Accounting 201

"Statement of cash flows"

A financial statement that measures activities involving cash receipts and cash payments over an interval of time.

Prepare a multiple-step income statement.

A multiple-step income statement reports multiple levels of profitability: Gross profit equals net sales minus cost of goods sold. Operating income equals gross profit minus operating expenses. Income before income taxes equals operating income plus non-operating revenues and minus non-operating expenses. Net income equals all revenues minus all expenses.

"Accounting"

A system of maintaining records of a company's operations and communicating that information to decision makers

Prepare a trial balance.

A trial balance is a list of all accounts and their balances at a particular date. Debits must equal credits, but that doesn't necessarily mean that all account balances are correct. The trial balance is useful to help identify when errors have been made during the posting process.

"Faithful representation"

Accounting information that is complete, neutral, and free from material error.

"Relevance"

Accounting information that possesses confirmatory value and/or predictive value.

Elements in the accounting equation are represented by what, often found in the financial ledger?

Accounts

A debit is used to decrease which of the following accounts?

Accounts PayableAccounts Payable

Analyze the impact of external transactions on the accounting equation.

After each transaction, the accounting equation must always remain in balance. In other words, assets always must equal liabilities plus stockholders' equity. The expanded accounting equation demonstrates that revenues increase retained earnings while expenses and dividends decrease retained earnings. Retained earnings is a component of stockholders' equity.

"Revenues"

Amounts earned from selling products or services to customers.

multiple-step income statement

An income statement that reports multiple levels of income (or profitability).

The primary purpose of a source document is to?

Analyze a transaction

A credit is used to decrease which of the following accounts?

Cash

"Dividends"

Cash payments to stockholders.

freight-out

Cost of freight on shipments to customers, which is included in the income statement either as part of cost of goods sold or as a selling expense.

Which of the following is possible for a particular business transaction?

Decrease assets; increase expenses

"Periodicity assumption"

Divides the economic life of an enterprise into artificial time periods for periodic financial reporting.

The basic steps in measuring external transactions.

External transactions are transactions between the company and separate economic entities. Internal transactions do not include an exchange with a separate economic entity. The six-step measurement process (Illustration 2-1) is the foundation of financial accounting.

Identify the three fundamental business activities that financial accounting measures.

Financing activities include transactions with lenders and owners. Investing activities generally include the purchase or disposal of productive assets. Operating activities relate to earning revenues and incurring expenses.

Record transactions using debits and credits.

For each transaction, total debits must equal total credits. A transaction may affect both sides of the accounting equation or it may increase and decrease the same side of the accounting equation.

Assess whether the impact of external transactions results in a debit or credit to an account balance.

For the basic accounting equation (Assets = Liabilities + Stockholders' Equity), accounts on the left side are increased with debits. Accounts on the right side are increased with credits. The opposite is true to decrease any of these accounts. The retained earnings account is a stockholders' equity account that normally has a credit balance. The retained earnings account has three components—revenues, expenses, and dividends. Revenues increase the balance of retained earnings, while expenses and dividends decrease the balance of retained earnings. Therefore, we increase revenues with a credit (similar to retained earnings) and increase expenses and dividends with a debit (opposite to retained earnings).

What is a collection of accounts used to keep track of increases and decreases in financial position elements?

General Ledger

Explain the financial statement effects and tax effects of inventory cost flow assumptions.

Generally, FIFO more closely resembles the actual physical flow of inventory. When inventory costs are rising, FIFO results in higher reported inventory in the balance sheet and higher reported income in the income statement. Conversely, LIFO results in a lower reported inventory and net income, reducing the company's income tax obligation.

"Auditors"

Hired by a company as an independent party to express a professional opinion of the accuracy of that company's financial statements.

What does n/30 mean?

If the customer does not take the discount, full payment is due within 30 days.

When doing service on credit, when is revenue recorded by a business?

Immediately, as long as future repayment is almost certain.

"Monetary unit assumption"

In order to measure financial statement elements, we need a uni or scale of measurement.

