Ch 1-4 Review and Definitions

Matching Principle

Guides accounting for expenses, ensures that all expenses are recorded when they are incurred during the period, and matches those expenses against the revenues of the period. (Pg. 121)

If a business had a net loss for the year, what would be the closing entry to close Income Summary and transfer the net loss to the Retained Earnings account?

If a business has a net loss, the closing entry to close Income Summary would be a debit to Retained Earnings and a credit to Income Summary.

If an accrued expense is not recorded at the end of the year, what is the impact on the financial statements?

If an accrued expense is not recorded at the end of the year, the financial statements will be inaccurate. On the balance sheet, liabilities will be understated and equity will be overstated. On the income statement, expenses will be understated (thus net income will be overstated).

Statement of Retained Earnings

Reports how the company's retained earnings balance changed from the beginning to the end of the period. (Pg. 20)

Balance Sheet

Reports on the assets, liabilities, and stockholders' equity of the business as of a specific date. (Pg. 21)

Income Statement

Reports the net income or net loss of the business for a specific period. (Pg. 19)

Revenue Recognition Principle

Requires companies to record revenue when it has been earned and determines the amount of revenue to record. (Pg. 120)

Sarbanes-Oxley Act (SOX)

Requires companies to review internal control and take responsibility for the accuracy and completeness of their financial reports. (Pg. 11)

How does retained earnings increase? What are the two ways that retained earnings decreases?

Retained earnings increases with revenues. Retained earnings decreases with expenses and dividends.

What is the calculation for return on assets (ROA)? Explain what ROA measures.

Return on Assets = Net income / Average total assets. ROA measures how profitably a company uses its assets.

How is net income calculated? Define revenues and expenses.

Revenues -Expenses = Net Income. Revenues are earnings resulting from delivering goods or services to customers. Expenses are the cost of selling goods or service.

What are reversing entries? Are they required by GAAP?

Reversing entries are special journal entries that ease the burden of accounting for transactions in a later period. Reversing entries are the exact opposite of certain adjusting entries. Reversing entries are used in conjunction with accrual-type adjustments, such as accrued salaries expense and accrued service revenue. Generally Accepted Accounting Principles do not require reversing entries.

Debt Ratio

Shows the proportion of assets financed with debt. Total Liabilities/ Total Assets=Debt Ratio. (Pg. 81)

What are the steps used when analyzing a business transaction?

Step 1: Identify the accounts and the account type. Step 2: Decide if each account increases or decreases. Step 3: Determine if the accounting equation is in balance.

What are the steps in the closing process?

Step 1: Make the revenue accounts equal zero via the Income Summary account. This closing entry transfers total revenues to the credit side of the Income Summary account. Step 2: Make expense accounts equal zero via the Income Summary account. This closing entry transfers total expenses to the debit side of the Income Summary account. Step 3: Make the Income Summary account equal zero via the Retained Earnings account. This closing entry transfers net income (or net loss) to the Retained Earnings account. Step 4: Make the Dividends account equal zero via the Retained Earnings account. This entry transfers the dividends to the debit side of the Retained Earnings account.

What are temporary accounts? Are temporary accounts closed in the closing process?

Temporary accounts (also known as nominal accounts) are accounts that relate to a particular accounting period and are closed at the end of that period. All temporary accounts (dividends, revenues, Income Summary and expenses) are closed (zeroed).

What is the role of the Financial Accounting Standards Board (FASB)?

The FASB oversees the creation and governance of accounting standards. They work with governmental regulatory agencies, congressional created groups, and private groups.

Explain the role of the International Accounting Standards Board (IASB) in relation to International Financial Reporting Standards (IFRS).

The IASB is the organization that develops and creates IFRS which are a set of global accounting standards that would be used around the world.

Normal Balance

The balance that appears on the increase side of an account. (Pg. 61)

What is the current ratio, and how is it calculated?

