Accounting exam 1

current assets

assets that are expected to turn to cash or use up within one year from the date of the balance sheet

Trial Balance

a list of accounts and their balances at a given time, proves debits=credits after posting, If don't equal can use trial balance to uncover errors

financial statements

a set of accounting reports that convey info to outsider users such as creditors and investor

T account

a tool for analyzing a business's financial position by showing, in a single table, the business's assets (on the left) and liabilities (on the right)

If credits are greater than the debits (t-account)

account will have a credit balance

If debits are greater than the credits (t-account)

account will have a debit balance

Depreciation Expense

debit, expense account, found on income statment, reduces net income, Represents the amount of the building or equipment 'used up' in the current year

left in journal entry

debits are left (what are you gaining)

long-term liabilities

debts paid longer than one year from balance sheet

current liabilities

debts paid within one year

decreases to equity

dividends (no effect on net income) and expenses (if income goes down equity goes down)

contra equity

dividends, reduces equity

financing activities outflows

dividends, repaying bank loan

accounting transactions

economic events that require recording in the financial statements (change in assets, liabilities, or equity accounts)

two ways to raise funds for business

equity or debt financing

double-entry accounting

every transaction must be record with at least one debit and one credit with the total debits always equals the total credits

how to Close dividends into retained earnings

Debit retained earnings for balance in dividends account and credit dividends for the same amount

how to Close expenses into retained earnings

Debit retained earnings for total expenses and credit each expense account for its balance

how to Close revenues into retained earnings

Debit revenue account for its balance and credit retained earnings for total revenues

journal entry credits and debits

Debits = credits in every entry

Why are audits necessary?

Managers might have an incentive to use 'flexible' accounting methods to manipulate statements (deceive investors/creditors, avoid paying taxes)

Acid Test Ratio (quick ratio) meaning

More conservative estimate of companies liquidity by using the most liquid current assets in the numerator

liabilities

The debts owed (creditors claims against the companies assets)

Operating Activities

affect the net income (cash exchanges that affect net revenues and expenses)

ledger

all accounts of the company taken together (all T accounts of the company)

Unearned revenue

amount of services still to be performed (liability) Does not affect net income

revenues

amounts earned during accounting period (will say revenue)

accounts receivable

amounts owed by customers to company (asset)

operating activities outflows

ash used to purchase inventory, salaries, taxes, interest

Historical Cost Concept

assets are reported at their cost (the amount at which the company paid to acquire them)

historical cost concept

assets are to be shown on the balance sheet at their cost (the amount which the company paid to acquire them)

examples of long-term liabilities

Long term note payable, mortgage payable (property loan), bonds payable

liquidity ratios

measure short term ability of company to pay its debts as they come due

when putting inventory in journal entry

need cost of goods sold (debit) and sales revenue (credit)

retained earnings

net income that hasn't been paid by owners to the dividend but used for growth/expansion

deferrals

transaction for which cash has been received or paid but the revenue or expense has not been recorded (exchange of cash has been occurred before the action)

accruals

transactions for which cash has NOT yet been received/paid but the revenue or expense has been earned or incurred and thus must be recorded (action has occurred before the exchange of cash)

Posting

transferring debt and credit amounts from the journal to the ledger (transferring journal entries to the T-accounts), allows us to determine ending balance in each account

Partnership

two or more people in control, requires more skills/resources

Find missing value of credits and debits

use Cost of goods sold = credits - debits

supplies

used in business operations (asset)

long-term assets

used in operations longer than one year

interest expense

when a company borrows money and must repay it with interest

Supplies Adjusting Entry

when purchased are classified as a current asset, Once they are 'used up' they are considered an expense 'supplies expense',

Analyzing transactions (equity)

whenever net income is changed that change will carry over into EQUITY (because affects retained earnings and that is part of equity)

Acid Test Ratio (quick ratio)

(Cash + accounts receivable) / current liabilities (Ratio in form of 'number of times')

annual depreciation expense equation

(cost - residual value) / useful life = depreciation expense

Balance sheet

(statement of financial position at a specific point in time 'snapshot'), provides info about a business assets and claims against those assets

Accounting Cycle Steps

1. Record transactions in the journal (journal entries) 2. Post debit and credit amounts from journal to ledger (to determine ending balance of each account) 3. Prepare an unadjusted trial balance 4. Prepare an adjusted trial balance 5. From adjusted trial balance, prepare financial statements

three things showed on balance sheet

1. economic resources owned by a business, debts owed, and amount of the owners investment in a business (assets, liabilities, equity)

current liabilities include

Accounts payable, short term note payable, salaries payable, income tax payable, utilities payable, salary, income tax, utiltiies

after closing entries are posted

All temporary accounts have zero balances, Balance in retained earnings represents all of the net income that the company has earned through its year that has not been paid out as a dividend to our stockholders (accumulated undistributed earnings)

fundamental accounting equation

Assets = liabilities + equity

independent auditors report

Auditor's opinion to if the financial statements are 'fair'

examples of debt financing

Banks, interest, creditors, payment schedule (borrowing)