"Investing Activities"

Include the purchase and sale of (1) long-term resources such as land, buildings, equipment, and machinery and (2) any resources not directly related to a company's normal operations

"Operating Activities"

Include transactions that relate to the primary operations of the company, such as providing products and services to customers and the associated costs of doing so, like utilities, taxes, advertising, wages, rent, and maintenance.

weighted-average cost method

Inventory costing method that assumes both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale.

first-in, first-out (FIFO) method

Inventory costing method that assumes the first units purchased (the first in) are the first ones sold (the first out).

specific identification method

Inventory costing method that matches or identifies each unit of inventory with its actual cost.

Finished goods

Inventory items for which the manufacturing process is complete.

perpetual inventory system

Inventory system that maintains a continual record of inventory purchased and sold.

Who are the two primary external users of financial accounting?

Investors and Creditors

Change in Stockholder's Equity Formula

Issue Common Stock + Net Income - Dividends

Inventory turnover ration formula

It equals cost of goods sold divided by average inventory.

A chronological record of all economic events affecting a company is called

Journal

"Financial Accounting"

Measurement of business activities of a company and communication of those measurements to external parties for decision-making purposes

Apply the procedure to account for notes receivable, including interest calculation.

Notes receivable are similar to accounts receivable except that notes receivable are more formal credit arrangements made with a written debt instrument, or note. We calculate interest as the face value of the note multiplied by the stated annual interest rate multiplied by the appropriate fraction of the year. We record interest earned on notes receivable but not yet collected by the end of the year as interest receivable and interest revenue.

A trial balance may not be free of errors because a trial balance

Only determines that debit equals credits

income before income taxes

Operating income plus nonoperating revenues less nonoperating expenses.

Which of the following transactions causes a decrease in stockholders' equity?

Pay salaries expense for the current month

"Financial Statements"

Periodic reports published by the company for the purpose of providing information to external users.

Transferring the debit and credit information from a journal to individual accounts in the general ledger is referred to as:

Posting

"Sarbanes-Oxley Act"

Provides regulations of auditors.

Which of the following transactions causes an increase in total liabilities?

Purchase office supplies on account

Allowance method

Recording an adjustment at the end of a period to allow for the possibility of future uncollectible accounts. Reduces assets and increases expenses.

"Materiality"

Reflects the impact of financial accounting information on investors' and creditors' decisions.

Which are stockholder equity accounts?

Retained earnings and common stock

Net income formula

Revenue - Expenses

Calculate net revenues using discounts, returns, and allowances.

Sales discounts, returns, and allowances are contra revenue accounts. We subtract the balances in these accounts from total revenues when calculating net revenues. Trade discounts are not recorded in the accounting records.

four methods for inventory costing

Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted-average cost

"Going concern assumption"

States that in the absence of information to the contrary, a business entity will continue to operate indefinitely.

"Cost effectiveness"

Suggests that financial accounting information is provided only when the benefits of doing so exceed the costs.

Purchasing office supplies on account for $100 is recorded as:

Supplies 100 Accounts Payable 100

"Comparability"

The ability of users to see similarities and differences between two different business activities.

income-statement approach

The amount it reports for cost of goods sold (which appears in the income statement) more realistically matches the current costs of inventory needed to produce current revenues.

balance-sheet approach

The amount it reports for ending inventory (which appears in the balance sheet) better approximates the current cost of inventory.

replacement cost

The cost to replace an inventory item in its identical form.

"Expenses"

The costs of providing products and services.

"Net income"

The difference between revenues and expenses.

gross profit

The difference between sales revenue and cost of goods sold.

Contrast the allowance method and direct write-off method when accounting for uncollectible accounts.

The direct write-off method reduces accounts receivable and records bad debt expense at the time the account receivable proves uncollectible. If the credit sale occurs in a prior reporting period, bad debt expense is not properly matched with revenues (credit sales). Also, accounts receivable will be overstated in the prior period. The direct write-off method typically is not acceptable for financial reporting.

"Understandability"

Users must be able to understand the information within the context of the decision they are making.

Use the aging method to estimate future uncollectible accounts.

Using the aging method to estimate uncollectible accounts is more accurate than applying a single percentage to all accounts receivable. The aging method recognizes that the longer accounts are past due, the less likely they are to be collected. Accounts receivable is always shown net of the Allowance for uncollectible accounts on the face of the balance sheet.

Apply the lower-of-cost-or-market method for inventories.