The current ratio measures a company's ability to pay its current liabilities with its current assets. This ratio is computed as follows: Current ratio = Total current assets / Total current liabilities.

What is the calculation for the debt ratio? Explain what the debt ratio evaluates.

The debt ratio is calculated by dividing total liabilities by total assets and shows the proportion of assets financed with debt. It can be used to evaluate a business's ability to pay its debts.

Which concept states that accounting information should be complete, neutral, and free from material error?

The faithful representation concept states that accounting information should be complete, neutral, and free from material error.

What does the going concern assumption mean for a business?

The going concern assumption assumes that the entity will remain in business for the foreseeable future and long enough to use existing resources for their intended purpose.

Accounting uses a double-entry system. Explain what this sentence means.

With a double-entry you need to record the dual effects of each transaction. Every transaction affects at least two accounts.

Trick for Keeping Track of Normal Balances For Accounts

A L E R EX + - - - + - + + + - Normal Balances (Dividends are Contra to Equity and Accumulated Depreciation are Contra to Assets) OR "All elephants do love rowdy children." (Assets, Expenses, and Dividends have normal debt balances. Liabilities, Revenues, and Common Stock have normal credit balances.)

What is a T-account? On which side is the debit? On which side is the credit? Where does the account name go on a T-account?

A T-account is a shortened form of each account in the ledger. The debit is on the left side, credit on the right side, and the account name is shown on top.

Classified Balance Sheet

A balance sheet that places each asset and each liability into a specific category. (Pg. 186)

Corporation

A business organized under state law that is a separate legal entity. (Pg. 7)

What does a ledger show? What's the difference between a ledger and the chart of accounts?

A chart of accounts and a ledger are similar in that they both list the account names and account numbers of the business. A ledger, though, provides more detail. It includes the increases and decreases of each account for a specific period and the balance of each account at a specific point in time .

Stockholders' Equity

A corporation's equity that includes paid-in capital and retained earnings. (Pg. 649)

Straight-Line Method

A depreciation method that allocates an equal amount of depreciation each year. SL=Cost-Residual Value/Useful Life (Pg. 126)

Account

A detailed record of all increases and decreases that have occurred in an individual asset, liability, or equity during a specific period. (Pg. 56)

Chart of Accounts

A list of all of a company's accounts with their account numbers. (Pg. 58)

Adjusted Trial Balance

A list of all the accounts with their adjusted balances. (Pg. 138)

Post-Closing Trial Balance

A list of the accounts and their balances at the end of the period after journalizing and posting the closing entries. It should include only permanent accounts. (Pg. 197)

Cost Principle

A principle that states that acquired assets and services should be recorded at their actual cost. (Pg. 9)

General Journal

A record of transactions in date order. (Pg. 64)

International Financial Reporting Standards (IFRS)

A set of global accounting guidelines, formulated by the International Accounting Standards Board (IASB) (Pg.10)

Reversing Entry

A special journal entry that eases the burden of accounting for transactions in the next period. Such entries are the exact opposite of a prior adjusting entry. (Pg. 204 Appendix)

Double-Entry System

A system of accounting in which every transaction effects at least two accounts. (Pg. 60)

U. S. GAAP (Generally Accepted Accounting Principles)

Accounting guidelines, currently formulated by the Financial Accounting Standards Board (FASB); the main US accounting rule book. (Pg.6)

Accrual Basis Accounting

Accounting method that records revenue when earned and expenses when incurred. (Pg. 118)

Cash Basis Accounting

Accounting method that records revenues only when cash is received and expenses only when cash is paid. (Pg. 118)

Adjusting Entry

An entry made at the end of the accounting period that is used to record revenues to the period in which they are earned and expenses to the period in which they occur. (Pg. 123)

Accountant's Worksheet

An internal document that helps summarize data for the preparation of financial statements. (Pg. 141)

Creditor

Any person or business to whom a business owes money. (Pg. 4)

Identify which types of accounts have a normal debit balance and which types of accounts have a normal credit balance.

