Mgmt 160 quiz 4

Purpose of accounting Principles

Accounting Principles - provide guidance on accounting policy decisions for a specific transaction or event - Companies must comply with certain rules and guidelines of GAAP

Liabilities

Creditors' claims for funds, usually because they have provided funds, or goods and services, to the firm - Examples: accounts payable, unearned income, notes payable, buildings, accrued salaries

Assets

Economic resources with the potential to provide future economic benefits to a firm - Examples: cash, accounts receivable, inventories, buildings, equipment, intangible assets (like patents)

What are the important elements of the Income Statement?

Net income = Revenues - Expenses = Revenues: inflows of assets from selling goods and services - Expenses: outflows of assets used in generating revenues - Income Statement links the beginning balance sheet with ending balance sheet - Retained earnings is increased by net income and decreased by dividends

Cash Basis Accounting

Recognizes revenues when cash is received and expenses when they are paid. - Does not recognize accounts receivable or accounts payable. - Pro: Simple to maintain and tracks how much cash a business has at any given time - Business's income isn't taxed until it's in the bank - Used by small businesses

Accrual Basis Accounting

Revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid - Pro: Gives a more realistic idea of income and expenses, and a better long-term picture of a business that cash accounting can't provide - Con: Doesn't provide any awareness of cash flow (business can appear profitable when in reality it has empty bank accounts - Used by large companies

The "Dual Aspect" explains that every transaction affects at least two items in the basic accounting equation and preserves the equation's equality. What is the fundamental accounting equation? (2 points)

assets = liabilities + stockholders' equity - Assets represent probable future, measurable economic benefits that the reporting entity has acquired through a transaction. Assets include items such as cash, inventories, and buildings - Liabilities are probably future sacrifices of measurable economic benefits arising from the entity's obligations to convey assets to or perform services for a person, firm, or another organization - Stockholders' or owners' equity represents the ownership interest in the entity. It is the excess of the entity's total assets over its total liabilities

What are the important elements of the Balance Sheet?

- Current assets: Convert to cash in 1 year or less - Non-current assets: All other assets - Current liabilities: Paid with cash in 1 year or less - Non-current liabilities: All other liabilities

What are the three core financial statements? Briefly define the purpose of each statement (i.e. what is the gist of each statement). Indicate for each statement if it is for a point in time or a period of time. Hint: "The Statement of Changes in Shareholders Equity" and "The Footnotes" are NOT one of the three core financial statements! (6 points)

1. Balance sheet - point in time - The balance sheet, also called a statement of financial position, portrays the financial position of the company by showing what the company owes and what it owes at the report date. - The balance sheet may be thought of as a snapshot, since it reports the company's financial position at a specific point in time. - Usually balance sheets represent the current period so that financial statement readers can easily identity significant changes - The balance sheet is divided into two halves: 1. Assets 2. Liabilities and Shareholders' Equity 2. income statement - period of time - The Income Statement can be thought of more like a motion picture, since it reports on how a company performed during the period(s) presented and shows whether that company's operations have resulted in a profit or loss 3. a statement of changes in shareholders' equity - The Statement of Changes in Shareholders' Equity reconciles the activity in the equity section of the balance sheet from period to period. Generally, changes in shareholders' equity results from company profits or losses, dividends and/or stock issuances. (- Dividends are payments to shareholders to compensate them for their investment)

12 basic accounting concepts and assumptions that anyone interested in financial statements need to understand

