Makoko First Exam; Ch 1-3
What is the accounting equation?
Assets = Liabilities + Stockholders' Equity
Monetary Unit
Assumes monetary unit is relatively stable; no adjustments made for inflation made in financial statements
retained earnings
An amount earned by a corporation and not yet distributed to stockholders.
transaction
Any business activity that changes assets, liabilities, or owner's equity and is recognized in a set of financial statements
Current Ratio
Current assets divided by current liabilities; measures the availability of current assets to pay current liabilities, high current ratio means high liquidity
Understandability
the quality of accounting information that makes it comprehensible to those willing to spend the necessary time
Faithful Representation
the quality of information that makes it complete, neutral, and free from error
Consistency
the quality that allows the use of the same accounting principles and methods from period to period within a company, makes them comparable
Accounting Standards
the rules that determine the accounting for individual business transactions
Posting
transferring information from a journal entry to a ledger account
General Ledger
a book, a file, a hard drive, or another device containing all of the accounts from the chart of accounts
Sole proprietorship
a business owned and managed by a single individual
Generally Accepted Accounting Principles (GAAP)
a set of accounting standards that is used in the preparation of financial statements
Corporations
entity organized under the laws of a particular state; ownership is evidenced by shares of stock
Going Concern
financial statements are prepared with the expectation that a business will remain in operation indefinitely; this justifies the use of historical cost
T account
format for showing amounts coming into and leaving an account
What does accounting consist of
identifying, measuring, communicating, economic information
Debits
increase assets and decrease liabilities
external events
interaction between an entity and its environment
external users of accounting information
investors, creditors, customers, government
What should occur to the accounting equation as transactions are recorded?
it MUST stay in balance
What does the right side of the accounting equation consist of?
liabilities and stockholders' equity; indicates who provided or has a claim to the assets as well as any debts the company has incurred
Internal users of accounting information
management, employees, owners
Who uses accounting information?
managers, stockholders, employees, creditors, suppliers, government agencies, financial analysis
Statement of Cash Flows Equation
+/- Cash Flow from Operating Activities +/- Cash Flow from Investing Activities +/- Cash Flow from Financing Activities = Net Change in Cash
The Business Decision Model
1. If you were a banker, would you be willing to loan money to a company? 2. gather information from the financial statements and other sources 3. compare the company's current ratios with industry averages and look at trends 4. loan money or find an alternative use for the money 5. monitor the loan periodically
Order of Financial Statements
1. Income Statement 2. Statement of Retained Earnings 3. Balance Sheet 4. Statement of Cash Flows
Types of Long term Assets
1. Investments: securities not expected to be sold within the next year 2. Property/Plants/Equipment: tangible, productive assets used in the operation of a business 3. Intangibles: lack physical substance (ex: trademarks, copyrights, franchise rights, patents, and goodwill)
Qualitative Characteristics of Accounting Information
1. Understandability 2. Relevance 3. Faithful Representation 4. Comparability 5. Consistency 6. Materiality 7. Conservatism
what is the financial decision framework?
1. formulate the question 2. gather information from the financial statements and other sources 3. analyze the information gathered 4. make the decision 5. monitor your decision
Ratio Analysis Model
1. how liquid is a company? 2. gather the information about current assets and current liabilities 3. calculate the current ratio 4. compare the ratio with prior years and with competitors 5. interpret the ratios - higher the current ratio, the more liquid the company
The forms of source documents
1. purchase invoice 2. sales invoice 3. cash register tape 4. time cards
Economic Entity Concept
1. the assumption that a single, identifiable unit must be accounted for in all situations 2. A specific entity must be the subject of a set of financial statements 3. Does not intermingle the personal assets and liabilities of the employees or any other stockholders
Public Company Accounting Oversight Board (PCAOB)
A five-member body created by an act of Congress in 2002 to set auditing standards
multiple-step income statement
A form of income statement that contains several sections, subsections, and subtotals. Shows classifications of revenues and expenses as well as important subtotals.
Classified Balance Sheet
A balance sheet that groups together similar assets and similar liabilities, using a number of standard classifications and sections, such as current and noncurrent. Ex: current assets, current liabilities, no current assets, long-term liabilities, and stockholders' equity
Statement of Cash Flows
A financial statement that provides financial information about the cash receipts and cash payments during the period from operating, investing, and financing activities
Cost Principle
A principle that states that acquired assets and services should be recorded at the original cost to acquire them. It is more objective than market value.
Double-entry system
A system that records the two-sided effect of each transaction in appropriate accounts. Ensures the accounting equation always stays in balance.
Comparability
Ability to compare the accounting information of different companies because they use the same accounting principles.
Time Period Assumption
Assumption that an organization's activities can be divided into specific time periods such as months, quarters, or years; these are the used as the basis for preparing financial statements.
Statement of Retained Earnings Equation
Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earnings
partnerships
Business organizations in which two or more persons share responsibilities, costs, profits, and losses. Often used by accounting and law firms.
Business
Consists of activities necessary to provide members of society with goods and services
Nonbusiness Entities
Government entities, private organizations
Investing Activities
Includes cash transactions involving the purchase and sale of long-term assets and current investments
single-step income statement
Income statement format that groups all revenues together and then lists and deducts all expenses together without calculating any subtotals.
long-term liabilities
Obligations not due to be paid within one year or the operating cycle, whichever is longer.
Current Liabilities
Obligations that a company expects to pay within the next year or operating cycle, whichever is longer.
