Intro to Financial Accounting (ACCY2001) EXAM 1 Study Guide
Intro to Financial Accounting (ACCY2001) EXAM 1 Study Guide ACCY 2001
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This 15 page Study Guide was uploaded by Anika Mian on Monday February 8, 2016. The Study Guide belongs to ACCY 2001 at George Washington University taught by James T Wood in Spring 2016. Since its upload, it has received 219 views. For similar materials see Intro to Financial Accounting in Accounting at George Washington University.
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Date Created: 02/08/16
INTRODUCTION TO FINANCIAL ACCOUNTING MIDTERM #1 STUDY GUIDE CHAPTER 1- INTRO TO FINANCIAL ACCOUNTING GAAP, or Generally Accepted Accounting Principles, govern the process of U.S Accounting. Basics of Financial Accounting include: o Bookkeeping Process of recording business transactions o Statements Summary of Transactions Summary of Transactions o Via a period of time If we do not divide up operating time, it does not tell us anything about specifics within that company or person’s transactions. o Include snapshots of account “balances” Financial Statements Income Statement (Consists of profit and loss) Statement of Stockholders Equity Balance Sheet Statement of Cash Flow Income Statement (Revenues – Expenses = Net Income) Statement that results in NET INCOME through subtracting Expenses from Revenue Revenues SALES MINUS: Expenses EXPENSES Total Net Income Net Income to be used for R/E statement Statement of Stockholders’ Equity/ Retained Earnings (Beg. Retained Earnings + Net Income – Dividends = End. Retained Earnings) Retained earnings are the income after dividends o Sometimes companies use R/E to reinvest back into their companies. Dividends is the money paid to investors Beg. Retained Earnings Beginning Retained Earnings from Previous Year ADD: Net Income Provided by Income Statement MINUS: Dividends -- End. Retained Earnings Ending Retained Earnings Balance Sheet (Assets – Liabilities = Equity/ Net Worth) Assets What a company OWNS MINUS: Liabilities What a company OWES Total Equity or Net Worth Total worth of a company Assets Probable future economic benefits owned or controlled by an entity as a result of past transactions or events; economic resources the entity acquired to use in operating the company in the future o Mostly listed in order of liquidity Current Assets are the resources that companies will use or turn into cash within one year. o Inventory is ALWAYS considered a current asset, regardless of how long it takes to produce and sell the inventories. Liabilities Probable future sacrifices of economic benefits arising from present obligations of a business as a result of past transactions or events. o Mostly listed in order or maturity (how soon the obligation is to be paid). Current Liabilities are liabilities that will need to be paid or settled within the coming year. Stockholder’s Equity The residual interest in the assets of the entity after subtracting liabilities- combination of the financing provided by the owners and by business operations. Contributed capital: financing provided by owners Earned Capital: financing provided by operations o Retained Earnings is the cumulative earnings of a company that have not been distributed to the owners and are reinvested in the business. The Accounting Equation ASSETS = LIABILITIES + EQUITY Using this equation, we can break Equity further + Contributed Capital + Retained Earnings + Beg. R/E + Revenues – Expenses - Dividends Using this break-down we can create the ultimate Accounting equation: EXPENSES + DIVIDENDS + ASSETS = COMMON STOCK + LIABILITIES + R/E + REVENUE Statement of Cash Flows NOT ALL transactions on the Income Statement and Balance Sheet are CASH. Figure It Out Beginning Cash Value --- ADD/SUBTRACT: OPERATING Activities I.S. ADD/SUBTRACT: INVESTING Activities ASSETS ADD/SUBTRACT: FINANCING Activities LIABILITIES Ending Cash Value -- Relationships Among the Statements 1. Income Statements a. Need net income to calculate retained earnings 2. Balance Sheet a. Helps to figure ending retained earnings 3. Statement of Cash Flows a. Checks out cash values spent/earned during the period CHAPTER 2-Investing and Financing Decisions and the Accounting System Fundamental Qualitative Characteristics For accounting information to be useful, it must be relevant and be a faithful representation. Relevant information is capable of influencing decisions by allowing users to assess past activities and/or predict future activities. Faithful information requires that the information be complete, neutral, and free from error. Comparability, verifiability, timeliness, and understandability are the characteristics that are represented. o They ENHANCE the FUNDAMENTAL Characteristics. Accounting Assumptions Economic Entity o Separate-entity assumption: A business’ activities are accounted for