We report inventory at the lower-of-cost-or-market; that is, at cost (specific identification, FIFO, LIFO, or weighted-average cost) or market value (replacement cost), whichever is lower. When market value falls below cost, we adjust downward the balance of inventory from cost to market value and recognize a loss in the period during which the inventory valuation is impaired.

Net Revenues

a company's total revenues less any amounts for discounts, returns, and allowances. We discuss these items next.

Trade Discounts

a reduction in the listed price of a product or service.

Net realizable value

amount of cash the firm expects to collect

Cost of goods sold

cost of the inventory it sold reported on income statement

Weighted average unit cost formula

costs of goods available for sale divided by number of units available for sale

A revenue account is increased with a

credit

"International Accounting Standards Board"

The standard-setting body responsible for this convergence effort.

Describe the two primary functions of financial accounting.

To measure business activities of a company. To communicate information about those activities to investors and creditors and other outside users for decision-making purposes.

Which of the following is true about a trial balance?

Total debit amounts should always equal total credit amounts

External transactions

Transactions between the company and separate economic entities

The process of transferring information from a journal entry to the specific accounts affected is referred to as?

Posting

A list of all account names used to record transactions of a company is referred to as the

chart of accounts

Inventory

items a company intends for sale to customers.

Manufacturing companies

manufacture the inventories they sell, rather than buying them in finished form from suppliers.

Merchandising companies

purchase inventories that are primarily in finished form for resale to customers.

Retailers

purchase inventory from manufacturers or wholesalers and then sell this inventory to end users.

The two components for calculating net income are

revenue and expenses

Sales Allowance

seller reduces the customer's balance owed or provides at least a partial refund while allowing the customer to keep the product.

"Verifiability"

Implies a consensus among different measures.

To increase the dividend account, one would what?

debit dividends

An account used generally for analysis

t-account

"Sole Proprietorship"

A business owned by one person.

"Partnership"

A business owned by two or more persons.

"Financing Activities"

Transactions involving external sources of funding

Internal transactions

Transactions that do not include transactions between external companies

Which step in the process of measuring external transactions involves assessing the equality of total debits and total credits?

Preparing a trial balance

What are the six steps in the measurement process?

1. Use source documents to identify the accounts affected by the external transaction 2. Analyze the effects of the transaction on the accounting equation 3. Assess whether the transaction results in a debit or credit 4. Record the transaction 5. Post the transaction to the T-account in the general ledger 6. Prepare a trial balance

"Balance Sheet"

A financial statement that presents the financial position of the company on a particular date.

"Income Statement"

A financial statement that reports the company's revenues and expenses over an interval of time.

"Statement of Stockholder's Equity"

A financial statement that summarizes the change in stockholders' equity over and interval of time.

"Liabilities"

Amounts owed to a creditor.

What is "accounts receivable" labeled as?

An Asset

What is the legal right to receive money from a company defined as?

An Asset

What records summary of effects for one item?

An account

LIFO adjustment

An adjustment used to convert a company's own inventory records maintained on a FIFO basis to LIFO basis for preparing financial statements.

average days in inventory formula

Approximate number of days the average inventory is held. It equals 365 days divided by the inventory turnover ratio.

Basic accounting equation

Assests = liabilities + stockholders' equity

What is reported at the end of the period?

At the end of the period, the amount the company reports for inventory is the cost of inventory not yet sold.

Identify career opportunities in accounting.

Because of the high demand for accounting graduates, the wide range of job opportunities, and increasing salaries, this is a great time to obtain a degree in accounting. You can find more information about accounting career opportunities at the websites for the AICPA (American Institute of CPAs) and the IMA (Institute of Management Accountants).

Determine the cost of goods sold and ending inventory using different inventory cost methods.

Companies are allowed to report inventory costs by assuming which units of inventory are sold and not sold, even if this does not match the actual flow. The three major inventory cost flow assumptions are FIFO (first-in, first-out), LIFO (last-in, first-out), and weighted-average cost.

Recognize accounts receivable.

Companies record an asset (accounts receivable) and revenue when they sell products and services to their customers on account, expecting payment in the future. Other types of receivable are nontrade receivables and notes receivable.

Raw materials

Components that will become part of the finished product but have not yet been used in production.