Types of Businesses
Product Companies: suppliers, manufacturers/producers, distributors/wholesalers, and retailers Service Companies: Transportation companies
Securities and Exchange Commission (SEC)
The agency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies.
Financial Accounting Standards Board (FASB)
the private board that establishes the generally accepted accounting principles used in the practice of financial accounting
Operating Cycle
The period of time between the purchase of inventory and the collection of any receivable from the sale of the inventory.
Statement of Retained Earnings
The statement that summarizes the income earned and dividends paid over the life of a business
Auditing
the job of reviewing and evaluating the information used to prepare a company's financial statements and ensures they are fairly presented; an auditors report is an opinion not a statement of fact
Materiality
the magnitude of an accounting information omission or misstatement that determines whether an item is large enough to likely influence the decision of somebody relying on the information
Definition of Source Documents
Used as evidence to record a transaction
Harbor City Corporations end of year balance sheet consisted of the following amounts; What amount should Harbor City report on its balance sheet for total assets?
a. $110,000 b. $170,000 c. $155,000 d. $190,000
To determine the source of a company's noncurrent assets, on which financial statement will you look?
a. Both the balance sheet and the income statement b. Both the income statement and the statement of retained earnings c. Income statement only d. Balance sheet only
Which of the following would not appear on an income statement?
a. Cost of goods sold b. Accounts receivable c. Sales revenue d. Insurance expense
Guinther & Sons, Inc. a retailer of mens clothing, earned a net profit of $77,000 for 2016. The balance sheet for G & S includes the following items. The average current ration for stores such as G & S is 2.4 to 1. What does this comparison tell you about its liquidity?
a. Guinther & So s, Inc. is more profitable than it's competitors b. it has more long-term assets than its competitors c. it is more liquid than its competitors d. since a rule of thumb for current ratios is 2 to 1, neither Guinther & Sons nor its competitors is liquid
Which of the following is a noncurrent asset?
a. None of these choices. b. Cash c. Land d. Accounts receivable
Which of the following items will be found in a corporate annual report?
a. Notes to the financial statements b. Company budgets c. Management's statement that the auditors are responsible for the financial statements d. Selected financial data from competitor companies
The securities and exchange commission (SEC) is concerned with
a. all companies in the US regardless of size b. companies that issue securities to the general public c. all domestic and international companies that issue accounting reports d. accounting reports issued by government entities
Which of the following would be internal users of accounting information?
a. employees and customers b. government and banks c. employees and managers d. customers and vendors
Which one of the following is not an external user of financial statements?
a. none of these choices b. the company's controller c. suppliers d. creditors
Why is the time period assumption necessary?
a. the federal government requires it b. inflation exists c. the dollar is the monetary unit in the united states d. external users of financial statements want statements that accurately reflect net income or earnings for a specific time period
Liquidity
ability to pay debts as they come due
notes
accounting policies; required
examples of current liabilities
accounts payable, salaries and wages payable, notes payable, interest payable, bank loans payable, and income taxes payable
Components of a T account
always shows the account name, debit side/left side of an asset account shows increases, credit side/right side of an asset account shows decreases
Nonbusiness Entities
an organization operated for some purpose other than to earn a profit, do not have an identifiable owner
long term assets
assets that are expected to be used in business operations for longer than one year
What goes on the balance sheet?
assets, liabilities, stockholders equity
What does the left side of the accounting equation consist of?
assets: valuable economic resources that will provide future benefit to the company
examples of long term liabilities
bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities
Financing Activities
borrowing, sale of stock
current assets
cash and other assets expected to be realized in cash, sold, or consumed within a year or operating cycle
Examples of current assets
cash, accounts receivable, inventory, supplies, marketable securities, prepaid insurance
Journal
chronological record of a company's transactions, a book of original entry, transactions are periodically posted from the journal to ledger accounts
What is the source of stockholders' equity
created when a company issues stock to an investor; retained earnings
Working Capital
current assets - current liabilities; negative working capital may signal the inability to pay creditors on a timely basis
Dividends
distribution of the net income of a business to its owners
Journalizing
the process of recording business transactions in a journal
credits
decrease assets and increase liabilities
International Accounting Standards Board (IASB)
develops worldwide accounting standards
profit margin
net income/net sales; high margin implies a company is generating revenue while also controlling its costs
Definition of a chart of accounts
numerical list of all accounts used by a company
Internal event
occurs entirely within an entity
Definition of Stockholders' Equity
owners claims on assets of the business; arise from two sources: contributed capital (capital stock and paid in capital in excess of par value) and retained earnings
American Institute of Certified Public Accountants (AICPA)
professional organization of certified public accountants (CPAs)
Definition of Account
record used to accumulate amounts for each individual asset, liability, revenue, expense, and component of stockholders' equity
Oreo Company has current assets of $20,000, current liabilities of $8,000, and long-term liabilities of $3,000. Oreo wants to buy new equipment. How much of its existing cash can Oreo use to acquire equipment without allowing its current ratio to decline below 2.0 to 1?
remember: current ratio = current assets/current liabilities a. $10,000 b. $12,000 c. $4,000 d. $8,000
Operating Activities
sale of products/services and the costs incurred to operate business
Business Entities
sole proprietorship, partnership, corporation
What is an income statement?
the Revenues - Expenses of a company for a period of time
Relevance
the capacity of information to make a difference in a decision
Conservatism
the practice of using the least optimistic estimate when two estimates of amounts are about equally likely
