Accounting exam 1
current assets
assets that are expected to turn to cash or use up within one year from the date of the balance sheet
Trial Balance
a list of accounts and their balances at a given time, proves debits=credits after posting, If don't equal can use trial balance to uncover errors
financial statements
a set of accounting reports that convey info to outsider users such as creditors and investor
T account
a tool for analyzing a business's financial position by showing, in a single table, the business's assets (on the left) and liabilities (on the right)
If credits are greater than the debits (t-account)
account will have a credit balance
If debits are greater than the credits (t-account)
account will have a debit balance
Depreciation Expense
debit, expense account, found on income statment, reduces net income, Represents the amount of the building or equipment 'used up' in the current year
left in journal entry
debits are left (what are you gaining)
long-term liabilities
debts paid longer than one year from balance sheet
current liabilities
debts paid within one year
decreases to equity
dividends (no effect on net income) and expenses (if income goes down equity goes down)
contra equity
dividends, reduces equity
financing activities outflows
dividends, repaying bank loan
accounting transactions
economic events that require recording in the financial statements (change in assets, liabilities, or equity accounts)
two ways to raise funds for business
equity or debt financing
double-entry accounting
every transaction must be record with at least one debit and one credit with the total debits always equals the total credits
how to Close dividends into retained earnings
Debit retained earnings for balance in dividends account and credit dividends for the same amount
how to Close expenses into retained earnings
Debit retained earnings for total expenses and credit each expense account for its balance
how to Close revenues into retained earnings
Debit revenue account for its balance and credit retained earnings for total revenues
journal entry credits and debits
Debits = credits in every entry
Why are audits necessary?
Managers might have an incentive to use 'flexible' accounting methods to manipulate statements (deceive investors/creditors, avoid paying taxes)
Acid Test Ratio (quick ratio) meaning
More conservative estimate of companies liquidity by using the most liquid current assets in the numerator
liabilities
The debts owed (creditors claims against the companies assets)
Operating Activities
affect the net income (cash exchanges that affect net revenues and expenses)
ledger
all accounts of the company taken together (all T accounts of the company)
Unearned revenue
amount of services still to be performed (liability) Does not affect net income
revenues
amounts earned during accounting period (will say revenue)
accounts receivable
amounts owed by customers to company (asset)
operating activities outflows
ash used to purchase inventory, salaries, taxes, interest
Historical Cost Concept
assets are reported at their cost (the amount at which the company paid to acquire them)
historical cost concept
assets are to be shown on the balance sheet at their cost (the amount which the company paid to acquire them)
examples of long-term liabilities
Long term note payable, mortgage payable (property loan), bonds payable
liquidity ratios
measure short term ability of company to pay its debts as they come due
when putting inventory in journal entry
need cost of goods sold (debit) and sales revenue (credit)
retained earnings
net income that hasn't been paid by owners to the dividend but used for growth/expansion
deferrals
transaction for which cash has been received or paid but the revenue or expense has not been recorded (exchange of cash has been occurred before the action)
accruals
transactions for which cash has NOT yet been received/paid but the revenue or expense has been earned or incurred and thus must be recorded (action has occurred before the exchange of cash)
Posting
transferring debt and credit amounts from the journal to the ledger (transferring journal entries to the T-accounts), allows us to determine ending balance in each account
Partnership
two or more people in control, requires more skills/resources
Find missing value of credits and debits
use Cost of goods sold = credits - debits
supplies
used in business operations (asset)
long-term assets
used in operations longer than one year
interest expense
when a company borrows money and must repay it with interest
Supplies Adjusting Entry
when purchased are classified as a current asset, Once they are 'used up' they are considered an expense 'supplies expense',
Analyzing transactions (equity)
whenever net income is changed that change will carry over into EQUITY (because affects retained earnings and that is part of equity)
Acid Test Ratio (quick ratio)
(Cash + accounts receivable) / current liabilities (Ratio in form of 'number of times')
annual depreciation expense equation
(cost - residual value) / useful life = depreciation expense
Balance sheet
(statement of financial position at a specific point in time 'snapshot'), provides info about a business assets and claims against those assets
Accounting Cycle Steps
1. Record transactions in the journal (journal entries) 2. Post debit and credit amounts from journal to ledger (to determine ending balance of each account) 3. Prepare an unadjusted trial balance 4. Prepare an adjusted trial balance 5. From adjusted trial balance, prepare financial statements
three things showed on balance sheet
1. economic resources owned by a business, debts owed, and amount of the owners investment in a business (assets, liabilities, equity)
current liabilities include
Accounts payable, short term note payable, salaries payable, income tax payable, utilities payable, salary, income tax, utiltiies
after closing entries are posted
All temporary accounts have zero balances, Balance in retained earnings represents all of the net income that the company has earned through its year that has not been paid out as a dividend to our stockholders (accumulated undistributed earnings)
fundamental accounting equation
Assets = liabilities + equity
independent auditors report
Auditor's opinion to if the financial statements are 'fair'
examples of debt financing
Banks, interest, creditors, payment schedule (borrowing)
Common stock equation
Beginning balance + additional sales of stock - ending contributed capital = CS
retained earnings equation
Beginning balance + net income - dividends = ending retained earnings
current ratio
CA/CL (Ratio in form of 'number of times')
investing activities
Cash associated with the purchase/sale of long term assets such as P-P-E
deferred revenues account
Cash received recorded as a liability, Only becomes revenue when company gives service/good, Reduce liability (what we owe) when we provide the service, and increase a revenue account
Three closing entries that need to be made every year (do opposite of normal to close it out)
Close revenues into retained earnings, Close expenses into retained earnings, Close dividends into retained earnings
Increases Equity
Common stock (investments by owners) and revenues
equity equation
Common stock + Retained earnings
deferred expenses (prepaid expenses)
Company pays for an expense item in advanced, Recorded as an asset Only becomes an expense when the asset is 'used up'
Which company is the right company stock to buy?
