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ACCT 201 Elements of financial accounting Midterm 1 study guide

by: Astrea Presley

ACCT 201 Elements of financial accounting Midterm 1 study guide Acct 201

Marketplace > California State University Long Beach > Accounting > Acct 201 > ACCT 201 Elements of financial accounting Midterm 1 study guide
Astrea Presley
Long Beach State
GPA 3.5

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Notes cover midterm 1.
Elements of Financial Accounting
Xiaoou Yu
Study Guide
Accounting, Study Guide, Midterm 1, elements of financial accounting, ACCT 201
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This 21 page Study Guide was uploaded by Astrea Presley on Tuesday February 16, 2016. The Study Guide belongs to Acct 201 at California State University Long Beach taught by Xiaoou Yu in Spring 2016. Since its upload, it has received 123 views. For similar materials see Elements of Financial Accounting in Accounting at California State University Long Beach.

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Date Created: 02/16/16
ACCT201Accounting Principles – Financial Midterm 1 Review Guide CHAPTER 1 Introduction to Financial Statements Learning Objectives 1. Describe the primary forms of business organization. 
 Proprietorship • Single owner - startup, easy to start this type of business • Owner liable for debts - risk Partnership • More complex than proprietorship • Two or more people own - harder to set up • Unlimited liability Limited Liability Company • Owners not liable • Popular for tax status and limited liability Corporation (e.x.Apple, Google) • Formed under state law • Stock holders own a portion • Pro: limited liability of the stockholders • Con: Double taxation (corporate and on dividends. 35-40%) Whats a dividend? It is a share of profit the corporation gives back to stock investors Double taxation? Dividend and corporate taxes. They’re taxed this way because these corporations are so large and lucrative it is thought that taxing them at a higher rate is fair because they should share the social burden and that it will encourage small business. Going “public”? Once a company goes public they are a corporation and people can buy shares. 2. Identify the users and uses of accounting information. 
 Internal users (involved in daily operating activity): • Managers who plan, organize and run a business • Marketing managers & production supervisors Use managerial accounting information External users (not involved in daily operating activity): • Stock holders • Creditors • Tax authority • Customers, Unions, etc. Use financial accounting information 3. Explain the three principal types of business activity. 
 Financing activities - external sources of funding 1. Owners/Stockholders 2. Lenders (Liability) Investing activities - the purchase and sale of: 1. Long-term assets (e.x. a car to drive for Uber) 2. Other resources (e.x. assets) Operating activity 1. Providing products and services - revenue 2. Costs of producing revenue - expenses (office supplies, wages paid, etc.) Example: You drive for Uber which is a service to the customer for which you make revenue, the gas and car are the expenses. 4. Describe the content and purpose of each of the financial statements. 
 Income statement: net income Revenue - Expenses = Net income (earnings/profit) Uber example: Revenue from services = $4000 Expenses (gas, car payment): $3000 $4000 - $3000 = $1000 net income Statement of stockholder’s equity: Common stock + Retained earnings Beginning common stock Beginning retained earnings +Issuances of c.s. +Net Income -Ending c.s. -Dividends =Ending common stock =Ending retained earnings Stockholder’s equity: Revenue - Expenses - Dividends Assets = Liabilities - Stockholders equity Uber example: Revenue: $2000 Expenses: $1500 = $500 profit $3000 (Assets) = $2000 (liabilities) + $1000 (equity) +$500 (profit) = + $500 (profit) $3500 = $2000 + $1500 You want to take $500 for vacation so you take it out of the business as a dividend and you are back where you began. Dividends are cash distribution to owners which decreases claims to companies resources. Balance Sheet: gives asset/liability information Resources (assets) = Claims to resources | | V V Assets = Liabilities + Stockholders equity Uber example: You have a $3000 car loan and have $1000 of your own money to invest…. $4000 = $3000 + $1000 If you want to purchase this business, how much would you pay? $1000 because you exclude the liability so… own - owe = residual for owners Statement of cash flows: Operating activities: Cash in: … Cash out: … Investing activities: Cash in: … Cash out: … Financing activities: Cash in: … Cash out: … Net cash flow: … 5. Explain the meaning of assets, liabilities, and stockholders’equity, and state the basic accounting equation. 