Assets, dividends, and expenses have a normal debit balance. Liabilities, common stock,and revenue have a normal credit balance.

Going Concern Assumption

Assumes that the entity will remain in operation for the foreseeable future. (Pg. 10)

What is the closing process?

Closing the books (often referred to as the closing process) consists of journalizing and posting the closing entries in order to get the accounts ready for the next period. The closing process zeroes out all revenue accounts and all expense accounts in order to measure each period's net income separately from all other periods. The closing process also zeroes out the dividends account. In addition, the closing process updates the Retained Earnings account balance for net income or loss during the period and any dividends paid to stockholders.

What is the purpose of the chart of accounts? Explain the numbering typically associated with the accounts.

Companies need a way to organize their accounts so they use a chart of accounts. Accounts starting with 1 are usually Assets, 2 -Liabilities, 3 -Equity, 4 -Revenues,and 5 -Expenses. The second and third digits in account numbers indicate where the account fits within the category.

When are credits increases? When are credits decreases?

Credits are increases for liabilities, common stock,and revenue.Credits are decreases for assets, dividends, and expenses.

When are debits increases? When are debits decreases?

Debits are increases for assets, dividends, and expenses.Debits are decreases for liabilities, common stock, and revenue.

Closing Entries

Entries that transfer the revenues, expenses, and dividends balances to the Retained Earnings account to prepare the company's books for the next period (Pg. 192)

List the four financial statements. Briefly describe each statement.

Income Statement -Shows the difference between an entity's revenues and expenses and reports the net income or net loss for a specific period. Statement of Retained Earnings -Shows the changes in retained earnings for a specific period including net income (loss) and dividends. Balance Sheet -Shows the assets, liabilities, and stockholders' equity of the business as of a specific date. Statement of Cash Flows -Shows a business's cash receipts and cash payments for a specific period.

Return on Assets (ROA)

Measures how profitably a company uses its assets. Net Income/Average Total Assets=ROA (Pg. 24)

Current Ratio

Measures the company's ability to pay current liabilities from current assets. Total Current Assets/Total Current Liabilities =Current Ratio. (Pg. 200)

Explain the purpose of Generally Accepted Accounting Principles (GAAP), including the organization currently responsible for the creation and governance of these standards.

The guidelines for accounting information are called GAAP. It is the main U.S. accounting rule book and is currently created and governed by the FASB. Investors and lenders must have information that is relevant and has faithful representation in order to make decisions and GAAP provides the framework for this financial reporting.

Accounting

The information system that measures business activities, processes the information into reports, and communicates the results to decision makers. (Pg. 2)

Financial statements in the United States are reported in U.S. dollars. What assumption supports this statement?

The monetary unit assumption states that items on the financial statements should be measured in terms of a monetary unit.

Financial Accounting Standards Board (FASB)

The private organization that oversees the creation and governance of accounting standards in the United States. (Pg.6)

Accounting Cycle

The process by which companies produce their financial statements for a specific period. (Pg. 199)

General Ledger

The record holding all the accounts of a business, the changes in those accounts, and their balances. (Pg. 59)

List the steps of the accounting cycle.

The steps of the accounting cycle are: Step 1. Start with beginning account balances. Step 2. Analyze and journalize transactions as they occur. Step 3. Post journal entries to the accounts. Step 4. Compute the unadjusted balance in each account and prepare the unadjusted trial balance. Step 5. Enter the unadjusted trial balance on the worksheet and complete the worksheet (optional). Step 6. Journalize and post adjusting entries. Step 7. Prepare the adjusted trial balance. Step 8. Prepare the financial statements. Step 9. Journalize and post the closing entries. Step 10. Prepare the post-closing trial balance.

Securities and Exchange Commission (SEC)

U.S. governmental agency that oversees the U.S. financial markets. (Pg. 6)