ACCN 2010 Final Exam Study Guide
ACCN 2010 Final Exam Study Guide ACCN 2010
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This 14 page Study Guide was uploaded by Tara Watkins on Thursday April 28, 2016. The Study Guide belongs to ACCN 2010 at Tulane University taught by Christine Smith in Spring 2016. Since its upload, it has received 36 views. For similar materials see Financial Accounting in Accounting at Tulane University.
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Date Created: 04/28/16
Accounting 2010 Final Exam Study Guide Accounting is a way of keeping track of any resources that an entity has Financial statements (balance sheet, income statement, statement of owner’s equity, statement of cash flows, and note disclosures) are provided to internal and external users so that they can determine the success of the company and make decisions on investing, downsizing, expanding, etc Always follow these assumptions: o Economic Entity Assumption Keep track of the entity as if it is completely separate from the owner even if it is not (only include assets that belong to the business) o Capitalistic Economy Assumption Have to assume that the organization is operating in a capitalistic economy Double entry bookkeeping The left side of a T-account is called the debit side The right side of a T-account is called the credit side Recording transactions in the general ledger is done using T accounts o Ex. Debit Credit (Left) (Right) When an account is debited, at least one other account must be credited Debits should always equal credits Debit does not always mean positive General ledger accounts on the left side of the vertical line (assets/expenses): o have positive debit balances o are always increased by a debit o are always decreased by a credit General ledger accounts on the right side of the vertical line (liabilities/owner’s equity/revenue): o have positive credit balances o are always increased by a credit o are always decreased by a debit General ledger accounts above of the horizontal line: o Are permanent accounts (balance sheet accounts) General ledger accounts below the horizontal line: o Are temporary accounts (income statement accounts) The total of the debits should always equal the total of the credits Accounting cycle: 1. Determine if the event is a recordable transaction 2. Journalize events 3. Post entries into the general ledger 4. Create financial statements 5. Analyze account balances o Matching principle o Create an adjusted trial balance after adjusting entries are made 6. Create new financial statements 7. At the end of the cycle, make sure that: o Closing entries have been journalized and posted o New total account balances have been calculated o Temporary account balances are $0 o A new post-closing trial balance has been calculated Perpetual and Periodic Inventory Systems Companies can choose to use one of two inventory systems: o Perpetual inventory system (most common) Records every sale. Always have access to the amount of inventory that should be available for sale (may not be 100% accurate due to theft (which is also called shrinkage)). Taking a physical count of the inventory and comparing it to what the system says should be on hand will reveal if shrinkage has occurred. Cost of Goods Sold is determined when each sale happens. More expensive because of the computer systems necessary. o Periodic inventory system Records the amount of inventory at the beginning of the period. Determines the Cost of Goods Sold (COGS) at the end of the period. COGS = Beginning inventory + net purchases – ending inventory More common in small businesses because it’s cheaper and their inventory is small enough to manage without constant monitoring. Multi-step income statement o Used to calculate Key Performance Indicators (KPI) which are intermediary measures of success. o KPIs are: Gross Profit (Gross Profit = Net Sales - Cost of Goods Sold) Operating Income (Operating Income = Gross Profit – Operating Expenses) Net Income (Net Income = Operating income + sum of all non-operating revenues/expenses) o Gross Profit rate = gross profit ÷ net sales Ex. 3,000 ÷ 9,000 = 33.3% The greater the rate, the more profitable the company is o Example format: Revenue: Merchandise Sales $ 10,000 Sales Discounts < 500 > Sales Returns and Allowances < 750 > Net Sales 8,750 Cost of Goods Sold < 5,500 > Gross Profit 3,250 Operating Expenses < 900 > Operating Income 2,350 Other Revenues and Expenses (can be + or -) 650 Income Before Income Taxes 3,000 Income Tax Expense < 800 > Net Income $ 2,200 Freight Costs o FOB shipping point – buyer pays the freight costs because ownership transfers when the goods are passed to the shipping carrier. o FOB destination – seller pays the freight costs because ownership transfers when the goods are delivered to the buyer. o When the buyer pays freight costs, inventory is increased because the cost of inventory includes all costs to get the items to their final destination for sale. o When the seller pays freight costs, an expense account called Freight-Out is increased. Purchase Returns and Allowances o Purchase return – when a buyer sends damaged or unsatisfactory goods back to the seller