 Assets: resources owned by the company Liabilities: creditor’s claims to said resources Stockholder’s equity: resources not claimed by creditors 6. Describe the components that supplement the financial statements in an annual report. 
 -Management discussion and analysis (MD&A) Management’s opinions/estimates -Notes to financial statements Gives clarity and detail -Auditors report Independent auditors audit company for a more exact report CHAPTER 2 AFurther Look at Financial Statements Learning Objectives 1. Identify the sections of a classified balance sheet. 
 Classifies assets and liabilities as current or long-term via liquidity (how quickly something can be turned into cash for the business). Includes information about current assets and liabilities, long-term investments and long-term liabilities, property, plant, and equipment (PP&E) From most to least liquid: Cash, accounts receivable, inventory, and PP&E Current assets: Assets the company intends to convert to cash or use in one year of operation Includes: Cash, short-term investments (debt investment due within a year), accounts receivable (money owed to company for serives, other receivables, inventory, prepaid expenses (rent, insurance, etc.) Long-term investments: Investments expected to be held for more than one year. Includes: stocks & bonds investments, long-term assets (real estate), long-term notes receivable (cash due to business after a year) PP&E: Assets that are in use to operate business Includes: land, buildings, equipment, vehicles, furniture, technology, etc. Depreciation: “the allocation of the cost of an asset to a certain number of years” Accumulated depreciation: the total expensed amount of depreciation the company thus far. Example:Abusiness pays $12000 for equipment. The equipment depreciates in value by $2000. The new value is $10000 and is recorded as an expense. PP&E: $12000 less accumulated depreciation $2000 $10000 Intangible assets: Assets that have no physical substance but benefit the company in some way. Example: patents (iPhone has many patents and sues over them regularly which generates revenue), trademarks (Coca-cola, most expensive trademark in the world), goodwill (a company invests money into a charity or gives a way a certain amount of profits). Liabilities: Current: within one-year Example: rent expense for that year, salaries and wages payable, accounts payable Long-term: over a year For example: Mortgages payable, bonds payable, pension payable. Pension is a % of a persons income that is put into a pension account and paid out after they retire. Stockholder’s equity Common Stock - investments of assets into the business by the stockholders. Retained Earnings - income retained for use in the business. 
 2. Identify tools for analyzing financial statements and compute ratios for analyzing a company’s profitability. 
 RatioAnalysis: expresses the relationship among financial statement data Profitability ratios : measure the income/operating success of a company Liquidity ratios : “measures short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash” Solvency ratios : “measure the ability of the company to survive over a long period of time” Using the income statement: Revenues - Expenses = Net income Profitability ratio: Earnings per share EPS: income earned for common stockholders per share Equation: (Income - Preferred dividends) / average number of common shares outstanding 3. Explain the relationship between a retained earnings statement and a statement of stockholders’equity. 
 Retained earnings statement describes the events that changed the retained earnings for that period. Beginning balance of retained earnings + net income - dividends = ending balance retained earnings Statement of stockholder’s equity reportsALL changes in SE accounts (ex stock issued) 4. Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. 
 Abalance sheet reports a company’s financial state and can be used for risk analysis. Liquidity is a company’s ability to pay obligations due within a year Working capital: the amount of current assets the company has to pay obligations Current assets - current liabilities Current ratio: The ability to pay current debt Current assets / current liabilities The HIGHER the ratio the LOWER the risk Debt to assets ratio: The ability of debt holders to force bankruptcy Total liabilities / total assets The HIGHER the ratio the HIGHER the risk Solvency is a company’s ability to pay debt over a long-term basis 5. Use the statement of cash flows to evaluate solvency. Free cash flow is the net amount of cash from operating activities after adjusting for capital expenditures and dividends paid out. Free cash flow = Net cash provided by operating activities - Capital expenditures - Cash dividends 6. Explain the meaning of generally accepted accounting principles. 