Common stock equation

Beginning balance + additional sales of stock - ending contributed capital = CS

retained earnings equation

Beginning balance + net income - dividends = ending retained earnings

current ratio

CA/CL (Ratio in form of 'number of times')

investing activities

Cash associated with the purchase/sale of long term assets such as P-P-E

deferred revenues account

Cash received recorded as a liability, Only becomes revenue when company gives service/good, Reduce liability (what we owe) when we provide the service, and increase a revenue account

Three closing entries that need to be made every year (do opposite of normal to close it out)

Close revenues into retained earnings, Close expenses into retained earnings, Close dividends into retained earnings

Increases Equity

Common stock (investments by owners) and revenues

equity equation

Common stock + Retained earnings

deferred expenses (prepaid expenses)

Company pays for an expense item in advanced, Recorded as an asset Only becomes an expense when the asset is 'used up'

Which company is the right company stock to buy?

Compare financial statements (two sets need to be prepared the exact same way for comparison to be meaningful)

depreciation deferral

Considered a deferral → cash is paid first when the asset is purchased, expense paid later when asset gets 'used up'

note to the financial statement

Footnotes, clarify financial statements, critical in understanding companies performance

Account Type: Equity

Increase: Credit Decrease: Debit Normal Balance: Credit

Account type: Liability

Increase: Credit Decrease: Debit Normal Balance: Credit

Account type: Revenue

Increase: Credit Decrease: Debit Normal Balance: Credit

Account Type: Expense

Increase: Debit Decrease: Credit Normal Balance: Debit

Account type: Asset

Increase: Debit Decrease: Credit Normal Balance: Debit

Audit of financial statements

Independent audits are required to safeguard investors/creditors from misleading financial statements (know they are prepared according to GAAP bc audited)

interest rate info

Interest rate will always be expressed as an annual rate, Will always be a fraction over 12 (bc 12 months in a year), Numerator represents number of months that have elapsed in the current year, Assume interest is repaid at the end of the loan rather than have monthly payments that include interest, ANY NOTE PAYABLE WILL HAVE INTEREST

equity financing examples

Investments from owners (stock), no repayment, dividends

financial ratios Common benchmarks/comparison points

Other companies that operate in the same industry, Industry averages, Past years (trend analysis)

Securities exchange commission (SEC)

Public sector organization that has express authority from congress to develop GAAP (allowed FASB to create rules and SEC enforces it)

gross profit

Represents the profit earned from selling inventory

net income equation

Revenues - Expenses = Net income

gross profit equation

Sales revenue -c ost of goods sold = gross profit

How to make a trial balance

Start with assets (in order of liquidity), then liabilities, equity, revenues and expenses

supplies t account (adjusted)

Supplies purchased are a debit, Supplies used up are a credit

Total Equity Equation

Total Equity = Contributed Capital + Retained Earnings (selling CS increases equity)

annual report

US companies that are publicly traded must provide this to their shareholders

financial accounting

Used by OUTSIDERS to make decisions (investors, creditors, banks/lenders)

Mangerial Accounting

Used by people INSIDE company to make decisions (management)

what is depreciation

Using up' of buildings and equipment, Need an adjusting entry every year to record the amount buildings/equipment have been 'used up', nothing to do with value of an asset

interest revenue

When a company lends money to someone and is to be repaid with interest

examples of financial statements

balance sheet, income statement, cash flow statement, owners equity statment

Ending Equity Formula

beginning equity + additional sales of CS + net income - dividends

investing activities (effect)

cash exchanges that affect long term assets such as PPE

operating activities inflows

cash from customers

cash receipts

cash inflows

cash payments

cash outflows

financing activities

cash used to fund the business

investing activities outflows

cash used to purchase assets (tangible/intangible)

current assets include

cash, accounts receivable, inventory, supplies

statement of cash flows

changes in cash for a period of time (same time covered by income statement)

nominal (temporary accounts)

closed to a zero balance at the end of every year, Includes revenues, expenses, dividends (make zero)

what makes up equity

common stock and retained earnings

residual value =

companies estimate of what the asset can be sold for at the end of its expected life (measured in years)

deferred revenues (unearned revenues)

company receives cash in advance for services/goods to be delivered later

expenses

costs incurred in process of earning revenues (includes cost of goods sold)

Management discussion and analysis (management's report)

covers the companies ability to pay near-term obligations, fund operations and expansion, and its results of operations, Must highlight favorable/unfavorable trends and identify significant events and uncertainties