for a refund or credit. Buyer would decrease inventory (credit) and decrease accounts payable (debit). o Purchase allowance – when a seller reduces the price of an unsatisfactory good and the buyer keeps the item. Purchase discounts o Pay attention to cash discounts which are listed on invoices. Ex. 2/10, n/60 – this means that if you pay within 10 days, you receive a 2% discount. If you pay after the 10 day period is over, you owe the full amount within 60 days. If the full amount was $1,000 and you paid it within the first 10 days, you would only pay $980. But if you paid it after the 10 days were over, you would pay $1,000. This is recorded by the buyer as a $1,000 debit to Accounts Payable, $980 credit to Cash, $20 credit to Inventory Sales Returns and Allowances o Sales Returns and Allowances and Sales Discounts are contra-revenue accounts for Sales Revenue. o Sales return - when a seller receives damaged or unsatisfactory goods from a buyer for a refund or credit. Seller would increase Sales Returns and Allowances (debit) and decrease accounts receivable (credit). Seller would also increase inventory (debit) and decrease Cost of Goods Sold (credit). o Sales allowance - when the buyer keeps the unsatisfactory good but the seller reduces the price of the item. Seller would increase Sales Returns and Allowances (debit) and decrease accounts receivable (credit). Sales Discounts o Same as purchase discounts (the difference is that sales discount is the name used by the seller instead of the buyer). Ex. 2/10, n/60 – this means that if the customer pays within 10 days, they receive a 2% discount. If they pay after the 10 day period is over, they owe the full amount within 60 days. If the full amount was $1,000 and they paid it within the first 10 days, they would only pay $980. But if they paid it after the 10 days were over, they would pay $1,000. This is recorded by the seller as a $980 debit to Cash, $20 debit to Sales Discounts, $1,000 credit to Accounts Receivable In periodic inventory systems, entries are slightly different than in the perpetual inventory system. o For buyers: When purchases are made, debit Purchases instead of Inventory account. When freight costs are incurred, debit Freight-In instead of Inventory account. When purchases are returned or allowances are granted, credit Purchase Returns and Allowances instead of Inventory. When a purchase discount is offered and taken, credit Purchase Discounts instead of Inventory. o For sellers: When sales are made, only an entry debiting Accounts Receivable and crediting Sales Revenue is recorded. When sales are returned or allowances are granted, only an entry debiting Sales Returns and Allowances and crediting Accounts Receivable is recorded. When a sales discount is offered and taken, Cash and Sales Discounts are still debited and Accounts Receivable is still credited. Cash Flow Assumptions To determine how inventory is valued, 3 factors must be considered: o 1. Physical goods Goods in transit – determine who has ownership in transit? FOB destination – buyer does not have ownership until its delivered FOB shipping point – buyer has ownership as soon as it is shipped o 2. Costs that are included in the cost of inventory Product costs Any cost that is necessary to get the goods to the destination in the condition necessary for sale (ex. item cost, shipping costs, taxes, insurance (during transport), etc.) o 3. Cost Flow Assumptions (One of the four) Specific Identification FIFO (First In, First Out) LIFO (Last In, First Out) Weighted Average Period costs are not included in capital, only expensed in the period incurred Each of the 4 Cost Flow Assumptions will return a different amount for inventory, Cost of Goods Sold, and Net Income GAAP does NOT require the cost flow assumption pattern to match what actually happens o Ex. a company can sell its newest products first and still use the FIFO assumption if they choose to An entity must choose which cost flow assumption they are going to use o For Specific ID cost flow assumption, each item has to have an ID unique to its cost (items that cost $10 would have a different ID than items that cost $5) Advantage: There is no guessing, the ID on the item tells the exact purchase price Disadvantages: Can be very expensive or even impossible to track each item Management could manipulate earnings by selling cheaper items at higher costs o For FIFO, the earliest (oldest) purchases are the first products sold Advantage: Higher gross profit Disadvantages: Higher income tax expense Higher checks that are paid to employees o For LIFO, the latest (newest) purchases are the first products sold Advantages: Lower income tax expense Lower checks that have to be paid to employees Disadvantage: Lower gross profit o For weighted average, the results are between those of FIFO and LIFO Receivables, Allowance Methods, and Depreciation Methods A receivable is a future economic benefit (asset) or claim to cash from an external party (or in simpler terms, payments owed to the company) o There are 3 types of receivables: 1. Accounts receivable – spoken promise to pay 2. Notes receivable - written, legally contractual promise to pay 3. Other