Companies with a high-volume of date often use a...

Computerized accounting system

Sales return

Customer returns a product

Uncollectible accounts

Customers' accounts that we no longer consider collectible

The effect of dividends on the expanded balance sheet equation is to

Decrease retained earnings

net income

Difference between all revenues and all expenses for the period.

"Financial Accounting Standards Board"

Establish the financial accounting and reporting standards in the United States.

percentage-of-receivables method (balance sheet method)

Estimating uncollectible accounts based on the percentage of accounts receivable expected not to be collected

Which of the following does not represent an external business transaction?

Expiration of an insurance policy over time

Describe the role that financial accounting plays in the efficient distribution of society's resources.

Financial accounting serves an important role by providing information useful in investment and lending decisions. No single piece of company information better explains companies' stock price performance than does financial accounting net income. A company's debt level is an important indicator of management's ability to respond to business situations and the possibility of bankruptcy.

Discuss how financial accounting information is communicated through financial statements.

Income statement compares revenues and expenses for the current period to assess the company's ability to earn a profit from running its operations. Statement of stockholders' equity reports information related to changes in common stock and retained earnings each period. The change in retained earnings equals net income less dividends for the period. Balance sheets demonstrates that the company's resources (assets) equal creditors' claims (liabilities) plus owners' claims (stockholders' equity) to those resources. Statement of cash flows reports cash transactions from operating, investing, and financing activities. All transactions that affect revenues or expenses reported in the income statement ultimately affect the balance sheet through the balance in retained earnings.

"Timeliness"

Information being available to users early enough to allow them to use it in the decision process.

last-in, first-out (LIFO) method

Inventory costing method that assumes the last units purchased (the last in) are the first ones sold (the first out).

periodic inventory system

Inventory system that periodically adjusts for purchases and sales of inventory at the end of the reporting period based on a physical count of inventory on hand.

Assets Formula

Liabilities + Stockholder's Equity

Post transactions to T-accounts in the general ledger.

Posting is the process of transferring the debit and credit information from transactions recorded in the journal to the T-accounts in the general ledger. During posting is when many errors are made in a manual accounting system.

gross profit ratio formula

Measure of the amount by which the sale price of inventory exceeds its cost per dollar of sales. It equals gross profit divided by net sales.

lower-of-cost-or-market (LCM) method

Method where companies report inventory in the balance sheet at the lower of cost or market value, where market value equals replacement cost.

Total Change in Cash Formula

Net Operating Flow + Net Investing Cash Flows + Net Financing Cash Flows

Work-in-process

Products that have started the production process but are not yet complete at the end of the period.

operating income

Profitability from normal operations that equals gross profit less operating expenses.

"Ethics"

Refer to a code or moral system that provides criteria for evaluating right and wrong behavior: Investors, creditors, government, and the general public rely on general ethical behavior among those who record and report the financial activities of businesses.

"Retained Earnings"

Represents the cumulative amount of net income, earned over the life of the company, that has not been distributed to the stockholders as dividends.

"Assets"

Resources owned by a company.

Trace the flow of inventory costs from manufacturing companies to merchandising companies.

Service companies earn revenues by providing services to customers. Manufacturing and merchandising companies earn revenues by selling inventory to customers.

"Economic entity assumption"

States that we can identify all economic events with a particular economic entity.

"Stockholders' Equity"

Stockholders', or owners', claims to resources, which equal the difference between total assets and total liabilities.

Analyze management of inventory using the inventory turnover ratio and gross profit ratio.

The Inventory turnover ratio indicates the number of times the firm sells, or turns over, its average inventory balance during a reporting period. The inventory turnover ratio is calculated by dividing Cost of Goods Sold by the Average Inventory balance. Average days in inventory measures the number of days average inventory is held. It is calculated by dividing 365 (days in a year) by the Inventory turnover ratio. The gross profit ratio measures the amount by which the sale price of inventory exceeds its cost per dollar of sales. Gross Profit ratio is calculated by dividing the Gross Profit by Net Sales.

Explain the nature of the conceptual framework used to develop generally accepted accounting principles.

The conceptual framework provides an underlying foundation for the development of accounting standards and interpretation of accounting information. To be useful for decision making, accounting information should have relevance and faithful representation.