Compare financial statements (two sets need to be prepared the exact same way for comparison to be meaningful)
depreciation deferral
Considered a deferral → cash is paid first when the asset is purchased, expense paid later when asset gets 'used up'
note to the financial statement
Footnotes, clarify financial statements, critical in understanding companies performance
Account Type: Equity
Increase: Credit Decrease: Debit Normal Balance: Credit
Account type: Liability
Increase: Credit Decrease: Debit Normal Balance: Credit
Account type: Revenue
Increase: Credit Decrease: Debit Normal Balance: Credit
Account Type: Expense
Increase: Debit Decrease: Credit Normal Balance: Debit
Account type: Asset
Increase: Debit Decrease: Credit Normal Balance: Debit
Audit of financial statements
Independent audits are required to safeguard investors/creditors from misleading financial statements (know they are prepared according to GAAP bc audited)
interest rate info
Interest rate will always be expressed as an annual rate, Will always be a fraction over 12 (bc 12 months in a year), Numerator represents number of months that have elapsed in the current year, Assume interest is repaid at the end of the loan rather than have monthly payments that include interest, ANY NOTE PAYABLE WILL HAVE INTEREST
equity financing examples
Investments from owners (stock), no repayment, dividends
financial ratios Common benchmarks/comparison points
Other companies that operate in the same industry, Industry averages, Past years (trend analysis)
Securities exchange commission (SEC)
Public sector organization that has express authority from congress to develop GAAP (allowed FASB to create rules and SEC enforces it)
gross profit
Represents the profit earned from selling inventory
net income equation
Revenues - Expenses = Net income
gross profit equation
Sales revenue -c ost of goods sold = gross profit
How to make a trial balance
Start with assets (in order of liquidity), then liabilities, equity, revenues and expenses
supplies t account (adjusted)
Supplies purchased are a debit, Supplies used up are a credit
Total Equity Equation
Total Equity = Contributed Capital + Retained Earnings (selling CS increases equity)
annual report
US companies that are publicly traded must provide this to their shareholders
financial accounting
Used by OUTSIDERS to make decisions (investors, creditors, banks/lenders)
Mangerial Accounting
Used by people INSIDE company to make decisions (management)
what is depreciation
Using up' of buildings and equipment, Need an adjusting entry every year to record the amount buildings/equipment have been 'used up', nothing to do with value of an asset
interest revenue
When a company lends money to someone and is to be repaid with interest
examples of financial statements
balance sheet, income statement, cash flow statement, owners equity statment
Ending Equity Formula
beginning equity + additional sales of CS + net income - dividends
investing activities (effect)
cash exchanges that affect long term assets such as PPE
operating activities inflows
cash from customers
cash receipts
cash inflows
cash payments
cash outflows
financing activities
cash used to fund the business
investing activities outflows
cash used to purchase assets (tangible/intangible)
current assets include
cash, accounts receivable, inventory, supplies
statement of cash flows
changes in cash for a period of time (same time covered by income statement)
nominal (temporary accounts)
closed to a zero balance at the end of every year, Includes revenues, expenses, dividends (make zero)
what makes up equity
common stock and retained earnings
residual value =
companies estimate of what the asset can be sold for at the end of its expected life (measured in years)
deferred revenues (unearned revenues)
company receives cash in advance for services/goods to be delivered later
expenses
costs incurred in process of earning revenues (includes cost of goods sold)
Management discussion and analysis (management's report)
covers the companies ability to pay near-term obligations, fund operations and expansion, and its results of operations, Must highlight favorable/unfavorable trends and identify significant events and uncertainties
Current assets on balance sheet
need to be listed in order of liquidity which means ease in converted to cash, so cash first
accumulated depreciation
credit, causes decrease in assets (contra asset account), normal balance is credit
Cost of Goods Sold Equation
credits - debits
right in journal entry
credits are right (what are you giving up)
total assets equation
current assets + P-P-E assets
Working capital
current assets - current liabilities (ratio in form of dollar amount)
to record a depreciaiton expense
debit depreciation expense and credit accumulated depreciation
interest expense adjusted entry
debit interest expense and credit interest payable
interest revenue adjusted entry
debit interest recievable and credit interest revenue
Financial statement analysis
examines relationships among financial statement numbers and the trends of those numbers overtime (Use past performance to predict future Evalue performance of company to identify problem areas)
accrued expenses
expenses incurred but not yet paid in cash or recorded (debit an expense account and credit a liability account)
