Exam 1 Content
Depreciation Expense
(cost - salvage value) / useful life
Characteristics of Financial Accounting
1. A means to an end 2. Historical in nature 3. Inexact and proximate measures 4. General-purpose assumption 5. Enhanced via explanation by management through notes & adequate disclosure
In what order are financial statements prepared?
1. Income Statement (to determine net income for RE) 2. Statement of Retained Earnings (to determine RE for balance sheet) 3. Balance Sheet 4. Statement of Cash Flows
Basic Functions of Accounting System
1. Interpret and record effects of business transactions 2. Classify effects of similar transactions that determines totals useful for management 3. Summarize and communicate information to decision makers
Accounting Cycle Steps
1. Journalize the transactions 2. Post to ledger accounts 3. Prepare a trial balance 4. End-of-period adjustments (post adjusting entries) 5. Prepare an adjusted trial balance 6. Prepare financial statements 7. Journalize and post closing entries 8. Prepare a post-closing trial balance
Characteristics of Managerial Accounting
1. Must be timely for planning purposes 2. Oriented toward the future 3. Measures efficiency and effectiveness 4. A means to an end 5. Designed for decision makers within the company
Effects of Adjusting Entries
1. Prepaid Expenses - N/A revenue, inc. expenses, dec. NI; dec. assets & OE, N/A liabilities 2. Unearned Revenue - inc. revenue, N/A expenses, inc. NI; N/A assets, inc. OE, dec. liabilities 3. Accrued Expenses - N/A revenue, inc. expenses, dec. NI; N/A assets, dec. OE, inc. liabilities 4. Accrued Revenue - inc. revenue, N/A expenses, inc. NI; inc. assets, inc. OE, N/A liabilities
Operating Cycle for a Merchandiser
1. purchase of merchandise 2. merchandise inventory 3. sale of merchandise on account 4. accounts receivable 5. collection of cash/receivables
When is a business considered as an entity separate from its owners from an accounting standpoint?
A business is always considered an accounting entity separate from its owners
Corporation
A business owned by stockholders who share in its profits but are not personally responsible for its debts
Financial Accounting Standards Board (FASB)
A private group that conducts research and determines GAAP
Ledger
A specialized accounting book or computer program in which information from accounting journals is accumulated into specific categories
audit
A thorough review of a company's financial statements
after-closing trial balance
A trial balance prepared after all closing entries have been made. Consists only of accounts for assets, liabilities, and owners' equity (only balance sheet accounts because income statement revenue & expense accounts have been closed)
Objectivity Principle
Accountants prefer to use objective, rather than subjective, information as the basis for accounting information (cost of asset is factual and can be confirmed by independent party; GAAP)
periodic inventory system
An inventory system in which a company does not maintain detailed records of goods on hand throughout the period and determines the cost of goods sold only at the end of an accounting period through a physical inventory *must create COGS account by (a) closing Inventory account (Cr.) and Purchases account (Cr.) to combine to new COGS account (Dr.) (b) take physical inventory (c) Dr. Inventory acct w/ physical count & Cr. COGS of same amount - small companies, run by an owner - inventory with low-cost items - high volume of sales - all items sold from one site
How are assets and liabilities presented on the balance sheet?
Assets are presented in their order of permanence; liabilities are presented in the order in which they become due
Cost Principle
Assets are valued at cost, rather than at estimated market values in balance sheet (GAAP)
Functions of Management Accounting
Create financial forecasts, perform cost accounting, complete internal audits (NOT audit financial statements)
Transactions involving purchases...
Credit Terms & Cash Discounts - Purchase Discounts Lost is an expense account - Purchase Discounts Taken is a contra-expense account to COGS - credit terms 2/10, n/30 is interpreted as...2% cash discount if the amount is paid within 10 days, or the balance due in 30 days Return of Unsatisfactory Merchandise Transportation Costs
Types of Adjusting Entries
Deferrals: Prepaid Expenses - supplies, rent, insurance Unearned Revenues Accruals: Accrued Revenues - accts receivable, interest receivable Accrued Expenses - interest, salaries, income taxes
Closing Entries
Entries that transfer the balances of all temporary accounts (revenues, expenses, and dividends) to the balance of the Retained Earnings account 1. Close (Dr.) revenue accounts (Cr. Income Summary) 2. Close (Cr.) expense accounts (Dr. Income Summary) 3. Close (Dr.) Income Summary (Cr. Retained Earnings) 4. Close (Cr.) dividends account (Dr. Retained Earnings)
Statement of Changes in Owner's Equity
Financial statement shows changes in Owner's Equity during an accounting period (increases & decreases of contributed capital and retained earnings)
Statement of Cash Flows
Financial statement that shows the amount of cash inflows and outflows that occurred during an accounting period - good for understanding an enterprise for investment and credit decisions
Stable Dollar Assumption
Financial statements are prepared under the assumption that the dollar is a stable unit of measurement and its value will not change drastically over time
Adequate Disclosure
Financial statements contain all information necessary to understand a business's financial condition (important accounting principle) - pending lawsuits - scheduled plant closings - significant events after balance sheet, but before release of financial statements - customers that account for more than 10% of company revenues - unusual transactions or conflicts of interest
interim financial statements
Financial statements covering periods of less than one year; usually based on one-, three-, or six-month periods.
