Ryan - Basic Principles of Accounting

Cost Principle

Assets are recorded at cost, which equals the value exchanged at the time of their acquisition. In the United States, even if assets such as land or buildings appreciate in value over time, they are not revalued for financial reporting purposes

Assets included on a Balance Sheet

Current Assets -A/R -Cash -Marketable Securities -Pre-paid Expenses PP&E Long-tern Investments Goodwill

Current Assets - assets that are reasonably expected to be converted into cash within one year in the normal course of business. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash. Current Liabilities - debts or obligations that are due within one year. Current liabilities appear on the company's balance sheet and include short term debt, accounts payable, accrued liabilities and other debts. Working Capital - Also known as "net working capital" or "working capital ratio". A measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as: Working Capital = Current Assets - Current Liabilities

Current Assets - assets that are reasonably expected to be converted into cash within one year in the normal course of business. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash.

Time Period Assumption

Most businesses exist for long periods of time, so artificial time periods must be used to report the results of business activity. Depending on the type of report, the time period may be a day, a month, a year, or another arbitrary period. Using artificial time periods leads to questions about when certain transactions should be recorded. For example, how should an accountant report the cost of equipment expected to last five years? Reporting the entire expense during the year of purchase might make the company seem unprofitable that year and unreasonably profitable in subsequent years. Once the time period has been established, accountants use GAAP to record and report that accounting period's transactions.

Notes Payable

A written note promising to pay a certain amount of money at a future date. May be a current liability (under 12 months) or long-term liability (over 12 months).

Principle of Conservatism

Accountants must use their judgment to record transactions that require estimation. The number of years that equipment will remain productive and the portion of accounts receivable that will never be paid are examples of items that require estimation. In reporting financial data, accountants follow the principle of conservatism, which requires that the less optimistic estimate be chosen when two estimates are judged to be equally likely.

Revenue Recognition Principle

Revenue is earned and recognized upon product delivery or service completion, without regard to the timing of cash flow. Suppose a store orders five hundred compact discs from a wholesaler in March, receives them in April, and pays for them in May. The wholesaler recognizes the sales revenue in April when delivery occurs, not in March when the deal is struck or in May when the cash is received. Similarly, if an attorney receives a $100 retainer from a client, the attorney doesn't recognize the money as revenue until he or she actually performs $100 in services for the client.

Current Liabilities

debts or obligations that are due within one year. Current liabilities appear on the company's balance sheet and include short term debt, accounts payable, accrued liabilities and other debts.

Long-term Investments

include purchases of debt or stock issued by other companies and investments with other companies in joint ventures. Long-term investments differ from marketable securities because the company intends to hold long-term investments for more than one year or the securities are not marketable.

Marketable Securities

include short-term investments in stocks, bonds (debt), certificates of deposit, or other securities. These items are classified as marketable securities—rather than long-term investments—only if the company has both the ability and the desire to sell them within one year.

Asset

is something of value the company owns. Can be tangible or intangible.

Inventory

is the cost to acquire or manufacture merchandise for sale to customers. Although service enterprises that never provide customers with merchandise do not use this category for current assets, inventory usually represents a significant portion of assets in merchandising and manufacturing companies.

Control Environment

is the management style and the expectations of upper‐level managers, particularly their control policies, determine the control environment. An effective control environment helps ensure that established policies and procedures are followed. The control environment includes independent oversight provided by a board of directors and, in publicly held companies, by an audit committee; management's integrity, ethical values, and philosophy; a defined organizational structure with competent and trustworthy employees; and the assignment of authority and responsibility.

Adequate Documents and Records

provide evidence that financial statements are accurate. Controls designed to ensure adequate recordkeeping include the creation of invoices and other documents that are easy to use and sufficiently informative; the use of pre-numbered, consecutive documents; and the timely preparation of documents.

Inventories

raw materials, work-in-process goods and finished goods considered to be the portion of a business's assets that are ready or will be ready for sale.

Balance Sheet

reports the resources (assets) and obligations (liabilities) of an organization at any given point in time.

Owner's Equity

represents the amount owed to the owner or owners by the company. Algebraically, this amount is calculated by subtracting liabilities from each side of the accounting equation. Owner's equity also represents the net assets of the company.