Allowance for uncollectible accounts

The contra asset account Allowance for Uncollectible Accounts represents the amount of accounts receivable we do not expect to collect

Calculate cost of goods sold.

The cost of beginning inventory plus the additional purchases during the accounting period makes up the Cost of Goods Available for Sale. Inventory is a current asset reported in the balance sheet and represents the cost of inventory not yet sold at the end of the period. (Goods available for sale − cost of goods sold) Cost of goods sold is an expense reported in the income statement and represents the cost of inventory sold. (Goods available for sale − ending inventory)

Costs of goods

The costs of beginning inventory plus the additional purchases during the year make up the cost of inventory (cost of goods) available for sale.

inventory turnover ratio

The number of times a firm sells its average inventory balance during a reporting period.

Record inventory transactions using a perpetual inventory system.

The perpetual inventory system maintains a continual—or perpetual—record of inventory purchased and sold. When companies purchase inventory using a perpetual inventory system, they increase the Inventory account and either decrease Cash or increase Accounts Payable. When companies sell inventory, they make two entries: With the first entry, they increase an asset account (Cash or Accounts Receivable) and increase Sales Revenue. With the second entry, they increase Cost of Goods Sold and decrease Inventory. Nearly all companies maintain their own inventory records on a FIFO basis, and then some prepare financial statements on a LIFO basis. To adjust their FIFO inventory records to LIFO for financial reporting, companies use a simple LIFO adjustment at the end of the period. For most companies, freight charges are added to the cost of inventory, whereas purchase returns and purchase discounts are deducted from the cost of inventory. Some companies choose to report freight charges on outgoing shipments as part of selling expenses instead of cost of goods sold.

Calculate key ratios investors use to monitor a company's effectiveness in managing receivables.

The receivables turnover ratio and average collection period can provide an indication of management's ability to collect cash from customers in a timely manner. Receivables Turnover Ratio is calculated as Net Credit Sales divided by Average Accounts Receivable. Average collection period equals 365 (number of days in a year) divided by the Receivable Turnover Ratio.

"Accounting equation"

The relationship among the three measurement categories.

Explain the term generally accepted accounting principles (GAAP) and describe the role of GAAP in financial accounting.

The rules of financial accounting are called generally accepted accounting principles (GAAP). The Financial Accounting Standards Board (FASB) is an independent, private body that has primary responsibility for the establishment of GAAP in the United States. The primary objective of financial accounting is to provide useful information to investors and creditors in making decisions.

"GAAP"

The rules of financial accounting.

"Consistency"

The use of similar accounting procedures either over time for the same company, or across companies at the same point in time.

Record an allowance for future uncollectible accounts.

We recognize accounts receivable as assets in the balance sheet and record them at their net realizable values, that is, the amount of cash we expect to collect. Under the allowance method, companies are required to estimate future uncollectible accounts and record those estimates in the current year. Estimated uncollectible accounts reduce assets and increase expenses. Adjusting for estimates of future uncollectible accounts matches expenses (bad debts) in the same period as the revenues (credit sales) they help to generate. Recording an allowance for uncollectible accounts correctly reports accounts receivable at their net realizable value.

What do you report inventory as on a balance sheet?

We report inventory as a current asset in the balance sheet—an asset because it represents a valuable resource the company owns, and current because the company expects to convert it to cash in the near term.

Apply the procedure to write off accounts receivable as uncollectible.

Writing off a customer's account as uncollectible reduces the balance of accounts receivable but also reduces the contra asset—allowance for uncollectible accounts. The net effect is that there is no change in the net receivable (accounts receivable less the allowance) or in total assets. We recorded the decrease to assets as a result of the bad debt when we established the allowance for uncollectible accounts in a prior year. The Allowance for doubtful accounts account must always carry a credit balance at the end of the accounting period after adjustment. A debit balance prior to adjustment means last year's estimate of uncollectible accounts was too low. A credit balance prior to adjustment means last year's estimate of uncollectible accounts was too high.

Sales Discounts

a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if payment is made within a specified period of time.

contra revenue account

an account with a balance that is opposite, or "contra," to that of its related revenue account.

bad debt expense

the cost of the estimated future bad debts.