separately from those of its owners. For e.g. When an owner purchases property for personal use, the property is not an asset of the business. Continuity (Going Concern) o States that businesses are assumed to continue into the foreseeable future For e.g. If there was a greater chance of bankruptcy, then its assets should be valued and reported on the balance sheet as if the company were to be liquidated. Time-Period o Picking a business’ transactions, and separating them into specific time periods Monetary Unit o States that accounting information should be measured and reported in the national monetary unit without any adjustments for changes in purchasing power. Historical Cost o States that the original price of an asset purchased must be included in any statements and/or reports- not the price it is worth now. For e.g. If my parents bought a home in 1990s worth $780,000 and now is worth $1.2 million- Even though the home is valued at $1.2 million, they are still must also include the original price they paid back in the 1990s. Other Important Items External Transactions o The exchange of assets, good, or services, by one party for assets, services, or promises to pay from one or more parties. For e.g. Company ABC purchases a machine from Supplier DEF to pursue the sale of merchandise to customers. Internal Transactions o Not exchanges between the business and other parties, but nevertheless have a direct and measurable effect on the entity. For e.g. Using up insurance paid in advance…. Or using buildings and equipment over several years. Common Stock and APIC o When a company sells shares of common stock, on the books of a company, it’ll have a weird value—The common stock will show that value per share. Common Stock = Par Value x Number of Shares APIC = Cash – Common Stock The Accounting Cycle 1. Analyze Transactions 2. Journalize Transactions 3. Post to General Ledger 4. Prepare a Trial Balance 5. Adjust the Accounts 6. Prepare Financial Statements 7. Close the Accounts Journal vs. Ledger Journal Entries o Specific Journals and General Journals o Double Entry Transactions (Bookkeeping) Idea of maintaining an EQUAL accounting equation (A = L + E) Two accounts for one transaction because the equation needs to be equal. o May impact more than one account o Chronological (Daily) as they happen General Ledger o Summary of Account Transactions and Balances by Account o Transfers from Journals are “Posted” Here. General Ledger Trial Balance Posted Transactions by Account Balances only Account o Always add up debits and credits and they must be o T-Accounts equal Account Balance (T or Shows us a summary/ precursor to the financial statements Column) We record and create it to make sure that our debits and credits are equal transactions Categories of Accounts Asset- Anything we have, own, or are owed rd Liability- something we owe, and claims on assets by 3 parties Equity- Owner’s Claims Revenue- Sales Expenses- Cost Dividend- Returns to Owners Debits and Credits If anything INCREASES on the LEFT-side of the ACCOUNTING equation—it is considered to be a DEBIT If anything INCREASES on the Right-side of the ACCOUNTING equation—it is considered to be a CREDIT ASSETS + EXPENSES + DIVID. = LIAB. + CAP. + R/E + REVENUE IF THE LEFT SIDE INCREASES, DEBIT GOES UP IF THE RIGHT SIDE INCREASES, CREDIT GOES UP Journal Entry Steps Analysis- Ask yourself/ analyze the transaction. 1. What Accounts Are Involved? 2. What Types of Accounts? 3. Are the Accounts Increasing or Decreasing? Write the Journal Entry a. Debits are written on the Top Column, and Left Row b. Credits are written on the Bottom Column, and Right Row. Debit Credit Debit Type of Account Total amount of Account Credit Type of Account Total Amount of Account EXAMPLES – for additional examples, see INTRO TO FINANCIAL ACCOUNTING CHAPTER 2 NOTES ON STUDY SOUP CURRENT RATIO = CURRENT ASSETS/ CURRENT LIABILITIES --- A company’s ability to pay off its current liabilities with current assets (a liquidity measure. CHAPTER 3- ACCRUAL ACCOUNTING Revenues Increase in assets o Through Cash or Promise of Cash (Receivables) Settlement of Liabilities o Decrease of Liability from Earning Revenue Revenues can be collected and recognized from operations as two types: o Earned o Unearned Expenses Outflow used to generate REVENUE o Salaries o Purchase of supplies o Cost of Goods Sold Uses up Assets o Cash o Equipment (Equipment depreciates overtime) Increase Liabilities o Borrow to pay expenses (to get a loan) o “On Account”/ Accounts Payable Non-Operating/ Other – As in NOT AFFILIATED WITH THE BUSINESS; Unless you’re a bank. Interest Income Interest Expense Gains/Losses on SALE o Sale of Property, Plant, and Equipment o Investments Income Tax o Not sales tax, this is what they pay in the end of the day ALL REVENUES – ALL EXPENSES Cash vs. Accrual Accounting When is Revenue recorded? Cash Basis: Revenue is recorded