receivables o GAAP requires receivables to be recorded separately on the balance sheet o There are 2 possible issues that can occur when dealing with receivables: 1. Recording the receivable properly Ex. when following the Revenue Recognition Principle, make sure that the revenue is recorded when it is earned not when it is paid for 2. Valuing the receivable The amount owed might not be paid in full or paid at all o Management is responsible for determining how much of the value of the products/services sold they expect will be paid for (net realizable value) o Allowance method – a way to estimate how much that is owed to the company will not be paid o Direct write-off method – the company waits until it is clear that a customer is not going to pay what they owe and then debits an account called Bad Debt Expense and credits Accounts Receivable for the amount owed Does not follow the matching principle Okay to use in small, non-public companies if their receivables are not material or important to the balance sheets o Allowance methods: Percentage of sales (Income Statement) method Percentage of receivables (Balance Sheet) method Long term assets o Are used in company operations to earn revenue o Have a useful life of more than 1 year o Are not considered current assets (long term assets are a separate category) 3 types of long term assets o Plant assets (ex. building, land, machinery, equipment, etc) Could also be called fixed assets or Property, Plant and Equipment o Natural resources o Intangible assets (ex. copyrights, patents, trademarks, etc) Land purchased speculatively (not used, saved for future use) is categorized as a long term investment Land purchased by a company to help them earn revenue (builders, real estate companies) is categorized as inventory GAAP says to capitalize all costs of acquisition involved in getting it to its condition and location for use --- similar to GAAP’s inventory cost rules o Under equipment, debit: Invoice price Processing fees FOB shipping point Taxes Insurance (during transportation) Assembly Unpacking Installation Door widening (if necessary to get equipment to the desired location for use) Testing costs o The total capitalized costs are allocated to an expense account (Depreciation account) To decide on a depreciation method, management needs to know: o Estimated useful life/Estimated Units of Production o Salvage value (how much we could get for the equipment at the end of its useful life) 3 methods of depreciation o Straight Line Method (time based) o Declining Balance Method (time based) o Units of Production Method (activity based) Each depreciation method yields different amounts No matter which method is chosen, while varying each year, the same amount of costs will be allocated by the end of the equipment’s estimated useful life Straight Line Method o S/L = Depreciable Base x (1/estimated useful life) Depreciable base = historical cost - salvage value If the historical cost of a new commercial oven with an estimated useful life of 5 years was $17,000 and its salvage value was $2,000, then its depreciable base would be $15,000. ($17,000 – 2,000 = $15,000) 1/estimated useful life is also called the straight line rate Assuming the same data and depreciable base as above, the S/L would be: $15,000 x (1/5) = $3,000 <- depreciation expense So therefore each year, we would debit the Depreciation expense account by $3,000 and credit the contra-asset account Accumulated Depreciation Expense Each year, the net book value of the equipment decreases by the depreciation amount (in this case, it decreases by $3,000 every year) Ex. year 1 – Acc. Dep. Exp = 3,000, net book value = 14,000 year 2 – Acc. Dep. Exp = 6,000, net book value = 11,000 year 3 – Acc. Dep. Exp = 9,000, net book value = 8,000 year 4 – Acc. Dep. Exp = 12,000, net book value = 5,000 year 5 – Acc. Dep. Exp = 15,000, net book value = 2,000 Net book value does NOT equal fair value (what you would get if you sold the equipment at a certain time) This is not a valuation process, it is simply a cost allocation process At the end of the equipment’s estimated useful life, the book value should never be lower than its salvage value Advantage: Easy to calculate Disadvantage: Does not follow the matching principle very well Declining Balance Method o Decl. Balance = Book value x ? x S/L rate ? is a number set by management Using the same numbers as earlier (starting book value of $17,000, salvage value of $2,000 and an estimated useful life of 5 years) and a ? value of 2, the declining balance would be: Year 1 = 17,000 x 2 x 1/5 = 6,800 <- Dep. Exp. Acc. Dep. Exp. = 6,800, net book value = 10,200 Year 2 = 10,200 x 2 x 1/5 = 4,080 <- Dep. Exp. Acc. Dep. Exp. = 10,880, net book value = 6,120 Year 3 = 6,120 x 2 x 1/5 = 2,448 <- Dep. Exp. Acc. Dep. Exp. = 13,328, net book value = 3,672 Year 4 = 3,672 x 2 x 1/5 = 1,468.80 <- Dep. Exp. Acc. Dep. Exp. = 14,796.80, net book value = 2,203.20 *Year 5 In this example, in year 5, the depreciation expense calculated would cause the book value to be below the salvage value. Since this is not allowed to happen, we would just record the depreciation expense of $203.20 which would make the net book