 United States: Accounting standards: generally accepted accounting principles (GAAP) Standard-setting body: the FinancialAccounting Standards Board (FASB) Regulator: the Securities and Exchange Commission (SEC) Outside the United States: Accounting standards: International Financial Reporting Standards (IFRS) Standard-setting body: the InternationalAccounting Standards Board (LASB) 7. Discuss financial reporting concepts. Financial accounts gives useful information to investors and creditors for financial decisions (such as investing in which stocks) Helps predict future cash flow Gives insight into the current state of the economy and resources CHAPTER 3
 TheAccounting Information System Learning Objectives 1. Analyze the effect of business transactions on the basic accounting equation. 
 The Accounting Information Systems collect and process transaction data. Not all activities represent a transaction Assets, liabilities, and stockholder’s equity change as a result of an economic event for example: you pay rent or buy a computer, these are transactions. You discuss marketing plans with employees, no economic event occurred so no transaction is recorded. Affects the accounting equation on both sides Transaction analysis: Assets = Liabilities + Stockholder’s equity (common stock + retained earnings (beginning retained earnings + net income (revenue- expenses) - dividends)) External events: between business and another party Internal events: within the business Accounts are the accumulated dollar amount of all transactions 2. Explain what an account is and how it helps in the recording process. 
 Account: “an individual accounting record of increases and decreases in a specific asset, liability, or stockholders’equity item.” An account consists of three parts: the title of the account, a left or debit side, and a right or a credit si
e. 3. Define debits and credits and explain how they are used to record business transactions. 
 Debit means left and credit means right. Entering information on the left is called debiting and entering information on the right is called crediting. The equation should be balanced under the double-entry system. Dividends Expenses +/^ = Debit -/v = Credit Assets — Liabilities Owner’s equity +/^ = Credit -/v = Debit Revenues Assets = Liabilities + Owner’s (stockholder’s) equity 4. Identify the basic steps in the recording process. 
 Step 1:Analyze each transaction’s effect on the varying accounts (ex bills, checks, receipts) Step 2: Enter the information into a journal. Step 3: Transfer journal information into the appropriate account in the ledger 5. Explain what a journal is and how it helps in the recording process. 
 Ajournal shows the debit and credit effects on accounts for every transaction and record transaction in a chronological order before they’re transferred to the accounts. For example: QuickBooks Helps prevent or locate errors. 6. Explain what a ledger is and how it helps in the recording process. 
 Aledger is the entire grouping of accounts of a certain company which contains all assets, liability, and stockholder’s equity and provides the balances of each account to management. Achart of accounts is the list of accounts (as seen above) and are typically listed in the order: assets, liabilities, stockholders’equity, revenues, and expenses. 7. Explain what posting is and how it helps in the recording process. 
 Posting is the act of transferring journal entries to the ledger and involves the following steps: Enter the debited amounts in the correct columns with the date. Enter the credited amounts in the correct columns with the date. 8. Explain the purposes of a trial balance. 
 Atrial balance is the list of accounts and their balances with the date, the purpose of this is to prove equality in both debits and credits. A trial balance uncovers errors, helps prepare financial statements, will help balance but not reveal errors in if: A transaction is not in the journal.
 Acorrect journal entry is not posted.
 Ajournal entry is posted twice
 Incorrect accounts are used in the journal or during posting, or
 Offsetting errors are made in recording the amount of a transaction. 9. Classify cash activities as operating, investing, or financing. 