when CASH IS RECEIVED Accrual Basis: Revenue is recorded when it has been EARNED and REALIZED (promise of cash) When is Expense recorded? Cash Basis: Expense is recorded when CASH IS PAID Accrual Basis: Expense is INCURRED (given a service or a good) Elements of the Conceptual Framework Time-Period Assumption Companies DIVIDE operations into PERIODS o Activities may impact multiple periods Revenue and Expenses are assigned to periods that are: o INCURRED – entry is record in a journal o EARNED—entry is part of recorded revenue o REALIZED—entry is a part of recorded revenue Guided by Matching and Revenue Recognition Revenue Recognition Only Recognize Revenue when it is in your FACE Fixed Price o No Uncertainties in Price Arrangement o Arranged form of payment either through CASH or a PROMISE OF CASH Collection Reasonably Assured o Cash/Check/Credit Card o Accounts Receivable (30-45 days) Earned o When a company Sells Goods AND they have been DELIVERED For e.g. Amazon cannot recognize revenue until the goods have been delivered to the people. o When a company actually PERFORMS the service requested/paid for. Matching Principle Cash Basis Cash is disbursed Accrual Basis In PERIOD when associated Revenue is Generated (Recognized) Only Recognize Costs Used to Earn Revenue in the PERIOD Match the Revenue with the Expense Accrual vs. Deferral Accrual accounts are earned revenues or incurred expenses in which no cash is paid, but we do recognize the revenue. o Payables/ Revenues Deferral accounts is unearned revenue, and we have deferred it until we receive that service or good. For e.g. Prepaid Accounts are an asset—someone else owes us services or goods. o Prepaid/ Unearned Revs Accrual Earned Revenue NOT PAID (NO CASH) Incurred Expense Deferral Cash Received or Disbursed Expense Not Incurred (PREPAID) NOT REALIZABLE Revenue Not Earned (UNEARNED) CHAPTER 4- ADJUSTMENTS, FINANCIAL STATEMENTS, AND THE QUALITY OF EARNINGS *Quick Review* At the sale of a good, we record two journal entries. One for Sales Revenue One for Cost of Goods Sold (COGS) The entry to recognize REVENUE would be: Debit Credit Debit CASH or A/R $100 Credit SALES REVENUE $100 The entry to recognize EXPENSE/ COST OF SALE would be: Debit Credit Debit COGS $75 Credit Inventory $75 On the Financial Statements: These two entries would be recorded on the BALANCE SHEET and the INCOME STATEMENT. Example: Company A sells a bicycle to a customer for $600 cash, which the company purchased from a vendor for $250. a. What is the company’s total REVENUE from the sale? a. Revenue is what a company earns from a sale. In this case, its $600. b. What is the company’s total PROFIT from the sale? a. Profit is subtracting the cost of goods sold from the sales revenue. The profit in this scenario is $350. c. Prepare a journal entry for this transaction. a. Debit: Cash for 600 and Credit: Sales Revenue for 600 b. Debit: Cost of Goods Sold for 250 and Credit: Inventory for 250 Adjusting Journal Entries (AJE) Done at the end of the period to account for any deferred or accrued account that is recognized NEVER EVER INCLUDE CASH ACCOUNTS Adjusting Journal Entries account for Deferred Revenues and Accrued Revenues Deferred Expenses and Accrued Expenses When to Record Deferred Revenue/ Accrued Revenue AJE Ask yourself the following: 1. Was the revenue or income earned, and NOT RECORDED? 2. Was cash already received or will it be received in the future? a. If YES—it’s for a DEFERRED REVENUE b. If no—it’s for an ACCRUED REVENUE. When adjusting to recognize the revenue, the unearned revenue becomes evened out from the newly recognized Sales Revenue. Cash is NEVER used when adjusting a journal entry. Accrued Revenue The accrued revenue or income earned must also equal out but with accrued revenue, there is NO previous cash receipt. Example: At the beginning of 2012, Customer A paid ABC Corp $20,000 for services to be performed over the next 3 years. By the end of 2012, ABC Corp had performed $5,000 worth of services. 1. Prepare the Journal Entry for ABC Corp that they would have recorded when they received the payment from Customer A o Customer A paid $20,000; ABC Corp made $20,000 worth of UNEARNED revenue 1/2012 DEBIT CREDIT DR CASH 20000 CR REV 20000 2. Prepare the ADJUSTED Journal Entry necessary at the end of the year. a. The unearned revenue decreases by 5,000 because $5,000 worth of services have been delivered to Customer A 12/31/2012 DEBIT CREDIT DR (UN) REV 5000 CR (SALES) REV 5000 When to Record Deferred/ Accrued Expenses AJE Ask yourself the following: 1. Was expense incurred and not recorded 2. Was cash already paid or will it be paid? a. If YES, it’s for a DEFERRED EXPENSE b. If no, it’s for an ACCRUED EXPENSE. Deferred Expenses Previously Purchased Assets o Prepaid Rent (Cash Paid in Advance) o Supplies o Equipment Expense is REDUCED when incurred Depreciation and Contra Accounts Depreciation