value $2,000 (equal to the salvage value). Advantage: Follows the matching principle well Disadvantage: If there is remaining estimated useful life left after you reach the point when the accumulated depreciation expense equals the depreciation base (in the example above, this does not occur but if it did, it would be $15,000), then it does not follow the matching principle well because in those years, you are reporting $0 in depreciation expenses. Units of Production Method o Units of production = depreciation base x (actual production/estimated production) Estimated Production is 10,000, year 1 actual = 3,000, year 2 actual = 2,000, year 3 actual = 1,500, year 4 actual = 4,500, year 5 actual = 2,400 Ex. Year 1 = $15,000 x (3,000/10,000) = 4,500 – Dep. Exp. Acc. Dep. Exp. = 4,500, net book value = $12,500 Year 2 = $15,000 x (2,000/10,000) = 3,000 – Dep. Exp. Acc. Dep. Exp. = 7,500, net book value = $9,500 Year 3 = $15,000 x (1,500/10,000) = 2,250 – Dep. Exp. Acc. Dep. Exp. = 9,750, net book value = $7,250 Year 4 = $15,000 x (4,000/10,000) = 6,000 – Dep. Exp. **this calculation would make the Acc. Dep. Exp. higher than the depreciation base and the net book value lower than the salvage value so the actual depreciation value for year 4 that would be reported would be $5,250. In year 5, no depreciation expense would be reported because the oven has already been fully depreciated. A different result is reported each year based on production Advantage: Follows the matching principle very well if revenue matches production (if what is made sells) Internal Controls Fraud occurs due to weaknesses or deficiencies in the company’s internal controls o Reasons for fraud include: 1. Opportunity – the employee has the time and access to commit these acts Most important reason 2. Rationalization - the employee feels that the company owes him/her more compensation because they work too hard or don’t get paid enough 3. Incentive/financial pressure – the reason why an employee might feel the need to commit fraud (ex. could be due to excessive amounts of debt, inability to pay bills, low income requiring multiple jobs just to make ends meet, etc) Internal controls are used by companies to: o 1. Protect their assets Ex. security systems/tags, door locks, safes o 2. Enhance the reliability of their accounting records Ex. having separate log-ins for each person, password protecting the files, o 3. Increase operating efficiency Ex. review each step of every process and make sure that they are all efficient o 4. Ensure that the company and its actions comply with all laws and regulations Ex. making sure that everything complies with EPA and OSHA standards The best internal control tool is bank reconciliation o Bank reconciliations are when you take the amount that the bank says is in an account and the amount that your records show and try to make them equal If the amounts do not equal after a bank reconciliation is correctly executed, fraud is likely occurring Differences between the bank and book amounts are caused by: 1. Deposits in transit (timing) - 2. Outstanding checks (timing) – a check that was written but hasn’t been deposited into the bank yet 3. Errors (on either the bank or the book side) 4. Bank memorandum (ex. banks crediting interest) Timing errors (deposits in transit and outstanding checks) never occur on the book side NSF (not sufficient funds) checks get sent back and subtracted o Accounts Receivable balance is reinstated (debit Accounts Receivable, credit Cash) o Checks are all or nothing payments. If the entire amount is not available, none of the amount is paid o Service charges may apply Either expense them or charge them to Accounts Receivable for the customer who wrote the NSF check When performing a reconciliation, on the bank side: o Add Deposits in Transit o Subtract Outstanding checks o Add or subtract bank errors when applicable When performing a reconciliation, on the book side: o Add/subtract amount of the differences in recording errors Subtract when the amount written > the amount recorded (in the journal, debit an expense account and credit Cash) Add when the amount written < the amount recorded o Add interest earned (in the journal, debit Cash and credit Interest Revenue ) o Subtract NSF checks (in the journal, debit Accounts Receivable and credit Cash) o Subtract Service Charges (in the journal, debit an expense account and credit Cash) Statement of Cash Flows Informs users: o 1. Where cash came from o 2. What cash was used for o 3. What the change in the cash balance was Is divided into the three different kinds of activities that a company can take part in: o Operating activities Cash flow from operations Used to determine net income Ex. net income, increases and decreases in Accounts Receivable, increases and decrease in “Payable” accounts (salaries payable, accounts payable, etc) o Investing activities Cash flow related to acquisition, sale, retirement, or disposal of long-term assets and other non-operating investments Ex. buying equipment, buying land, buying a building, retiring equipment, selling equipment, discarding equipment o Financing activities Cash flow related to transactions with non-trade