Current assets on balance sheet

need to be listed in order of liquidity which means ease in converted to cash, so cash first

accumulated depreciation

credit, causes decrease in assets (contra asset account), normal balance is credit

Cost of Goods Sold Equation

credits - debits

right in journal entry

credits are right (what are you giving up)

total assets equation

current assets + P-P-E assets

Working capital

current assets - current liabilities (ratio in form of dollar amount)

to record a depreciaiton expense

debit depreciation expense and credit accumulated depreciation

interest expense adjusted entry

debit interest expense and credit interest payable

interest revenue adjusted entry

debit interest recievable and credit interest revenue

Financial statement analysis

examines relationships among financial statement numbers and the trends of those numbers overtime (Use past performance to predict future Evalue performance of company to identify problem areas)

accrued expenses

expenses incurred but not yet paid in cash or recorded (debit an expense account and credit a liability account)

matching concept

expenses must be recorded in the same accounting period that the related revenue is earned

Accrued Liabilities

expenses that have been incurred but have not been paid at the end of the accounting period (salary, income tax, utilities)

an annual report includes

financial statements, note to the financial statement, independent auditors report, management report

equity financing

funds provided by the owners of a company

debt financing

funds raised through various forms of borrowing that must be repaid

Property-plant equipment (P-P-E)

have physical substance (land, buildings, equipment)

operating activities

inflows and outflows of cash associated w primary operations of business (transactions that creates revenues/expenses)

Accrual of Interest

interest rev or expense is recorded first and cash will be paid later

contributed capital

investments made by owners by purchasing stock (common stock in equity)

contributed capital (common stock)

investments made by owners into the business through the purchase of the organization's stock

adjusting entries

journal entries made at end of accounting period (end of year, end of month) to update account balances and make sure matching concept and accrual accounting are following

intangible assets

lack physical substance, patents, trademark, copyright (long-term assets)

long-term assets include

land, buildings, equipment, patents, trademark, and copyright

permanent (real) accounts

never closed to zero at end of the year (amount stays), includes assets, liabilities, equity

Generally accepted accounting principles (GAAP)

oncepts, standards, guidelines, and conventions, companies are supposed to follow when preparing financial statements

Sole Proprietorship

owned by1 person, owner controlled, simple to establish

dividends and its effect

payments corporations make to its stockholders, Not an expense so have no effect on income statement, Will always be on debit side, Classified as a contra equity account since it reduces equity by reducing retained earnings

Dividends

payments of cash from a corporation to its stockholders (contra equity)

Jounral

place where accounting transactions are initially recorded

account

place where all increased/decreases in financial statement items are recorded (use T account)

interest equation

principal x rate x time

inventory

product company sells (asset)

closing entries

purpose to transfer a net income or net loss and dividends to retained earnings

Statement of owner's equity

record of the change in owners' equity from the end of one fiscal period to the end of the next

Realization Principle

record revenue when product/service is delivered and cash has been received OR they promise to pay for service later (record when provide good to customer), Record revenue independent of exchange of cash (record when goods are sold not when cash is received)

Cash Accounting

record revenues when cash is received, Record expenses when cash is paid, Can be used by any company who does not sell stock (does not follow GAAP)

Gains

recorded when you sell an asset other than inventory for more than its cost, revenue account

Losses

recorded when you sell an asset other than inventory less than its cost, expense account

accrual accounting

records revenues when earned (use GAAP), Required to be used by companies who sell stock (securities) to the public, If company does not sell stock and they want a bank loan required to present financial statements using accrual accounting

contra asset account

reduction of assets

Financial ratios

relationships between financial statement amounts, Used by investors/creditors to make decisions (loan/invest)

If you see "prepaid"

represents an asset account (specifically the unused portion of repayment), As asset gets used up → the amount used is recorded as an expense

"bill" in journal entries

represents an expense

assets

resources owned by a business

payment from a customer in a journal entry

revenue account

Accrued Revenues

revenues for services performed but not yet received in cash or recorded (debit an asset account and credit a revenue account)

investing activities inflows

sale of assets (land, buildings, equipment)

financing activities inflows

selling stock, bank loan

financial statements

set of accounting reports that convey financial info to outside users such as creditors/investors

Accumulated Depreciation

shown in decrease of PPE (contra asset)

statment of owner's equity

shows changes in owners equity for a period of time (same period of time as the income statment)

Income statment

shows profitability of the company for a period of time (month/year)

cooperation

stockholders own it, no personal liability, separate legal entity from owners

depreciation

systematic allocation of the cost of a plant asset (buildings and equipment) to expense over its useful life

Equity (stockholders equity for corporation)

the amount of the owner's investment in the business

Journal entry

the format used for recording business transactions

Financial accounting standards board (FASB)

the primary accounting standard-setting body in the US

normal balance (t-account)

the side of the account that is increased, what side of the T-account the beginning and end account balance will be found