 Operating activities: activities performed for profit. Example: cash spent on accounts payable, inventory, gas for Uber driver Investing activities: purchase/sale of long-term assets that support business operation, purchase/sale of investments (bonds, stocks) Financing activities: borrowing money, share issuance, paying dividends, etc. CHAPTER 4AccrualAccounting Concepts Learning Objectives 1. Explain the revenue recognition principle and the expense recognition principle. 
 Revenue Recognition Principal • revenue must be acknowledged in the time period that it was performed or when there is obligation. For example: a company agrees to sell 30 units of their product to Jane Doe within one year. This is called a performance obligation. • Service companies record revenue when the service is completed • Expenses must be matched with the revenue for that period meaning that services performed cost cash to carry out, those expenses must be recorded with the revenue earned from the service or product. 2. Differentiate between the cash basis and the accrual basis of accounting. 
 Cash-basis accounting: • Records revenues and expenses when cash is exchanged. • Does not satisfy GAAP (GenerallyAcceptedAccounting Principles) Accrual-basis accounting • Records revenue when it is earned (when they receive a purchase order for example) and expenses when the product/service is received • Uses the revenue recognition principle and expense recognition principle 3. Explain why adjusting entries are needed, and identify the major types of adjusting entries. 
 Entry adjustment is needed to check for error and make sure the entries follow the revenue and expense recognition principles. The trial balance may be out of date because: • Some events are not recorded on a day-to-day basis • Some costs expire • Some go unrecorded completely Entry adjustment is done when a company prepares a financial statement and include one income statement and one balance sheet. 4. Prepare adjusting entries for deferrals. 
 Each entry adjustment can be classified as a deferral or accrual Deferrals: prepaid expenses, unearned revenue • Prepaid expenses: recorded as assets until they’re used (rent, insurance, supplies). Debit (increase) to expense account and credit (decrease) to asset account. • Unearned revenue: cash received before the service is performed. Recorded as liability. Debit (decrease) to liability account and credit (increase) to revenue account. • Deferrals decrease balance sheet and increase income statement 5. Prepare adjusting entries for accruals. 
 Accruals: accrued revenue/expenses Accrued revenues: services performed but cash is not yet received. Debit (increase) to asset account and credit (decrease) to revenue account. Accrued expenses: incurred but not paid for in cash yet. Debit (increase) to expense account and credit (decrease) to liability account. Accruals increase balance sheet and income statement 6. Describe the nature and purpose of the adjusted trial balance. 
 Adjusted trial balances are prepared after all journals and postings have been adjusted An adjusted trial balance has the following purposes: • Shows the balances of every account at accounting period end. • Proves the equality of debits and credits in the ledgerAFTER adjustments Financial statements prepared from adjusted trial balance • 7. Explain the purpose of closing entries. 
 Closing entries do the following: • Transfers net income/loss and dividends to Retained earnings • Produces a zero balance for each temporary account (revenue, expenses, dividends) which prepares them for the next accounting period. Permanent accounts do not get closed out and their balances are carried into next accounting period. 8. Describe the required steps in the accounting cycle. 
 1. Analyze 2. Journalize 3. Post to ledgers 4. Prepare trial balance 5. Journalize/post deferral and accrual adjustments 6. Prepare adjusted trial balance 7. Prepare financial statements (income, retained earnings, balance sheet) 8. Journalize/post closing entries 9. Prepare post-closing trial balances • Quality of earnings is affected when company tries to meet a target earnings number. • Earnings management: plans revenue, expenses, gains/losses • This is done by propping up earnings number, inflating revenue numbers for a short period of time, improper adjustments. Encouraged regulation with the Sabarnes-OxleyAct • High quality of earnings: company is transparent and gives all information to those that use their financial statements • Low quality of earnings: misleading to investors/creditors 9. Understand the causes of differences between net income and cash provided by operating activities. Net income: • Accrual based accounting • After adjustments • Cash provided by operating activities: • Net income via cash-basis accounting • Compares cash received to cash expenses 


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