creditors (such as financial institutions) Ex. bank loans To prepare a Statement of Cash Flow, you will first need: o Comparative Balance Sheets (current and prior period’s balance sheets) o Income Statement o Selected transaction data Then choose one of two preparation methods for the operating section o 1. Direct method (Income Statement method) – deducts operating cash disbursements from operating cash receipts o 2. Indirect method (Reconciliation method) – adjusts net income for items that did not actually affect cash Helpful tips when working on the Operating Activities section: o Increases to assets will be subtracted o Decreases to assets will be added o Increase to liabilities will be added o Decreases to liabilities will be subtracted The Cash starting balance plus the Net Increase in Cash gives you the ending cash balance Ending cash balance should equal the amount of cash listed on the balance sheet Example Format (values made up to show where addition/subtraction would occur): - Bolded and underlined words will change depending on whether the value is + or - - “Provided by” is used for a positive value while “used in” is for a negative value Company Name Statement of Cash Flows For the Year Ended December 31, 2015 Operating Activities Net Income $10,000 Adjustments made to reconcile net income to cash provided by/used in operating activities Increase in Accounts Receivable < 2,000 > Increase in Accounts Payable 1,350 < 650 > Net Cash provided by/used in operating activities 9,350 Investing Activities Purchase of Land < 2,500 > Purchase of Equipment < 3,000 > < 5,500 > Net Cash provided by/used in investing activities 3,850 Financing Activities Issuance of note receivable (loan) 6,000 Net Cash provided by/used in financing activities 6,000 Net increase in cash 9,850 Beginning Balance in Cash (from Balance Sheet of prior year) XXXX Ending Balance in Cash (net increase + beginning balance 9,850 + XXXX should match current balance sheet cash value) Stocks Corporations have a certain number of authorized shares of stock and cannot sell more than that number Two sources of equity: o Contributed capital – investors buy stock Stocks typically have a par value or stated value, which is the minimum amount that they can be sold for Privileges of owning common stock: Voting for who is on the Board of Directors during the annual shareholders meeting Long-term investment because a shareholder buys the stock and then holds onto it until its value increases and then they sell it for a profit Privileges of owning preferred stock: Preference on dividends and assets upon liquidation “preemptive right” - when new stock is released, preferred stockholders are given the option to buy a proportion of the new stock so that they will still hold the same proportion of ownership as before Immediate return because of the dividends that are paid Preferred stock is more expensive because of its immediate privileges Additional Paid-In Capital (APIC) For both common stock and preferred stock An account that contains the excess values paid that are above the par or stated value of a share To record the transactions, debit Cash, credit Common Stock or Preferred Stock (for the par value times the number of shares) and credit Additional Paid-In Capital (for Common Stock or Preferred Stock) for the difference If a par or stated value is not given, there will be no APIC account o Earned Capital (Retained Earnings) Retained earnings is accumulated owner’s equity increases Treasury Stock o When a company buys its own stock from the available shares in the market o Is a contra account for owner’s equity Reasons a company might hold treasury stock: To create interest in the stock To keep ownership Decrease owner’s equity If shares are offered to employees and no more authorized shares remain, the company must buy some shares back from those available in the market 3 types of dividends can be issued o Cash (check) o Property (land, equipment, buildings, etc) o Stock (additional shares of stock) Stock splits do not require an entry in the general ledger or journal Dividends cause equal decreases in owner’s equity (debit) and in cash (credit) Outstanding shares = issued shares – treasury stock shares Example Format of the Shareholder’s Equity part of the Balance Sheet (numbers simply to illustrate what is added and what is included in this section of the balance sheet): o Preferred Stock would be recorded in the same format as Common Stock o Authorized, issued, and outstanding amounts of shares must be listed o Dividends Distributable would also be included if dividends had been declared o Do not put a dollar sign or double underline total stockholder’s equity (this is only the end of this section, not the end of the entire balance sheet) Company Name Balance Sheet As of December 31, 2015 Stockholder’s Equity Common Stock, $10 par value, 25,000 shares authorized $200,000 20,000 shares issued, 18,000 shares outstanding Additional Paid-In Capital, Common Stock 120,000 Total Paid-In Capital 320,000 Retained Earnings 586,500 Less: Treasury Stock at Cost, 2,000 shares < 20,000 > Total Stockholder’s Equity 886,500
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