1. Business Entity - Financial statements are prepared for a business entity that is separate and distinct from its owners - the affairs of the owners are irrelevant to the those financial statements 2. Going Concern - Unless evidence suggests otherwise, those preparing and auditing general purpose financial statements for a business entity must assume that the entity will continue operations into the foreseeable future 3. Monetary Unit - Accounting is a measurement process dealing only with events that can be measured in monetary terms. A monetary unit concept reflects the fact that money is the common denominator and is used in business to measure the exchange value of goods, services, and capital. 4. Historical Cost - For accounting purposes, business transactions are measured initially in terms of their actual (historical) cost, a value that is usually easily documented by reliable sources such as contracts, invoices, and other readily available sources 5. Accounting Period - For decision-marking purposes, managers and investors need periodic "test readings" of the progress of the business. Accounting recognizes this, breaking the flow of business activity into a series of reporting periods or fiscal years that are usually 12 months in length 6. Consistency - The consistency concept states that once an entity has decided on one accounting method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods 7. Matching - The income or profit reported on a financial statement is the net result of the matching of related costs and revenues of a period. This process can be described as matching "effort and accomplishments" - costs measure effort, and revenues measure the related accomplishments 8. Dual Aspect - Every transaction affects at least two items in the basic accounting equation and preserves the equation's equality. The fundamental accounting equation is: Assets = Liabilities + Stockholders' equity 9. Reliability of Evidence - Accountants recording events rely as much as possible on objective, verifiable documentary evidence instead of on the subjective and potentially biased judgments of a person. Acceptable evidence includes source documentation (paper and digital) of such items as: sales invoices, purchase (supplier) invoices, checks written and received, payment vouchers, banks statements, receiving reports, time cards and payroll journals, credit memos - The audit is the mechanism that allows users of financial statements to place trust in those reports 10. Disclosure - Accounting reports should disclose enough information that they will not mislead careful readers who are reasonably well informed in financial matters 11. Materiality - Accounting standards apply only to material items. Inconsequential items can be dealt with expediently. This is the materiality concept. - Whether or not a material is immaterial is a matter of judgment. One common test of materiality is whether the decision of a reasonably well informed reader of financial statements would be altered if the item were treated differently. If the decision would change, then the item is material 12. Conservatism - The conservatism concept prescribes a degree of skepticism in assessing the prospects that incomplete transactions will be concluded successfully. - The conservatism concept is controversial and requires considerable judgement.

The article discusses 12 basic accounting concepts and assumptions that anyone interested in financial statements need to understand. Excluding the "Dual Aspect", list FOUR of the other 11 and describe in a sentence or two. (8 points)

1. Business Entity - This concept defines the accountant's area of interest: a business entity that is separate and distinct from its owners. The accountant's role is to prepare financial statements for the business entity - the affairs of the owners are irrelevant to the those financial statements - Financial statements are prepared for a business entity that is separate and distinct from its owners 2. Going Concern - Unless evidence suggests otherwise, those preparing and auditing general purpose financial statements for a business entity must assume that the entity will continue operations into the foreseeable future 5. Accounting Period - For decision-marking purposes, managers and investors need periodic "test readings" of the progress of the business. Accounting recognizes this, breaking the flow of business activity into a series of reporting periods or fiscal years that are usually 12 months in length - Accounting measures activities for a specific interval of time, called the accounting period. 6. Consistency - Once an entity has decided on one accounting method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods 7. Matching - The income or profit reported on a financial statement is the net result of the matching of related costs and revenues of a period. This process can be described as matching "effort and accomplishments" - costs measure effort, and revenues measure the related accomplishments 9. Reliability of Evidence - Accountants recording events rely as much as possible on objective, verifiable documentary evidence instead of on the subjective and potentially biased judgments of a person. Acceptable evidence includes source documentation (paper and digital) of such items as: sales invoices, purchase (supplier) invoices, checks written and received, payment vouchers, banks statements, receiving reports, time cards and payroll journals, credit memos - The audit is the mechanism that allows users of financial statements to place trust in those reports 10. Disclosure - Accounting reports should disclose enough information that they will not mislead careful readers who are reasonably well informed in financial matters 11. Materiality - Accounting standards apply only to material items. Inconsequential items can be dealt with expediently. This is the materiality concept. - Whether or not a material is immaterial is a matter of judgment. One common test of materiality is whether the decision of a reasonably well informed reader of financial statements would be altered if the item were treated differently. If the decision would change, then the item is material 12. Conservatism - The conservatism concept prescribes a degree of skepticism in assessing the prospects that incomplete transactions will be concluded successfully. - The conservatism concept is controversial and requires considerable judgement.

3 Types of Accounting

1. Managerial accounting - specifically intended to be used by managers for planning and controlling a business 2. Tax accounting - Based on specific accounting requirements set by governmental taxing agencies 3. Financial accounting - A formal set of accounting principles intended for use by outside owners, investors, and regulators