Segregation of Duties

requires that different individuals be assigned responsibility for different elements of related activities, particularly those involving authorization, custody, or recordkeeping. For example, the same person who is responsible for an asset's recordkeeping should not be responsible for physical control of that asset Having different individuals perform these functions creates a system of checks and balances.

Current Assets

typically include cash and assets the company reasonably expects to use, sell, or collect within one year. Current assets appear on the balance sheet in order, from most liquid to least liquid.

PP&E

vital asset that cannot be easily liquidated. The value of property, plant and equipment is typically depreciated over the estimated life of the asset, because even the longest-term assets become obsolete or useless after a period of time.

Goodwill

amount paid/willing to pay for the company over book value usually accounts for the target firm's intangible assets.

Liquid Assets

assets are readily convertible into cash or other assets, and they are generally accepted as payment for liabilities.

Retained Earnings

equal net income or loss over the life of the business less any amounts given back to stockholders in the form of dividends. Dividends affect stockholders' equity in the same way that owner withdrawals affect owner's equity in sole proprietorships and partnerships.

Cash

includes cash on hand (petty cash), bank balances (checking, savings, or money-market accounts), and cash equivalents. Cash equivalents are highly liquid investments, such as certificates of deposit and U.S. treasury bills, with maturities of ninety days or less at the time of purchase.

Internal Control

is the process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations. Safeguarding assets against theft and unauthorized use, acquisition, or disposal is also part of internal control.

Property, Plant, and Equipment

is the title given to long-lived assets the business uses to help generate revenue. This category is sometimes called fixed assets. Examples include land, natural resources such as timber or mineral reserves, buildings, production equipment, vehicles, and office furniture. With the exception of land, the cost of an asset in this category is allocated to expense over the asset's estimated useful life.

Proper Authorization

of transactions and activities helps ensure that all company activities adhere to established guide lines unless responsible managers authorize another course of action. For example, a fixed price list may serve as an official authorization of price for a large sales staff. In addition, there may be a control to allow a sales manager to authorize reason able deviations from the price list.

Independent Checks

on performance, which are carried out by employees who did not do the work being checked, help ensure the reliability of accounting information and the efficiency of operations. For example, a supervisor verifies the accuracy of a retail clerk's cash drawer at the end of the day. Internal auditors may also verity that the supervisor performed the check of the cash drawer.

Contributed Capital Accounts

record the total amount invested by stockholders in the corporation. If a corporation issues more than one class of stock, separate accounts are maintained for each class.

Net Assets

represents owner's equity.

Long-term Liabilities

Obligations of the company that become due more than one year into the future. Long-term liabilities include items like debentures, loans, deferred tax liabilities and pension obligations.

Owner's Equity

Represents the accumulated value of a company, or assets in excess of liabilities. For a corporation, Equity includes Stock Issued, Paid in Capital and Retained Earnings.

Liabilities on a Balance Sheet

-Current Liability -A/P -Notes Payable Long-term Debt Deferred Tax Liabilities

Economic Entity Assumption

Financial records must be separately maintained for each economic entity. Economic entities include businesses, governments, school districts, churches, and other social organizations. Although accounting information from many different entities may be combined for financial reporting purposes, every economic event must be associated with and recorded by a specific entity. In addition, business records must not include the personal assets or liabilities of the owners.

Full Disclosure Principle

Financial statements normally provide information about a company's past performance. However, pending lawsuits, incomplete transactions, or other conditions may have imminent and significant effects on the company's financial status. The full disclosure principle requires that financial statements include disclosure of such information.

Financial Statements

Formal record of the financial activities of a business. Usually includes: Income Statement Balance Sheet Statement of Retained Earnings Statement of Cash Flows

Stockholders' Equity

In a corporation, ownership is represented by shares of stock, so the owners' equity. is called stockholders' equity or shareholders' equity. Corporations use several types of accounts to record stockholders' equity activities: preferred stock, common stock, paid‐in capital (these are often referred to as contributed capital), and retained earnings.

Accrual Basis Accounting

In most cases, GAAP requires the use of accrual basis accounting rather than cash basis accounting. Accrual basis accounting, which adheres to the revenue recognition, matching, and cost principles discussed below, captures the financial aspects of each economic event in the accounting period in which it occurs, regardless of when the cash changes hands. Under cash basis accounting, revenues are recognized only when the company receives cash or its equivalent, and expenses are recognized only when the company pays with cash or its equivalent.