matching concept
expenses must be recorded in the same accounting period that the related revenue is earned
Accrued Liabilities
expenses that have been incurred but have not been paid at the end of the accounting period (salary, income tax, utilities)
an annual report includes
financial statements, note to the financial statement, independent auditors report, management report
equity financing
funds provided by the owners of a company
debt financing
funds raised through various forms of borrowing that must be repaid
Property-plant equipment (P-P-E)
have physical substance (land, buildings, equipment)
operating activities
inflows and outflows of cash associated w primary operations of business (transactions that creates revenues/expenses)
Accrual of Interest
interest rev or expense is recorded first and cash will be paid later
contributed capital
investments made by owners by purchasing stock (common stock in equity)
contributed capital (common stock)
investments made by owners into the business through the purchase of the organization's stock
adjusting entries
journal entries made at end of accounting period (end of year, end of month) to update account balances and make sure matching concept and accrual accounting are following
intangible assets
lack physical substance, patents, trademark, copyright (long-term assets)
long-term assets include
land, buildings, equipment, patents, trademark, and copyright
permanent (real) accounts
never closed to zero at end of the year (amount stays), includes assets, liabilities, equity
Generally accepted accounting principles (GAAP)
oncepts, standards, guidelines, and conventions, companies are supposed to follow when preparing financial statements
Sole Proprietorship
owned by1 person, owner controlled, simple to establish
dividends and its effect
payments corporations make to its stockholders, Not an expense so have no effect on income statement, Will always be on debit side, Classified as a contra equity account since it reduces equity by reducing retained earnings
Dividends
payments of cash from a corporation to its stockholders (contra equity)
Jounral
place where accounting transactions are initially recorded
account
place where all increased/decreases in financial statement items are recorded (use T account)
interest equation
principal x rate x time
inventory
product company sells (asset)
closing entries
purpose to transfer a net income or net loss and dividends to retained earnings
Statement of owner's equity
record of the change in owners' equity from the end of one fiscal period to the end of the next
Realization Principle
record revenue when product/service is delivered and cash has been received OR they promise to pay for service later (record when provide good to customer), Record revenue independent of exchange of cash (record when goods are sold not when cash is received)
Cash Accounting
record revenues when cash is received, Record expenses when cash is paid, Can be used by any company who does not sell stock (does not follow GAAP)
Gains
recorded when you sell an asset other than inventory for more than its cost, revenue account
Losses
recorded when you sell an asset other than inventory less than its cost, expense account
accrual accounting
records revenues when earned (use GAAP), Required to be used by companies who sell stock (securities) to the public, If company does not sell stock and they want a bank loan required to present financial statements using accrual accounting
contra asset account
reduction of assets
Financial ratios
relationships between financial statement amounts, Used by investors/creditors to make decisions (loan/invest)
If you see "prepaid"
represents an asset account (specifically the unused portion of repayment), As asset gets used up → the amount used is recorded as an expense
"bill" in journal entries
represents an expense
assets
resources owned by a business
payment from a customer in a journal entry
revenue account
Accrued Revenues
revenues for services performed but not yet received in cash or recorded (debit an asset account and credit a revenue account)
investing activities inflows
sale of assets (land, buildings, equipment)
financing activities inflows
selling stock, bank loan
financial statements
set of accounting reports that convey financial info to outside users such as creditors/investors
Accumulated Depreciation
shown in decrease of PPE (contra asset)
statment of owner's equity
shows changes in owners equity for a period of time (same period of time as the income statment)
Income statment
shows profitability of the company for a period of time (month/year)
cooperation
stockholders own it, no personal liability, separate legal entity from owners
depreciation
systematic allocation of the cost of a plant asset (buildings and equipment) to expense over its useful life
Equity (stockholders equity for corporation)
the amount of the owner's investment in the business
Journal entry
the format used for recording business transactions
Financial accounting standards board (FASB)
the primary accounting standard-setting body in the US
normal balance (t-account)
the side of the account that is increased, what side of the T-account the beginning and end account balance will be found
