock
Authorized Shares: The maximum shares a corporation may legally issue.
Issued Shares: Shares actually issued to investors.
Outstanding Shares: Issued shares minus any treasury stock repurchased.
Treasury Stock: A corporation's investment in its own stock.
Par Value: The dollar amount written on a stock certificate.
No-par Stock: Shares with no dollar amount written on the certificate.
Stated Value: An accounting value equivalent to par value given to no-par stock.
Common Stock: Represents the basic ownership of a corporation.
Preferred Stock: Stock with certain special privileges.
Stock Certificate: Document evidencing ownership.
Retained Earnings: Equity account containing all earnings never distributed to stockholders.
Preemptive Right: The right to buy a portion of new stock issuances to maintain an ownership percentage.
Dividends:
Cash Dividend: Profits distributed to stockholders in cash.
Stock Dividend: Proportional distribution of small amounts of stock.
Declaration Date: When the board declares the dividend.
Date of Record: Whoever owns stock on this date gets the dividend.
Stock Split: A large distribution (e.g., ) where old certificates are exchanged for new ones.
Withdrawal (or Draw): Money the owner takes for personal use or to pay personal bills.
Financial Analysis Techniques
Vertical Analysis: Comparing all numbers in a report with a single key number from that same report.
Horizontal Analysis: Comparing current results with results from a previous year.
Percentage Analysis: One number is assigned as . In balance sheets, this is total assets; in income statements, it is sales.
Ratio Analysis: Computing ratios from financial statement numbers to analyze results.
Benchmarking: Comparing financial statements with those of similar companies.
Advanced Reporting Items
Continuing Operations: Income from normal, expected operations plus gains/losses from asset/investment sales.
Discontinued Operations: Combined income/expenses/gains/losses from a sold business segment, reported net of tax as a single number.
Extraordinary Gains and Losses: Items that are both unusual and infrequent.
Net of Tax: Figures shown after a reduction for income taxes.
Other Comprehensive Income: Found at the bottom of the income statement; includes foreign currency adjustments and unrealized gains on available-for-sale investments.
Cumulative Effect of a Change in Accounting Method: A single number, net of tax, showing the total effect as if a new method had been used from day one.
Closely Held Corporation: A corporation with few stockholders, usually less than .