Deferred Tax Liabilities

Income tax amounts that are deferred to future years as a result of differences in the way expenses are reported for income tax and financial reporting purposes.

Long-term Assets

The value of a company's property, equipment and other capital assets, minus depreciation.

Going Concern Principle

Unless otherwise noted, financial statements are prepared under the assumption that the company will remain in business indefinitely.

Assets

an economic resource that can be used in the business. Examples include Cash, Machinery, Inventory.

Liabilities

an obligation arising from past transactions or events, the settlement of which may result in economic benefits in the future. Examples include loans or amounts due to a vendor.

Accounts Receivable

are amounts owed to the company by customers who have received products or services but have not yet paid for them.

Prepaid Expenses

are amounts paid by the company to purchase items or services that represent future costs of doing business. Examples include office supplies, insurance premiums, and advance payments for rent. These assets become expenses as they expire or get used up.

Tangible Assets

are generally divided into three major categories: Current assets (including cash, marketable securities, accounts receivable, inventory, and prepaid expenses); Property, plant, and equipment; and Long‐term investments.

Control Activities

are the specific policies and procedures management uses to achieve its objectives. The most important control activities involve segregation of duties, proper authorization of transactions and activities, adequate documents and records, physical control over assets and records, and independent checks on performance. A short description of each of these control activities appears below

Footnotes

are used disclose details often required by GAAP or other information volunteered by management. They often include but are not limited to the following details: Accounting method used Asset valuation Terms of debt agreements Lease information Pension plan disclosures Contingent claims and liabilities

Prepaid Expenses

asset that arises on a balance sheet as a result of business making payments for goods and services to be received in the near future.

Working Capital

Also known as "net working capital" or "working capital ratio". A measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as: Working Capital = Current Assets - Current Liabilities

Monetary Unit Assumption

An economic entity's accounting records include only quantifiable transactions. Certain economic events that affect a company, such as hiring a new chief executive officer or introducing a new product, cannot be easily quantified in monetary units and, therefore, do not appear in the company's accounting records. Furthermore, accounting records must be recorded using a stable currency. Businesses in the United States usually use U.S. dollars for this purpose.

Accounts Payable

Money owed by an organization to its creditors. Accounts Payables generally refer to payments owed to suppliers.

Long-term Debt

Loans and financial obligations lasting over 1 year.

Matching Principle

The costs of doing business are recorded in the same period as the revenue they help to generate. Examples of such costs include the cost of goods sold, salaries and commissions earned, insurance premiums, supplies used, and estimates for potential warranty work on the merchandise sold. Consider the wholesaler who delivered five hundred CDs to a store in April. These CDs change from an asset (inventory) to an expense (cost of goods sold) when the revenue is recognized so that the profit from the sale can be determined.

Balance Sheet - Equity

This portion of the balance sheet contains information on funds that have been contributed by stockholders or that have been internally-generated as it carries out its business activities. Equity = Assets - Liabilities Owner's Equity/Stakeholder's Equity -Preferred Stock -Common Stock -Paid-in Capital Internally-generated Treasury Stock

Relevance, Reliability, and Consistency

To be useful, financial information must be relevant, reliable, and prepared in a consistent manner. Relevant information helps a decision maker understand a company's past performance, present condition, and future outlook so that informed decisions can be made in a timely manner. Reliable information is verifiable and objective. Consistent information is prepared using the same methods each accounting period, which allows meaningful comparisons to be made between different accounting periods and between the financial statements of different companies that use the same methods.

Intangible Assets

lack physical substance, but they may, nevertheless, provide substantial value to the company that owns them. Examples of intangible assets include patents, copyrights, trademarks, and franchise licenses.

Marketable Securities

liquid securities that can quickly be converted to cash at a reasonable price. Typically have maturities of less than a year.

Physical Property

over assets and records helps protect the company's assets. These control activities may include electronic or mechanical controls (such as a safe, employee ID cards, fences, cash registers, fireproof files, and locks) or computer-related controls dealing with access privileges or established backup and recovery procedures.

Accounts Receivables

payments due to an organization by its customers/clients for goods supplied and/or services rendered.