Financial Accounting Chapter 2 Key Concepts

Accounts on a Statement of Retained Earnings

-Beginning RE Balance -Dividends (less) -Net Income (add) (or less net loss) Ending RE balance

Types of Asset Accounts

-Cash -Accounts Receivable (which are increased by credit sales or sales on account or on credit and decreased by customer payments) -Note receivable or promissory note, promising an entity will pay another a specific sum of money on a specified future date -Prepaid Accounts: assets from prepayments of future expenses (expenses expected to be incurred in future accounting periods and later transferred to expense accounts) i.e. prepaid insurance, prepaid rent -Supplies: assets until they are used up -Equipment: is an asset until it is used and worn down that it later gets reported as an expense (called depreciation) -Buildings: they provide future benefits -Land: cost of land, separate from buildings account

Typical Accounts on a Balance Sheet

-Interest Payable -Accounts Receivable -Equipment -Prepaid Insurance -Buildings -Office Supplies

Typical Accounts on an Income Statement

-Services Revenue -Salaries Expense -Rental Revenue -Interest Expense -Insurance Expense

Steps in the Accounting Process that focus on analyzing and recording

1 - analyze each transaction from source documents 2 - record relevant transactions in a journal 3 - Post journal information to ledger accounts 4 - Prepare and analyze the trial balance

Preparing a trial balance

1. list each account and its amount (from ledger) even with a zero 2. Compute the total debit balances and total credit balances 3. Verify (prove) total debit balances equal total credit balances the total of debit balances equals the total credit balances for the trial balance. trial balance not a financial statement

General Journal

All-purpose journal for recording the debits and credits of transactions and events

Types of Liability Accounts

Claims by creditors against assets -Accounts payable -Note Payable -Unearned Revenue: liability that is settled in the future when a company delivers its products or services. i.e. magazine subscriptions collected in advance -Accrued Liabilities: amounts owed that are not yet paid. i.e. wages payable, taxes payable, interest payable.

Account Balance

Difference between total debits and total credits (including the beginning balance) for an account More debits than credits = debit balance more credits than debits = credit balance debits = credits - account has a zero balance

Costco's debt ratio ranges from a low of 0.63 to a high of 0.70, suggesting a higher than average risk from financial leverage. Is financial leverage good or bad for Costco?

If Costco is making more money with this debt than it is paying the lenders, then it is successfully borrowing money to make more money. A company's use of debt can turn unprofitable quickly if its return from that money drops below the rate it is paying lenders.

Debit

Recorded on the left side; an entry that increases an asset or expense account, or decreases a liability, revenue, or equity account; abbrv. Dr to enter amounts on the left is to debit the account

Credit

Recorded on the right side; an entry that decreases an asset or expense account, or increases a liability, revenue, or equity account; abbr. Cr to enter amounts on the right is to credit the account

Four Steps of Processing Transactions

Step 1 and 2 - transaction analysis and the accounting equation Step 3 and 4 - Record each transaction chronologically in journal and transfer entries from journal to ledger

T-Account

Tool used to show the effects of transactions and events on individual accounts; shaped in the form of a T

Posting Reference (PR) column

a column in journals in which individual ledger account numbers are entered when entries are posted to those ledger accounts

Financial Leverage

a company that finances a relatively large portion of its assets with liabilities

Chart of Accounts

a list of accounts used by a company; includes an identification number for each account; the account numbers typically have 3-digit codes

Journal

a record in which transactions are entered before they are posted to ledger accounts; also shows debits and credits for each transaction; also called book of original entry

Account

a record within an accounting system in which increases and decreases are entered and stored in a specific asset, liability, equity, revenue, or expense.

Identify the normal balance (debit or credit) for each of the following accounts

a. Fees Earned (Revenues) - Credit b. Office Supplies - Debit c. Dividends - Debit d. Wages Expense - Debit e. Accounts Receivable - Debit f. Prepaid Rent - Debit g. Wages Payable - Credit h. Building - Debit i. Common Stock - Credit Cash receipts fall under Dr. in the Cash T-Account Cash disbursements fall under Cr. in the Cash T-Account

Indicate whether a debit or credit decreases the normal balance of each of the following accounts

a. Interest Payable - Debit b. Service Revenue - Debit c. Salaries Expense - Credit d. Accounts Receivable - Credit e. Common Stock - Debit f. Prepaid Insurance - Credit g. Buildings - Credit h. Interest Revenue - Debit i. Dividends - Credit j. Unearned Revenue - Debit k. Accounts Payable - Debit l. Land - Credit

Identify whether a debit or credit results in the indicated change for each of the following accounts

a. To increase Land - Debit b. To decrease Cash - Credit c. To increase Fees Earned (Revenues) - Credit d. To increase Salaries Expense - Debit e. To decrease Unearned Revenue - Debit f. To Decrease Prepaid Rent - Credit g. To increase Notes Payable - Credit h. To decrease Accounts Receivable - Credit i. To increase Common Stock - Credit j. To increase Store Equipment - Debit

To record entries in a general journal

a. date the transaction b. enter titles of accounts and enter the amounts in the Debit column on the same line c. enter titles of accounts credited and then enter in the amounts in the Credit column on the same line d. enter a brief explanation of the transaction on the line below the entry

Double-Entry Accounting

accounting system in which each transaction affects at least two accounts and has at least one debit and one credit total amount debited must equal total amount credited left side is normal balance for assets; right side is normal balance for liabilities and equity. The ending balance is on the side with the larger dollar amount. Plus (+) and minus (-) are not used in a T-Account

Balance Column Account

an account with debit and credit columns for recording entries and another column for showing the balance of the account after each entry

Unclassified Balance Sheet

broadly groups accounts into assets, liabilities, and equity

Classified Balance Sheet

groups accounts in classifications (such as land and buildings into Plant Assets) and it reports current assets before noncurrent assets and current liabilities before noncurrent liabilities

Trial Balance

list of ledger accounts and their balances (either debit or credit) at a point in time; total debit balances equal total credit balances

DrEAD

means debit (Dr) is the normal balance side for Expense, Asset, and Dividend accounts; credit the others.

Types of Equity Accounts

owner's claim on a company's assets -Stockholder's equity or shareholder's equity -Common Stock -Dividends (that actually reduce the equity because they are distributed to business owners) -Revenue Accounts (Sales, Commissions Earned, Rent Revenue, Interest Revenue) -Expense Accounts (Salaries expense, utilities expense, insurance expense) -Equity impacted by common stock, dividends, revenues & expenses EQUITY = Common Stock - Dividends + Revenue - Expenses

Debt Ratio

ratio of total liabilities to total assets; used to reflect risk associated with a company's debts

General Ledger

simply ledger; a record containing all accounts (with amounts) for a business

Source Documents

source of information for accounting entries that can be in either paper or electronic form; also called business papers. i.e. receipts, checks, purchase orders, bills, etc

Journalizing

the process of recording transactions in a journal

Posting

the process of transferring journal entry information to the ledger; computerized systems automate this process