Careers in Accounting
Government, Management, Public Accounting & Accounting Education
Net Income
Gross Profit (Revenue - COGS) - Expenses - always results in an increase in owner's equity - no direct relationship with assets on hand
Owner's Equity
Increases with...investment of cash or other assets by owners OR earnings from profitable business operation Decreases with...cash payments or transfer of assets to owners OR losses from unprofitable business operation
Concept of Materiality
Is measured as an item significant enough to influence the decisions of users of financial statements; all material items must be properly reported in financial statements *Justifies ignoring the matching principle or the realization principle in certain circumstances
Conservatism Principle
Losses should be recorded when probable, but gains only when certain so that liabilities and expenses are not understated and assets and revenues are not overstated (apply accounting treatment of lowest estimate of net income for current accounting period)
The need for familiarity with accounting concepts...
Necessary for anyone entering the world of business
Return on Equity (ROE)
Net Income / Average Stockholders' Equity (measures profitability)
Going Concern Assumption
One reason for valuing assets such as buildings and equipment at cost rather than at their current market values is the assumption that the business will use these assets rather than sell them (GAAP)
Cash Basis Accounting
Reporting income when the cash is received and expenses when the cash is paid.
GAAP (Generally Accepted Accounting Principles)
Rules that govern the preparation of financial reports, which public companies within the U.S. prepare as defined by FASB ("generally accepted" = Are understood and observed by all the participants in the financial reporting process); provide a framework for financial reporting that is understood by both the preparers and the users of financial statements
Transactions relating to sales...
Sales Returns & Allowances - Sales Returns & Allowances is a contra-revenue account (is a separate account to Sales Revenue so that management can see how many products are being returned) - when documenting sales returns, must follow matching principle and document COGS again (Cr. the account) Sales Discounts - Sales Discounts is a contra-revenue account Delivery Expenses Sales Taxes
Balance Sheet
The financial statement concerned with reporting the financial position of a business at a particular time
Income Statement
The financial statement that reports revenues, expenses, and net income over a period of time - The Income Statement may also be called the earnings statement (or statement of operations or profit/loss statement) - The measurement of income is not absolutely accurate or precise due to assumptions and estimates. - The Income Statement only includes those events that have been evidenced by actual business transactions. - The net income (or net loss) generated on the Income Statement appears at the BOTTOM of the company's year-end balance sheet.
Realization Principle
The generally accepted accounting principle that determines revenue is realized when services are rendered to customers or when goods sold are delivered to customers (revenue is recognized when it is earned)
Internal Control
The measures used by an organization to provide reasonable assurance that the organization produces reliable financial reports, complies with applicable laws and regulations, and conducts its operations in an efficient and effective manner
General Journal
The simplest type of journal with two amount columns in which all kinds of entries can be recorded - and can later be posted to the ledger
Statement of Retained Earnings
The statement that summarizes the income earned and dividends paid over the life of a business End Period RE = Begin Period RE + NI - Dividends *Dividends are not an expense; not recorded in income statement or used to compute NI
point-of-sale (POS) terminal
a computer used to collect, store, and report all the information of a sales transaction using an item's bar code (makes perpetual inventory system possible for businesses with low cost, high volume sales)
special journal
a journal used to record only one kind of transaction
Trial Balance
a proof of the equality of debits and credits in a general ledger - contains balance sheet & income statement accounts - assures debits = credits, and that addition of account amounts are correct - CANNOT prove that transactions themselves have been correctly analyzed/noted and recorded to the proper accounts
Financial Accounting
accounting information and analyses prepared for people outside the organization - provide useful information to make good decisions - primarily for investors & creditors (also customers, the public, owners, labor unions, governmental agencies, suppliers and trade associations)
Sole Proprietorship
an unincorporated business owned by one person
Partnership
an unincorporated business owned by two or more people
COGS
beginning inventory + purchases - ending inventory
subsidiary ledger
contains the details related to a given general ledger account (e.g. 500 individual subsidiary ledger accounts within the Accounts Receivable general ledger account)
Components of Internal Control
control environment (ethics, management, accountability, policies & practices), risk assessment, control activities (approvals, verifications, reviews), information and communication, monitoring
Book Value
cost - accumulated depreciation
Working Capital
current assets - current liabilities (measures liquidity)
Current Ratio
current assets / current liabilities (measures liquidity)
SEC
governmental agency with legal power to establish accounting principles and financial reporting requirements for publicly owned corporations
Integrity of Accounting is preserved by...
institutional features (internal control, audits, rules for preparing accounting info); professional accounting organizations (FASB, SEC); ethics & judgement of professional accountants
perpetual inventory system
inventory system that maintains a continual record of inventory purchased and sold *when inventory is sold, 2 entries are necessary: COGS & revenue earned - large companies with professional management - want specific information about items in inventory and quantities of items that are selling - low volume of sales - merchandise stored at multiple locations
Adjusting Entries
needed to ensure that the revenue recognition and expense recognition principles are followed (matching & realization principles)
net income percentage
net income / net sales (total revenue) (measures profitability)
Gross Profit
net sales (revenue) - cost of goods sold
tax accounting
planning tax strategy and preparing tax returns for firms or individuals
window dressing
presenting the company accounts in a favorable light - to flatter the business performance
Functions of Financial Accounting
provide information that is useful in investment and credit decisions (understand return of investment & return on investment), and provide information that is useful in assessing amount/timing/uncertainty of future cash flows
Matching Principle
recognize expenses in the same period as the revenues they help to generate
Accrual Basis Accounting
reporting income when it is earned and expenses when they are incurred *the most important principle fo accrual basis is the matching principle
Management Accounting
the area of accounting concerned with preparing data for use by managers within the organization
Depreciation
the systematic allocation of cost to expense over an asset's useful life
shrinkage
unrecorded losses in inventory due to shoplifting, employee theft, spoilage, and damage