o Allocation of COST overtime (as an expense) o Adjusting Entry must be applied EACH PERIOD Example of JE: DR. Depreciation Expense XXXX CR. Accumulated Depreciation XXXX Contra Account o Balance to opposite type of related account o Contra Asset is a CREDIT balance o Accumulated Depreciation OFFSETS Property, Plant, and Equipment. o Allows Doubtful Accounts to OFFSET Accounts Receivable. Example—Depreciation Company ABC owns a CAD machine which has a 5-year lifespan. The machine depreciates $4,000 each year. Record the necessary adjusting journal entry to account for depreciation if financial statements were created half-way through the year. Keyword in this example is DEPRECIATES mostly because this helps us find out first account: Depreciation Expense. o Using Accumulated Depreciation as our Contra Account, we can even this entry out. DR. Depreciation Expense $2,000 CR. Accumulated Depreciation $2,000 Adjusted Trial Balance We must calculate the adjusted trial balance in order to verify that our Debits and Credits even out so we are sure we haven’t missed a certain entry. Closing the Accounts Permanent Accounts vs. Temporary Accounts PERMANENT accounts are Carried Forward o Balance Sheet Accounts TEMPORARY accounts are zeroed out via Closing o Income Statement Accounts 1. ZERO OUT REVENUE Accounts to RETAINED EARNINGS DR. REVENUES XXXX CR. RETAINED EARNINGS XXXX 2. ZERO OUT EXPENSE Accounts to RETAINED EARNINGS DR. RETAINED EARNINGS XXXX CR. EXPENSES XXXX CHAPTER 5- Communicating and Interpreting Accounting Information FRAUD Committing fraud is a POR choice Pressure (something enticing us to commit fraud), is increased with the Opportunity to commit fraud is given to someone. Then, that person tends to Rationalize their actions by either convincing themselves that they’re doing the right thing or will in the future. Fraud Prevention So a few people at top companies fake adjust their numbers… no biggie, right? Fraud prevention and deterrence matters because financial statements become unreliable, and investors get scammed by the fake Continuity assumption that a company may give off. Plus, accuracy counts in order to gain fair loans. Regulations Securities and Exchange Commission (ENFORCER) Maintain the rules by enforcing them onto public companies FASB (RULE MAKER) Decides what principles make up GAAP and creates rules PCAOB (AUDITOR CHECKER) Oversee auditors to make sure that they are executing their jobs correctly Players Management o CEO, CFO—ULTIMATELY RESPONSIBLE for personally certifying the validity of financial statements Board of Directors o Represent Stockholders o Audit Committee Auditors o Independent o BIG 4 (PwC, Deloitte, KPMG, EY) Auditor Opinions Fair representation is an outlook on how a company is doing based on their accurate financial statements. Materiality is an amount of an asset that is large enough to impact an investor’s decision- material to financial statements. UNQUALIFIED—Financial reports have a fair representation QUALIFIED—Financial reports have a fair representation BUT … [insert some issue here] ADVERSE—Financial reports are NOT fair DISCLAIMER—No opinion; there is something incorrect or wrong with the standards of GAAP Classified Income Statement Income statements report nonrecurring items separately because they are not useful in predicting the future income of a corporation. Nonrecurring items are listed at the BOTTOM of the Income Statement o May include discontinued operations Ties that are cut with an organization or certain company o Extraordinary items Unusual circumstances that impact a company Notes of the Financial Statements These are written at the end of the financial statements 1. Accounting Rules Applied a. Revenue Recognition is different for companies; auditors have to discuss how they tackled revenue and how they classified what rules they applied to recognize revenue 2. Underlying Details (Numbers) a. The amount of Property, Plant, and Equipment and Accumulated Depreciation 3. Disclosures a. Anything that investors should know about a company. The Financial Statement answers the following: If a company will/has/is • Exist in the future • Competitive • A Strong Foundation • Resources to Pay (Dividends, Supplies, Interest, Employees) • Profits (Future Profits) • Debt • Equity • Liquidity ○ Ability to pay off liabilities with current assets as of the following year (see Current Ratio) • Solvency ○ Ability to pay of liabilities with current assets in total-- If your total liabilities exceed your total assets, your company will go bankrupt. SEC FILINGS In this class, we are only to worry about the 10-K and a bit of the 8K but we will not be tested on the particular details of each form. **** In the sections of the 10K the most important section for this class is NUMBER 8, which is the FINANCIAL STATEMENTS (AUDITORS OPINION)
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